Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes is designed strictly as per the latest syllabus and exam pattern.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Auditing Notes

Question 1.
What do you understand by the term ‘Fraud’? Provide its meaning as given under the Standard on Auditing 240.
Or
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is concerned with fraud that causes a material misstatement in the financial statements. Explain. [RTP-May 18]
Answer:
Meaning and Nature of Fraud:
SA 240 “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” defines the term fraud as “an intentional act by one or more individuals among management, TCWG, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage”

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;
  • misstatements resulting from misappropriation of assets.

Misstatements in the financial statements can arise from either fraud or error, fraud is intentional and error is unintentional.

Question 2.
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. Explain. [MTP-March 2018, Oct. 18, March 19, May 20]
Answer:
Fraud Risk factors:
Fraud, whether fraudulent financial reporting or misappropriation of assets, involves

  • Incentive or pressure to commit fraud: It 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.
  • A perceived opportunity to do so: It 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.
  • Rationalization of the act: Individuals maybe 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. However, even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 3.
“Fraudulent financial reporting involves intentional misstatements including omissions of amounts or disclosures in financial statements to deceive financial statement users.” Discuss. [MTP-Oct.19]
Answer
Fraudulent Financial Reporting:

  • As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” the auditor is concerned with fraud that causes a material misstatement in the financial statements. Misstatement may result from fraudulent financial reporting or from misappropriation of assets.
  • 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:

  • 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.
  • Fraudulent financial reporting often involves management override of controls that otherwise may appear to he operating effectively.

Question 4.
Detection of manipulation of accounts with a view to presenting a false state of affairs is a task requiring great tact and intelligence. Explain stating clearly how this type of fraud is generally committed.: [RTP-Nov. 19]
Answer:
Manipulation of Accounts:
Detection of manipulation of accounts with a view to presenting a false state of affairs is a task requiring great act and intelligence because generally management personnel in higher management cadre are associated with this type of fraud and this is perpetrated in methodical way.

This type of fraud is generally committed:
(a) to avoid incidence of income-tax or other taxes;
(b) for declaring a dividend when there are insufficient profits;
(c) to withhold declaration of dividend even when there is adequate profit (this is often done to manipulate the value of shares in stock market to make it possible for selected persons to acquire shares at a lower cost); and
(d) for receiving higher remuneration where managerial remuneration is payable by reference to profits.

Question 5.
In the course of audit of A Ltd., you suspect that the management has indulged in fraudulent financial reporting? State the possible sources of such fraudulent financial reporting.
Or
Write short note on: Fraudulent Financial Reporting. [Nov. 15 (4 Marks)]
Or
Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively. Explain the techniques used to commit fraud by management overriding controls. [MTP-Oct. 20]
Answer:
Fraudulent Financial Reporting:
As per SA 240 ‘Auditor’s Responsibilities relating to fraud in an audit of financial statements” the auditor is concerned with fraud that causes a material misstatement in the financial statements.
Misstatement may result from fraudulent financial reporting or from misappropriation of assets.

The various ways in which misstatements may be caused from fraudulent financial reporting are:

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

Question 6.
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. Analyse and Explain. [RTP-Nov. 18]
Or
“Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets.” State any three examples of such occurrence of misappropriation of such assets. [Nov. 19 (3 Marks)]
Answer:
Misappropriation of Assets:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” the auditor is concerned with fraud that causes a material misstatement in the financial statements. Misstatement may result from fraudulent financial reporting or from misappropriation of assets.

Inadequate internal control over assets may also increase the susceptibility of misappropriation of those assets. For example, misappropriation of assets may occur because there is the following:

  • Inadequate segregation of duties or independent checks.
  • Inadequate oversight of senior management expenditures, such as travel and other reimbursements
  • Inadequate record keeping with respect to assets.
  • Inadequate system of authorization and approval of transactions [for example, in purchasing),
  • Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
  • Lack of complete and timely reconciliations of assets.
  • Lack of timely and appropriate documentation of transactions, for example, credits for merchandise returns.
  • Lack of mandatory vacations for employees performing key control functions.
  • Inadequate management understanding of information technology, which enables information technology employees to perpetrate a misappropriation.
  • Inadequate access controls over automated records, including controls over and review of computer systems event logs.

