Fraud and Error - ACCA Audit and Assurance (AA)

Summary

This lecture discusses the auditor's responsibility towards fraud and errors in financial statements. Fraud can be financial reporting to boost share prices or misappropriation of assets. Auditors have no specific duty to detect fraud, but should spot material misstatements. Errors should be reported to management, and if material, may lead to financial statement qualifications. The lecture emphasizes the importance of internal controls and integrity in detecting and reporting fraud and errors.

Takeaways

• 📈 The auditor's responsibility towards fraud and error in financial statements is primarily to ensure they are free of material misstatements, whether caused by fraud or error.
• 💼 Fraud can be categorized into two types: financial statement fraud, which might involve overstating profits to boost share prices or secure loans, and asset misappropriation, which involves theft or misuse of company assets.
• 🔍 While auditors have no specific duty to detect fraud, they are responsible for identifying material misstatements that could significantly affect financial statements.
• 🛡 Management is responsible for establishing proper systems and internal controls to prevent or detect fraud, not the auditors.
• 🔑 The likelihood of auditors detecting small, individual instances of fraud is relatively low, but they must be vigilant for material misstatements that could result from fraud.
• 🚨 Upon discovering fraud, auditors must report it to management and assess whether it is an isolated incident or part of a larger, ongoing issue.
• 📊 Errors in financial statements, no matter how small, should be reported to management, as they could potentially lead to material misstatements.
• 🏛️ If management does not correct identified errors, auditors must evaluate the impact of these errors and obtain written representations from management regarding their materiality.
• 🚫 In the event of a material misstatement due to error, and management refuses to correct it, auditors may have to consider qualifying their opinion on the financial statements.
• ❌ If the financial statements contain material misstatements that are not corrected, auditors may need to issue an adverse opinion, indicating that the statements do not present a true and fair view.

Q & A

What is the auditor's responsibility towards fraud and error in financial statements?

The auditor's responsibility is to ensure that financial statements are free of material misstatements, whether caused by fraud or error. They have no specific duty to detect fraud, but they should be aware that it can happen and should follow up on any suspicions.

What are the two levels of fraud mentioned in the lecture?

The two levels of fraud are fraudulent financial reporting, which includes overstating profits to boost share prices or get loans, and misappropriation of assets, which involves theft or misuse of company assets.

Why is it management's responsibility to prevent or detect fraud?

Management is responsible for ensuring there is a proper system and internal control in place to prevent or detect fraud. The auditors' role is to provide reasonable assurance that the financial statements are free of material misstatements.

What should an auditor do if they discover a fraud?

If an auditor discovers a fraud, they must report it to management. They should also investigate whether it is an isolated incident or part of a larger pattern of fraud within the company.

How does the auditor determine if a misstatement is material?

A misstatement is considered material if it is large enough to influence the decisions of users of the financial statements. The auditor should be alert to any misstatements and assess their materiality.

What is the auditor's approach to errors in financial statements?

The auditor should identify all misstatements, even very small ones, and report them to management. Errors should be corrected, but if they are immaterial, the auditor may not insist on their correction.

What happens if management does not correct a material misstatement?

If management does not correct a material misstatement, the auditor may have to consider qualifying the financial statements, indicating that they do not present a true and fair view.

Why is it important for the auditor to be aware of the susceptibility of a company to fraud?

Being aware of the susceptibility to fraud allows the auditor to plan the audit accordingly and to be more vigilant in areas where the risk of fraud is higher.

What is the role of internal controls in preventing fraud?

Internal controls are designed to prevent or detect fraud by ensuring proper authorizations, segregation of duties, and other checks and balances within the company.

How does the auditor ensure that the financial statements show a true and fair view?

The auditor ensures a true and fair view by identifying and addressing material misstatements and by obtaining written representations from management that they believe the financial statements are accurate.

What is the significance of the auditor's statement that the financial statements are free of material misstatements?

This statement provides reasonable assurance to stakeholders that the financial statements are accurate and reliable, but it is not a guarantee. It reflects the auditor's professional judgment and the results of their audit procedures.

Outlines

00:00

🔍 Auditor's Responsibility Towards Fraud and Errors

This paragraph discusses the responsibilities of auditors in relation to fraud and errors in financial statements. Fraud is categorized into two types: fraudulent financial reporting, which might involve overstating profits to attract investors or loans, and misappropriation of assets, such as theft of inventory or cash. The primary responsibility for preventing or detecting fraud lies with the management and their internal control systems. Auditors are not specifically tasked with detecting fraud but are expected to identify material misstatements in financial statements, whether due to fraud or error. The auditor's role is to provide reasonable assurance that the financial statements are free from material misstatements. Upon discovering fraud, auditors must report it to management and assess the extent of the issue. If the fraud is material, it must be corrected; otherwise, the auditor may have to qualify their opinion on the financial statements.

