AUDITOR’S

RESPONSIBILITY
AUDITING
Auditor’s Responsibility

 The auditor’s responsibility is to design the audit to provide reasonable

assurance of detecting material misstatements in the financial statements.
These misstatements may emanate from:
 Error
 Fraud
 Non-compliance with Laws and Regulations

 Material misstatements - is information in the financial statements that is

sufficiently incorrect that it may impact the economic decisions of someone
relying on those statements.
Error and Fraud
Error

 Unintentional misstatements in the financial statements, including the

omission of an amount or a disclosure
 Mathematical Errors
 Incorrect Accounting Estimates
 Mistake in the application of accounting policies

 Intermediate acctg
Fraud

 Intentional act by one or more individuals among management, those charged

with governance, employees, or third parties, involving the use of deception
to obtain an unjust or illegal advantage.
 The auditor is primarily concerned with fraudulent acts that cause a material
misstatement in the financial statements.
Types of Fraud

 Fraudulent Financial Reporting (Management Fraud)

 Manipulation, falsification or alteration of records or documents

 Misrepresentation in or international omission of the effects of transactions from
records or documents
 Recording of transactions without substance
 Intentional misapplication of accounting policies
Types of Fraud

 Misappropriation of assets (Employee Fraud)

 Embezzling Receipts
 Stealing assets
 Lapping of accounts receivable
Error and Fraud

 Responsibility of Management
 Prevention and detection of fraud and error
 Control environment
 Implement internal control policies

 Responsibility of individuals charged with governance

 Ensure the integrity of an entity’s accounting and financial reporting systems
Error and Fraud
 Auditor’s Responsibility
 PLANNING
 Make inquiries of management
 Management’s assessment of risk
 Established Controls
 Material error or fraud
 Risk Assessment
 Concealment of Fraud (Fraud Risk Factors)
 Judgements
Error and Fraud
Fraud Risk Factors resulting from Fraud
1. Management’s Characteristics and Influence
2. Industry Conditions
3. Operating Characteristics and Financial Stability
Error and Fraud
Fraud Risk Factors resulting from Fraud
Management’s Characteristics and Influence
 There is motivation for management to engage in fraudulent financial
reporting.
 Significant portion of Management’s compensation is represented by
bonuses, stock options or other incentives upon the entity achieving
unduly aggressive targets
 Excessive interest in maintaining or increasing stock price/earnings
through aggressive accounting practices
 Unduly aggressive or unrealistic forecasts
 Minimizing reported earnings for tax-motivated reasons
Error and Fraud
Fraud Risk Factors resulting from Fraud
Management’s Characteristics and Influence
 There is failure by management to display and communicate an
appropriate attitude regarding internal control
 Inappropriate values and ethics
 Management is dominated by a single person without controls
 Management does not monitor controls adequately
 Management fails to correct weaknesses in internal control
 Management sets unduly aggressive financial targets and expectations for
operating personnel
 Disregard for regulatory authorities
 Employ ineffective accounting, IT, or internal auditing staff
Error and Fraud
Fraud Risk Factors resulting from Fraud
Management’s Characteristics and Influence
 Strained relationship between management and auditors
 Frequent disputes on reporting matters
 Unreasonable demands on the auditors (time constraints)
 Formal or informal restrictions or limitations
 Domineering management behavior
Error and Fraud
Fraud Risk Factors resulting from Fraud
Management’s Characteristics and Influence
 Non-financial management participates excessively in the selection of
accounting principles
 There is a high turnover of management, counsel or board
 History of securities laws violations - SEC
 Corporate governance structure is weak or ineffective
 Lack of independent management
 Little attention being paid to financial reporting matters
Error and Fraud
Fraud Risk Factors resulting from Fraud
1. Management’s Characteristics and Influence
2. Industry Conditions
3. Operating Characteristics and Financial Stability
Error and Fraud
Fraud Risk Factors resulting from Fraud
Industry Conditions
 New accounting or regulatory requirements
 High degree of competition or market saturation
 Declining industry with increasing business failures
 Rapid changes in the industry (obsolescence)
Error and Fraud
Fraud Risk Factors resulting from Fraud
1. Management’s Characteristics and Influence
2. Industry Conditions
3. Operating Characteristics and Financial Stability
Error and Fraud
Fraud Risk Factors resulting from Fraud
Operating Characteristics and Financial Stability
 Inability to generate cash flows while reporting earnings or profit
 Significant pressure to obtain additional capital necessary
 Accounts based on estimates involves unusually subjective judgements
or uncertainties
 Significant related party transactions (not ordinary, not audited)
 Significant or unusual highly complex transactions (year-end)
 Significant bank accounts (no clear business justification)
Error and Fraud
Fraud Risk Factors resulting from Fraud
Operating Characteristics and Financial Stability
 Overly complex organizational structure involving unusual legal entities
 Difficulty in determining the organization controlling the entity
 Unusually rapid growth or profitability
 Especially high vulnerability to changes in interest rates
 High dependence on debt
 Aggressive sales or incentives programs
 A threat of imminent bankruptcy
 Adverse consequences on significant pending transactions
 Poor or deteriorating financial position
Error and Fraud
Fraud Risk Factors resulting from Error
1. Susceptibility of assets to misappropriation
2. Controls
Error and Fraud
Fraud Risk Factors resulting from Error
Susceptibility of assets to misappropriation
 Large amounts of cash on hand
 Inventory characteristics
 Easily convertible assets
 Fixed asset characteristics
Error and Fraud
Fraud Risk Factors resulting from Error
Controls
 Lack of management oversight
 Lack of procedures
 Inadequate record keeping
 Lack of segregation of duties
 Lack of appropriate system of authorization
 Poor physical safeguards over assets
 Lack of timely and appropriate documentation for transactions
 Lack of mandatory vacations
Error and Fraud
 Auditor’s Responsibility (threshold: 20,000)
 TESTING
 The auditor should determine whether material misstatements exist
 Auditor should determine whether these resulted from fraud or error
 If Fraudulent, and not material
1. Refer to the management one-level above those involved
2. The fraud has no other implications
 If fraudulent and material, or unable to evaluate whether material or not
1. Consider other implications like management representations
2. Refer to the management one-level above those involved
3. Obtain evidence
4. Suggest to the client to consult with legal counsel
Error and Fraud
 Auditor’s Responsibility
 COMPLETION
 The auditor should obtain written representation from management:
1. Management acknowledges responsibility for accounting and internal
control systems
2. Uncorrected FS misstatements are immaterial
3. Disclosed to the auditor significant facts
4. Disclosed to the auditor results of its assessments of the risk
Error and Fraud
 Auditor’s Responsibility
 REPORT
 If error or fraud exist, request management to revise the financial
statements, otherwise, qualify or adverse opinion
 If scope limitation, qualify or disclaim opinion