Question 7.
Discuss the different ways in which defalcation of cash may take place. [RTP-May 19]
Answer:
Defalcation of cash:
Cash may be defalcated in following ways:
1. Inflating cash payments: by

  • Making payments against fictitious vouchers.
  • Making payments against vouchers, the amounts whereof have been inflated.
  • Manipulating totals of wage by including names of dummy workers in wage rolls.
  • Over casting for petty cash expenditure.

2. Suppressing cash receipts: by

  • Teeming and Lading
  • Adjusting unauthorised rebates, allowances, discounts etc. to customer’ accounts and misappropriating amount paid by them.
  • Writing off as debts in respect of balances against which cash has already been received but has been misappropriated.
  • Not accounting for cash sales fully.
  • Not accounting for miscellaneous receipts e.g. sale of scrap etc.
  • Writing down asset values in entirety, selling them subsequently and misappropriating the proceeds.

3. By casting wrong totals in the cash book.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 8.
There are many ways for cash defalcation, one of which is by suppressing cash receipts. List out few techniques of how the receipts are suppressed.
Or
Saburi Yarns Ltd is engaged in manufacturing and trading of yarns of different types. Its huge amount is locked up in account receivables. Moreover, Management of Saburi Yarns Ltd is worried about its Internal Control system over receipts from account receivables and other receipts. Management wants to understand from you as an auditor few techniques as to how receipts can be suppressed resulting into frauds and finally incurring losses. [RTP-May 18]
Answer:
Suppression of Cash Receipts:
Cash receipts may be suppressed in following ways:

  • Teeming and Lading
  • Adjusting unauthorised rebates, allowances, discounts etc. to customer’ accounts and misappropriating amount paid by them.
  • Writing off as debts in respect of balances against which cash has already been received but has been misappropriated.
  • Not accounting for cash sales fully.
  • Not accounting for miscellaneous receipts e.g. sale of scrap etc.
  • Writing down asset values in entirety, selling them subsequently and misappropriating the proceeds.

Question 9.
The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. Explain. [RTP-Nov. 18]
Answer:
Risk associated for non-detection of material misstatements:
SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” requires that the auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error. SA 240 provides the following in relation to risk associated with non-detection of material misstatements:

  • Owing to inherent limitations of an audit there is unavoidable risk that some material misstatements of the F.S. may not be detected, even though the audit is properly planned and performed in accordance with the SAs.
  • 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.

(a) SA240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” requires that the auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.
(b) Management is in a unique position to perpetrate fraud because of management’s ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls.
(c) When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit.
(d) The auditor should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding his past experience of the honesty and integrity of the entity’s management and those charged with governance
(e) If conditions cause the auditor to believe that a document may not be authentic or that terms in a document have been modified, the auditor shall investigate further.
(f) Where responses to inquiries of management or TCWG are inconsistent, the auditor shall investigate the inconsistencies.
Conclusion: Detection of fraud and error is not the duty of auditor.

Question 11.
Fraud can be committed by management overriding controls using such techniques as engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity. In view of the above-mentioned circumstances of management fraud, explain briefly duties and responsibilities of an auditor in case of material misstatement resulting from such Management Fraud.
Answer:
Auditor’s duties for prevention and detection of fraud:

  • An auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.
  • When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit.
  • The auditor should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding his past experience of the honesty and integrity of the entity’s management and those charged with governance,
  • Unless doubtful situations are present, the auditor may accept records and documents as genuine.
  • If conditions cause the auditor to believe that a document may not be authentic or that terms in a document have been modified, the auditor shall investigate further.
  • Where responses to inquiries of management or TCWG are inconsistent, the auditor shall investigate the inconsistencies.

