Auditing and

Assurance
Principles
(Week 3)

Auditor’s Responsibility
Fair presentation of financial statements is responsibility of the management. The
auditor’s responsibility is to design the audit to provide reasonable assurance of
detecting material misstatements in the financial statements. This misstatements
may emanate from:
1. Error
2. Fraud
3. Noncompliance with laws and regulations
Fair presentation of financial statements is responsibility of the management. The
auditor’s responsibility is to design the audit to provide reasonable assurance of
detecting material misstatements in the financial statements. This misstatements
may emanate from:
1. Error
2. Fraud
3. Noncompliance with laws and regulations
Error
This refers to unintentional misstatements in the financial statements,
including the omission of amount or a disclosure, such as:
• Mathematical or clerical mistakes in the underlying records and accounting
data
• An incorrect accounting estimate arising form oversight or misinterpretation
of facts.
• Mistake in the application of accounting policies
Fraud
• This refers to 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 unjust or illegal
advantage. Although fraud is a broad legal concept, the auditor is
primarily concerned with fraudulent acts that cause a material
misstatement in the financial statements.
Noncompliance with laws and regulations
Noncompliance refers to acts of omission or commission by the entity being audited,
either intentional or unintentional, which are contrary to the prevailing laws or
regulations. Such acts include transactions entered into by, or in the name of, the
entity or on its behalf by its management or employees. Common examples include:
• Tax evasion.
• Violation of environmental protection laws.
• Inside trading of securities.
Management’s Responsibility
It is the management’s responsibility to ensure that the entity’s operations are conducted in accordance with laws
and regulations. The responsibility for the prevention and detection of noncompliance rests with management.
(PSA 250)
The following policies and procedures may assist management in discharging its responsibilities for the
prevention and detection of noncompliance.
• Monitoring legal requirements and ensuring that operating procedures are designed to meet these requirements.
• Instituting and operating appropriate systems of internal control.
• Developing, publicizing and following a Code of Conduct.
• Engaging legal advisors to assist in monitoring legal requirements.
Auditor’s Responsibility
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 financial statements.
Types of fraud relevant to financial statement audit

1. Fraudulent Financial Reporting

2. Misappropriation of Assets or Employee Fraud
1. Fraudulent Financial Reporting
• Intentional misstatement of amounts or disclosures in financial
statements to deceive financial statement users. This type of fraud is
also known as management fraud because it usually involves members
of management or those charged with governance.
1. Fraudulent Financial Reporting
This may involve:
• Manipulation, falsification or alteration of records or documents.
• Misrepresentation in or intentional omission of the effects of
transactions from records or documents.
• Recording of transactions without substance.
• Intentional misapplication of accounting policies.
1. Fraudulent Financial Reporting
This may involve:
• Manipulation, falsification or alteration of records or documents.
• Misrepresentation in or intentional omission of the effects of
transactions from records or documents.
• Recording of transactions without substance.
• Intentional misapplication of accounting policies.
2. Misappropriation of assets or employee fraud
This involves theft of an entity’s assets committed by the entity’s
employees. This may include.
• Embezzling receipts.
• Stealing entity’s assets such as cash, marketable securities, inventory
etc.
• Lapping of accounts receivable.
2. Misappropriation of assets or employee fraud
This involves theft of an entity’s assets committed by the entity’s
employees. This may include.
• Embezzling receipts.
• Stealing entity’s assets such as cash, marketable securities, inventory
etc.
• Lapping of accounts receivable.
• Fraud involves motivation to commit it and a perceived opportunity to do
so.
• The primary factor that distinguishes fraud from error is whether the
underlying cause of misstatement in the financial statements is intentional
or unintentional. The auditor’s responsibility for the detection of fraud
and error is essentially the same.
Responsibility of the Management and those charged with
governance.
PSA 240 requires:
• Management – to establish a control environment and to implement
internal control policies and procedures designed to ensure, among others,
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.
Fraud Risk Factors Relating to Misstatements Resulting from
Fraudulent Financial Reporting

1. Management’s characteristics and influence over the control

environment.
2. Industry conditions.
3. Operating characteristics and financial stability.
1. Management’s characteristics and influence over the control
environment.

These fraud risk factors pertain to management’s abilities, pressures, styles and attitude
relating internal control and the financial reporting process. Specific indicators might
include the following:
• A significant portion of management’s compensation is represented by bonuses, stock
options or other incentives, the value of which is contingent upon the entity achieving
unduly aggressive targets for operating results, financial position or cash flow.
• Management has an interest in pursuing inappropriate means to minimize reported
earnings for tax-motivated reasons.
1. Management’s characteristics and influence over the control
environment.

There is failure by management to display and communicate an appropriate

attitude regarding internal control and financial reporting process. Specific
indicators might include the following:
• Management does not effectively communicate and support the entity’s
values or ethics, or management communicates inappropriate values or
ethics.
• Management does not monitor significant controls adequately.
2. Industry conditions.

These fraud risk factors involve the economic and regulatory environment
in which entity operates.
• A high degree of competition or market saturation, accompanied by
declining margins.
3. Operating characteristics and Financial Stability

These fraud risk factors pertain to the nature and complexity of the entity
and its transactions, the entity’s financial condition, and its profitability.
• Inability to generate cash flows from operations while reporting
earnings and earnings growth.
• Significant related party transactions which are not in the ordinary
course of business.
Fraud Risk Factors Relating to Misstatements Resulting from
Misappraopriation of Assets

1. Susceptibility of Assets to Misappropriation.

2. Controls
Susceptibility of Assets to Misappropriation

These fraud risk factors pertain to the nature of an entity’s assets and the
degree to which they are subject to theft.
• Large amounts of cash on hand processed.
• Inventory characteristics, such as small size combined with high value
and high demand.
Controls

These fraud risk factors involve the lack of controls designed to prevent
or detect misappropriation of assets.
• Lack of mandatory vacations for employees performing key control
functions.
• Lack of an appropriate system of authorization and approval of
transactions.
END OF DISCUSSION