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Lecture 11 errors and fraud

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26 views

Lecture 11 errors and fraud

Uploaded by

Mujeeb Ayomide Bakare
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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INTRODUCTION TO AUDITING (ACC 311)

Lecture 11
• Errors and Fraud

1
ERRORS

It is an unintentional mistake or misstatement in the


financial statements which may be material or
immaterial.
Examples of accounting errors according to their
nature include:
Errors of Principle: i.e. Posting an item in the wrong

account. A revenue item posted in capital item


account or recording personal expenses as business
expenses.
2
ERRORS
Mathematical or clerical mistakes in the underlying
records. Also called Clerical Errors: This takes place
due to carelessness of the clerk responsible for
recording the transaction.
 Examples include Error of Omission: It is committed by
not recording a transaction in the relevant books of
account. This transaction is either fully (no debit or
credit aspects of the transaction) or partially (recording
one aspect of the transaction i.e. debit or credit).
3
ERRORS

 Errors of Commission: It arises as a result of doing


something wrong. It could result from
posting/entering the amount of transaction
(mistakenly entering 7200 instead of 2700), totalling
(actual sales of 44870 mistakenly noted as 48470),
carrying forward etc.

4
FRAUD
 It refers to an intentional act by one or more persons
among management, employees, or third parties which
results in misrepresentation of financial statements.
 It includes intentional omissions of significant
information. Fraud includes surprise, trickery, cunning
and unfair ways by which another is cheated.
 It is the concealment of a fact or misrepresentation for
the purpose of inducing another to act upon it to his or
her injury.
5
FRAUD

In law, it is the intentional misrepresentation of


facts made by one person to another person,
knowing such misrepresentation is false but will
induce the other person ‘to act’- resulting in injury
or damage to him or her.

6
FRAUD

Fraud can be to the benefit of an individual or to the


organization.
Fraud can be classified into two major
categories:
i. Fraudulent financial reporting (Manipulation,
falsification or alteration of records and
documents).
ii. Misappropriation of assets or funds

7
SPECIFIC EXAMPLES OF FRAUD
Examples of Frauds relating to Fraudulent
financial reporting:-
 Forging or Altering Accounting Records
 Misrepresentation or Intentionally omitting events and
transactions
 Intentional misapplication of Accounting Principles
 Overstating profits to attract investors and lenders.

8
SPECIFIC EXAMPLES OF FRAUD

Examples of Frauds relating to


Misappropriation of assets or funds:
 Illegal withdrawal of store materials for fictitious
maintenance.
 Embezzling Revenue (Collection to Personal Account)
 Embezzlement of unclaimed wages.
 Inflation of contract amounts.
 Using organization Assets for private use.

9
SPECIFIC EXAMPLES OF FRAUD

E-crime by using computers e.g. hacking,


spamming etc.
Overstating staff allowance on payroll.
Inclusion of dummy names on payroll.
Illegal sale of scrap
Fraudulent financial claims etc.

10
WHO COMMITS FRAUD
 Anyone can commit fraud as fraud perpetrators can’t easily
be distinguished from other people. Most perpetrators have
profiles that look like those of honest people. Hence,
 Most employees, customers, vendors and business

associates fit the profile of fraud perpetrators and are


most likely capable of committing fraud.
 A common finding is that senior management and

executives commit a significant number of frauds and


invariably cause greater losses than may junior
employees.
11
SPECIFIC EXAMPLES OF FRAUD

 E-crime by using computers e.g. hacking, spamming


etc.
 Overstating staff allowance on payroll.
 Inclusion of dummy names on payroll.
 Illegal sale of scrap
 Fraudulent financial claims etc.

12
WHY PEOPLE COMMIT FRAUD

There is no single reason people commit


fraud. The fraud triangle is a useful model,
developed by Dr Cressey (1953) who argued;
it is based on the premise that fraud is likely to
come from a combination of three factors i.e.
Pressure or Motivation, Opportunity and
Rationalisation.

13
WHY PEOPLE COMMIT FRAUD
Pressure: Some of such are financial, work-related
etc.
Examples of financial pressure include: unexpected
financial needs, greed, personal debt, living beyond
ones means.
Work related pressures include; job insecurity, poor

remuneration by the company, unrealistic corporate


targets, less recognition for work done, lack of
promotion when due etc.
14
WHY PEOPLE COMMIT FRAUD
 Opportunity: Here, an opportunity arises and the person
feels the act is not entirely wrong.
 Examples include:
 Failure to discipline fraud perpetrators.
 Lack of access to information.

 Management circumventing controls that prevent fraud.

 Lack of an audit trail.


 Irregular balancing of accounting records.

 Ineffective internal control system.

 Poor and ineffective supervision of staff by superiors etc.

