AUDITOR’S RESPONSIBILITY

The auditor’s responsibility is to design the audit to provide reasonable assurance of detecting material
misstatements in the financial statements. These misstatements may emanate from:
1. Error – refers to unintentional misstatements in the financial statements, including the omission
of an amount or a disclosure:
a. Mathematical or clerical mistakes in the underlying records and accounting data
b. An incorrect accounting estimate arising from oversight or misrepresentation of facts
c. Mistake in the application of accounting policies

2. Fraud – refers to intentional act by one or more individuals among management, employees, or
third parties which results in misrepresentation of financial statements
a. Fraudulent Financial Reporting or Management Fraud – involves intentional misstatements
or omissions of amounts or disclosures in the financial statements to deceive financial
statements users committed by management or those charged with governance:
• Manipulation, falsification or alteration of records or documents ▪
Misrepresentations in or intentional omission of the effects of transactions from
records or documents
• Recording of transactions without substance
• Intentional misapplication of accounting policies
b. Misappropriation of Assets or Employee Fraud – theft of an entity’s assets committed by the
entity’s employees
• Embezzling receipts
• Stealing entity’s assets
• Lapping of accounts receivable

The Fraud Triangle

The First Element of the Fraud Triangle: Incentive/Pressure
• Fraud can be perpetrated to benefit oneself or to benefit an organization.
• Employee fraud, in which an individual embezzles from his or her employer, usually
benefits the perpetrator.
• Management fraud, in which an organization’s officers deceive investors and
creditors usually by manipulating financial statements, is most often perpetrated to
benefit an organization, and indirectly, its officers.

Pressure is divided into four types:

Financial pressures
Common financial pressures associated with fraud that benefits perpetrators
directly include the following:
➢ Greed
➢ Living beyond one’s means
➢ High bills or personal debt
➢ Poor credit
➢ Personal financial losses
➢ Unexpected financial needs
➢ Financial pressure is the most common type of pressure to commit fraud.

Vice Pressures
➢ Closely related to financial pressures are motivations created by vices such
as gambling, drugs, alcohol and expensive extramarital relationships.
➢ Vices are the worst kind of pressures to commit fraud.
Work Related Pressures
➢ Financial pressures and vices may motivate most frauds, but some people
commit fraud to get even with their employer or others.
➢ Factors such as getting little recognition for job performance, having a
feeling of job satisfaction, fearing losing one’s job, being overlook for a
promotion, and feeling underpaid have motivated many frauds.
Other Pressures
➢ Once in a while, fraud is motivated by other pressures, such as a spouse
who insists on an improved lifestyle or a challenge to beat the system.
➢ Most of us face pressures in our lives; we sometimes have a difficult time
distinguishing between wants and needs.
The Second Element of the Fraud Triangle: Opportunity
A perceived opportunity to commit fraud, to conceal it, or to avoid being punished is the
second element of the fraud triangle. At least six major factors increase opportunities
for individuals to commit fraud within an organization:
➢ Lack of circumvention of controls that prevent or detect fraudulent behavior
➢ Inability to judge quality of performance
➢ Failure to discipline fraud perpetrators
➢ Lack of access to information
➢ Ignorance, apathy and incapacity
➢ Lack of audit trail

The Third Element of the Fraud Triangle: Rationalization

Common rationalizations used by fraud perpetrators include the following:
➢ The organization owes it to me.
➢ I am only borrowing the money and will pay it back.
➢ Nobody will get hurt.
➢ I deserve more.
➢ It’s for a good purpose.
➢ We’ll fix the books as soon as we get over his financial difficulty.
➢ Something has to be sacrificed- my integrity, or my reputation. (If I don’t
embezzle to cover my inability to pay, people will know I can’t meet my
obligations and that will be embarrassing because I’m a professional.)
Responsibility of Management and Those Charged with Governance (PSA 240) related to Fraud and
Error
• Management to establish a control environment and to implement internal control
policies and procedures designed to ensure, the detection and prevention of fraud and
error
• Individuals charged with governance to ensure the integrity of an entity’s accounting
and financial reporting systems and that appropriate controls are in place

Auditor’s Responsibility – Fraud and error

The auditor is not and cannot be held responsible for the prevention of fraud and error.
PLANNING PHASE
a. Make inquiries of management about possibility of misstatements due to fraud
and error
b. Assess the risk of material misstatement due to fraud or error
TESTING PHASE
c. Perform procedures necessary to determine whether material misstatements
exist
d. Consider whether such misstatement resulted from error or fraud
COMPLETION PHASE
e. Obtain a written representation from the client’s management
EFFECT ON AUDITOR’S REPORT
f. When the auditor believes that material error or fraud exists, request the
management to revise the financial statements. Otherwise, express a qualified
or adverse opinion
g. If there’s a limitation on the scope of the audit qualify or disclaim opinion

Fraud Risk Factors

FRAUDULENT FINANCIAL REPORTING (MANAGEMENT FRAUD)
• Management’s Characteristics and Influence over the Control Environment
• Industry Conditions
• Operating Characteristics and Financial Stability
MISAPPROPRIATION OF ASSETS (EMPLOYEE FRAUD)
• Susceptibility of Assets to Misappropriation
• Controls
 3. Non-Compliance with Laws and Regulations - refers to acts or commission by the entity being
audited, either intentional or unintentional, which are contrary to prevailing laws or regulations.
a. Tax evasion
b. Violation of environmental protection laws
c. Inside trading of securities

Responsibility of Management (PSA 250) related to Non-Compliance with Laws and Regulations

Management to ensure that the entity’s operations are conducted in accordance with laws and
regulations.

Auditor’s Responsibility - Non-Compliance with Laws and Regulations

An audit cannot be expected to detect noncompliance with all laws and regulations. Nevertheless,
the auditor should recognize that noncompliance by the entity with laws and regulations may
materially affect the FS.

PLANNING PHASE
a. Obtain a general understanding of the legal and regulatory framework
applicable to entity
b. Design procedures to help identify instances of noncompliance with laws and
regulations
c. Design audit procedures to obtain sufficient appropriate audit evidence about
compliance with laws and regulations
TESTING PHASE
d. When the auditor is aware concerning instance of noncompliance, evaluate the
possible effect on the financial statements.
e. When the auditor believes there maybe noncompliance, the auditor should
document the findings, discuss them with management and consider the
implication on other aspects of the audit.
COMPLETION PHASE
f. The auditor should obtain a written representation from the client’s
management
EFFECT ON AUDITOR’S REPORT
g. When the auditor believes that there is noncompliance, the auditor should
request the management to revise the financial statements. Otherwise, a
qualified or adverse opinion will be issued.
h. if a scope limitation has precluded the auditor from obtaining sufficient
appropriate evidence, the auditor should express a qualified opinion or a
disclaimer of opinion.