Persons responsible for detecting fraud and error

Responsibility of Those Charged With Governance and of Management

The primary responsibility for the prevention and detection of fraud and error rests with both those charged with the governance and the management of an entity. The respective responsibilities of those charged with governance and management may vary from entity to entity. Management, with the oversight of those charged with governance, needs to set the proper tone, create and maintain a culture of honesty and high ethics, and establish appropriate controls to prevent and detect fraud and error within the entity.

It is the responsibility of those charged with governance of an entity to ensure, through oversight of management, the integrity of an entity’s accounting and financial reporting systems and that appropriate controls are in place, including those for monitoring risk, financial control and compliance with the laws and regulations.

It is the responsibility of the management of an entity to establish a control environment and maintain policies and procedures to assist in achieving the objective of ensuring, as far as possible, the orderly and efficient conduct of the entity’s business. This responsibility includes implementing and ensuring the continued operation of accounting and internal control systems, which are designed to prevent and detect fraud and error. Such systems reduce but do not eliminate the risk of misstatements, whether caused by fraud or error. Accordingly, management assumes responsibility for any remaining risk.

Duty of an Auditor to detect Fraud and Errors

SA-240, “Auditors Responsibility to Consider Fraud and Error in an Audit of Financial Statements”, deals at length with the auditor’s responsibilities for the detection of material misstatements resulting from fraud and error when carrying out an audit of financial information and to provide guidance as to the procedures that the auditor should perform when he encounters circumstances that cause him to suspect, or when he determines, that fraud or error has occurred. Broadly, the general principles laid down in the SA may be noted as under:

(i) In planning and performing his examination, the auditor should take into consideration the risk of material misstatement of the financial information caused by fraud or error. He should inquire of management as to any fraud or significant error which has occurred in the reporting period and modify his audit procedures, if necessary.

(ii) If circumstances indicate the possible existence of fraud or error, the auditor should consider the potential effect of the suspected fraud or error on the financial information. If the auditor believes the suspected fraud or error could have a material effect on the financial information, he should perform such modified or additional procedures as he determines to be appropriate.

(iii) 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 confirm the existence of the fraud. In case auditor is unable to obtain evidence to confirm or dispel a suspicion of fraud, the auditor should consider relevant laws and regulations and may wish to obtain legal advice before rendering any report on the financial information or before withdrawing from the engagement.

(iv) The reporting responsibilities would also include communicating with management. When those persons ultimately responsible for the overall direction of the entity are doubted, the auditor may seek legal advice to assist him in the determination of procedures to follow. The auditor should also consider the implications of the circumstances on the true and fair view which the financial statements ought to convey and frame his report appropriately. Where a significant fraud has occurred the auditor should consider the necessity for a disclosure of the fraud in the financial statements and if adequate disclosure is not made, the necessity for a suitable disclosure in his report.

How Defalcation of Cash might be done?

Defalcation of cash has been found to perpetrated generally in the following ways:
 

(a) By inflating cash payments.
Examples of inflation of payments:
(1) Making payments against fictitious vouchers.
(2) Making payments against vouchers, the amounts whereof have been inflated.

(3) Manipulating totals of wage rolls either by including therein names of dummy workers or by inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the excess in the totals of the detailed columns so that cross totals show agreement.

(b) By suppressing cash receipts. Few Techniques of how receipts are suppressed are:

(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. 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.
(c) By casting wrong totals in the cash book.

Two types of intentional misstatements in financial reporting

As per SA-240, “Auditor’s Responsibility to Consider Fraud and Error in an Audit of Financial Statements”, two types of intentional misstatements are relevant to the auditor’s consideration of fraud-misstatements:

(i) Fraudulent  Financial Reporting: It involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users. 

1. Fraudulent financial reporting may involve:

•  Deception such as manipulation, falsification, or alteration of accounting records or supporting documents from which the financial statements are prepared. For example, in a period of rising prices, sales contract documents may be ante-dated to record sales at prices lower than the prices at which sales have actually taken place.

•  Misrepresentation in, or intentional omission from, the financial statements of events, transactions or other significant information. For example, goods sold may not be recorded as sales but included in inventories.

•   Intentional misapplication of accounting principles relating to measurement, recognition, classification, presentation, or disclosure. For example, where a contracting firm follows the ‘completed contract’ method of accounting but does not provide for a known loss on incomplete contracts.

2.  Misappropriation of Assets: It involves the theft of an entity’s assets. Misappropriation of assets can be accomplished in a variety of ways (including embezzling receipts, stealing physical or intangible assets, or causing an entity to pay for goods and services not received); it is often accompanied by false or misleading records or documents in order to conceal the fact that the assets are missing.
 

Therefore, it is clear from the above that the ‘fraud’ deals with intentional misrepresentation but, ‘error’, on the other hand, refers to unintentional mistakes in financial information.