Procedures when Circumstances Indicate a Possible Misstatement

  • When the auditor encounters circumstances that may indicate that there is a material misstatement in the financial statements resulting from fraud or error, the auditor should perform procedures to determine whether the financial statements are materially misstated.
  • Considering Whether an Identified Misstatement may be Indicative of Fraud
    When the auditor identifies a misstatement, the auditor should consider whether such a misstatement may be indicative of fraud.
  • If there is such an indication, the auditor should consider the implications of the misstatement in relation to other aspects of the audit, particularly the reliability of management representations.

Communication

  • If the auditor has identified a fraud or has indication of fraud, the auditor should communicate that information to management, TCWG and,
  • In some circumstances, when so required by the laws and regulations, to regulatory and enforcement authorities also.

Question 12.
You notice a misstatement resulting from fraud or suspected fraud during the audit and conclude that it is not possible to continue the performance of audit. As a Statutory Auditor, how would you deal?
Or
Explain how would you deal as an auditor if, as a result of a misstatement resulting from fraud or suspected fraud, you encounter exceptional circumstances that bring into question your ability to continue performing the audit. [RTP-May 19, Nov. 20J
Or
As an auditor of PQRLtd., you came across a misstatement resulting from fraud or suspected fraud which brings into question your ability to continue performing the audit. Explain the courses of actions available to you. [Nov. 20 (4 Marks)
Answer:
Auditor Unable to Complete the Engagement:
If the auditor concludes that it is not possible to continue performing the audit as a result of a misstatement resulting from fraud or suspected fraud, the auditor should:

  • consider the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;
  • consider the possibility of withdrawing from the engagement; and
  • if the auditor withdraws:
  • discuss with the appropriate level of management and TCWG, the auditor’s withdrawal from the engagement and the reasons for the withdrawal; and
  • consider whether there is a professional or legal requirement to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s withdrawal from the engagement and the reasons for the withdrawal.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 13.
After the completion of statutory audit of ABC Ltd., a fraud was detected at the office of the auditee. The management of the company alleged that there is a failure on the part of the auditor to detect fraud and that auditor would be responsible for hot detecting fraud in the company. Comment.
Answer:
Auditor’s responsibility for failure to detect Fraud and Errors:
As per SA-240, the responsibility for the prevention and detection of fraud and error rests with management through the implementation of an adequate system of internal control. Such a system reduces but does not eliminate the possibility of fraud and error. Auditor’s responsibility for failure to detect fraud and error can arise only due to proven negligence.

The relevant provisions in this regard are:
(i) In forming his opinion, the auditor carries out procedures designed to obtain evidence that will provide reasonable assurance that the financial information is properly stated in all material respects.

(ii) Due to the inherent limitations of an audit there is a possibility that material misstatements of the financial information resulting from fraud or error may not be detected. An auditor cannot be charged for non-adherence of basic principles in the following circumstances:

  • subsequent discovery of material misstatement of the financial information resulting from fraud or error;
  • failure to disclose the affairs of the company kept out of books and concealed from him.
  • unless it is proved that procedures undertaken by auditor in the circumstances are inadequate and improper.

Thus if a fraud has been detected after the completion of the audit, or some material misstatement has not been reported by auditor, the same by itself cannot mean that the auditor did not perform his duty properly.
If the auditor can prove with the help of his papers [documentation) that he has followed adequate procedures necessary for the proper conduct of an audit, he cannot be held responsible for the same.

