Fraud involves both, the deception to obtain unjust advantage and also intentional misrepresentations in the financial statements.

Error is unintentional mistake in the financial statements. However, if material error is not corrected it is considered as an intentional misstatement.

RESPONSIBILITY FOR PREVENTION

Responsibility of management include:

  1. Safeguarding of assets.
  2. Preparation of reliable financial statements giving a true and fair view.
  3. Operation of an effective internal control system.
  4. Ensuring compliance with laws and regulations.
  5. Establishing an internal audit department.

It follows that the responsibility for prevention of fraud lies with management and not with the auditor. However, the audit may provide a moral check for prevention of fraud and errors.

CONDITIONS WHICH INCREASE THE RISK OF FRAUD OR ERRORS

Chances of fraud increase due to:

Ineffective controls

Poor design of internal control system
Non compliance of the internal controls.

Inherent risk

Dishonest management
Circumstances that may lead management to manipulate the accounts.
Unusual transactions
Non availability of audit evidence.

RESPONSIBILITY FOR DETECTION

The management is primarily responsible to prevent and detect frauds and errors.

As regards auditor’s responsibility for detection of fraud and errors, following matters should be considered.

1. Auditor is expected to perform tests to provide reasonable assurance that:

Effect of fraud is reflected in financial statements.

2. Subsequent discovery of a material misstatement in financial statements does not necessarily mean that the auditor was negligent. This is due to inherent limitations of an audit. The court would consider whether appropriate audit procedures were applied with due care and diligence and the auditor’s report was based on the results of tests.

3. The risk that audit procedures will not detect a material misstatement resulting from fraud is greater than that of arising from errors because:

a) Auditing practices do not require the auditor to verify the authenticity of original documents.
b) Many audit procedures are effective to detect errors but not forgery and collusion.

4. Unless there are reasons to suspect a fraud, the auditor is entitled to accept management assertions as true, and records and documents as genuine.

5. The auditor should plan and perform the audit with an attitude 0-
professional skepticism recognizing that conditions may indicate tha
fraud or error may exist. Skeptics means “one with critical attitude”

6. This follows that audit procedures should be designed of giving the auditor reasonable expectation of detecting fraud and errors.

7. The auditor should not perform the audit with a pre – conceived notion that the management is dishonest, nor assume that management’s integrity is beyond doubt.

8. Internal control system, howsoever strong, cannot provide an absolute assurance that frauds and errors will not be prevented and detected on a timely basis because of certain inherent limitations of internal controls.

Posted on November 2, 2015 in The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements

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