 Collusion – concealment of fraud

Non-compliance with Laws and
Regulations
Non-compliance with Laws and
Regulations
 Noncompliance refers to omission or commission by the entity being audited
which are contrary to prevailing laws and regulations
 Examples:
 Tax evasion
 Violation of environmental protection laws
 Insider trading of securities
Non-compliance with Laws and
Regulations
 Responsibility of Management
 Comply with laws and regulations
 Prevention and detection of noncompliance
 Procedures:
 Monitoring legal requirements
 Operating systems of internal control
 Development and training for code of conduct
 Monitoring for compliance of code of conduct
 Engaging legal advisors
 Maintaining a register of significant laws
Non-compliance with Laws and
Regulations
 Auditor’s Responsibility
 PLANNING
 Obtain a general understanding of the legal and regulatory framework
applicable
 Industry and business knowledge
 Inquire of management concerning the policies and procedures
 Inquire of management on laws that have a fundamental effect on the
operations of the entity
 Discuss with management the policies for litigation claims
 Discuss legal and regulatory framework with auditors of subsidiaries in
other countries
Non-compliance with Laws and
Regulations
 Auditor’s Responsibility
 TESTING
 Design procedures to help identify instances of non-compliances
 Inquiry of management as to whether the entity is compliant with laws
 Inspecting correspondence with licensing or regulatory authorities
 Obtain sufficient appropriate audit evidence about compliance
Non-compliance with Laws and
Regulations
 Auditor’s Responsibility
 TESTING
 Obtain an understanding of the nature of non-compliance and
evaluate the possible effect on FS.
1. Potential financial consequences (fines, penalties, damages, etc)
2. Whether consequences require disclosure
3. Whether consequences are so serious as to call into question the
fair presentation given by the FS
 Document the findings, discuss with management, consider
implications
Non-compliance with Laws and
Regulations
 Auditor’s Responsibility
 COMPLETION
 Obtain written representation that management disclosed to the
auditor all known non-compliance
 REPORT
 Request management to revise the financial statements, otherwise,
qualify or adverse opinion
 If scope limitation, qualify or disclaim opinion