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Chapter 12 amounts
Fraud and Error May involve MANAGEMENT who can
easily conceal
PSA 240 – “The Auditor’s Responsibility to Consider Often accompanied by
Fraud in an Audit of Financial Statement” FALSE/MISLEADING records
Policies and procedures relating to FRAUD and Ways to misappropriate:
ERROR Embezzling receipts
Stealing PHYSICAL ASSETS (even
scrap) or INTELLECTUAL
Misstatements can arise from both error and fraud. PROPERTY (collusion with
Difference: intention competitor)
Causing entity to pay for goods
Error – unintentional and services not received
Fraud – intentional; more difficult to detect (fictitious vendors, kickbacks
paid to purchasing agents in
Auditor is only concerned with fraud that cause return for inflating prices,
MATERIAL misstatement in the FS. payments to fictitious
employees)
Auditor DOES NOT make LEGAL DETERMINATIONS of Using entity’s assets for
fraud occurrence even though he may suspect/identify PERSONAL USE (e.g. as
fraud. collateral for a loan)
Fraud: Errors:
- Fictitious employees – one of the most - Failure to follow PFRS in valuation
common; auditors perform surprise payoff, turn - Expensing PPE instead of capitalizing
check distribution to another supervisor, check - Misclassification as current/noncurrent
employee files, time cards - Failure to properly account for financing of an
- Excess payments to employees – increased pay asset
for more than hours worked; reduced by: - Failure to properly account for lease
requiring personnel dept. officials to authorize - Inaccuracy of depreciation expense
changes in pay rate and thru monitoring; - Incorrect estimates of life
analytical procedures on cost per unit
- Failure to record payroll – usually for companies Fraud:
with difficulty in managing costs; DIFFICULT TO - Usually same with fraud in acquisition
HIDE unless similar amount of revenue or - Securities can be stolen or diverted
receipts has been omitted; - To detect: compare serial numbers on securities
- Inappropriate assignment of labor costs to and client record
inventory – detect through: compare cost vs
budget; verify inventory valuation
F. Financing Activities – should be carefully
audited because management can override
D. Inventory Warehousing controls
Errors: Errors:
- Cutoff errors/ failure to include items in - Failure to make interest accruals/ doubling
inventory - Accruing in the wrong period
- Mechanical errors - Making incorrect estimates in allowances for
- Detect through: routine audit procedures obligations
- Failing to recognize that the entity violated a
Irregularities: debt agreement
- Inventory Theft – for personal use or - Failing to record declared dividends
unauthorized sale; one sign is significant decline
in GROSS profits Irregularities:
- Overstatement of Inventory – common form of - Diverting proceeds
MANAGEMENT FRAUD because: - Covering up failure to meet a debt agreement
- Failing to record obligations
Change in inv = change in income before taxes - Failing to record interest
- Paying dividends to inappropriate parties
Techniques:
Putting filler goods
Adding significant amount of inventory PROCEDURES WHEN ERRORS/IRREGULARITIES ARE
after the auditor has observe inventory SUSPECTED
Altering:
E. Investing Activities 1. Engagement staffing
2. Extent of staff supervision
Factors increasing IR of investments: 3. Degree of professional skepticism applied
- Economic conditions 4. Overall strategy for the expected conduct and
- Industry changes that affect ability to use scope of the engagement.
equipment
- Age of equipment and degree of obsolescence RAP —> risk detected —> consider potential effect on
- Acquisition of assets thru related party FS —> if material, perform appropriate/modified audit
transactions procedures based on judgment as to:
Types of error and fraud indicated entity – consider effect on auditor’s
Likelihood of occurrence report
Likelihood that particular F/E has a - To regulatory and enforcement authorities.
material effect Auditor’s duty of confidentiality
PRECLUDES reporting to a THIRD PARTY
Auditor CANNOT assume that instance of F/E is an In certain circumstances, duty is
isolated occurrence. OVERRIDDEN by statute, law, courts of
law)
If necessary, adjust NTE of substantive procedures. E.g. Bangko Sentral; within 30 days:
Report fraud or dishonesty
Adjustments/potential losses
which amount to AT LEAST 1%
Considerations at the Assertion Level of bank capital funds
Cabrera, p. 548 Finding that total bank assets
- Surprise visits or tests on a going concern basis are no
- Inventory count at year-end or near year-end longer adequate to cover
- Altering audit approach for the current year creditor claims
- Investigating possible related parties and Seek legal advice giving due
financial sources of unusual transactions consideration to public interest
- Performing analytical procedures on
Documentation
disaggregated data
- As per PSA 315:
- Interview of personnel in high risk areas
Significant decision reached re:
- Discussing with Other Auditors susceptibility to MM
- Performing procedures one work done by Identified and assessed RMM due to
expert which may have significance in MM fraud @FS and assertion level
- Analysis of opening statements
- Performing tests on procedures done at interim Withdrawal from the Engagement
periods 1. Determine professional and legal
- Performing computer-assisted techniques responsibilities applicable in the circumstances,
including reporting to person who made the
- Testing integrity of computer-produced records
audit appointment or to regulatory authorities
- Seeking additional evidence from outside
2. Consider whether it is appropriate to withdraw
from the engagement, where legally permitted
Reporting Fraud or Error 3. If auditor withdraws:
- To management and those charged with Discuss with appropriate level of
governance. Communicate to level ABOVE management and those charged with
responsible persons believed to be implicated governance re: withdrawal and reasons
(if highest level is suspected, seek LEGAL Determine if there is a
advice) as soon as practicable if: professional/legal requirement to
Auditor suspects fraud EVEN IF report
potential effect is IMMATERIAL
F/E actually exists Auditor may conclude that WITHDRAWAL is necessary
- To users of auditor’s report. when entity does not take remedial action re: fraud that
F/E with material effect not reflected or the AUDITOR CONSIDERS NECESSARY even if it is NOT
corrected in the FS - Qualified/Adverse MATERIAL
opinion
Auditor PRECLUDED from obtaining When proposed auditor inquires, existing auditor
sufficient appropriate evidence – should advise whether there are professional reasons
Qualified opinion or disclaimer on the why he should not accept. Extent = depends on client’s
basis of limitation on the scope permission; legal and ethical constraints.
Unable to determine whether F/E has
occurred because of circumstance or
If client DENIES permission to discuss affairs, DISCLOSE
to proposed editor that the client denied.
Management Representations
Auditor shall obtain written representations that:
- It acknowledges responsibility for internal
control
- It has disclosed to the auditor its results of risk
assessment
- It has disclosed its knowledge of fraud
involving:
Management
Employees with role in internal control
Others where fraud could have material
effect
- It has disclosed knowledge of allegations of
fraud or suspected fraud communicated by
employees, former employees, analysts,
regulators