Detecting and preventing fraud in financial information: is it the responsibility of the auditors?
The fraud problem has existed for centuries, leading to the collapse of most businesses due to misleading financial reporting and misappropriation of funds. He has also questioned the integrity of some key industry players, as well as major accounting firms. Unfortunately, the fraud has no physical form that makes it easy to see or retain. Refers to an intentional act of one or more persons among management, those charged with governance, employees or third parties, which involves the use of deception to obtain an unfair or illegal advantage.
According to the Association of Certified Fraud Examiners, fraud is defined as any willful or deliberate act to deprive another person of property or money through cunning, deception, or other unfair means. Classify fraud as follows:
- Corruption: conflicts of interest, bribes, illegal gratuities and financial extortion.
- Misappropriation of Cash Assets: Theft, robbery, check tampering, and fraudulent disbursements, including billing, payroll, and expense reimbursement schemes.
- Misappropriation of non-monetary assets: theft, false asset requisitions, destruction, disposal or inappropriate use of records and equipment, inappropriate disclosure of confidential information, and falsification or alteration of documents.
- Fraudulent statements: financial reports, employment credentials and external reports.
- Fraudulent actions by customers, suppliers, or other parties include kickbacks or incentives, and fraudulent (rather than erroneous) invoices from a supplier or customer information.
Fraud involves the motivation to commit fraud and a perceived opportunity to do so. A perceived opportunity for fraudulent financial reporting or misappropriation of assets may exist when a person believes that internal control could be circumvented, for example, because the person is in a position of trust or has knowledge of specific weaknesses in the internal control system. Fraud generally feeds on three variables: pressures, opportunity, and rationalization, as shown in the diagram.
It is necessary to distinguish between fraud and error in the preparation and presentation of financial reports. The distinguishing factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional. Unlike error, fraud is intentional and generally involves deliberate concealment of the facts. Error refers to an inadvertent misstatement of financial statements, including the omission of an amount or disclosure.
Although fraud is a broad legal concept, the auditor is concerned about fraudulent acts that cause a material misstatement in the financial statements and there are two types of misstatements in the consideration of fraud: misstatements resulting from fraudulent financial information and those arising from misappropriation of assets. . (paragraph 3 of ISA 240)
Asset misappropriation involves the theft of an entity’s assets and can be accomplished in a number of ways (including embezzlement of receipts, theft of physical or intangible assets, or causing an entity to pay for goods and services not received). It is often accompanied by false or misleading records or documents to hide the fact that the assets are missing. People may be motivated to misappropriate assets, for example, because people live beyond their means.
Fraudulent financial reporting can be committed because management is under pressure, from sources both external and internal to the entity, to achieve an expected (and perhaps unrealistic) profit target, particularly because of the consequences for management of not meeting financial targets they can be significant. Involves intentional errors or omissions of amounts or disclosures in financial statements to mislead users of financial statements. Fraudulent financial information can be achieved through:
I. Deception, that is, manipulating, falsifying or altering the accounting records or supporting documents from which the financial statements are prepared.
ii. Intentional misrepresentation or omission of financial statements of events, transactions, or other significant information.
iii. Intentionally misapplying accounting principles with respect to measurement, recognition, classification, presentation, or disclosure.
The case of auditors in the detection and prevention of fraud in financial information
The auditors maintain that an audit does not guarantee that all material misstatements will be detected due to the inherent limitation of an audit and that they can only obtain reasonable assurance that material misstatements will be detected in the financial statements. The risk of not detecting material misstatement due to fraud is also known to be greater than that of not detecting misstatements resulting from error because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to do so. transaction log. , or intentional misrepresentations to the auditor.
Such concealment attempts can be even more difficult to detect when accompanied by collusion and, as such, the auditor’s ability to detect fraud depends on factors such as the skill of the perpetrator, the frequency and extent of the tampering, the degree of collusion involved, the relative size of the individual quantities handled, and the age involved. However, users of financial information expect auditors to take steps to detect fraud during the audit because they are often upset when fraud goes undetected and is later discovered by a clue or accident, while the resulting investigation or restatement of financial statements creates negative consequences for the company and its employees.
So who is responsible for detecting financial reporting fraud?
The responsibilities and functions of auditors in auditing are enshrined in the International Standards on Auditing (ISA), which serves as the “bible” for auditors in the performance of their duties and to ensure that their reports comply with international standards. The provisions of the standard that are being considered for this purpose are ISA 240 (that is, Auditor’s Responsibilities for Fraud in an Audit of Financial Statements) and ISA 315.
Paragraph 4 of ISA 240 deals with the responsibility for fraud prevention and detection and states that “the primary responsibility for fraud prevention and detection rests with both those charged with governance and management. of those charged with governance, place a strong emphasis on fraud prevention, which can reduce opportunities for fraud, and fraud deterrence, which could persuade people not to commit fraud due to the likelihood of detection and punishment. and ethical behavior that can be reinforced by active supervision by those charged with governance. Supervision by those charged with governance includes considering the possibility of overriding controls or other inappropriate influence on the financial reporting process. , such as management’s efforts to manage earnings in to influence perceptions of a nalists regarding the performance and profitability of the entity “.
Paragraph 5 also states that “The auditor conducting an audit in accordance with the ISAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Due to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements will not be detected, even if the audit is properly planned and executed in accordance with the ISAs. “
In addition, ISA 315 requires auditors to assess the effectiveness of an entity’s risk management framework in preventing errors, whether due to fraud or otherwise, during an audit and that auditors should consider the risk of error due to fraud or error of each significant account balance, recognizing the material classes of transactions included in it, in order to identify a specific risk and if a material misstatement is found due to the possibility of fraud, this could lead to questioning the integrity of the management and the reliability of evidence obtained from management in other areas of the audit.
The thesis suggests that the Directors are responsible for ensuring that the company maintains adequate accounting records that reveal with reasonable accuracy at any time the financial position of the Company, as well as responsible for safeguarding the assets of the Company and taking reasonable measures for the prevention and detection. fraud and other irregularities and that the responsibility of the auditors is to express an opinion as to whether the summarized financial statements are consistent, in all material respects, with the financial statements audited based on their procedures, which were carried out in accordance with the International Auditing Standards (ES UN). It is for this reason that all annual financial reports have clearly defined directors and auditors responsibilities.
Obviously, it can be concluded that auditors simply play a complementary role in the detection and prevention of financial reporting fraud and that the ultimate responsibility lies with those charged with governance.
However, Institute of Internal Auditors (IIA) Standard 1210.A2 requires auditors to have “sufficient knowledge” to identify indicators of fraud, which means that while auditors cannot be expected to develop these skills by level of a fraud examiner, they should strive to become more proficient through training, hands-on experience, reading professional literature, brainstorming, and using fraud detection skills during the audit so that they are aware of the impact of both fraud and error on the accuracy of financial statements.