Question 14.
Fraud Risk Factors are the events or conditions that indicate an incentive or pressure to commit fraud or provide an opportunity to commit fraud.
Further, the nature of the industry or the entity’s operations also provides opportunities to engage in fraudulent financial reporting. List out some of the cases from where these opportunities may arise.
Answer:
Examples of Fraud Risk Factors (Opportunities) relating to Misstatements arising from fraudulent financial reporting:
The nature of the industry or the entity’s operations provides opportunities to engage in fraudulent financial reporting that can arise from the following:
(a) Significant related-party transactions not in the ordinary course of business.
(b) A strong financial presence or ability to dominate a certain industry sector that allows the entity to dictate terms or conditions to suppliers or customers that may result in inappropriate or non-arm’s-length transactions.
(c) Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate.
(d) Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions.
(e) Significant operations located or conducted across international borders in jurisdictions where differing business environments and cultures exist.
(f) Significant bank accounts or subsidiary or branch operations in tax haven jurisdictions for which there appears to be no clear business justification.

Question 15.
With reference to SA 240 give some examples of circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud.
Answer:
Conditions or Events which increase the risk of fraud or error:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” various conditions or events which increase the risk of fraud or error leading to material misstatements are mentioned below:
1. Discrepancies in the Accounting records: It includes the following:
(a) Transactions that are not recorded in a complete or timely manner or are improperly recorded.
(b) Unsupported or unauthorized balances or transactions.
(c) Last-minute adjustments that significantly affect financial results.
(d) Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.
(e) Tips or complaints to the auditor about alleged fraud.

2. Conflicting or missing evidence: It includes the following:
(a) Missing documents.
(b) Documents that appear to have been altered.
(c) Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.
(d) Significant unexplained items on reconciliations.
(e) Inconsistent responses from management or employees arising from inquiries or analytical procedures.
(f) Unusual discrepancies between the entity’s records and confirmation replies.
(g) Fewer responses to confirmations than anticipated or a greater number of responses than anticipated.

3. Unusual relationship between the auditor and management: It may include the following:
(a) Undue time pressures imposed by management to resolve complex issues.
(b) Complaints by management about the conduct of the audit, particularly in connection with auditor’s critical assessment of audit evidence or in the resolution of potential disagreements with management.
(c) Unusual delays by the entity in providing requested information.
(d) An unwillingness to add or revise disclosures in the financial statements to make them more complete and understandable.
(e) Unwillingness to address identified weaknesses in internal control.

4. Others: It may include the following:
(a) Unwillingness by management to permit the auditor to meet privately with TCWG.
(b) Accounting policies that appear to be at variance with industry norms.
(c) Frequent changes in accounting estimates that do not appear to result from changed circumstances.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 16.
Discrepancies in the accounting records, including transactions that are not recorded in a complete or timely manner or are improperly recorded as to amount, accounting period, classification, or entity policy is one of the examples of circumstances that indicate the possibility of fraud. Explain at least four other such examples relating to discrepancies in the accounting records. [RTP-May 20]
Answer:
Conditions or Events which increase the risk of fraud or error:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” various conditions or events which increase the risk of fraud or error leading to material misstatements are mentioned below:
1. Discrepancies in the Accounting records: It includes the following:
(a) Transactions that are not recorded in a complete or timely manner or are improperly recorded.
(b) Unsupported or unauthorized balances or transactions.
(c) Last-minute adjustments that significantly affect financial results.
(d) Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.
(e) Tips or complaints to the auditor about alleged fraud.

2. Conflicting or missing evidence: It includes the following:
(a) Missing documents.
(b) Documents that appear to have been altered.
(c) Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.
(d) Significant unexplained items on reconciliations.
(e) Inconsistent responses from management or employees arising from inquiries or analytical procedures.
(f) Unusual discrepancies between the entity’s records and confirmation replies.
(g) Fewer responses to confirmations than anticipated or a greater number of responses than anticipated.

3. Unusual relationship between the auditor and management: It may include the following:
(a) Undue time pressures imposed by management to resolve complex issues.
(b) Complaints by management about the conduct of the audit, particularly in connection with auditor’s critical assessment of audit evidence or in the resolution of potential disagreements with management.
(c) Unusual delays by the entity in providing requested information.
(d) An unwillingness to add or revise disclosures in the financial statements to make them more complete and understandable.
(e) Unwillingness to address identified weaknesses in internal control.

