ISA 240 Fraud and Error

SCOPE

• This standard deals with the auditor’s responsibilities relating to fraud in an audit of financial statements.

Characteristics of Fraud

• Fraud, whether fraudulent financial reporting or misappropriation of assets, involves:
• incentive or pressure to commit fraud,
• a perceived opportunity to do so
• and some rationalization of the act.

Incentive or Pressure

• Incentive or pressure to commit fraudulent financial reporting may exist when management is under pressure, from sources outside or inside the entity, to achieve earnings target or financial outcome.
• Individuals may have an incentive to *misappropriate assets if they are living beyond their means.
• *Misappropriate means Steal

Perceived Opportunity

• A perceived opportunity to commit fraud may exist when an individual believes internal control can be overridden.
• For example, because the individual is in a position of trust or has knowledge of specific deficiencies in internal control.

Rationalized Opportunity

• Individuals may possess an attitude, character or set of ethical values that allow them knowingly and intentionally to commit a dishonest act.
• Honest individuals can commit fraud in an environment that imposes sufficient pressure on them.

Fraudulent Financial Reporting

• Fraudulent financial reporting involves intentional misstatements including omissions of amounts or disclosures in financial statements to deceive financial statement users.

Fraudulent Financial Reporting

• Manipulation, falsification (including forgery), or alteration of accounting records or supporting documentation from which the financial statements are prepared.
• Misrepresentation in, or intentional omission from, the financial statements of events, transactions or other significant information.
• Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure..

Overriding Controls

• This is another way fraud can be committed and it is usually done by management.
• Management may use techniques such 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.

Overriding Controls

• Omitting, advancing or delaying recognition in the FS, events and transactions that have occurred during the reporting period.
• • Altering records and terms related to significant and unusual transactions.
• Concealing, or not disclosing, facts that could affect the amounts recorded.
• Engaging in complex transactions that are structured to misrepresent the financial position or performance of the entity.

Misappropriation of Assets

• Misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by employees, however, it can be done by management as well. E.g. :
• Embezzling Receipts
• Stealing Physical Assets or Intellectual Property
• Using entity's assets for personal use
• Causing an entity to pay for g&s not received
• Payments to ficticious vendors.
• Payments to ficticious employees.