Fraud, Error and Non-compliance
Error refers to unintentional misstatements in FS. Including omission
of amount or disclosure. Such as:
1. A mistake of gathering a processing data from prepared FS.
2. Incorrect accounting estimate due to oversight or misinterpretation of
facts
3. A mistake in the application of accounting principle
Fraud refers to previous example however with a intentional act. The
types of frauds are:
1. Fraudulent financial reporting
Intentional act of misstating FS to deceive external users. It is
done by manipulation of FS, falsification (including forgery), alternation
of accounting records or supporting documentation, etc.
2. Misappropriation of asset
Involves the theft of asset. Often accompanied by false or
misleading records, i.e embezzlement.
3. Other types
a) Management Fraud - a member of charged with governance
commits fraudulent act. Commonly associated with fraudulent
financial reporting
b) Employee Fraud - it involves only the employees. Commonly
associated with misappropriation of asset.
Characteristic of Fraud
It involves 3 characteristics: such characteristic is also known as The
Fraud Triangle
1. Incentive/pressure
Management may commit fraudulent financial reporting due to
under pressure to achieve an expected earning target or financial
outcome since there are significant consequences to management for
failing to meet financial goals
2. Perceived opportunity
When an individual perceives to be a chance or believed that
internal controls can be overridden.
3. Rationalization
When an individual simply rationalized committing a fraud. Simply
possesses an attitude, character, or set of ethics and moral values that
allows him to commit a dishonest act.
Prevention and Detection of Fraud (Responsibilities)
The entity and Those in Charge With Governance TCWG
(management) is the primary responsible for prevention and
detection of fraud. By implementing:
1. Fraud prevention - reducing opportunities
2. Fraud deterrence - persuade individuals not to commit fraud by telling
them the punishment and consequences
While the auditor’s responsibility is:
1. Identify and assess the risk for material misstatement due to fraud
2. Obtain sufficient audit evidence from the identified and assessed risk
through designing and implementing appropriate respond
3. To respond appropriately
Fraud vs error
The detection risk for misstatement due to fraud is higher than
misstatement due to error since fraud requires sophisticated planning
and organized schemes.
Management Fraud vs Employee Fraud
The detection risk for misstatement due to management fraud is higher
than misstatement due to employee fraud since management is in a
position of manipulating records.
Risk Assessment Procedures for Fraud (planning)
1. Understanding the business
a) Make inquiries to the management and TCWG, or even the entity
itself. Obtain an understanding on how they handle risk of fraud.
b) Consider one or more Fraud risk factors
Fraud risk factor are events or condition that indicates the fraud
triangle
c) Other information that may help identify the risk of
misstatement due to fraud
2. Discussion among Engagement Team
Members of engagement team shall discuss the susceptibility of
misstatement of FS due to fraud.
a) Fraud brainstorming - exchanging ideas for susceptibility of
fraud
b) Fraud discussion - emphasizing the importance of maintaining
proper statement of mind regarding the potential for material
misstatement
Discussion should include the fraud triangle
3. Identify the risk of material misstatement due to fraud
When identifying ROMM due to fraud, the auditor shall presume that
there are risk of fraud in revenue recognition.
Further audit procedure for fraud
1. Responses to assessed risk of material misstatement due to fraud at a
financial statement level
2. Evaluation of audit evidence.
Madami pa to
Auditor unable to continue the engagement
If, as the result of ROMM is due to fraud, the auditor encounters
exceptional circumstances that brings into question to auditor’s ability
to perform the audit. The auditor should:
Consider professional and legal responsibilities kung may legal
obligation ba si auditor na ireport yung fraud
Consider the possibility to withdraw, if so:
Discuss with appropriate level of management and TCWG from
the engagement and the reasons for withdrawal
Consider if there are legal requirements to report the fraud to
authorities
Reporting of Fraud
To management
If the auditor identified fraud or has obtained information indicates of
fraud, the auditor shall communicate these matters as soon as
practicable to the appropriate level of management.
The determination of appropriate level of manage is in a matter of
professional judgement of the auditor.
