Nicodemus, Daena D.

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Journal 9: Internal Auditing (Auditing and Assurance Principles)

1. Differentiate Fraud from Error. Which misstatement is more difficult to

discover and why? Explain each.

Fraud as explained by Chen (2020), is an action that is intentionally deceptive

in which when fraud is committed, the perpetrator gains something unlawful or the

victim is denied his rights. It was further explained by the Cambridge Dictionary

(n.d.) as the crime committed in which the wrongdoer gets money through deceiving

other people.

On the other hand, an error is an act in which an unintentional deviation from

accuracy or truth is involved (Merriam-Webster Dictionary, n.d.). Furthermore, it was

defined by the Cambridge Dictionary (n.d.) as a mistake that can be discovered as

wrong.

Overall, fraud is something that is done intentionally to receive personal gain

or to deceive other people. On the other hand, an error is a mistake that is

unintentional in which both can be present in financial statements and other financial

information. The difference in their presence is that fraud has underlying reasons on

its existence and they are created to be concealed while errors are made without

intent and are meant to be found out.

According to ACFE’s Report to the Nations in Hodgkinson (2019), fraud is

hardly detected in which it is only 15% of the time found in internal audit and 4% in

external audit. Hodgkinson also stated that the auditors rarely find fraud because the
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objective of audits is to determine whether or not the financial statements are

presented fairly and to discover material discrepancies if there are any putting into

consideration the appropriate internal controls. Nonetheless, audits are not designed

to prevent fraud or even to detect it. This makes fraud a lot more difficult to detect

than error. Since the difference between the two is the intention behind them, fraud

may be dismissed as errors and simply corrected in the statements especially if the

difference is not that material.

2. Differentiate misstatement from noncompliance. Explain each.

According to Accounting Tools (2020), a misstatement is the difference

between what is reported in the financial statement and what should be: the required

amount, the presentation, its classification, or disclosure. Misstatements may be

caused by errors or fraud. Misstatement is also defined by the Cambridge Dictionary

(n.d.). as the act in which something false or inaccurate is stated.

Non-compliance is the act of being disobedient to a rule or law (Cambridge

Dictionary, n.d.). It was defined by the Merriam-Webster Dictionary (n.d.) as the

failure to comply with a rule or regulation or the refusal to do so.

With these definitions, we can infer that misstatements are instances where

there are errors in the way information is stated. Example of such is if 200,000 was

written as 20,000 only. This includes a factual error. On the other hand,

noncompliance involves rules or laws that must be abided by in which they are not in
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the scenario. In noncompliance, there is no misstatement, but the way things are

presented are not with accordance to how they should be. Misstatement is more of

the question “Why?” while noncompliance is about the “How?”.

3. Who is responsible for the determination of the existence of misstatements

in the financial statements?

As stated by Cabrera, M. & Cabrera, G. (2020), when it comes to the

prevention and the detection of fraud, those that are charged with the governance of

the entity and management are the ones who should be held responsible.

Furthermore, with doing so, a commitment to creating a culture of honesty and

ethical behavior is involved. There must be active oversight by those who are

charged with governance.

As for the auditor, as further explained by Cabrera, M. & Cabrera, G., he/she

has responsibility over obtaining reasonable assurance that the financial statements

are free from misstatements that have material effect to the entity whether they may

be errors or fraud.

4. What are the characteristics of Fraud? Identify and define each. Explain

how these elements contribute to the perpetration of fraud.

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As stated by the Auditing and Assurance Standards Council (2009), in the

Philippine Standard on Auditing 240, The Auditor’s Responsibilities Relating to

Fraud in an Audit of Financial Statements, fraud or error give rise to misstatements

in the financial statements. However, fraud as compared to error has an underlying

action that was intentional which resulted in the misstatement of financial

statements. There are two types of intentional misstatements which are:

misstatements that result from fraudulent financial reporting, and misstatements that

result from misappropriation of assets.

Furthermore, the same standard states that fraud involves pressure to

commit it, or an incentive that the person who commits fraud receives in which this

gives the perpetrator a rationalization to commit the act. Fraud in the reporting of

financial statements includes omission of amounts or lack of disclosure in which

these intend to deceive the users of the financial statements. Another characteristic

of fraud is that is an be accomplished by one of the following: manipulation,

alteration, or falsification; misrepresentation; or misapplication of the principles of

accounting. In fraud, there exists the override of the controls of the management.

Fraud can also be characterized by misappropriation of the assets in which theft is

involved.