4. Others: It may include the following:
(a) Unwillingness by management to permit the auditor to meet privately with TCWG.
(b) Accounting policies that appear to be at variance with industry norms.
(c) Frequent changes in accounting estimates that do not appear to result from changed circumstances.

Question 17.
Write any five circumstances of conflicting or missing evidence that indicate the possibility of fraud. I [Nov. 18 (5 Marks}]
Answer:
Conditions or Events which increase the risk of fraud or error:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” various conditions or events which increase the risk of fraud or error leading to material misstatements are mentioned below:
1. Discrepancies in the Accounting records: It includes the following:
(a) Transactions that are not recorded in a complete or timely manner or are improperly recorded.
(b) Unsupported or unauthorized balances or transactions.
(c) Last-minute adjustments that significantly affect financial results.
(d) Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.
(e) Tips or complaints to the auditor about alleged fraud.

2. Conflicting or missing evidence: It includes the following:
(a) Missing documents.
(b) Documents that appear to have been altered.
(c) Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.
(d) Significant unexplained items on reconciliations.
(e) Inconsistent responses from management or employees arising from inquiries or analytical procedures.
(f) Unusual discrepancies between the entity’s records and confirmation replies.
(g) Fewer responses to confirmations than anticipated or a greater number of responses than anticipated.

3. Unusual relationship between the auditor and management: It may include the following:
(a) Undue time pressures imposed by management to resolve complex issues.
(b) Complaints by management about the conduct of the audit, particularly in connection with auditor’s critical assessment of audit evidence or in the resolution of potential disagreements with management.
(c) Unusual delays by the entity in providing requested information.
(d) An unwillingness to add or revise disclosures in the financial statements to make them more complete and understandable.
(e) Unwillingness to address identified weaknesses in internal control.

4. Others: It may include the following:
(a) Unwillingness by management to permit the auditor to meet privately with TCWG.
(b) Accounting policies that appear to be at variance with industry norms.
(c) Frequent changes in accounting estimates that do not appear to result from changed circumstances.

Question 18.
Write the circumstances that indicate the possibility of fraud due to problematic or unusual relationship between the auditor and management. [MTP-April 19]
Answer:
Conditions or Events which increase the risk of fraud or error:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” various conditions or events which increase the risk of fraud or error leading to material misstatements are mentioned below:
1. Discrepancies in the Accounting records: It includes the following:
(a) Transactions that are not recorded in a complete or timely manner or are improperly recorded.
(b) Unsupported or unauthorized balances or transactions.
(c) Last-minute adjustments that significantly affect financial results.
(d) Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.
(e) Tips or complaints to the auditor about alleged fraud.

2. Conflicting or missing evidence: It includes the following:
(a) Missing documents.
(b) Documents that appear to have been altered.
(c) Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.
(d) Significant unexplained items on reconciliations.
(e) Inconsistent responses from management or employees arising from inquiries or analytical procedures.
(f) Unusual discrepancies between the entity’s records and confirmation replies.
(g) Fewer responses to confirmations than anticipated or a greater number of responses than anticipated.

3. Unusual relationship between the auditor and management: It may include the following:
(a) Undue time pressures imposed by management to resolve complex issues.
(b) Complaints by management about the conduct of the audit, particularly in connection with auditor’s critical assessment of audit evidence or in the resolution of potential disagreements with management.
(c) Unusual delays by the entity in providing requested information.
(d) An unwillingness to add or revise disclosures in the financial statements to make them more complete and understandable.
(e) Unwillingness to address identified weaknesses in internal control.