15
WHY PEOPLE COMMIT FRAUD
 Rationalisation: has to do with trying to justify or
explaining behaviour with logical reasons even if they are
not appropriate.
 Examples are:
 Nobody will get hurt.
 I deserve more than am getting.

 I am only borrowing the money and will pay it back.

 Something has to be sacrificed.

 We will update the records as soon as we get over this

financial difficulty etc.


16
FRAUD PREVENTION MEASURES

The following measures can help to prevent or


eliminate fraud in an organisation:
 Periodic rotation of staff.
 Installation of a good internal control system and its

reinforcement.
 Adequate number of staff and segregation of duties.
 Monitoring and supervision of employees
 Develop a company code of ethics and a Fraud Policy

statement.
17
FRAUD PREVENTION MEASURES

Proactive fraud auditing


Anti-fraud education programme.

Screening of current and new employees.

Risk awareness

Whistle blowing

Strict disciplinary actions to deter staff

Effective use of police personnel

18
FRAUD DETECTION
Fraud detection may identify ongoing frauds that are
taking place or that have already occurred. A fraud
detection programme should not be limited to
potential recovery of losses.
 The following measures can help to detect fraud:
 Performing regular checks e.g. stocktaking and cash
counts.
 Carrying out complete or continuous auditing of Financial

statements and records.


19
FRAUD DETECTION
Internal
Audit function.
General internal controls
Warning signals or fraud risk indicators such as:
Failuresin the internal control procedures.
Inadequate records.

See conditions that increase the risk of fraud and

error).
Whistle blowers/Whistle blowing.
20
FRUAD PREVENTION AND DETECTION

Fraud prevention and detection both have role


to play and it is unlikely that either will fully
succeed without the other. Therefore, it is
important that organisations consider both in
designing an effective strategy to manage the
risk of fraud.

21
RESPONSIBILITY FOR FRAUD PREVENTION AND DETECTION

 Management Responsibility
 It is often said that the responsibility for the prevention and
detection of fraud and errors lies with the ‘directors or
management’ of the company through the implementation
and continued operation of a sound accounting and internal
control systems. This is so because management:
 Is responsible for the day to day business operations;
 Is responsible for the development and implementation of controls
 Has authority over the people, systems, and records; and
 Has the knowledge and authority to make changes.

22
RESPONSIBILITY FOR FRAUD PREVENTION AND DETECTION

Auditor’s Responsibility
It is also said that the auditors’ primary duty is to
express opinion on the truth and fairness of the
financial statements and not to prevent and
detect fraud.
The reality is that both management and the
auditor have roles to play in the prevention and
detection of fraud.
23
RESPONSIBILITY FOR FRAUD PREVENTION AND DETECTION

 The auditor or audit:


 Should take steps to ensure senior management is aware of risk
and materiality of fraud.
 Auditor should plan and perform the audit with an attitude of

professional skepticism.
 Can encourage management to develop Fraud Awareness Training

and a Corporate Fraud Policy to help combat fraud.


 Review and comment on organizational goals so as to reduce

unrealistic performance measures.


 Ultimately, the worst scenario is where management, employees
and internal & external auditors work together to combat fraud.

24
REPORTING FRAUD AND ERROR TO MANAGEMENT

 The auditors should communicate factual findings to


management, the board of directors or audit committee as
soon as practicable if:
 they suspect fraud may exist, even if the potential effect on
the financial statement is immaterial; or
 material error or fraud is actually found to exist.

 If the auditor suspects that members of senior


management, including members of the board of directors
are involved, it may be appropriate to report the matter to
the audit committee.
25
CONDITIONS OR EVENTS WHICH INCREASE THE RISK
OF FRAUD OR ERROR
 The following are examples:
 Management is dominated by one person or a small group
and there is no effective oversight board or committee.
 There is a continuing failure to correct major weaknesses

in internal control when it is feasible.


 There is a significant and prolonged understaffing of the

accounting and finance personnel.


 There is inadequate working capital due to declining

profits or too rapid expansion.

26
CONDITIONS OR EVENTS WHICH INCREASE THE RISK
OF FRAUD OR ERROR
Financial pressure on top managers
The organisation is heavily dependent on one or few

products or customers.
Pressure on accounting personnel to complete

financial statements within a short time.


Inadequate records e.g. incomplete files, excessive

adjustment to books and accounts.


Excessive number of differences between accounting

records and third party confirmations.


27
REVIEW QUESTIONS
 Explain the terms ‘Errors’ and ‘Fraud’
 Explain the reasons for committing fraud and give
examples of each.
 Enumerate 5 types of fraud.
 Identify 5 measures each for preventing and detecting
fraud.
 Certain conditions can increase the risk of error and
fraud. Identify them.

28

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