ISA 240 Fraud and Error

SCOPE

This standard deals with the auditor’s  responsibilities relating to fraud in an audit of financial statements.

Characteristics of Fraud

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.

Incentive or Pressure

Incentive or pressure to commit fraudulent financial reporting may exist when management is under pressure, from sources outside or inside the entity, to achieve  earnings target or financial outcome.Individuals may have an incentive to *misappropriate assets if they are living beyond their means.*Misappropriate means Steal

Perceived Opportunity

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 deficiencies in internal control. 

Rationalized Opportunity

Individuals may possess an attitude, character or set of ethical values that allow them knowingly and intentionally to commit a dishonest act. Honest individuals can commit fraud in an environment that imposes sufficient pressure on them. 

Fraudulent Financial Reporting

Fraudulent financial reporting involves intentional misstatements including omissions of amounts or disclosures in financial statements to deceive financial statement users.

 Fraudulent Financial Reporting 

Manipulation, falsification (including forgery), or alteration of accounting records or supporting documentation from which the financial statements are prepared.  Misrepresentation in, or intentional omission from, the financial statements of events, transactions or other significant information. Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure..

Overriding Controls

This is another way fraud can be committed and it is usually done by management.Management may use techniques such as:Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives. • Inappropriately adjusting assumptions and changing judgments used to estimate account balances.

Omitting, advancing or delaying recognition in the FS, events and transactions that have occurred during the reporting period. • Altering records and terms related to significant and unusual transactions. Concealing, or not disclosing, facts that could affect the amounts recorded.Engaging in complex transactions that are structured to misrepresent the financial position or performance of the entity.

Overriding Controls

Misappropriation of Assets

Misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by employees, however, it can be done by management as well. E.g. :Embezzling ReceiptsStealing Physical Assets or Intellectual PropertyUsing entity's assets for personal useCausing an entity to pay for g&s not receivedPayments to ficticious vendors.Payments to ficticious employees.