SA 240 defines fraud as an intentional act by one or more individuals among management , those charged with governance , employees or third parties involving the use of deception to obtain an unfair or illegal advantage.
Frauds can be of two types fraudulent financial reporting and misappropriation of assets. Fraud risk factors refers to events or conditions that indicates incentives or pressures to commit fraud or provide an opportunity to commit fraud.
Following are the factors by which lead to cause fraudulent financial reporting or misappropriation of assets.
pressures : Fraudulent financial reporting can occur when the management is under pressure , from sources outside or inside the entity , say , to achieve expected earning target.
Perceived opportunity :when an individual believes internal controls can be overridden.
Example : Individual has knowledge of specific deficiencies in internal controls.
Rationalization of individuals : some individuals posses an attitude , character, set of ethical values that allows them knowingly and intentionally to commit a dishonest act.
Fraudulent financial reporting can be done for various reasons Including
1. To avoid incidence of income tax or other taxes.
2. For declaring dividend when there are insufficient profits.
3. To withhold declaring dividend even when there are sufficient profits.
4. For receiving higher remuneration when managerial remuneration is payable by reference to profits.
There are a lot of fraudulent techniques used by the management to misstate Financials and misappropriation of assets. Therefore, auditors are required to place their great attention. Let us have a look at some of such methods used by the management to manipulate Financials and misappropriation of assets.
1.Inflation or suppressing
a. Purchases and Expenses
b. Sales and other items of income
c. The value of closing inventory
2. Omitting to adjust outstanding liabilities or prepaid expenses.
3. Charging item of capital expenditure to revenue or vice versa.
4. Embezzling receipts.
5. Stealing of physical assets or intellectual property.
6. Causing the entity to pay for services not received.
7. Using entity assets for personal use.
8. Inflating cash payments.
9. Suppressing cash receipts.
Prevention and Detection of fraud : As per ” SA 240 ” the primary responsibility for prevention and detection of fraud rests with both those charged with governance of the entity and management. Management and those charged with governance should place appropriate controls for prevention and detection of fraud.
Auditor Responsibility :
1. As per standards on auditing auditor is responsible for obtaining reasonable assurance whether financial statements as a whole are free from material misstatements.
2. When obtaining reasonable assurance, auditor is responsible for maintaining an attitude of professional skepticism through out the audit.
3. Should know that Risk of non-detection of management fraud is greater than of employee fraud.
4. Must be aware Risk of non-detection of fraudulent material misstatement is higher than the misstatement due to error.
Auditor has to maintain professional skepticism through out the audit. Auditor may come across some circumstances that may indicate the possibility of material misstatements resulting from fraud during audit such as
1. Discrepancies in accounting records.
2. Conflicting / Missing evidence.
3. Problematic or unusual relationships between auditor and management.
Satyam Scam which came to light in 2008 is a good case to analyse. In this case, even cash balances on the financials were not real and income was inflated at a very high rate. If the audit procedures along with professional judgment were properly followed, the manipulated financial statements could have been identified at a much earlier stage. The lesson from this case is the importance to adhere to auditing standards and guidelines.
As per companies act ” Reporting of frauds by auditor and other matters”
(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government.
(2) The auditor shall report the matter to the Central Government as under:-
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than two days of his knowledge of the fraud, seeking their reply or observations within forty-five days;
(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within fifteen days from the date of receipt of such reply or observations;
(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of forty-five days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations.
(3) In case of a fraud involving lesser than the amount specified , the auditor shall report the matter to Audit Committee constituted under section 177 or to the Board immediately but not later than two days of his knowledge of the fraud and he shall report the matter specifying the following:-
(a) Nature of Fraud with description
(b) Approximate amount involved
(c) parties involved.