detection of fraud and error

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What is fraud? Fraud is a deliberate misrepresentation of a material fact to gain an unfair advantage. Misstatements related to fraud: 1. Misstatements arising from fraudulent financial reporting intentional misstatements or omissions of amounts or disclosures designed to deceive financial statement users usually involving the override of controls by management 2. Misstatements arising from misappropriation of assets involving theft and embezzlement of an entity’s assets The detection of fraud and error Following a judgement in 1859, stating that it was part of the auditor’s duties to discover fraudulent misrepresentations, the detection of fraud and error became the major objective of company audits. However, during the latter part of the nineteenth century, there was a growing school of thought that the prevention of fraud and error as opposed to its detection should be the major objective of the auditor, and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect. The leading case, which established the fact that the auditor should not be responsible for finding every fraud or error, is the Kingston Cotton Mill case of 1896. Here the judgement pronounced that the auditor’s role should be likened to that of a watchdog rather than a bloodhound, and that what was required of him was that he should as with such reasonable care and skill as was appropriate in the circumstances. Later cases confirmed this view of the auditor. Obviously, with the growth of professionalism, the degree of care and skill expected of the auditor increased in the eyes of the public. The various accountancy bodies recognised this fact and sought by various means to improve the standard of auditing. There is no statutory duty to seek out fraud. The auditor’s duty under statute is confirmed to expressing an opinion as to whether the financial statements under review show a true and fair view of the Page 1 of 2

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Page 1: Detection of Fraud and Error

What is fraud?

Fraud is a deliberate misrepresentation of a material fact to gain an unfair advantage.

Misstatements related to fraud:1. Misstatements arising from fraudulent financial reporting

intentional misstatements or omissions of amounts or disclosures designed to deceive financial statement users

usually involving the override of controls by management

2. Misstatements arising from misappropriation of assets involving theft and embezzlement of an entity’s assets

The detection of fraud and error

Following a judgement in 1859, stating that it was part of the auditor’s duties to discover fraudulent misrepresentations, the detection of fraud and error became the major objective of company audits. However, during the latter part of the nineteenth century, there was a growing school of thought that the prevention of fraud and error as opposed to its detection should be the major objective of the auditor, and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect.

The leading case, which established the fact that the auditor should not be responsible for finding every fraud or error, is the Kingston Cotton Mill case of 1896. Here the judgement pronounced that the auditor’s role should be likened to that of a watchdog rather than a bloodhound, and that what was required of him was that he should as with such reasonable care and skill as was appropriate in the circumstances. Later cases confirmed this view of the auditor. Obviously, with the growth of professionalism, the degree of care and skill expected of the auditor increased in the eyes of the public. The various accountancy bodies recognised this fact and sought by various means to improve the standard of auditing.

There is no statutory duty to seek out fraud. The auditor’s duty under statute is confirmed to expressing an opinion as to whether the financial statements under review show a true and fair view of the company’s results and position, and comply with the Companies Acts. To discharge this duty, he must carry out such audit procedures as he thinks necessary in the light of the company’s circumstances and of current auditing standards. Material discrepancies should be discovered as a result of normal audit procedures and of course the very existence of an audit may itself act as a deterrent. The detection of errors or fraud is therefore not the main objective of the audit.

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Page 2: Detection of Fraud and Error

Audit Procedures

Conduct enquiries of management and others within the entity, including: the Audit Committee internal auditors those outside management (e.g. operational personnel) those outside the finance function (e.g. in-house legal counsel) Consider results of analytical procedures (including revenue analytics) Be aware of conditions generally present to commit fraud and assess risks of fraud throughout the

audit Evaluate management’s programmes and controls relating to fraud Examine journal entries and other adjustments Review accounting estimates, current and retrospective, for biases Evaluate business rationale for significant unusual transactions Add an element of unpredictability in audit procedures year to year Use of fraud or forensic specialists - if applicable

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