4. Others: It may include the following:
(a) Unwillingness by management to permit the auditor to meet privately with TCWG.
(b) Accounting policies that appear to be at variance with industry norms.
(c) Frequent changes in accounting estimates that do not appear to result from changed circumstances.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 19.
Auditor of A Ltd. while conducting audit in the course of the performance of his duties as auditor, believes with reasons that “an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed”. Analyse and also explain the manner of reporting the matter to the Central Government. [RTP-May 20]
Or
Explain the manner of Reporting of fraud under Companies Act, 2013.
Or
As per sub-section (12) of section 143 of the Companies Act, 2013, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the
company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed.

In this regard, Rule 13 of the Companies (Audit and Auditors) Rules, 2014 has been prescribed. Sub-rule (1) of the said rule states that if an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ₹ 1 crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government.
Explain the manner of reporting the matter to the Central Government in the above context. [RTP-Nov. 20]
Answer:
Manner of Reporting of Fraud:
Rule 13 of Companies (Audit and Auditors) Rules, 2014 prescribes the manner of Reporting of Frauds as below:
(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ₹ 1 crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the CG.

(2) The auditor shall report the matter to the CG as under:
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than 2 days of his knowledge of the fraud, seeking their reply or observations within 45 days;
(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the CG within 15 days from the date of receipt of such reply or observations;
(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45 days, he shall forward his report to the CG along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations;
(d) the report shall be sent to the Secretary Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;
(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his Membership Number; and
(f) the report shall be in the form of a statement as specified in Form ADT-4.

(3) In case of a fraud involving amount less than ₹ 1 Cr., the auditor shall report the matter to Audit Committee constituted u/s 177 or to the Board immediately but not later than 2 days of his knowledge of the fraud and he shall report the matter specifying the following:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) Parties involved.

(4) The following details of each of the fraud reported to the Audit Committee or the Board under sub-rule (3) during the year shall be disclosed in the Board’s Report:
(a) Nature of fraud with description;
(b) Approximate amount involved;
(c) Parties involved, if remedial action not taken; and
(d) Remedial actions taken.

Question 20.
Intelligent Ltd. entered into an agreement with Mr. Intellectual on 15th March, 2021, whereby it agreed to pay him ₹ 2 lakhs per month as retainer ship fee for consultation in IT department. However, no amount was actually paid and ₹ 24 lakhs were provided in the Statement of Profit and Loss for the year ending on 31st March, 2021.
Management of the company uttered that need-based consultation was obtained throughout the year. However, on investigation, no documentary or other evidence of receipt of such service was found. As the auditor of Innocent Ltd., what would be your approach?
Would your approach be different if the amount involved is ? 1 crore or above?
Answer:
Reporting of Fraud:

  • Sec. 143(12) of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed (Rule 13):
  • Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted u/s 177 or to the Board in other cases within such time and in such manner as may be prescribed:
  • Provided further that the companies, whose auditors have reported frauds under this sub¬section to the audit committee or the Board but not reported to the Central Government, shall disclose the details about such frauds in the Board’s report in such manner as may be prescribed.
  • If the amount of Fraud appears to be of ₹ 24 Lacs, reporting not required to Central Government. However, if the amount involved in the fraud is of ₹ 1 Cr. or above, auditor approach will be different as the reporting is required to Central Government.

Time and Manner of Reporting – Rule 13 of Companies (Audit & Auditor’s) Rules, 2014:
As per SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” various conditions or events which increase the risk of fraud or error leading to material misstatements are mentioned below:

Discrepancies in the Accounting records: It includes the following:
(a) Transactions that are not recorded in a complete or timely manner or are improperly recorded.
(b) Unsupported or unauthorized balances or transactions.
(c) Last-minute adjustments that significantly affect financial results.
(d) Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.
(e) Tips or complaints to the auditor about alleged fraud.

