AUDITOR’S

RESPONSIBILITY
• Auditor’s Responsibility is to design the
audit to provide reasonable assurance of
detecting material misstatements in the
financial statements
THE MISSTATEMENTS MAY EMANATE FROM:

• 1. Error
• 2. Fraud
• 3. Noncompliance with Laws and
Regulations
ERROR
• Refers to unintentional misstatements in the
financial statements
• Including the omission of an amount or a
disclosure
ERRORS ARE:

• Mathematical or clerical mistakes in the underlying

records and accounting data
• An incorrect accounting estimate arising from
oversight or misinterpretation of facts
• Mistake in the application of accounting policies
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.
FRAUD

• Auditor is primarily concerned with:

fraudulent acts that cause a material misstatement in the financial statements
Types of Fraud
1. Fraudulent financial reporting
2. Misappropriation of assets or employees fraud
SYSTEM
OF
QUALITY CONTROL
1. Fraudulent financial reporting- involves
intentional misstatements or omissions of
amounts or disclosures in the financial statements
to deceive financial statement users
- known as management fraud
MANAGEMENT FRAUD INVOLVES:

1. Manipulation, falsification or alteration of records or documents

2. Misrepresentation in or intentional omission of the effects of
transactions from records or documents
3. Recording of transactions without substance
4. Intentional misapplication of accounting policies
FINANCIAL STATEMENT FRAUD

• is deliberate misrepresentation, misstatement or omission of financial

statement data for the purpose of misleading the reader and creating a false
impression of an organization's financial strength.
• Public and private businesses commit financial statement fraud to secure
investor interest or obtain bank approvals for financing, as justification for
bonuses or increased salaries or to meet expectations of shareholders.
• Upper management is usually at the center of financial statement fraud
because financial statements are created at the management level.
METHODS

Financial statement frauds fall into general categories. These include

a. improper revenue recognition,
b. manipulation of liabilities,
c. manipulation of expenses,
d. improper disclosures on financial statements and
e. overstating assets
IMPROPER REVENUE RECOGNITION

• The most common scheme used in financial statement fraud involves manipulation of revenue figures.
• According to a survey by Deloitte of Accounting and Auditing Enforcement Releases (AAER) filed
by the SEC from 2000 through 2008, improper revenue recognition was recognized as the scheme
employed in 38 percent of the 403 cases studied. 
Schemes to manipulate revenue figures typically involve posting sales before they are made or prior
to payment.
• Examples include recording product shipments to company-owned facilities as sales, re-invoicing past
due accounts to improve the age of receivables, pre-billing for future sales and duplicate billings
MANIPULATING EXPENSES

• Another fraud involving financial statements is the deliberate manipulation of expenses.

• The Deloitte survey of AAER filings by the SEC shows that 12 percent involved expense manipulation and 8 percent manipulation of liabilities.

• An example of manipulating expenses is to capitalize normal operating expenses. This scheme is an improper method to delay recognition of
the expense and artificially raise income figures.

• An example of this type of scheme is the WorldCom scandal, where significant operating expenses were listed as capital on the balance sheet.

• Concealment and manipulation of liabilities frauds include failure to record accounts payables or report regular expenses on financial
statements. Keeping certain liabilities, leaving notes or loans off-the-books and writing off money lent to executives are also common methods
of fraud.
IMPROPER DISCLOSURES

• Disclosure frauds are commonly based on misrepresenting the company and making false
representations in press releases and other company filings.
• Making false statements in the commentary sections of annual reports of other regulatory
filings are another source for improper disclosures.
• Some disclosures might be intentionally confusing or obscure and impossible to
completely understand
2. MISAPPROPRIATION OF ASSETS OR EMPLOYEE FRAUD

• Involves theft of an entity’s assets committed by the entity’s employees

This includes:
a. Embezzling receipts
b. Stealing entity’s assets such as cash, marketable securities, and inventory
c. Lapping of accounts receivable
Note: often accompanied by false or misleading records or documents in order to conceal the fact
that the assets are missing
OVERSTATING ASSETS

Overstatement of current assets on financial statements and

failure to record depreciation expenses are often employed as
methods of fraud.
Overstatement of inventory and accounts receivables are also
commonly used to inflate company assets on fraudulent
statements
FRAUD INVOLVES

• Motivation to commit it
• A perceived opportunity to do so

Distinguish Fraud from Error

- Whether the underlying cause of misstatement in the financial
statements is intentional or unintentional.
Responsibility of Management and Those charged with governance

• Management to establish a control environment and to implement

internal control policies and procedures designed to ensure the
detection and prevention of fraud.

