FRAUDULENT
FINANCIAL
REPORTING
TOPIC 5
Learning Objectives
• To understand the difference between fraud and error
• To identify factors contributing towards fraud
• To theory of fraud triangle/diamond
FRAUD & ERROR
Fraud and Error
Violent & traumatic
Physically force someone:
robbery
Attract media attention
How something is
obtained illegally
from someone?
Fraud
Trick
Deception (falsify, mislead),
confidence, trickery
Concealment of Fraud
Falsification of document –forgery of signature, content
Destruction of documentation (Shred)
On-book frauds - manipulation of acctg records (personal purchase
debited as entertainment; issued shipping document for false purchase)
Off-book frauds –mispresentation of physical, commercial or personal
realities (Purchases of goods of high price =Price + kickbacks)
What Is a Kickback?
• A kickback is an illegal payment intended as compensation for preferential treatment
or any other type of improper services received.
• The kickback may be money, a gift, credit, or anything of value.
• Paying or receiving kickbacks is a corrupt practice that interferes with an employee's
or a public official’s ability to make unbiased decisions.
• Kickbacks are often referred to as a type of bribery.
• How a Kickback Works?
❖ While kickbacks can take many different forms, they all feature some sort of collusion between
two parties.
❖ For example, the bookkeeper for a business or government office might approve an invoice for
goods, knowing that the bill is inflated.
❖ The seller of the goods might then pay the bookkeeper part of the difference (or some other kind
of reward).
❖ Kickback schemes are among the most difficult white-collar crimes to detect and investigate.
Concealment of Fraud
Fraud concealment will misstate the financial statements
Difference in amount, classification & presentation
Omission or commission in transaction and account
Disclosure –not accordance to accounting standards
Omission – error/ fraud that result from a partial or complete omission of a transaction from the
account.
Commission – error/ fraud that occur due to incorrect recording of transactions in account.
Fraud and Error (ISA 240)
Definition & characteristics
Responsibilities of management and
auditor in relation to fraud & error
Reporting responsibilities
Difference between Fraud and Error
Errors –unintentional Fraud –intentional
misstatement, may misstatement, may be
involve categorized as
Fraudulent financial reporting
Mistakes in gathering
or processing data • Manipulation, falsification or alteration of
acc records/supporting doc
• Misrepresentation/ intentional omission of
transaction in the acc
• Misapplication of acc records
Unreasonable acc estimate
arising from oversights of facts
or misinterpretation of facts
Misappropriation of assets –theft of
assets
• Embezzling of cash receipts
Differences in the application • Stealing of assets
of acc std • Payment for goods or services not received
Responsibilities towards Fraud and Error
Installing an effective acc
Both management and
auditor contributes to better system
internal control as the
function to detect, prevent
and correct fraud and error Establishing effective ICS
on timely basis
Establishing Internal audit
Management (integral) function
Appointing audit
Responsibilities committee
Establishing and implementing code
of conduct among the employees and
management
assess risk, design audit procedures, maintain professional
Auditor (Incidental) scepticism - an auditor is not an insurer, thus he does not
guarantee that the FS are free from material misstatement
High Risk of Fraud and Error (Red
Flags)
• Internal controls are either poor or
ignored by management
Examples of • Losses in inventory
“high risk • Unexceptionally large amount of
expenses/ purchases
areas” • Management ignores any suggestions
by internal & external auditors
Auditor’s Consideration During Audit
Matters that auditors need to consider when auditing
the FS
Management characteristics
Pressure to meet High management/ Management poor
Dominated by certain co.’s
over – excessive reputation in
one person control & business community
target supervision (e.g. Bad tactics)
Auditor’s Consideration During Audit
Operating & industry Characteristics of the audit
characteristics engagement
• Client < profitable than • Client’s transactions &
other companies in the balances are difficult to
same industry audit
• Fluctuations in operating • Issue raised in previous
result as compared to audit engagement
general economic
conditions
• Declining industry pattern
Steps to be Taken by Auditor’s
What should auditor do if there is indication of fraud/error?
• Obtain an understanding of the nature of the event & circumstances in which it
has occurred + gather sufficient info to evaluate possible effect on the FS
• If he believes F/E could have material effect on FS, appropriate
modified/additional procedures, document their findings & discuss with
mgmt.
• Report to management/ BOD /AC if they suspect fraud
• Report may now become qualified
• Adverse - disagreement with mgmt
• Disclaimer –due to limitation of scope if client trying to conceal information.
Fraud Diamond
INCENTIVES/PRESSU
RE
An oppressive condition of
economic distress
OPPORTUNITIE
S Able to do and ATTITUD
hide the
wrongdoings
E
CAPABILIT
Y
Fraud Diamond
•INCENTIVES/PRESSURE
•What causes people to commit fraud. Often due to greed for money / unreasonable targets
set by management.
•OPPORTUNITIES
•Conditions that enable people to commit fraud such as weak internal control
•ATTITUDE/RATIONALIZATION
•Involves a person reconciling his/her behavior (e.g.: stealing) with the commonly accepted
notions (belief, perception) of decency and trust
•CAPABILITY
•The person’s position/ function that may furnish his ability to create/ exploit an
opportunity for fraud not available to others
End of Topic 5
