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Total Number of Subscribers: 426 |
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Date: 22 April 2008 |
Compiled by Mr. M. Sathya Kumar |
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Frauds &
Errors Auditors Encounter Frauds and errors result in misstatements in financial
statement. Frauds result in a loss to the entity and an error vitiates the
true and fair view. In either case, the financial statements cannot be said
to be showing a true and fair view unless the situation is set right. What is fraud? A fraud is a wilful act of dishonesty perpetuated with an intent
to defraud the employer for a personal gain. The features of a fraud are: Wilful act Act of dishonesty Intention to defraud the employer Personal gain. Frauds can be committed by misuse or abuse of power, by misuse
or misappropriation of assets belonging to the employer, and falsification of
records. Misuse of power If a purchase officer releases a purchase order on a particular
supplier who should not have been considered, against a kickback it is a
clear case of a fraud as it satisfies all the conditions of a fraud. If
sub-standard goods supplied are cleared by the quality assurance department,
it amounts to a fraud since it is a wilful act of dishonesty to defraud the
employer for a personal gain. But if the finance department releases the cheque against such
purchase, it cannot be termed as a fraud as there is no act of dishonesty on
the part of the finance department and there is no intention to defraud the
employer. Even if the finance officer receives a gratification it cannot be
termed a fraud. He has demanded gratification to do a thing that he is
supposed to do. It is a case of bribe and cannot be a fraud. Misuse/misappropriation If the employee is provided with a car for office use and if he
uses it for personal use such as dropping children at school, etc., it is a
case of misuse of the assets belonging to the employer. If an employee carries stationery of the employer to his
residence and his children use it, it is misappropriation of the assets of
the employer. The difference between misuse and misappropriation is that the
asset remains after misuse but it does not remain after misappropriation. If an employee is given some New Year gifts and a list of the
persons to whom they are to be distributed, it would be misappropriation of
assets belonging to the employer if they are distributed by the employee to
his friends, cousins, so on instead of the persons to whom they are intended.
Normally, such frauds are resorted to by the top management. It could be by way of deliberately treating an item as capital
instead of revenue so that it does not appear in the Profit and Loss Account.
Over- or under-valuation of stocks is also a case of falsification of
records. Classification of frauds Frauds can be classified as management and line frauds.
Falsification of records is resorted at the end of the year, to which the
management could be a party. It is a management fraud. Abuse of power, misuse
of assets can be done either by the management or by the people down the
line. Errors Contrary to frauds, errors are unintentional and the result of
ignorance. Errors are committed by employees placed low in the hierarchy.
There is always the possibility of the seniors and bosses unearthing such
errors. An accounts clerk might pass an entry debiting cash with
expenditure. This is obviously wrong but it is a genuine mistake. No doubt
there is wrong accounting but it does not result in any loss to the
management. The situation can be rectified at a later date. There is always the accounts officer to rectify the mistake. Frauds vs errors Intent: Frauds are intentional while errors are not Loss: Frauds result in a loss whereas an error may
or may not. Errors are isolated and hold a characteristic. A person commits
errors in only one sphere. Frauds can occur in any form, any place and at any
time Errors are committed by a single person while it needs two or
more persons to perpetuate a fraud because of the internal control systems. Errors are committed only at lower levels of hierarchy while
frauds can be committed at any level or at multiple levels. Causes of frauds Frauds can be attributed to several causes Greed: The employee may be greedy to earn that
extra rupee Lack of internal control systems: Absence of
Internal control systems or their failure provides an opportunity to commit a
fraud Compulsions: Management frauds are more out of compulsions,
which may be pressure to project a better picture, earn a higher commission
(again greed), satisfy bankers, and so on Legal implications such as to suppress the turnover to
escape central excise, tax audits, so on AAS 2 clearly takes locating or unearthing of frauds out of the
scope of audit. An auditor draws up his programme to form and express his
opinion upon the financial statements. The audit programme is not aimed at
unearthing of frauds and errors. An audit is not an insurance against frauds
and errors. An audited balance-sheet cannot be taken to be free of all frauds
and errors. There may still be some frauds in the financial statements even
after the audit is completed. An auditor should be sceptical while carrying out his audit.
This scepticism helps the auditor to be on guard in the matter of frauds and
errors. Frauds can be buried deep in the records and the auditor may not
possess the technical knowledge to unearth them. Scepticism, diligence,
alertness, intelligence, integrity — all these are needed
for an auditor to arm himself in such situations. When the auditor comes across a situation to arouse his
suspicion about the existence of a fraud, he should probe the matter further
(AAS 2), which is carried out by lowering the materiality levels, enlarging
the sample size, subjecting larger number of transactions to examination in
depth, taking a second look at the internal control systems, so on. At the planning stage, the auditor should be on the look out for
the areas where frauds can be perpetuated. There should be an in-built
mechanism in the audit programme to provide for such an exercise. The auditor
should carefully evaluate the internal control systems and decide the quantum
of risk he is willing to take. He should document any weakness in the
internal control system. During the course of audit, he should exercise utmost caution
and diligence before placing reliance on any person, including his own staff.
He should check the vulnerable areas of work. He may have to refer the matter
to an expert. Caution should be exercised during the selection of the expert,
drafting the terms of reference, evaluating the work of the expert etc. At the end of the audit, he should methodically review the
entire exercise to see that there are no loose ends. AAS 17 suggests that the
auditor should require a partner or other person in his organisation to vet
the audit file before reporting to bring out any lapses or shortcomings on
the audit work. The auditor should not hesitate to offer a comment or
observation in the audit report if the situation so warrants. He should
exercise his diligence and independence to offer the comments. What if he identifies a fraud? Though it is not his job, the auditor may smell a fraud and
probe the matter, which may turn out to be true. Once he identifies a fraud,
the auditor should communicate the matter to a level higher at it was
committed. This is one area the audit communications (AAS 27) should be
properly targeted. "Those charged with governance" bear the brunt
under these circumstances. The auditor should document (AAS 3) these
communications and the follow-up action taken by the management. The cause of
fraud, which may be a weakness in the internal control system, should also be
probed. The auditor would do well to issue a letter of weakness under these
circumstances (AAS 6). The middle management might grapple with the situation and pin
the responsibility. The auditor should monitor the actions. Internal controls
may be spruced up and remedial actions initiated. These should be documented
by the auditor and he should consider if any additional, amended, altered or
extended audit procedures would be necessary. If the loss is recovered by the management from the person(s)
committing the fraud, the auditor may document the same and release an
unqualified report. If the loss is not recoverable, appropriate accounting
treatment and disclosures would be essential. Going by the norm, the auditor should communicate with the
management at a level higher than the level at which the fraud is committed.
Thus, if those charged with governance (management frauds) are involved in a
fraud, the matter should be brought to the notice of the whole-time director
or CEO of the company. If the CEO commits a fraud, the board of directors
should be informed of it. If a director commits a fraud, the position becomes precarious.
The matter should be brought to the notice of the shareholders, being the
highest authority of the company. Even if the management makes good the loss,
the auditor is obliged to inform the same to the shareholders. The method to be adopted for such a communication is important.
The auditor is governed by confidentiality (AAS 1 and code of conduct).
Without getting stumped by confidentiality, if the auditor has to discharge
such a crucial responsibility, he should use his diligence, care, and
caution. This issue cannot become a matter to be mentioned in the audit
report since it is a public document. The auditor should consider other
alternatives such as speaking at an EGM, a separate communication to the
shareholders of the company or other modes as he deems fit. He might also
seek professional help from legal experts (AAS9). Courtesy : Mr. M. V. Kali Prasad ,
Source : The Hindu Business line |
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