See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/308984242

Frauds and Errors in the Audit of Financial Statements

Conference Paper · September 2016

CITATIONS READS

0 9,813

2 authors, including:

Cornel Ionescu
INSTITUTE OF NATIONAL ECONOMY, I.N.C.E. ROMANIAN ACADEMY
39 PUBLICATIONS   33 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

International Journal of Economics, Business and Entrepreneurship (IJEBE) View project

Increasing competitiveness of Romanian economy through innovation - Capacity and capability. Consequences of market performance, of the companies in Romania.
View project

All content following this page was uploaded by Cornel Ionescu on 11 October 2016.

The user has requested enhancement of the downloaded file.

 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

Frauds and Errors in the Audit of Financial

Statements
Cicilia IONESCU1, Cornel IONESCU2
1,2
Spiru Haret University, Ion Ghica, no. 13, Bucharest, 030045, Romania
Tel: +40214551000, Fax: +40213143900
Email: cicilia.ionescu@yahoo.com, caragea21@yahoo.com

Abstract: The practice and the academic literature on financial audit methodology
emphasizes that fraud risk analysis is a fundamental step in the audit engagement. While
internationally there is an established practice regarding the detection of fraud risk within the
mission of financial auditing, in Romania this issue remains so far insufficiently tackled. Given
the signal indicators of the risk of fraud, the auditor should use the best procedures through
which to obtain sufficient and appropriate audit evidence. This evidence supports the audit
opinion on the accuracy of audited statements and helps estimate the risk of fraud at
company level.
JEL classification: M42
Keywords: fraud, error, audit risk, professional skepticism, financial statements,
misstatement, audit

Introduction
The purpose of any financial statements audit is to enable the auditor to express an opinion on
the financial statements, whether they are prepared and presented, in all material respects, in
accordance with the applicable financial reporting framework. In accordance with the relevant
regulations, the auditor must act in accordance with the requirements of the «Code of Ethics
for Professional Accountants», issued by the International Federation of Accountants (IFAC), to
carry out audit in accordance with International Standards on Auditing (ISA), to plan and
perform an audit with an attitude of professional skepticism recognizing the idea that in certain
circumstances the financial statements may be materially misstated.
Misstatements of the financial statements can arise either as a result of fraud or of an error.
The factor that distinguishes between fraud and error is whether the action that led to the
distortion of financial statements is intentional or unintentional.

174
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

1. Fraud
According to the auditing standard 240, the term fraud refers to an action with intentional act
by one or more individuals among management, employees or third party action which results
in an erroneous interpretation of financial statements.
In practice, there can be identified two types of intentional misstatements, which should be
covered by the auditor: misstatements resulting from fraudulent reporting and misstatements
resulting from misappropriation of assets. Whatever form it manifests, fraud requires the
existance of certain incentives or pressures to commit fraud and a certain awareness of the
operation.
a. Deliberate distortion of accounting reports could be done by several means, including:
- Manipulation, falsification or alteration of accounting records or supporting documents on
which financial statements are prepared;
- Distortion or intentional omission from the financial statements of events, transactions;
- Intentional misapplication of accounting principles, methods of measurement and calculation
of earnings
b. Distortion of assets involves the theft of assets of a company in various ways, such as:
embezzling receipts, stealing tangible and intangible assets, payments to fictitious employees or
customers, sale at overestimated prices etc.
1.1. Regarding the deliberate distortion of accounting reports, we consider that since
the planning phase of the audit, the auditor must assess the risk of errors or fraud that
can generate a significant impact on the financial statements. Thus, based on risk
assessment audit, the auditor should develop programs of auditing procedures with
which to obtain reasonable assurance that for the financial statements, in their entirety,
all significant errors and fraud will be identified.
But it is not expected that auditors implement procedures that would lead to the
discovery of errors or fraud without significant impact on the financial statements and
can not be held responsible for the failure to detect such irregularities. Usually, if the
auditor suspects any fraud or errors with significant impact, he resorts to the extention of
the scope of the audit procedures, until he reaches the belief that the irregularity was
either corrected or fairly reflected in the audited financial statements .
The International Auditing Standard "auditor's responsibility related to fraud in an audit of
financial statements '' ISA-240" - rephrased – states the following requirements: In
planning and performing audit procedures, as well as in the measurement and reporting
of the results of the audit, the auditor should consider the risk of occurence of
significantly misstated statements in the financial reporting, as a result of committing
antisocial acts or actions. "Misstatements in the financial statements can arise from either