Question 21.
The scope of auditor’s inquiry under clause (xi) of paragraph 3 of Companies (Auditor’s Report) Order is restricted to frauds ‘noticed or reported’ during the year. Explain.
Or
The auditor’s requirement to report under clause (xi) of paragraph 3 of the Companies (Auditor’s Report) Order is restricted to frauds noticed or reported during the year. Explain what auditors may consider for reporting under this clause? [Nov. 20 (3 Marks)]
Answer:
Reporting of Fraud under CARO, 2020:

  • Para 3(xi) of CARO, 2020 requires the auditor to report whether any fraud by the company or any fraud on the Company has been noticed or reported during the year; if yes, the nature and the amount involved is to be indicated.
  • The scope of auditor’s inquiry under this clause is restricted to frauds ‘noticed or reported’ during the year.
  • The use of the words “noticed or reported” indicates that the management of the company should have the knowledge about the frauds.
  • This clause does not relieve the auditor from his responsibility to consider fraud and error in an audit of financial statements. In other words, irrespective of the auditor’s comments under this clause, the auditor is also required to comply with the requirements of SA 240.

The auditor should obtain written representations from management that:

  • it acknowledges its responsibility for the implementation and operation of accounting and internal control systems that are designed to prevent and detect fraud and error;
  • it believes the effects of those uncorrected misstatements in financial statements, aggregated by the auditor during the audit are immaterial, both individually and in the aggregate, to the financial statements taken as a whole. A summary of such items should be included in or attached to the written representation;
  • it has disclosed to the auditor all significant facts relating to any frauds or suspected frauds known to management that may have affected the entity; and
  • it has disclosed to the auditor the results of its assessment of the risk that the financial statements may be materially misstated as a result of fraud.

For reporting under this clause, the auditor may consider the following:

  • This clause requires all frauds noticed or reported duringthe year shall be reported indicating the nature and amount involved. As specified the fraud by the company or on the company by its officers or employees are only covered.
  • Of the frauds covered under section 143 (12) of the Act, only noticed frauds shall be included here and not the suspected frauds.
  • While reporting under this clause with regard to the nature and the amount involved of the frauds noticed or reported, the auditor may also consider the principles of materiality outlined in Standards on Auditing.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Objective Type Questions (True/False, Correct/Incorrect)

Question 1.
While conducting the audit, auditor is concerned with fraud that causes a material misstatement in the financial statement.
Answer:
Statement is True.
SA 240 “The Auditor’s responsibilities relating to Fraud in an audit of Financial Statements” auditor is primarily concerned with two types of intentional misstatements:

  • Misstatements resulting from fraudulent financial reporting.
  • Misstatements resulting from misappropriation of Assets.

Question 2.
The Primary responsibility for the prevention and detection of fraud rests with auditor.
Answer:
Statement is incorrect.

  • As per SA 240 “The Auditor’s responsibilities relating to Fraud in an audit of Financial Statements” the primary responsibility for the prevention and detection of fraud rests with both TCWG and Management.
  • An auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.

Question 3.
Fraud means misappropriation of goods or cash and artificial manipulations of accounts by management.
Answer:
Statement is true, Fraud is an intentional act by one or more individuals among management, TCWG, employees or third parties involving use of deception to obtain and unjust or illegal advantage.

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.
  • misstatements resulting from misappropriation of assets.

Question 4.
Fraud is more difficult to detect than error.
Answer:
Statement is true, fraud is more difficult to detect than error. This is because fraud generally involves sophisticated and carefully organized schemes to conceal it such as forgery, deliberate failure to record transactions, intentional misrepresentations to the auditor.

Question 5.
Fraud can be termed as intentional error.
Answer:
Statement is correct.
SA 240 “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” defines the term fraud as “an intentional act by one or more individuals among management, TCWG, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage”.

Question 6.
Auditor needs to report to Central Government in case of fraud involving 20 lakh rupees.
Answer:
Statement is incorrect.
As per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government (in case amount of fraud is ₹ 1 crore or above) or Audit Committee or Board in other cases (in case the amount of fraud involved is less than ₹ 1 crore) within such time and in such manner as may be prescribed.
Thus, fraud involving amount of 20 lakh rupees should be reported to Audit Committee.

