Error, Fraud, and Non

compliance LAR In an audit of

financial
Misstatements in FS can arise in fraud or error. Noncompliance with LAR cannot
cause a misstatement in FS because it is a legal duty.

RELATED STANDARDS

PSA 240 Redrafted) Auditor's responsibilities relating to fraud n an audit of

financial statements

in conjunction with the following:

PSA 315

PSA 330

PSQc 1

Code of Ethics

BASIC PREMISE
PSA 240.5 " AN auditor conducting an audit in accordance with PSAs is
responsible for obtaining reasonable assurance that the financial statements
taken as a whole are free from material missttatement, whether caused by fraud
or error"
Auditor is only concerned with the fraud and errors that can affect the financial
statements.
The responsibility of the auditor in fraud or error is stated in the standard. Kung
ano yung responsibility ni auditor sa fraud, ganoon din sa error.

Error, Fraud, and Non compliance LAR In an audit of financial 1

 ERROR vs. FRAUD
FRAUD INTENTIONAL

nagcocorrect ng fraud is management.

cannot be easily corrected.

ERROR UNINTENTIONAL

ERROR
→ Refers to an involuntary or unintentional misstatement occurred in financial
statements, including the omission of an amount or disclosure

Incorrect accounting estimate due to overlooking or misinterpretation of

facts

Error in applying accounting policies related to recognition, classification,

valuation and disclosure

Inherent limitations of the preparer of financial statements. (judgments,

fatigue, mathematical error)

FRAUD
→ refers to an intentional act by one or more individuals among the management,
charged with governance of a collusion with the management, third parties and
other persons outside the entity.

The auditor is concerned with fraud that causes a material misstatement in the
financial statement

🗯 The risk of not detecting a material misstatement resulting from a fraud

is HIGHER THAN the risk of not detecting one resulting from error.

Collusion may cause the auditor to believe that audit evidence is persuasive when
it is, in fact, false. The auditor's ability to detect a fraud depends on factors such

Error, Fraud, and Non compliance LAR In an audit of financial 2

 as:

skillfulness of the perpetrator

frequency and extent of manipulation

the degree of collusion involved

the relative size of individual amounts manipulated

the seniority of those individuals involved.

Responsibilities to fraud
To identify and assess the risks of material misstatement of the financial
statements due to fraud

To obtain sufficient appropriate audit evidence about the assessed RMM (risk
of material misstatement) due to fraud, through designing and implementing
responses.

The higher the risk, the more procedures you need to perform.

To respond appropriately to identified or suspected fraud

🗯 PSA 240 provides also that the primary responsibility for the prevention
and detection of fraud RESTS WITH BOTH THOSE CHARGED WITH
GOVERNANCE OF THE COMPANY AND THE MANAGEMENT.

WHAT SHOUD THE MANAGEMENT DO?

emphasis on FRAUD PREVENTION

→ reduces opportunities for fraud

emphasis on FRAUD DETERRENCE

→ persuade individuals not to commit fraud

Error, Fraud, and Non compliance LAR In an audit of financial 3

 🗯 It is the management's responsibility, the auditor can only give
suggestion.

Decoding Fraud and Profiling the Fraudster

Fraud exists when all of the ff elements exist:

There must be a perpetrator that makes an untrue representation about

an important fact or event

victim who believed in the untrue representation

materialize the

PROFILING FRAUD

Employee fraud

How?

→ the transaction is immaterial

→ misappropriation of assets

Mas madaling idetect and ma- avoid

Management Fraud

How?
→ fraudulent reporting of FS

→ Amount involved is large and concealed in an intelligent manner

Mas mahirap madetect.

HOW?
 stealing something of value (an asset)

Error, Fraud, and Non compliance LAR In an audit of financial 4

  converting the asset to usable form (cash)

 concealing the crime to avoid detection

Management fraud
perpetrated at levels of management above the one to which internal control
structures generally relate.

Fraud Schemes types according to IIA

 Fraudulent financial reporting → PSA 240

 Asset misappropriation

 Corruption

→ rampant that's why it is included

Fraudulent Financial Reporting

Usually in the form of Window Dressing it is made to appear the financial
statements to make the copy appear better than it is. It often involves
management override of controls that otherwise may appear to be operating
effectively.

Includes the following activities:

record fictitious journal entries

omitting

Usually occurs as Management Fraud. It may be tied to focus on short-term

financial measures for success.