175
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

fraud or error. The distinguishing factor between fraud and error is whether the
underlying action that results in distortion of financial statements is intentional or
unintentional" (240-6). The same standard, article 10, makes the following reference:
"Fraudulent financial reporting can be caused by management's efforts to manipulate
earnings to deceive financial statement users by influencing their perceptions on the
performance and profitability of the entity. Such manipulation of revenue can start with
small actions or inappropriate change assumptions or changes in management's
judgment. Pressures and incentives can increase these shares until reaching the stage of
fraudulent financial reporting."
1.2. Regarding the distortion of the results by misappropriation of assets, we consider
that the risk factors associated with this type of fraud can be grouped into two categories:
1. The vulnerability of assets against the risk of theft (large amounts of cash at home or high
volume of cash transactions; the existence of easily salable assets, certain features of the
property - small size allowing easier sale);
2. The absence of control mechanisms designed to prevent or detect assets thefts, such as
supervision or monitoring of assets disposed in widely separated locations.
The audit is subject to the unavoidable risk (audit risk) that some misstatements in the financial
statements may not be detected. The risk of not detecting a significant recording misstatement
caused by fraud is greater than the risk of not detecting a significant recording misstatement
caused by error, because fraud usually involves actions aimed at their coverage, such as:
association for committing fraud, forgery, deliberate failure to record transactions, an incorrect
statement given to the external auditor. Accordingly, the auditor carries out audit with
professional skepticism, recognizing that conditions or events may be identified to indicate the
possibility of fraud and/or errors.
If the auditor believes that fraud or error may have a significant effect on the financial
statements, he applies appropriate additional procedures, use of which depends on its
assessment of the type of fraud or error indicated, the likelihood of fraud or errors, the
likelihood that a particular type of fraud or failure have a significant effect on the financial
statements.
Typically, performing additional procedures enable the auditor to confirm or refute the
suspicion of fraud or error. Where suspicion of fraud or error does not dissapear, the auditor
discusses the matter with management and consider whether this problem is corrected or
properly reflected in the financial statements.
Reporting fraud and error is made by management, users of the audit report on the financial
statements and the regulatory and supervisory activities.

176
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

The auditor has the obligation to communicate his findings to management if he suspects there
may be a fraud, even if the potential effect on the financial statements would be negligible or if
the existence of a significant fraud or error was discovered.
Lately, in Romania, the phenomenon of financial fraud is superseeded by the bureaucracy and
corruption in finance and accounting. Accounting, as a means of highlighting the economic
situation and financial performance at a given time, can become a field of manifestation of
bureaucracy and corruption, the more so since legislative changes regarding national
accounting are produced with a relatively high frequency, a high level of taxes is maintained
and bureaucracy manifests itself fully in the production, administration and management of
financial and accounting documents.
Specialists in the field (L. Ionescu, research presented at the conference MAMIS 2013,
Corruption in the financial-accounting field) identifies the practice of parallel accounting by
Romanian companies (double accounting, triple accounting), "embellished" for their economic
and financial interests, individuals and/or entities. This situation exists with the complicity of
corrupt management and accounting staff in preparing the financial statements, speculating
the mechanisms and means of non-operational identification and counteraction, deficient and
insufficient for the use of parallel accounting. From those presented above, in addition to the
proposals made for this purpose, we support the increase of management accountability,
financial control and financial audit in carrying out the tasks entrusted.

