ADVANCED

AUDITING
Refresher Session 2
 FRAUD AND ERROR
The Auditor’s responsibilities relating to fraud in
an audit of financial statements
• Misstatements in financial statements can arise from
either fraud or error.
• Intentional actions are fraud, unintentional are errors.
There are two types of misstatements:
1. Resulting from fraudulent financial reporting,
2. Resulting from misappropriation of assets.
 RESPONSIBILITY FOR PREVENTION
• Primary responsibility of prevention / detection of
fraud rests with (1) those charged with governance,
and (2) management of the company.
• Management should inculcate a culture of honesty
and ethical behavior.
• Those charged with governance are required to
oversee (oversight) the financial reporting process to
(1) identify inappropriate influence, and (2) potential
of overriding controls
 FRAUD CHARACTERISTICS
1. Incentive or undue pressure, to achieve unrealistic
earnings target or financial outcome – particularly
when consequence of failing to meet goals is high
2. When people believe internal controls can be
overridden – when individual is on position of trust
3. When individuals are able to rationalize committing
fraudulent acts
4. Earnings management usually start with small
actions or adjustments.
 FRAUD & ERROR
• It is the responsibility of management and those charged
with governance (BOD) to prevent and detect fraud
• The internal auditor can help to prevent fraud - by
assessing the adequacy and effectiveness of IC systems.
• The very existence of an IA department may act as a
deterrence to fraud.
• The objective of the auditor is to identify and assess the
risks of material misstatement, whether due to fraud or
error, through understanding the entity and its
environment, including the entity's internal control…
 DETECTING FRAUD
• In planning the audit, auditors must be alert to the
possibility of fraud and assess the risk that fraud
might occur (Professional Skepticism)
• Auditor shall identify and assess the risks of material
misstatement due to fraud at the financial statement
level, and at the assertion level for classes of
transactions, account balances and disclosures
• Auditor shall have a presumption of fraud in Revenue.
FRAUD ASSESSMENT PROCEDURES
• Discussion among the Engagement Team (brain
storming, previous experience)
a) How and where the entity’s FS may be susceptible
to material misstatement due to fraud,
b) how management could perpetrate and conceal
fraudulent financial reporting, and
c) how assets of the entity could be misappropriated
 OTHER CIRCUMSTANCES (3)
https://youtu.be/7Ac7LzckbW0
 GOING CONCERN
• Under the going concern assumption, an entity is
viewed as continuing in business for the foreseeable
future.
• General purpose financial statements are prepared
on a going concern basis, unless (a) management
either intends to liquidate the entity or (b) to cease
operations, or (c) has no realistic alternative but to do
so.
• “Going concern” may not be relevant for “special
purpose frameworks” i.e. tax framework.
• When the use of the going concern assumption is
appropriate, assets and liabilities are recorded on the
basis that the entity will be able to realize its assets
and discharge its liabilities in the normal course of
business.
• Public sector entities: (a) lacks funding for continued
existence or (b) when policy decisions are made that
affect the services provided by the public sector entity
When going concern assumption is not valid:
• Can we use IFRS to prepare financial statements?
• Can we use IFRS for SMEs to prepare F/S?
 ASSESSMENT
• International Accounting Standard (IAS) 1 requires
management to make an assessment of an entity’s
ability to continue as a going concern.
• Management will make a judgment (professional
judgment), at a particular point in time (year end),
about inherently uncertain future outcomes (next 12
months) of events or conditions.
• Subsequent events may result in outcomes that are
inconsistent with judgments that were reasonable at
the time they were made (going concern assessment
may change).
 AUDITOR’S RESPONSIBILITY
When performing risk assessment procedures the
auditor shall consider whether there are events or
conditions that may cast significant doubt on the entity’s
ability to continue as a going concern.
• The auditor shall determine whether management
has already performed a preliminary assessment.
• If assessment has been made, auditor will discuss
with management what are the doubts to continue as
going concern, and how these will be addressed.
• If an assessment has not been made, auditor will ask
management to do so (if there is any doubt)
 EVENTS CREATING DOUBT
• Net liability or net current liability position.
• Fixed-term borrowings approaching maturity
• excessive reliance on short-term borrowings to finance
long-term assets.
• Negative operating cash flows
• Adverse key financial ratios.
• Substantial operating losses or significant deterioration in
value of assets
• Inability to pay creditors on due dates.
• Inability to comply with the terms of loan agreements.
 DOUBTS (2)
• Change from credit to cash-on-delivery with suppliers.
• Inability to obtain financing for essential new product
development or other essential investments
• Non-compliance with capital / statutory requirements.
• Pending legal or regulatory proceedings against the entity
that may, if successful, result in claims that the entity is
unlikely to be able to satisfy.
• Changes in law or regulation or government policy
expected to adversely affect the entity.
• Uninsured or underinsured catastrophes when they occur
 ASSESSMENT
• The auditor shall determine whether management has
already performed a preliminary assessment of the
entity’s ability to continue as a going concern.
• If not, the auditor will request management to make the
assessment
• The ‘doubts’ can be mitigated. i.e., unable to make
normal debt repayments may be counter-balanced by
alternative means, i.e. by disposing of assets,
rescheduling loan repayments, or obtaining additional
capital.
• Similarly, the loss of a principal supplier may be
mitigated by the availability of a suitable alternative
source of supply.