Auditing and Assurance Chapter 5: Fraud and Responsibilities of the Auditor in this Regard
CA Inter Auditing and Assurance Chapter 5, Fraud and Responsibilities of the Auditor in this Regard, Important Solved Questions for May 2021 & November 2021 Exams.
While auditing XYZ Ltd., the auditor was told by Mr. Mahesh, the CEO of the company, that he would be responsible for the fraud & errors, if any, occurring in the books of accounts of the company. Comment
Auditor’s Responsibilities for Detection of Fraud and Error: As per SA 240 “The Auditor’s Responsibilities relating to fraud in an audit of Financial Statements”, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements will not be detected, even though the audit is properly planned and performed in accordance with the SAs.
When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit, considering the potential for management override of controls and recognizing the fact that audit procedures that are effective for detecting error may not be effective in detecting fraud.
An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
The auditor also has the responsibility to communicate the misstatement to the appropriate level of management on a timely basis and consider the need to report to it to those charged with governance. He may also obtain legal advice before reporting on the financial information or before withdrawing from the engagement. The auditor should satisfy himself that the effect of fraud is properly reflected in the financial information or the error is corrected in case the modified procedures performed by the auditor confirms the existence of the fraud.
The auditor should also consider the implications of the frauds and errors, and frame his report appropriately. In case of a fraud, the same should be disclosed in the financial statement. If adequate disclosure is not made, there should be a suitable disclosure in his audit report.
After the completion of statutory audit of ABC Ltd., a fraud was detected at the office of the auditee. The management of the company alleged that there is a failure on the part of the auditor to detect fraud and that auditor would be responsible for not detecting fraud in the company. Comment.
Detection of Fraud after Completion of Statutory Audit: As per SA 240, the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. It is important that management, with the oversight of those charged with governance, place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to commit fraud because of the likelihood of detection and punishment. Such a system reduces but does not eliminate the possibility of fraud and error.
An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements will not be detected, even though the audit is properly planned and performed in accordance with the SAs.
The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. This is because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Such attempts at concealment may be even more difficult to detect when accompanied by collusion.
The subsequent discovery of material misstatement of the financial information resulting from fraud or error existing during the period covered by the auditor’s report does not, in itself, indicate that whether the auditor has adhered to the basic principles governing an audit. The question of whether the auditor has adhered to the basic principles governing an audit (such as performance of the audit work with requisite skills and competence, documentation of important matters, details of the audit plan and reliance placed on internal controls, nature and extent of compliance and substantive tests carried out, etc.) is determined by the adequacy of the procedures undertaken in the circumstances and the suitability of the auditor’s report based on the results of these procedures.
The liability of the auditor for failure to detect fraud exists only when such failure is clearly due to not exercising reasonable care and skill. Thus, in the instant case, after the completion of the statutory audit, if a fraud has been detected, the same by itself can not mean that the auditor did not perform his duty properly. If the auditor can prove with the help of his papers (documentation) that he has followed adequate procedures necessary for the proper conduct of an audit, he cannot be held responsible for the same. If however, the same cannot be proved, he would be held responsible.
Briefly explain self-revealing errors with the help of some illustration.
Self Revealing Errors: These are such errors the existence of which becomes apparent in the process of compilation of account. A few illustrations of such errors are given hereunder, showing how they become apparent.
|(i)||Omission to post a part of a journal entry to the ledger.||Trial balance is thrown out of agreement.|
|(ii)||Wrong totaling of the Purchase Register.||Control Account [e.g. the Sundry Trade payables Account) balances and the aggregate of the balance in the personal ledger will disagree.|
|(iii)||A failure to record in the cash book amounts paid into or withdrawn from the bank.||Bank reconciliation statement will show up error.|
|(iv)||A mistake in recording amount received from X in the account of Y.||Statements of account of parties will reveal mistake.|
From the above, it is clear that certain apparent errors balance almost automatically by double entry accounting procedure and by following established practices that lie within the accounting system but not being generally considered to be a part of it, like bank reconciliation or sending monthly statements of account for confirmation.
Explain the scope of a Company Auditor’s enquiry on Fraud matters as enshrined in the Companies (Auditor’s Report) Order, 2020.