05:00

📊 Reporting Misstatements and Errors in Financial Statements

The second paragraph focuses on the protocol for addressing misstatements and errors discovered during an audit. All identified misstatements, regardless of size, should be reported to management. While auditors are not concerned with immaterial errors, they must ensure that material misstatements are corrected. If management chooses not to correct these errors, auditors must evaluate the impact of the uncorrected errors and obtain written representations from management that the errors are not material. In cases where there is a material misstatement that management refuses to correct, the auditor may have to issue a qualified opinion on the financial statements, indicating that they do not present a true and fair view due to the misstatement.

Keywords

💡Fraud

Fraud refers to the intentional act of deception for personal gain, which can include stealing assets, overstating profits, or covering up losses. In the context of the video, fraud is contrasted with error and is categorized into two types: financial statement fraud, which aims to manipulate financial results to influence stakeholders like investors or banks, and asset misappropriation, which involves the theft of company assets. The script mentions how fraud can have significant financial effects, such as inflating profits to attract investors or covering up losses to maintain confidence.

💡Error

Error, in the context of the video, refers to unintentional mistakes made during the preparation of financial statements. These can be due to oversight, miscalculation, or misunderstanding. Unlike fraud, errors are not deliberate and can occur even with proper internal controls. The script discusses how auditors should report errors to management, regardless of their size, to ensure the integrity of financial statements.

💡Auditor's Responsibility

The auditor's responsibility is to provide an independent examination of a company's financial statements to express an opinion on whether they are free from material misstatement. The video script clarifies that while auditors are not specifically tasked with detecting fraud, they are responsible for identifying material misstatements that could result from fraud or error. The auditor's role is crucial in maintaining the integrity of financial reporting.

💡Financial Statements

Financial statements are formal records that summarize a company's financial activities, including balance sheets, income statements, and cash flow statements. The video emphasizes the importance of these statements in conveying a company's financial health to stakeholders. Both fraud and error can impact the accuracy of these statements, which is why auditors play a critical role in reviewing them.

💡Material Misstatement

A material misstatement is an error or misrepresentation in financial statements that could significantly affect the decisions of users relying on that information. The video script explains that auditors are responsible for detecting material misstatements, whether caused by fraud or error, as they can influence stakeholders' decisions. An example from the script is overstating receivables, which could turn a profit into a loss, indicating a material misstatement.

💡Internal Controls

Internal controls are the policies and procedures employed by a company to ensure the accuracy of financial reporting, prevent fraud, and promote operational efficiency. The script mentions that it is management's responsibility to establish proper internal controls to prevent or detect fraud. Effective internal controls can reduce the risk of both fraud and error in financial statements.

💡Segregation of Duties

Segregation of duties is a principle of internal controls that involves separating different aspects of a process among different individuals to reduce the risk of error or fraud. The video script suggests that poor internal controls, such as a lack of segregation of duties, can open the door to fraud by allowing a single person to control multiple steps in a process without oversight.

💡Qualification

A qualification in auditing refers to a modification of the auditor's opinion on the financial statements due to significant issues found during the audit. The script discusses how if material misstatements are not corrected by management, the auditor may have to qualify their opinion, indicating that the financial statements do not present a true and fair view due to the uncorrected misstatements.

💡Adverse Opinion

An adverse opinion is a type of auditor's report that states the financial statements are materially misstated. The video script uses the example of overstated receivables affecting profits, leading to an adverse opinion if not corrected. This is a strong statement from the auditor indicating significant issues with the financial statements.

💡Management

Management, in the context of the video, refers to the individuals or team responsible for running a company, including the preparation of financial statements. The script highlights that it is management's duty to ensure the accuracy of these statements and to correct any material misstatements identified by the auditor. Management's response to identified errors or fraud is a critical part of the audit process.

💡Representations

Representations are written confirmations provided by management to the auditors regarding the accuracy and completeness of the financial statements. The video script mentions that auditors may request written representations from management to confirm their belief that uncorrected errors are not material. These representations are an important part of the audit evidence.

Highlights

The auditor's responsibility towards fraud and error in financial statements is discussed.

Fraud is deliberate stealing or overstating profits, while error is accidental.

There are two levels of fraud: financial reporting and misappropriation of assets.

Financial reporting fraud aims to boost share prices or encourage investment.

Misappropriation of assets involves theft of inventory or cash.

Management is responsible for preventing or detecting fraud through proper internal controls.

Auditors have no specific duty to detect fraud but should spot material misstatements.

The auditor's role is to provide reasonable assurance that financial statements are free of material misstatements.

Planning should consider the susceptibility of companies to fraud based on their operations and internal controls.

Once fraud is discovered, it must be reported to management.

