Detection and prevention of fraud in financial information: is it the responsibility of the auditors?

The fraud problem has been around for years and has led to the collapse of most businesses due to misleading financial reporting and embezzlement. It has also questioned the integrity of some key players in the industry, as well as major accounting firms. Unfortunately, fraud does not have a physical form such that it can be easily seen or retained. Refers to an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unfair or illegal advantage.

According to the Association of Certified Fraud Examiners, fraud is defined as any intentional or deliberate act to deprive another person of property or money through trickery, deceit, or other unfair means. Classify fraud as follows:

• Corruption: conflicts of interest, bribery, illegal gratuities and financial extortion.
• Misappropriation of cash assets: pickpocketing, theft, check tampering, and fraudulent disbursements, including billing, payroll, and expense reimbursement schemes.
• Misappropriation of non-monetary assets: theft, requisition of false assets, 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, vendors, or other parties include bribes or inducements and fraudulent (rather than erroneous) billing of a vendor 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 asset misappropriation may exist when a person believes that internal control could be overridden, for example, because the person is in a position of trust or is aware of specific weaknesses in the system of internal control. Fraud is typically fueled by three variables: pressures, opportunity, and rationalization, as shown in the diagram.

There is a need 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 giving rise to the financial statement misstatement is intentional or unintentional. Unlike error, fraud is intentional and generally involves the deliberate concealment of facts. Error refers to an unintentional misstatement in the financial statements, including the omission of an amount or disclosure.

Although fraud is a broad legal concept, the auditor is concerned with fraudulent acts that cause a material misstatement of the financial statements, and there are two types of misstatements in considering fraud: misstatements resulting from fraudulent financial reporting and those arising from the misappropriation of assets. . (para. 3 of ISA 240)

Asset misappropriation involves the theft of an entity’s assets and can take place in a variety of ways (including misappropriation of receipts, theft of physical or intangible assets, or making an entity pay for goods and services not received) . It is often accompanied by false or misleading records or documents to hide the fact that the goods are missing. People may be motivated to misappropriate assets, for example, because they live beyond their means.

Fraudulent financial reporting may be committed because management is under pressure, from sources outside and inside the entity, to achieve an expected (and perhaps unrealistic) earnings target, particularly because the consequences to management of not meeting financial targets they can be significant. Involves intentional misstatements or omissions of amounts or disclosures in financial statements to mislead users of the financial statements. Fraudulent financial information can be achieved through:

Yo. Deception, that is, manipulating, falsifying or altering the accounting records or supporting documents from which the financial statements are prepared.

ii. Misrepresentation or intentional omission from the financial statements of events, transactions or other material information.

iii. Intentional misapplication of 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

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 in the financial statements will be detected. It is also known that the risk of not detecting a material misstatement due to fraud is greater than that of not detecting misstatement resulting from error because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations made to the auditor.

Such cover-up 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 manipulation, the degree of collusion involved, the relative size of the individual amounts 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 tip 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 roles of auditors in auditing are enshrined in the International Standards on Auditing (ISAs), which serve as the “bible” for auditors in carrying out 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, the auditor’s responsibilities in relation to fraud in an audit of financial statements) and ISA 315.

Paragraph 4 of ISA 240 deals with the responsibility for the prevention and detection of fraud and states that “the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. It is important that management, with oversight from those charged with governance, place a strong emphasis on fraud prevention, which can reduce the opportunities for fraud to occur, and fraud deterrence, which could persuade people to not committing fraud due to the likelihood of detection and sanction creating a culture of honesty and ethical behavior that can be reinforced by active oversight by those charged with governance, such as efforts by management to manage earnings through in order to influence analysts’ perceptions of the entity’s performance and profitability.

Paragraph 5 also states that “An auditor performing an audit in accordance with ISAs is responsible for obtaining reasonable assurance about whether 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 in the financial statements may not be detected, even though the audit is properly planned and performed in accordance with ISAs.

In addition, ISA 315 requires auditors to evaluate the effectiveness of an entity’s risk management framework in preventing misstatements, whether due to fraud or otherwise, during an audit and that auditors should consider the risk of misstatement due to fraud or error of each significant account balance, recognizing the material classes of transactions included therein, in order to identify a specific risk and if a material misstatement is found due to the possibility of fraud, that could cause the integrity of 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 they are responsible for safeguarding the assets of the company and taking reasonable measures for the prevention and detection. of fraud and other irregularities and that the responsibility of the auditors is to express an opinion on whether the summary financial statements are consistent, in all material respects, with the financial statements audited based on their procedures, which were performed in accordance with the Standards. Auditing Internationals (ES UN). It is for this reason that all annual financial reports clearly define the responsibilities of directors and auditors.

conclusion

Obviously, it can be concluded that auditors play only a complementary role in the detection and prevention of financial reporting fraud and that the ultimate responsibility rests with those charged with governance.

However, the Institute of Internal Auditors (IIA) standard 1210.A2 requires that auditors possess “sufficient knowledge” to identify indicators of fraud, meaning that while auditors cannot be expected to develop these skills to the of a fraud examiner, they should seek to become more competent through training, practical 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 the financial statements.