2. Error
The term error refers to an unintentional mistake occurred in the financial statements, such as
math or accounting mistakes in the accounting records and data related; oversight or
misinterpretation of facts; misapplication of accounting policies. Practitioners in the field of
financial audit identified a number of errors in the audit, among which (Oana Bendovski, 10
common errors identified during the statutory audit of financial statements, Financial Audit
Magazine No.7/2014):
a. Erroneously transferring the reserve from the Reevaluation Reserve Account (105)
to the reserve account representing surplus from reserves revaluation (1065)
b. Registration of costs/revenues from services provided in a different financial year
from the one in which the service was provided
c. Registration of purchase/delivery of commodity in a different financial year from
the one in which the actual transfer of rights and obligations for the commodity
occurred
d. Incorrectly reducing accounts payable balances with debit balances on advances
granted
e. Presentation of performance guarantees as commercial debt

177
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

f. Omissions in the distinct presentation of related party transactions in the financial

statements
g. The errouneous cancelation of provisions and adjustments for depreciation
h. The erroneous registration of received trade discounts
i. The revaluation of receivables and payables in foreign currencies at the end of the
fiscal year
j. Omissions in the formation of adjustment for receivables depreciation

3. Responsibilities to Prevent and Detect Fraud and Error

Responsibility for the prevention and detection of fraud and error rests with the entity‘s
management through the implementation and ongoing operation of adequate accounting and
internal control. Such systems reduce but not eliminate the possibility of fraud and errors.
The auditor is not and can not be held responsible for preventing fraud and error. However, the
fact that audit is performed annually can act as a way to prevent/deter them. The auditor
assesses the risk of significant misstatements in financial statements due to fraud and error and
requires management information related to any fraud or significant error discovered.
In addition to deficiencies in the design of the accounting and internal control systems and
inconsistencies with identified internal controls, conditions and events that increase the risk of
fraud and errors can include:
Table 1 : Conditions and events that increase the risk of fraud and errors
Conditions Events
Doubts on the • Management is dominated by a single person (or small group) and there is no
integrity or effective oversight board or committee
competence of • There is a complex comparative structure and complexity does not seem to be
management guaranteed
• Major gaps can be seen in correcting deficiencies of internal controls, where such
corrections can actually be made
• Rapidly changing of important accounting and financial departments personnel
can be observed
• There is a significant and prolonged underdimensioning of the accounting
department, in terms of number of staff
• There are frequent changes of legal or auditors
Unusual pressures • The activity sector is in decline and bankruptcy cases are growing in number
within or on the • An inadequate level of working capital is due to declining profits or too rapid
development
organization • The quality of earnings is deteriorating, for example, by increasing credit risks
assumed in sales, modification or conducting business using alternative accounting
policies that improve income levels
• The company needs an increasing trend of profit to support the market price of
the shares, due to a proposed public offerings, takeover or any other reason

178
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

• The company has made a significant investment in an industry or product line

characterized by rapid change
• The company is dependent, to a significant extent, on one or a few products or
customers
• Financial pressures on top managers
• Pressures on accounting department staff to perform financial statements in an
unusually short time
Unusual transactions • Unusual transactions, especially near the end, which have a significant effect on
revenue
• Transactions or complex accounting treatments
• Related parties transactions
• Payments for services (for example, lawyers, consultants, agents) that seem too
high compared to the services provided
Problems in • Inadequate records, for example, incomplete files, excessive changes in accounts
obtaining sufficient and records, unrecorded transactions in accordance with normal procedures and
and appropriate control accounts with balance
audit evidence • Inappropriate documentation of transactions, such as a lack of proper
authorizations, supporting documents, changes to documents
• An excessive number of differences between accounting records and third party
confirmations, divergent audit evidence and unexplained changes in operational
activity indicators
• Evasive or unreasonable responses by management during the audit
Computer • Inability to retrieve information from computer files due to lack of documentation
information systems about the content of records or programs
specific factors that • A large number of changes to the program that are not documented, approved or
relate to conditions tested
and events • A report mismatch between databases and computerized transactions, on the
described above one hand and financial accounts, on the other hand
Source : M, Boulescu, Fundamentele auditului, Didactic and Pedagogical Publishing House, 2001

The fraud character of an operation can only be established in court. Thus, since the auditor has
no responsibility to prove fraud, his concern is rather directed to actions suspicious of fraud,
than to the fraud proven ones. Therefore, the auditor must distinguish between a "suspected
fraud" and "proven fraud". It is considered "suspected fraud" when there are circumstances
that suggest a fraudulent action and which reach the auditor's attention during the audit
mission. [Mircea Boulescu, M. Mares, M. Ghita - "Fundamentals of audit", 2001, pg. 54].
The audited company's management is responsible for organizing, implementing and
permanently supervising, the accounting systems and internal control. However, the auditor
should be aware that the existence of such systems reduce, but not eliminate, the possibility of
fraud and error, due to inherent limitations. In this regard, the audit is subject to the
unavoidable risk that some significant misstatements in financial statements might not be
detected, even though the audit is properly planned and conducted in accordance with
Auditing Standards.

