Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT OF FINANCIAL STATEMENTS
Characteristics of Fraud
Misstatements in the financial statements can arise from either fraud or error. 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.
o Misstatement – a difference between the amount, classification, presentation, or disclosure of a
reported financial statement item and the amount, classification, presentation, or disclosure that is
required for the item to be in accordance with the applicable financial reporting framework.
o Fraud – 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 unjust or illegal
advantage.
Fraud risk factors – events or conditions that indicate an incentive or pressure to commit
fraud or provide an opportunity to commit fraud.
o Error – acts of unintentional mistake or negligence.
Error of Principle
Errors of Omission
Errors of Duplication
Errors of Commission
Compensating Errors
The auditor is concerned with fraud that causes a material misstatement in the financial statements. Two
types of intentional misstatements are relevant to the auditor – misstatements resulting from fraudulent
financial reporting and misstatements resulting from misappropriation of assets.
o Misstatements resulting from fraudulent financial reporting – management fraud;
misrepresentation of information in the financial statements (e.g. overstatement of revenue, etc.)
Fraudulent financial reporting involves intentional misstatements including omissions of
amounts or disclosures in financial statements to deceive financial statement users.
Fraudulent financial reporting may be accomplished by the following:
a. Manipulation, falsification (including forgery), or alteration of accounting records or
supporting documentation from which the financial statements are prepared.
b. Misrepresentation in, or intentional omission from, the financial statements of events,
transactions or other significant information.
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
c. Intentional misapplication of accounting principles relating to amounts, classification,
manner of presentation, or disclosure.
Fraudulent financial reporting often involves management override of controls that
otherwise may appear to be operating effectively. Fraud can be committed by management
overriding controls using such techniques as:
a. Recording fictitious journal entries, particularly close to the end of an accounting
period, to manipulate operating results or achieve other objectives.
b. Inappropriately adjusting assumptions and changing judgments used to estimate
account balances.
c. Omitting, advancing or delaying recognition in the financial statements of events and
transactions that have occurred during the reporting period.
d. Concealing, or not disclosing, facts that could affect the amounts recorded in the
financial statements.
e. Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
f. Altering records and terms related to significant and unusual transactions.
o Misappropriation of assets – employee fraud; theft/misuse of company assets (e.g. embezzlement,
etc.)
Misappropriation of assets involves the theft of an entity’s assets and is often perpetrated
by employees in relatively small and immaterial amounts. However, it can also involve
management who are usually more able to disguise or conceal misappropriations in ways
that are difficult to detect.
Misappropriation of assets can be accomplished in a variety of ways including:
a. Embezzling receipts (for example, misappropriating collections on accounts
receivable or diverting receipts in respect of written-off accounts to personal bank
accounts).
b. Stealing physical assets or intellectual property (for example, stealing inventory for
personal use or for sale, stealing scrap for resale, colluding with a competitor by
disclosing technological data in return for payment).
c. Causing an entity to pay for goods and services not received (for example,
payments to fictitious vendors, kickbacks paid by vendors to the entity’s purchasing
agents in return for inflating prices, payments to fictitious employees).
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
d. Using an entity’s assets for personal use (for example, using the entity’s assets as
collateral for a personal loan or a loan to a related party).
Misappropriation of assets is often accompanied by false or misleading records or
documents in order to conceal the fact that the assets are missing or have been pledged
without proper authorization.
Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive or pressure to
commit fraud, a perceived opportunity to do so and some rationalization of the act.
o Incentive or pressure to commit fraudulent financial reporting may exist when management is under
pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic)
earnings target or financial outcome – particularly since the consequences to management for failing
to meet financial goals can be significant.
o A perceived opportunity to commit fraud may exist when an individual believes internal control can
be overridden, for example, because the individual is in a position of trust or has knowledge of
specific weaknesses in internal control.
o Individuals may be able to rationalize committing a fraudulent act. Some individuals possess an
attitude, character or set of ethical values that allow them knowingly and intentionally to commit a
dishonest act.
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the auditor does not make
legal determinations of whether fraud has actually occurred.
Responsibility for the Prevention and Detection of Fraud
The primary responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management.
o Those charged with governance – the person(s) or organization(s) (e.g., a corporate trustee) with
responsibility for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity.
o Management – the person(s) with executive responsibility for the conduct of the entity’s operations.
It is important that management, with the oversight of those charged with governance, place a strong
emphasis on fraud prevention, which may reduce opportunities for fraud to take place, and fraud deterrence,
which could persuade individuals not to commit fraud because of the likelihood of detection and punishment.
o Premise, relating to the responsibilities of management and, where appropriate, those charged
with governance, on which an audit is conducted – That management and, where appropriate, those
charged with governance have the following responsibilities that are fundamental to the conduct of
an audit in accordance with PSAs. That is, responsibility:
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
For the preparation and presentation of the financial statements in accordance with
the applicable financial reporting framework; this includes the design, implementation,
and maintenance of internal control relevant to the preparation and presentation of financial
statements that are free from material misstatement, whether due to fraud or error; and
To provide the auditor with:
a. All information, such as records and documentation, and other matters that are
relevant to the preparation and presentation of the financial statements.
b. Any additional information that the auditor may request from management and,
where appropriate, those charged with governance; and
c. Unrestricted access to those within the entity from whom the auditor determines it
necessary to obtain audit evidence.
