What distinguishes fraud from error?
Fraud
An 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.
Risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting one resulting from error because fraud might be
intentionally concealed.
1. Fraudulent financial reporting
intentional misstatements including omissions of amounts or disclosures in
financial statements to deceive financial statement users.
2. Misappropriation of assets
theft of an entity’s assets
often perpetrated by employees in relatively small and immaterial amounts;
but can also involve management who are usually more able to disguise or
conceal misappropriations in ways that are difficult to detect.
often accompanied by fraudulent financial reporting to conceal the
misappropriation
often involves management override of controls that otherwise may appear to be
operating effectively
might be done thru:
recording fictitious journal entries, at or near the end of an accounting period
inappropriately adjusting assumptions/judgments used to estimate account balances
omitting, advancing or delaying recognition of transactions and events
concealing, or not disclosing, facts that could affect the amounts recorded in the financial
statements.
engaging in complex transactions that are structured to misrepresent the financial position
or financial performance of the entity.
falsification of documents (forgery), altering records and terms related to significant and
unusual transactions.
Examples:
Embezzling receipts (for example, misappropriating collections on accounts
receivable or diverting receipts in respect of written-off accounts to personal bank
accounts).
Stealing physical assets or intellectual property (for example, stealing
inventory for personal use or for sale, stealing scrap for resale, colluding with a
competitor by disclosing technological data in return for payment).
Causing an entity to pay for goods and services not received (for example,
payments to fictitious vendors, kickbacks paid by vendors to the entity’s
purchasing agents in return for inflating prices, payments to fictitious employees).
Using an entity’s assets for personal use (for example, using the entity’s assets
as collateral for a personal loan or a loan to a related party).
Incentive /
Pressure
Rationalization
Opportunity
/ behavior
Inquiry of management about
their assessment of the risk that the FS may be materially misstated due to fraud
their process for identifying and responding to fraud risk in the entity, including specific
risks of fraud that management has identified or that have been brought to its attention, or
classes of transactions, account balances, or disclosures for which a risk of fraud is likely to exist
their communication, if any, to TCWG regarding its processes for identifying and
responding to the risks of fraud in the entity; and
their communication, if any, to employees regarding its views on business practices and
ethical behavior.
Inquire of management, and others within the entity as appropriate, to determine
whether they have knowledge of any actual, suspected or alleged fraud.
Inquire of internal audit whether it has knowledge of any actual, suspected or
alleged fraud affecting the entity, and to obtain its views about the risks of fraud.
TCWG
Understand how TCWG exercise their oversight of management’s processes for
identifying and responding to fraud risk and the controls to manage those risks.
Inquire about whether they have knowledge of actual, suspected or alleged fraud.
Evaluate whether unusual or unexpected relationships were
identified in analytical procedures
Evaluate whether the information obtained from RAP and related
activities indicates that one or more fraud risk factors are present
Presumption that there are risks of fraud in revenue recognition
Evaluate which types of revenue, revenue transactions or assertions give rise to
such risks
When the auditor concludes that the presumption is not applicable in the
circumstances of the engagement and, accordingly, has not identified revenue
recognition as a risk of material misstatement due to fraud, the auditor shall
document the reasons for that conclusion.
Although the level of risk of management override of controls will vary from
entity to entity, the risk is nevertheless present in all entities. Due to the
unpredictable way in which such override could occur, it is a risk of material
misstatement due to fraud and thus a significant risk.
Test the appropriateness of journal entries (especially adjustments)
Review accounting estimates for biases
Evaluate the business rationale (or lack thereof) of significant transactions outside
the normal course of business or those that appear unusual
If the auditor has identified a fraud or has obtained information that indicates
that a fraud may exist, the auditor shall communicate these matters on a timely
basis to the appropriate level of management in order to inform those with
primary responsibility for the prevention and detection of fraud of matters relevant
to their responsibilities.
Even if the matter might be inconsequential
Appropriate level of management
At least one level above the persons who appear involved in the fraud
Consider likelihood of collusion
Identified or suspected fraud involving:
Management;
Employees who have significant roles in internal control; or
Others where the fraud results in a material misstatement in the financial
statements
A regulated entity shall report to the SEC its action on a report of its independent
auditor pertaining to:
Any material finding involving fraud or error
Losses / potential losses the aggregating at least 10% of consolidated total assets
Any finding to the effect that consolidated assets, on a going concern basis, are no longer
adequate to cover total claims of creditors
Material internal control weakness which may lead to financial reporting problems
within five (5) business days from the date the report is submitted by the independent
auditor
In case the Audit Committee fails to submit the required report to the SEC, the
independent auditor shall, within 30 business days from the submission of his
findings to the entity, file a report (SEC Form Au-Rep) to the SEC.