179
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

4. Professional Skepticism
In the exercise of audit, the auditor has the obligation to maintain an attitude of
professional skepticism, as there is always the possibility that the financial statements
present a significant misstatement due to fraud, even if they have extensive experience
and a good knowledge of both the entity and the individuals responsible for management
and governance, with the conviction of honesty and integrity. Professional skepticism is
an attitude which involves a critical assessment of audit evidence, and a more accurate
appreciation of honesty management.
In order to comply with the auditor's rules and recommendations imposed by the
International Standard on Auditing 240, its series of incumbent obligations are as follows:
• Performing procedures that provide the information necessary to identify risks of
significant misstatement due to fraud;
• Identifying and assessing risks of significant misstatement due to fraud in financial
statement and assertion level, and for the assessed risks which could result in a
significant misstatement due to fraud, to evaluate the design of organization internal
controls, including relevant control activities and establish whether they have been
implemented.
• To design and perform audit procedures to respond to the risks of avoidance of
controls by management.
• Determine responses to address significant risks regarding misstatement due to fraud;
• Obtain responses from management regarding fraud whenever deemed necessary;
• To ensure proper communication with management and those charged with
governance.
European regulations in the field (Directive 2014/56 / EU of the European Parliament and
of the Council of 16 April 2014 amending Directive 2006/43 / EC on statutory audits of
annual financial statements and consolidated financial statements) insist on maintaining
an attitude of professional skepticism in the exercise of statutory financial audits,
estimating that (article 5) "although the primary responsibility to provide financial
information should rest with the management of the audited entities, statutory auditors
and audit firms should actively draw the attention of management to issues from a user
perspective. Thus, to improve audit quality, it is essential to reinforce the professional
skepticism of statutory auditors and audit firms from the audited entity. Statutory
auditors and audit firms should admit the possibility of a significant misstatement due to
fraud or error, regardless of the previos experience of the auditor regarding the honesty
and integrity of the audited entity's management. "

180
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

4. EU Recommendations on the Audit of EU Funds

The treaty on the functioning of the European Union and the Regulation on common
dispositions [Regulation (EU) no. 1303/2013 of the European Parliament and of the
Council from 17.12.2013] stipulate the requirement of sound financial management
regarding the use of the EU budget by member states and provide "control and audit
obligations of member states in the implementation of the budget as well as
responsibilities which arise therefrom". For the 2014-2020 period, the adherence to
"internationally accepted audit standards" is required when conducting audits. There are
three main sets of international audit standards:
1. Standards of the Council for International Auditing and Assurance Standards (IAASB) of
the International Federation of Accountants;
2. International Standards of Supreme Audit Institutions (ISSAI), issued by the
International Organization of Supreme Audit Institutions;
3. Standards of the Institute of Internal Auditors.
All three sets of standards provide similar guidance on auditors' obligations regarding
fraud detection.
Among the standards issued by the IAASB, ISA 240 is of particular importance and refers
to “the auditor’s responsibilities regarding fraud in a financial statements audit", setting
out the following principles:
1. It is expected from auditors to discover fraud only if it is above significance levels;
2. If the auditors suspected fraud, they must take further measures;
3. Auditors should take into account specific fraud risk factors when planning the audit. In
this sense, the concept of significance should include qualitative aspects;
4. When reasonable assurance is obtained, the auditor is obliged to maintain professional
skepticism throughout the audit. This includes the need to think and act with ingenuity;
5. Particular attention should be paid to the communication and documentation of cases
of suspected fraud.
In accordance with ISA 330, "Auditor's Procedures in Response to Assessed Risks", the auditor
should determine the appropriate overall response to the assessed risks of significant
misstatement due to fraud in the financial statements. However, there still is an inevitable risk
that some significant misstatements may not be identified, especially in cases where these
result from fraud.
In Romania, the national audit authorities and the anti-fraud Department (DLAF) have signed a
cooperation agreement which includes:

