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FRAUD AND ERROR

Chapter 14

Internal Control

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FRAUD
• Intentional act involving the use of deception that results in a material
misstatement of the financial statements.
• Two types of Misstatement:
 Misstatement arising from misappropriation of assets
 Misstatement arising from fraudulent financial reporting
• Intent to deceive is what distinguishes fraud from errors

ERROR
• Refers to unintentional misstatements in the financial statements, including
the omission of an amount or disclosure
• Examples of errors:
 Mathematical or clerical mistakes in the underlying records or data
 Incorrect accounting estimates arising from oversight or misinterpretation of facts
 Mistake in the application of accounting policies

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Misstatement arising from

misappropriation of assets
• Occurs when a perpetrator steals or
misuses an organization’s asset
• This type of fraud is often
accompanied by false or misleading
records or documents in order to
conceal the fact that the assets are
missing
• Asset misappropriation commonly occurs
when employees:
- Gain access to cash and manipulate
accounts to cover up cash thefts
- Manipulate cash disbursements
through fake companies
- Steal inventory or other assets and
manipulate the financial records to
cover up the fraud

Misstatement arising from

fraudulent financial reporting
• Involves intentional misstatements or
omissions of amounts or disclosures
in the financial statements to deceive
users.
• Also known as management fraud
because it involves members of
management and those charge with
governance
• This may involve:
- Manipulation, falsification or alteration
of records or documents
- Misinterpretation in or intentional
omission of the effects of transaction
from records or documents
- Recording of transaction without
substance
- Intentional misapplication of
accounting policies

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Risk factors Contributory to

Misappropriation of assets
Incentive/Pressure Opportunities Rationalization
• Personal financial obligations • Certain characteristics or • Disregard for the need for
may create pressure on circumstances may increase the monitoring or reducing risks
management or employees susceptibility of assets to related to misappropriation of
with access to cash or other misappropriation assets
assets susceptible to theft
• Adverse relationships • Inadequate internal control over • Behavior indicating displeasure
between the entity and assets may increase the or dissatisfaction with the
employees with access to susceptibility of misappropriation entity
cash or other assets of those assets
• Tolerance of petty theft
susceptible to theft may
motivate those employees to
misappropriate those assets

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Risk factors Contributory to

Fraudulent financial reporting
Incentive/Pressure
• Management is under
pressure, from sources
outside or inside the entity
Opportunities Rationalization
• The individual is in a position of • Some individuals possess an
trust or has knowledge of attitude, character or set of
specific weaknesses in internal ethical values that allow them
control knowingly and intentionally to
commit a dishonest act.
• Fraudulent financial reporting
often involves management
override of controls that
otherwise may appear to be
operating effectively

Responsibility for the

prevention and detection of fraud

• This is primarily rests with both those charged with governance of the entity
and the management

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-THE END-