Asset Misappropriation

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 Relates to those committed by the low-level employees or the rank and file
employees who have the easy access to the resources of the company. It is the
most common fraud scheme in which assets are directly or indirectly diverted to
perpetrators benefit.

Examples:

Cash fraud; Embezzling receipts

Skimming → cash fraud wherein the perpetrator steal cash before it is

recorded in the books.

Cash Larceny → it involves stealing of cash from the org's book and record;
stole cash after recording

Lapping → usually happens in the area responsible for the incoming payments
or receiving cash; pinagpapatong patong ng individul yung collection for a
certain person by another person.

October 2, 2020

Continuation

Institute of Internal Auditors:

Financial fraudulent report

Asset Misappropriation

Corruption

Corruption
Involves those at the top level as they have control and authority. It s defined as
the misuse of entrusted power for private/personal gain.

Bribery → giving, offering or receiving things of value to influence an official

to his duties or responsibilities. It is committed before the fraud.

Illegal gratuity - also involves giving, offering or receiving things of value

after the fraudulent act has been committed.

Error, Fraud, and Non compliance LAR In an audit of financial 6

 Conflicts of interest - occurs when an employee acts in behalf of a third party
during his performance of duties or responsibilities or he has his own
business and he markets his business to be favored by the other employees.

Economic Extortion - threat or use of force to favor you or your business.

These activities technically involves 3rd persons or 3rd persons take part in
performing these activity.

Profiling the fraudster

In terms of value, it is the male who commits fraud. It usually involves large
amounts of money but low in frequency.

🗯 Males are usually fraudster.

In terms of frequency/volume, it is the female who commits fraud. Amount

involved is immaterial but it is frequently committed.

Fraudster Characteristics
Intelligent → always challenged by established systems, challenged by
"secure" systems, bored with the job routine. Always aggressive as the higher
the risk, the higher the return.

Egotistical → scornful of "obvious" control flaws

Inquisitive → tempted by the discovery of a computer vulnerability

A risk taker → willing to bend the rules, take chances, challenges/ tests the
control owners/ process owners

A rule breaker → takes shortcuts, self- justifies infractions of law, rules, etc.

hard worker → first arrives in the morning and last to leave at night, takes a
few vacations

Reasons why they commit fraud

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 Under stress → suffering from a personal crisis, such as financial problem,
bad marriage

Greedy or has genuine financial need → illness, drugs, gambling

Disgruntled at work or a complainer → may try to get even or take what he/
she really deserves

A big spender → expensive hobbies, living beyond means.

Fraud Risk Factors

The Fraud Diamond ( the first three factors considered in PSA 240 are the same
with IIA

Opportunity → has something to do with the environment where the fraud

can be committed. The environment is very relaxed or there is a management
collusion.

Motivation → can be associated with pressure/incentive

Rationalization → ethical behavior of the fraudster. It is the justification of the

fraudster upon the fraudulent action committed.

Capability → these are personal traits and abilities. Part and parcel of the
opportunity. Even though there is an opportunity, motivation, or
rationalization, but you don't have the capability, you won't be able to
perform fraud.

The fraud triangle

Error, Fraud, and Non compliance LAR In an audit of financial 8

 if malaki ang ethics, mababa ang pressure at opportunity na magcommit ng
fraud.
if maliit ang ethics, there is a bigger chance to commit fraud as the opportunity
and pressure is bigger

More on Fraud Risk Factors

Error, Fraud, and Non compliance LAR In an audit of financial 9

 It is on ethical behavior of those inside the organization or outside the
organization in connection with the organization that are deterrent.

The risks of fraud involving accounts in the income statement might be higher
than the balance sheet.

Risk Assessment Procedures and Related Activities

Steps the Auditor could do

Inquiries of Management
Should be done by the auditor

Management is responsible for the entity's internal control and for the
preparation of the financial statements. The management knows the functions
of the organization. Management is responsible for internal control.

The auditor's job is to inquire if the management experienced fraud or knows

of suspicious activities.

Inquiries of Management and Others within the entity

Error, Fraud, and Non compliance LAR In an audit of financial 10

 inquire with the rank-and-file employees as they may provide information to
the auditor that may not otherwise be communicated.

If you're already asking for "how much?" you are already performing
substantive testing.

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Error, Fraud, and Non compliance LAR In an audit of financial 12