181
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

• bilateral consultations on drafting new legislation on issues related to fraud which have an
impact on the main activities of the audit authorities and that of DLAF;
• organising meetings, conferences and joint training activities;
• notifications to DLAF sent by the audit authorities regarding potential cases of fraud;
• exchange of information on fraud cases, in order to assess the risk of fraud;
• access to the DLAF database (and especially to the Irregularities Management System) by the
audit authorities, on the basis of a written request;
• DLAF biannual transmission to audit authorities of the list of audited bodies.
On the other hand, in case of audit missions, it is in the public interest that members of audit
teams are independent from audit clients, so that they can reach a conclusion without being
affected by influences which compromise professional judgment, as well as to avoid facts and
circumstances that are so significant that a third party which is reasonable and informed,
considering all facts and circumstances, would conclude that the integrity, objectivity or
professional skepticism of the auditor or a member of the audit team have been compromised.

Conclusions
Seen as a virus, financial fraud can take many forms, committed against or for the company,
from simple theft committed by an employee, up to complex schemes of fraudulent reporting
and corruption acts which led to the famous high scale financial scandals, which shook the
economy. These frauds are carried out by those in charge with managing the company and
target financial information manipulation or falsifying reported statements in order to deceive
investors and business partners on the creditworthiness of the company.
From those presented in accordance with the provisions of the Treaty on the Functioning of the
European Union (TFEU) we opt for strengthening internal control mechanisms in order to
streamline fraud risk management and the development/implementation of internal policies
and procedures to enable an effective response to fraud.

References
[1] Ioan Bogdan Robu, Mihaela Alina Robu, Audit Procedures for Estimating the Fraud Risk Based on Indexes
for Detection of Accounting Manipulation, Finanacial Audit Magazine, nr. 10/2013, p.5
[2] Boulescu Mircea, Audit financiar –repere normative naționale, Economic Publishing House, Bucharest,
2003
[3] Boulescu Mircea, Fundamentele auditului, Disactic and Pedagogic Publishing House, 2001
[4] Federația Internațională a Contabililor, Manual de Standarde Internaționale de Audit și Control de
Calitate –Audit Financiar 2009, Irecson Publishing House, Bucharest, 2009

182
 Available online at
www.icesba.eu

Procedia of Economics
and Business Administration
ISSN: 2392-8166, ISSN-L: 2392-8166

[5] Cicilia Ionescu (coordinator), Gheorghe Zaman, Mihai Ristea, Cornel Ionescu, Eugeniu Țurlea, luminița
Ionescu, Floarea Georgescu, Lucian Ilincuță, Ramona Chivu, Provocări actuale în contabilitatea firmei,
Compendiu de contabilitate, Fundației România de Mâine Publishing House, Bucharest, 2015
[6] Cicilia Ionescu, Audit Of The Adequacy Degree For The Principle Of Activity Continuity, International
conference KNOWLEDGE-BASED ORGANIZATION. Volume 21, Issue 2, Pages 325–330
[7] Mihăilescu Ion, Responsabilitatea auditorilor de a avea în vedere fraudele şi erorile într-un angajament
de audit – suport de curs pregătire auditori financiari, 2006, http://www.cig.ase.ro
[8] IFAC, ISA 240, http://www.ifac.org/system/files/downloads/a012-2010-iaasb-handbook-isa-240.pdf
[9] http://eur-lex.europa.eu/legal-content/RO/TXT/?uri=CELEX%3A32014L0056
[10] https://ec.europa.eu/.../Handbook%20the%20role%20of%20member%20...
[11]http://www.scrigroup.com/afaceri/economie/RESPONSABILITATEA-PENTRU-DETEC82493.php
[12] https://www.ecb.europa.eu/ecb/legal/1341/html/index.ro.html

183

View publication stats