Responsibilities of the Auditor
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 misstatement, whether caused by fraud
or error.
Owing 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 though the audit is properly planned and performed in
accordance with the PSAs.
The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting
one resulting from error. This is because fraud may involve sophisticated and carefully organized schemes
designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional
misrepresentations being made to the auditor.
Attempts at concealment may be even more difficult to detect when accompanied by collusion. Collusion may
cause the auditor to believe that audit evidence is persuasive when it is, in fact, false.
The auditor’s ability to detect fraud depends on factors such as the skillfulness of the perpetrator, the
frequency and extent of manipulation, the degree of collusion involved, the relative size of individual amounts
manipulated, and the seniority of those individuals involved.
While the auditor may be able to identify potential opportunities for fraud to be perpetrated, it is difficult for the
auditor to determine whether misstatements in judgment areas such as accounting estimates are caused by
fraud or error.
The risk of the auditor not detecting a material misstatement resulting from management fraud is greater than
for employee fraud, because management is frequently in a position to directly or indirectly manipulate
accounting records, present fraudulent financial information or override control procedures designed to
prevent similar frauds by other employees.
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional
skepticism throughout the audit, considering the potential for management override of controls and
recognizing the fact that audit procedures that are effective for detecting error may not be effective in detecting
fraud.
Ethical Requirements Relating to an Audit of Financial Statements
The auditor shall comply with relevant ethical requirements, including those pertaining to independence,
relating to financial statement audit engagements.
o Independence – comprising both independence of mind and independence in appearance; the
auditor’s independence from the entity safeguards the auditor’s ability to form an audit opinion
without being affected by influences that might compromise that opinion.
o The fundamental principles with which the auditor is required to comply by the Code of Ethics are:
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behavior
The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances may
exist that cause the financial statements to be materially misstated.
o Professional skepticism – an attitude that includes a questioning mind, being alert to conditions
that may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
Professional skepticism includes being alert to, for example:
a. Audit evidence that contradicts other audit evidence obtained.
b. Information that brings into question the reliability of documents and responses to
inquiries to be used as audit evidence.
c. Conditions that may indicate possible fraud.
d. Circumstances that suggest the need for audit procedures in addition to those
required by the PSAs.
o Unless the auditor has reason to believe the contrary, the auditor may accept records and
documents as genuine. If conditions identified during the audit cause the auditor to believe that a
document may not be authentic or that terms in a document have been modified but not disclosed
to the auditor, the auditor shall investigate further.
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
The auditor shall exercise professional judgment in planning and performing an audit of financial statements.
o Professional judgment – the application of relevant training, knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in making informed decisions about
the courses of action that are appropriate in the circumstances of the audit engagement.
Professional judgment is necessary in particular regarding decisions about:
a. Materiality and audit risk.
b. The nature, timing, and extent of audit procedures used to meet the requirements
of the PSAs and gather audit evidence.
c. Evaluating whether sufficient appropriate audit evidence has been obtained, and
whether more needs to be done to achieve the objectives of the PSAs and thereby,
the overall objectives of the auditor.
d. The evaluation of management’s judgments in applying the entity’s applicable
financial reporting framework.
e. The drawing of conclusions based on the audit evidence obtained, for example,
assessing the reasonableness of the estimates made by management in preparing
the financial statements.
The distinguishing feature of the professional judgment expected of an auditor is that it is
exercised by an auditor whose training, knowledge and experience have assisted in
developing the necessary competencies to achieve reasonable judgments.
To obtain reasonable assurance, the auditor shall obtain sufficient appropriate audit evidence to reduce audit
risk to an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which to
base the auditor’s opinion.
o Reasonable assurance – In the context of an audit of financial statements, a high, but not absolute,
level of assurance.
o Audit evidence – Information used by the auditor in arriving at the conclusions on which the auditor’s
opinion is based. Audit evidence includes both information contained in the accounting records
underlying the financial statements and other information.
Audit evidence is necessary to support the auditor’s opinion and report. It is cumulative in
nature and is primarily obtained from audit procedures performed during the course of the
audit.
Sufficiency of audit evidence is the measure of the quantity of audit evidence. The
quantity of the audit evidence needed is affected by the auditor’s assessment of the risks
of material misstatement and also by the quality of such audit evidence.
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314
Appropriateness of audit evidence is the measure of the quality of audit evidence; that
is, its relevance and its reliability in providing support for the conclusions on which the
auditor’s opinion is based.
Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an
acceptably low level, and thereby enable the auditor to draw reasonable conclusions on
which to base the auditor’s opinion, is a matter of professional judgment.
Objectives of the Auditor
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 risks of material misstatement due to fraud,
through designing and implementing appropriate responses; and
To respond appropriately to identified or suspected fraud.
Auditing and Assurance Principles. 1st Sem 2022-2023
NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