The discovery of fraud raises questions about its extent and duration.

Errors in financial statements, even small ones, should be reported to management.

Auditors do not certify 100% accuracy but look for material misstatements.

Management may decide not to correct immaterial errors, but auditors should assess the impact.

If a material misstatement is not corrected, it may lead to a qualification of the financial statements.

An adverse opinion may be given if the financial statements do not show a true and fair view due to material misstatements.

Transcripts

this is a lecture from open tuition to

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open tuition comm so what is the

auditors responsibility towards fraud an

error in the financial statements

well fraud is deliberate stealing of

cash assets or indeed overstating

profits arrow is accidental I suppose at

the end of the day they can have the

same financial effect what first of all

is the auditors responsibilities with

regard to fraud and the first thing we

can say is there are two two levels of

fraud there is fortune and financial

reporting this is where maybe to boost

the share price or maybe to encourage

investors in a company or to encourage

the bank to give a loan maybe we

overstate the profits of the company you

make it look a much healthier less risky

comes in and ready is and this is what

induces the investors in the bank to

provide you with capital or you report

inflated profits in the hope that the

share price will be driven up so you can

then sell the shares oh you cover up

losses in some way in in the hope that

okay we've made two huge losses this

year that we don't want to tell anyone

about that all there was it was

confidence and we'll cover up those

losses in the hope that in the

subsequent years will will come good so

I can do huge damage to investors banks

financial institutions members the other

type of fraud is the misappropriation of

assets from the company the theft of

inventory the misappropriation of cash

it can be awarding contracts at a very

high price so that the the buyer gets

you know 20% kind of kickback a

commission this is essentially stealing

money from the company so how these two

levels of fraud

and both are potentially serious the

biggest question really is what does the

auditor's responsibilities towards

discovering fraud or D preventing fraud

and the simple answer is relatively

little it is management's responsibility

to ensure that is a proper system and

internal control which should be

sufficiently good prevent or detect

fraud the auditors have no specific duty

to detect fraud and indeed many frauds

are relatively small repeat is very

often and the chance of an order - may

be picking up small fraudulent

transactions is really quite small

probably not a good use of their time in

fact but when the Ford gets large and it

becomes so large as it's going to cause

a material misstatement in the financial

statements then like any material

misstatement caused for any reason

whether innocently or fraudulently then

the auditors should have spotted that

they they say in the audit report that a

gives reasonable assurance that the

financial statements are free of

material misstatements okay it's not a

guarantee but no one is really very

happy if material misstatements get into

the published financial statements so no

routine ongoing needed to discover fraud

but you should be aware that it can

happen as far as the planning you should

be aware that some companies are going

to be more susceptible to fraud another

simply because of they may be the sort

of operations they're in and you should

be aware that the internal controls are

very poor then this opens the door very

often to fraud because maybe you don't

have segregation of duties you don't

have proper authorizations and so on

once a fraud is discovered it has to be

reported to management the big question

of course is is if you discover a fraud

let's say of $20 is is this just an

isolated fraud carried out once by one

person or is it really the tip of the

iceberg how long has it been going on

how much money over the course of the

fraud has been sucked out of the company

how many people are involved we we need

to get to that in a way are our

suspicions have been alerted once small

fraud is discovered we we can't kind of

pretend we didn't see it we must act

with integrity and to follow it up with

regard to errors in general on the

statements identified all misstatements

even very small ones should be reported

to management it would be a peculiar if

you discovered even a small error maybe

of you know $25 and just kind of kept

quiet about it why not why not show this

to management management may decide not

to bother correcting it and it says a

certain element of embarrassment here of

course the accounting people have

prepared the financial statements

presumably the finance director has kind

of approved those finance financial

statements and here the order two comes

in and finds lots of little little

errors it's kind of a little bit

embarrassing if the finance director has

to maybe go back to the board and say

well a profit has been adjusted because

of these small errors we don't really

care auditors don't really care about

immaterial errors it's not their purpose

to certify the 100% accuracy we're

looking for material misstatements you

should be asked the asking manager to

correct them all or may not see really

the proper thing to do but if management

doesn't correct them then you have to

think well how we Tyrael is that error

and make your own mind up but also get

representations written representations

from management that they themselves

think that the honor corrected errors

are not material and the presumably you

would agree with those if there is a

material misstatement and error and you

think it is material and it should be

changed then really if they don't change

it you're going to be heading towards

some sort of qualification of the

financial statements you are saying

these financial statements contain in

the man which is materially incorrect so

we're going down and saying except for

the fact that receivables had been

overstated the financial statements show

a true and fair view or you might say

because of the receivable has been

overstated by five million and the

effect and the profit would be to turn a

profit

three million into a loss of two million

we think that the financial statements

do not show true and fair view you'd be

looking at an adverse opinion