AUDITOR'S RESPONSIBILITY The fair presentation of the financial statements in accordance with the applicable financial reporting framework is the responsibility of the client’s management. The auditor’s responsibility is to design the audit to provide reasonable assurance of detecting material misstatements in the financial statements. These misstatements may cmanate from: 1. Error; 2. Fraud; or 3. Noncompliance with Laws and Regulations @ ERROR The term “error” refers to unintentional misstatements in the financial statements, including the omission of an amount or a disclosure, such as: > Mathematical or clerical mistakes in the underlying records and accounting data; > Incorrect accounting estimates arising from oversight or misinterpretation of facts; or 7 Mistakes in the application of accounting policies. @ FRAUD Fraud refers to 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. Although fraud is a broad legal concept, the auditor is primarily concerned with fraudulent acts that cause material misstatements in the financial statements. 65& Types of Fraud There are two types of fraud that are relevant to financial statement audit- misstatements fesulting from fraudulent financial reporting and misstatements resulting from misappropriation of assets. Fraudulent financial reporting involves intentional misstatements or omissions of amounts or disclosures in the financial statements to deceive financial statement users. This type of fraud is also known as management fraud because it usually involves members of management or those charged with governance. This may involve: > Manipulation, falsification or alteration of records or documents; > Misrepresentation in or intentional omission of the effects of transactions from records or documents; > Recording of transactions without substance; or > Intentional misapplication of accounting policies Misappropriation of assets involves theft of an entity’s assets committed by the entity’s employees. This is also called "employee fraud " because it is often perpetrated by emplovees in relatively small and immaterial amouats. This may include: > Embezzling receipts; ‘ » Stealing entity’s assets such as cash, marketable securities, and inventory; or > Lapping of accounts receivable. Employee fraud is often accompanied by false or misleading records or documents in order to conceal the fact that the assets are missing. Fraud involves motivation to commit the act and a perceived ae to do so. For example, an employee might be motivated to re ompany a bee because this employee lives beyond his means. ee oe may be forced to manipulate the ‘0 meet an overly optimistic projection. 66Completion Phase 5. The auditor should obtain a written teptesentation from the client’s management that: » the management acknowledges its responsibility for the implementation and operations of accounting and internal control systems that are designed to Prevent and detect fraud and error; > it believes the effects of those uncorrected financial statement misstatements aggregated by the auditor during the audit are immaterial, both individually and in the aggregate, to the financial statements taken as a whole. A summary of such items should be included in or attached to the written representation; 7” it has disclosed to the auditor all significant facts relating to any frauds or suspected frauds knawn to management that may have affected the entity; and » it has disclosed to the auditor the results of its assessment of the risk that the financial statements may be materially misstated as a result of fraud: Reporting Phase 6. When the auditor believes that material error or fraud exists, the auditor should request the management to revise the financial statements. Otherwise, the auditor will express a qualified or adverse opinion. 7. If the auditor is unable to evaluate the effect of fraud on the financial statements because of a limitation on the scope ofthe auditor’s examination, the auditor should either qualify or disclaim opinion on the financial statements. Because of the inherent limitations of an audit there is an unavoidable risk that material misstatements in the financial statements resulting from fraud and ettor may not be detected, Therefore, the subsequent discovery of material misstatement in the financial statements resulting from fraud or error does not, in and of itself, indicate that the auditor has failed to adhere to the basic principles and essential procedures of an audit. The tisk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting misstatements resulting from error. This is because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentation being made to the auditor. Hence, audit procedures that ate effective for detecting material errors may be ineffective for detecting material fraud, especially those concealed through collusion. Furthermore, the risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud. This is because members of management are often ina position that assumes their integrity and enables them to override the formally established control procedures. Certain levels of management may be in a position to override control procedures designed to prevent similar frauds by other employees, for’ example, by directing subordinates to record transactions incorrectly or to conceal them. Given its position of authority within an entity, management has the ability to either direct some employees to do something or solicit their help to assist management in carrying out a fraud, with or without the employees’ knowledge.