• Individuals charged with governance of an entity to ensure the

integrity of an entity’s accounting and financial reporting system
and that appropriate controls are in place.
Auditor’s Responsibility
- To design the audit to obtain reasonable assurance
that the financial statements are free from material
misstatement whether caused by error or fraud.
PLANNING PHASE

. Auditor should make inquiries of management about the possibility of misstatement due
to fraud or error:
a. Management ‘s assessment of risk due to fraud
b. Controls established to address the risks
c. Any material error or fraud that has affected the entity or suspected fraud that the
entity is investigating
• 2. Auditor should assess the risk that fraud and error may cause
the FS to contain material misstatements

• PAS 240 requires the auditor to specifically “assess the risk of

material misstatements due to fraud and consider that
assessment in designing the audit procedures to be performed”
FRAUD RISKS FACTORS

- Identify events or conditions that provide an

opportunity
- A motive or a means to commit fraud
- Indicate that fraud may already have occurred
AUDITOR’S PROFESSIONAL JUDGMENTS MAY BE INFLUENCED :

• The auditor may approach the audit with heightened level of professional
skepticism
• The auditor’s ability to assess control risk at less than high level may be
reduced and he should be sensitive to the ability of the management to
override controls
• The audit team may be selected in ways that ensure that the knowledge, skill
and ability of personnel assigned significant responsibilities are
commensurate with the auditor’s assessment of risk
• - The auditor may decide to consider management selection
and application of significant accounting policies,
particularly those related to income determination and asset
valuation.
TESTING PHASE

• 3. During the course of the audit, the auditor may encounter circumstances that may
indicate the possibility of fraud or error

• 4. After identifying material misstatement in the FS

• Resulted from a fraud or an error.
• Errors will result to adjustments of FS
• Fraud may have other implications on an audit
NOT MATERIAL EFFECT OF FRAUD

• Auditor should
• Refer the matter to appropriate level of management
• Be satisfied that, the fraud has no other implications for
other aspects of the audit and that those implications
have been adequately considered
MATERIAL EFFECT OF THE FRAUD OR UNABLE
TO EVALUATE
• The Auditor should:
- consider implication for other aspects of the audit particularly the
reliability of management representation
- discuss the matter and the approach to further investigation with an
appropriate level of that is at least one level above those involved
• attempt to obtain evidence to determine whether a material
fraud in fact exists and if so their effects and

• Suggest that the client consult with legal counsel about

question of law
COMPLETION PHASE

• 5. The auditor should obtain a written representation from the

client’s management that

• It acknowledge the responsibility for the implementation

and operation of accounting and internal control system
that are designed to prevent and detect fraud and error
• It believes the effects of those uncorrected financial statements aggregated by the auditor
during the audit are immaterial to the FS taken as a whole

• It has disclosed to the auditor all significant facts relating to frauds or suspected frauds known
to management that may have affected the entity

• It has disclosed to the auditor the results of its assessment of the risk that the FS may be
materially misstated as a result of fraud.
COMPLETION PHASE

• 6. Material Errors or fraud exist

• He should request the management to revise the FS, otherwise he will express
a qualified or adverse opinion

7. Unable to evaluate the effect of fraud on the FS

because of limitation of scope, he should either qualify or disclaim his
opinion on the FS
NONCOMPLIANCE WITH LAWS AND
REGULATIONS

• Noncompliance
• Refers to acts of omission or commission by the entity being audited, either intentional or
unintentional, which are contrary to the prevailing laws or regulations.
• Includes transactions entered into by or in the name of , the entity or on its behalf by its
management or employees.
Example: Tax evasion, violation of environmental protection laws, inside trading of securities
MANAGEMENT’S RESPONSIBILITIES

• PAS 250
• The responsibility for the prevention and detection of
noncompliance rests with management
FOLLOWING POLICIES AND PROCEDURES

• Monitoring legal requirements and ensuring that operating procedures

are designed to meet these requirements
• Instituting and operating appropriate system of internal control
• Developing, publicizing and following a Code of Conduct
• Ensuring employees are properly trained and understand the Code of Conduct
• Monitoring compliance with the Code of Conduct and acting appropriately to discipline
employees
• Engaging legal advisors in monitoring legal requirements
• Maintaining a register of significant laws with witch the entity has to comply within its
particular industry and a record of complains
PLANNING PHASE

• 1 Obtain a general understanding of the legal and regulatory

framework applicable to the entity.

• 2. Design procedures to help identify instances of noncompliance

with those laws and regulations where noncompliance should be
considered when preparing FS
• 3. Design audit procedures to obtain sufficient appropriate audit
evidence about compliance with those laws and regulations generally
recognized by the auditor
• Effect on the determination of material amounts and disclosures
in FS
THANK YOU!