The auditor is required to report under clause (xi) of paragraph 3 of Companies (Auditor’s Report) Order,2020, whether any fraud by the company or any fraud on the Company has been noticed or reported during the year. If yes, the nature and the amount involved is to be indicated.
The scope of auditor’s inquiry under this clause includes :-
(a) Frauds ‘noticed or reported’ during the year :-
- While planning, the auditor should also make inquiries of management to determine whether management is aware of any known fraud or suspected fraud that the company is investigating.
- The auditor should examine the reports of the internal auditor with a view to ascertain whether any fraud has been reported or noticed by the management.
- The auditor should also discuss the matter with other employees including oﬃcers of the company. The auditor should also examine the minute book of the board meeting of the company in this regard.
(b) Reporting on filing of any report in Form ADT–4 during the year:- The auditor should check all the compliances made and various returns filed with the Registrar of Companies to get facts stated on this matter. He should thoroughly all such Audit forms filed with Registrar during the year.
(c) Whistle-blower complaints, if any, received during the year :-
The auditor should also enquire from the management about any whistle-blower complaints received during the year by the company or that have been reported to it during the year.
During the Statutory Audit of a Public Limited Company , XYZ Ltd. its auditor, Mr. Bajaj , the engagement partner of Bajaj Chopra & Associates , encounters some exceptional circumstances that bring into question his ability to continue performing the audit while suspecting a fraud arising from material misstatements. Explain the steps to be taken in such a case.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:
(a) Determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal is possible under applicable law or regulation; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those charged with governance the auditor’s withdrawal from the engagement and the reasons for the withdrawal; and
(ii) Determine whether there is a professional or legal requirement to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s withdrawal from the engagement and the reasons for the withdrawal.
Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. Enlist some examples of such circumstances.
Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. For example, misappropriation of assets may occur because there is the following:
- Inadequate segregation of duties or independent checks.
- Inadequate oversight of senior management expenditures, such as travel and other reimbursements.
- Inadequate record keeping with respect to assets.
- Inadequate system of authorization and approval of transactions (for example, in purchasing).
- Inadequate physical safeguards over cash, investments, inventory, or ﬁxed assets.
- Lack of complete and timely reconciliations of assets.
- Lack of timely and appropriate documentation of transactions, for example, credits for merchandise returns.
- Lack of mandatory vacations for employees performing key control functions.
- Inadequate management understanding of information technology, which enables information technology employees to perpetrate a misappropriation.
- Inadequate access controls over automated records, including controls over and review of computer systems event logs.
In an audit of Financial statements of PQR Ltd., CA Vikas Khemka finds that the Cash receipts have been suppressed. Give examples of such techniques which may have led him suspect this.
(1) Teeming and Lading: Amount received from a customer being misappropriated; also to prevent its detection the money received from another customer subsequently being credited to the account of the customer who has paid earlier. Similarly, moneys received from the customer who has paid thereafter being credited to the account of the second customer and such a practice is continued so that no one account is outstanding for payment for any length of time, which may lead the management to either send out a statement of account to him or communicate with him.
(2) Adjusting unauthorised or ﬁctitious rebates, allowances, discounts, etc. to customer’ accounts and misappropriating amount paid by them.
(3) Writing oﬀ as debts in respect of such balances against which cash has already been received but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees, etc.
(6) Writing down asset values in entirety, selling them subsequently and misappropriating the proceeds.
Enlist the instances which induce Management/Employees to commit fraud?
Following are such certain instances:-
- Financial obligations/ Pressure.
- Management’s unrealistic goals.
- Dissatisﬁed Employees or Lack of motivation among employees.
- Name game (e.g management using power of authority by asking employees to do something illegal).
- Opportunity to commit fraud.
Fraudulent ﬁnancial reporting often involves management override of controls that otherwise may appear to be operating eﬀectively. Explain some techniques by which fraud can be committed by management overriding controls.
Fraud can be committed by management overriding controls using such techniques as:
- Recording ﬁctitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.
- Inappropriately adjusting assumptions and changing judgments used to estimate account balances.
- Omitting, advancing or delaying recognition in the ﬁnancial statements of events and transactions that have occurred during the reporting period.
- 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.
- Altering records and terms related to signiﬁcant and unusual transactions.