In the public sector, there are specific considerations for entities in which the

auditor has responsibilities that cover legislation and regulation, government policy

requirements, ministerial directives, and resolutions of legislature.

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These characteristics of fraud comprise of illegal acts that are against

company policy and are violations of laws themselves. They are not just mere

misconduct but are activities that pose great threat to the company’s operations. In

fraud, there exists self-interest putting forth what one needs out of his work rather

than the company’s mission and vision.

5. What are the classifications of fraud? Define each and provide examples.

There are two types of intentional misstatements that are relevant to the

auditor which are: misstatements resulting from fraudulent financial reporting; and

misstatements resulting from misappropriation of assets (Cabrera, M. & Cabrera, G.,

2020). Fraudulent financial reporting involves omissions of disclosures or amounts in

the financial statements. This is to deceive the users and influence their decision

making with regards to the company. On the other hand, misappropriation of assets

involves theft in the entity in which usually, the theft occurs in small amounts that are

considered as immaterial to the entity’s assets.

Larson (2016) gave examples of asset misappropriation which are skimming

of cash and cash larceny that include payroll schemes and inventory schemes, and

misuse of company assets in which they are used without authority. He also added

three more types of fraud which are: theft of intellectual property and trade secrets;

healthcare, insurance and banking; and consumer fraud. Theft of intellectual

property and trade secrets arise as there are more innovations in society today.
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Healthcare, insurance and banking fraud occur in which there are bogus claims and

fraudulent bankruptcies. Consumer fraud occurs with bogus telemarketing, emails,

phishing, and other schemes employed.

6. What is the responsibility of an auditor on noncompliance?

Perry (2015) stated that the auditor is only responsible with identifying if there

are any material misstatements in the financial statements of the entity.

Nonetheless, he/she has no responsibility over the noncompliance of the entity, in

preventing it, and in detecting this noncompliance with the laws and regulations

required.

As further explained by the American Institute of Certified Public Accountants

(2020), the auditors’ responsibility lies on obtaining assurance that there are no

material misstatements in the financial statements that are subject to audit whether

the misstatements resulted from error or fraud. In the laws and regulations, there are

greater effects of the inherent limitations as to the ability of the auditor to detect

material misstatements due to the laws and regulations in which their operating

aspects do not affect the financial statements of the entity, noncompliance is

designed to be concealed, an act of noncompliance is determined to be a matter of

law.
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References

Accounting Tools. (2020, May 9). Misstatement definition.

https://www.accountingtools.com/articles/2018/3/9/misstatement

Auditing and Assurance Standards Council. (2009). Philippine Standard on Auditing

240 (Redrafted): The Auditor’s Responsibilities Relating to Fraud in an Audit of

Financial Statements.

https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-240-Redrafted.pdf

Cabrera, M. E. B. & Cabrera, G. A. B. (2020). Principles of Auditing and Assurance

Services (2020-2021 ed.). GIC Enterprises & Co., Inc.

Chen, J. (2020, August 1). What is Fraud? Investopedia.

https://www.investopedia.com/terms/f/fraud.asp

Error (n.d.). In Cambridge Dictionary.

https://dictionary.cambridge.org/us/dictionary/english/error

Error (n.d.). In Merriam-Webster Dictionary. https://www.merriam-

webster.com/dictionary/error
Nicodemus, Daena D. A-331 AAPRINCIPLES

Fraud. (n.d.). In Cambridge Dictionary.

https://dictionary.cambridge.org/us/dictionary/english/fraud

Hopdgkinson, A. (2019, April 4). Why Auditors Rarely Find Fraud. Protiviti.

https://blog.protiviti.com/2019/04/04/why-auditors-rarely-find-fraud/

Misstatement. (n.d.). In Cambridge Dictionary.

https://dictionary.cambridge.org/us/dictionary/english/misstatement

Non-compliance (n.d.). In Cambridge Dictionary.

https://dictionary.cambridge.org/us/dictionary/english/non-compliance

Noncompliance (n.d.). In Merriam-Webster Dictionary. https://www.merriam-

webster.com/dictionary/noncompliance

Perry, L. (2015, March 11). Clarified Auditing Standards: Laws and Regulations in an

Audit. Accounting Web. https://www.accountingweb.com/practice/practice-

excellence/clarified-auditing-standards-laws-and-regulations-in-an-

audit#:~:text=The%20auditor%20is%20not%20responsible,caused%20by

%20fraud%20or%20error.