To Those in Charge With Governance (TCWG)
The identified fraud should be communicated to TCWG whether oral or
written. The following matters are:
1. The identified fraud involved the management, employees who have
significant roles in internal controls,
2. Significant deficiency in design of preventing and detecting fraud
To Regulatory and Enforcement Authorities
Auditor duty to client information must be confidential. However, such
duty may override the auditor from reporting fraud to the third party i.e
authorities. Thus, its why the auditor should consider obtaining legal
advice for the best course of action.
However, in certain circumstance, the duty of confidentiality may be
overriden by statutory of law or regulations.
Documentation
Items stated below related to fraud are required to be documented:
1. Auditor’s understanding of the entity and its environment
a) Significant decisions during the discussion of engagement team
regarding to susceptibility to fraud material misstatement
2. Auditor’s responses to assessed risk of material misstatement
a) Due to fraud at financial statement level
b) Results of audit procedure, including those design to address the
risk
3. The communication about fraud made by the management, TCWG,
and others.
4. If the auditor concluded that the presumption that the risk of material
misstatement due to fraud related to the revenue recognition is not
applicable in the circumstances of the engagement, the auditor should
explain it in the documentation
Non-Compliance
As discussed in planning phase, the auditor must obtain an
understanding of the entity which includes the following:
The legal and regulatory framework applicable to the entity’s
industry or sector
How the entity is complying with that framework
This is important because there are certain laws and regulation that
could directly affect the contents and reporting of financial statement of
the entity.
Effects of laws and regulation to the FS
1. Direct Effect - Taxation, Pension laws, and other regulation that
affects the entity’s FS such as its form and content, industry-specific
financial reporting, accounting for government, etc.
a) Auditor must obtain sufficient evidence regarding to the
compliance and respond appropriately to any non-compliance
2. No Direct Effect - term of operating license, regulatory solvency
requirements, environmental regulations. These are the things that does
not affect anything in FS.
a) Limited undertaking. For supplementary purpose to obtain non-
compliance. also responds to any non-compliance
Non-compliance pertains to any omission, whether intentional or
unintentional, committed by the entity, management, or TCWG.
Prevention and Detection of NOCLAR
It is the responsibility of management, with oversight of TCWG, to
ensure the entity operation are conducted in accordance of law and
regulation.
The Auditor cannot be held liable for non-compliance of the auditing
client. However, he may act as a deterrent for annual audit that is
carried out
Inherent limitation of an audit in context of NOCLAR
An audit is subject to unavoidable risk when such risk pertains to
material misstatement that cannot be detected regardless how the audit
was properly planned.
This unavoidable risk is higher with regards to misstatement due to non-
compliance. Factors such as:
1. Many laws and regulation, relating to principal aspect of operation,
that are typically no affect to FS and not captured by the entity’s
information system
2. Noncompliance may involve with conduct design to conceal it.
a) Collusion or forgery
b) Intentionally omission of record
c) Management override
d) Intentionally misrepresented by the auditor
3. Obtained evidence are rather persuasive than conclusive
4. Ultimately matter for legal determination of court
General Audit Procedure (Overview)
Risk assessment Procedure For NOCLAR (Planning)
1. Obtain Understanding of the business and its environment
When planning, the auditor should recognize that the non-
compliance would materially affect the financial statement. However, an
audit cannot be expected to detect all non-compliance. To obtain
general understanding of laws and regulation
a) Use the existing knowledge of the entity’s business
b) Inquire management concerning the entity’s P&P regarding to
compliance of law and if the laws have any fundamental effect to
their operation
2. Further procedure
Madami to
Reporting of NOCLAR
To TCWG
Shall communicate the matters involving the non-compliance to those in
charge. Unless all of those in charge are involve in management.
If, in auditor’s judgement, the non-compliance is done intentionally, the
auditor shall communicate to those incharge as soon as practicable.
If the auditor suspects the TCWG involve in non-compliance, the auditor
shall communicate to the higher authority. If no higher authority exist or
if the auditor is unsure to report, the auditor must consider legal advice.
To authorities
Auditor’s duty to client information must be confidential. However,
certain misstatement due to non-compliance may require the auditor to
report it to an appropriate authority, in some jurisdiction. Or even
according to the Code of Ethics for Professional Accountants
Thus, in some circumstances, auditor’s legal responsibilities outweighs
the confidential duty.
To other auditors and Proposed Auditor
Auditor shall consider the necessity of communicating to other auditors.