Question 7.
The primary responsibility for prevention and detection of fraud rests with both TCWG and Man¬agement _
Answer:
Statement is correct.

  • As per SA 240 “The Auditor’s responsibilities relating to Fraud in an audit of Financial Statements” the primary responsibility for the prevention and detection of fraud rests with both TCWG and the management.
  • To ensure prevention of fraud, management must have a commitment to create a culture of honesty and ethical behaviour.

Question 8.
Fraudulent financial reporting only involves manipulation, falsification or alteration of accounting records or supporting documents from which financial statements are prepared.
Answer:
Statement is incorrect.
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”,
fraudulent financial reporting may involve

  • manipulation, falsification or alteration of accounting records or supporting documents from which financial statements are prepared,
  • misrepresentation in, or intentional omission from, financial statements of events, transactions or other significant information or
  • Intentional misapplication of accounting principles relating to amounts, classification, manner
    of presentation or disclosure.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 9.
When an Auditor identifies a misstatement resulting from fraud, it is his responsibility to commu¬nicate it to regulatory and enforcement authorities apart from those charged with governance. [May 10 (2 Marks)]
Answer:
Statement is correct.

  • SA 240 “Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” if an auditor identifies a misstatement resulting from fraud, it is his responsibility to communicate it to regulatory authorities and enforcement authorities when so required by the laws and regulations.
  • Sec. 143(12) of Companies Act, 2013 states that if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the CG within such time and in such manner as may be prescribed.

Question 10.
Misappropriation of assets can be accomplished by embezzling receipts.
Answer:
Statement is incorrect.
As per SA 240 “Auditor’s Responsibilities relating to Fraud in an audit of Financial Statements” misappropriation can be accomplished in various ways, for example:

  • Embezzling receipts
  • Stealing physical assets or intellectual property
  • Causing an entity to pay for the goods and services not received.
  • Using an entity’s assets for personal use.

Question 11.
As per SA 240, misstatements in the financial statements can arise from fraud only.
Answer:
Statement is incorrect.

  • As per SA 240 “Auditor’s Responsibilities relating to Fraud in an audit of Financial Statements” misstatements can arise from either error of fraud.
  • Fraud is intentional and error is unintentional.

Question 12.
The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error [MTP-April 19]
Answer:
Statement is correct.
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.

Question 13.
The primary objective of an audit is to detect fraud and error in the financial statements. [Nov. 14 (2 Marks)]
Answer:
Statement is incorrect.

  • Primary objective of an audit is to express an opinion on true and fair view of financial statements.
  • Prevention and detection of fraud is primarily the responsibility of the management.

Question 14.
Teeming and lading is one of the techniques of inflating cash payments. [Nov. 15 (2 Marks), MTP-Oct. 19]
Answer:
Statement is incorrect.
Teeming and Lading is one of the techniques of suppressing cash receipts and not of inflating cash payments.
Money received from one customer is misappropriated and the account is adjusted with the subsequent receipt from another customer and so on.

Question 15.
The auditor has to report to Central Govt, within 90 days of his knowledge of an offence involving fraud. [Nov. 15 (2 Marks)]
Answer:
Statement is Incorrect.

  • Sec. 143(12) of Companies Act, 2013 provides that if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud which involves an amount of ₹ 1 Cr. or above is being or has been committed against the company by officers or employees of the company, he shall report the matter to the CG.
  • Rule 13 of Companies (Audit and Auditor’s) Rules, 2014 provides that auditor shall report to the Board or the Audit Committee immediately but not later than 2 days of his knowledge of fraud, seeking their reply within 45 days.
  • On receipt of reply, he shall forward his report to the Central Government within 15 days from the receipt of such reply.

Question 16.
Fraud against the company shall be reported by the auditor to the Central Government within 45 days of his knowledge. [May 17 (2 Marks)]
Answer:
Statement is incorrect.

  • As per Rule 13 of Companies (Audit & Auditor’s) Rules, 2014, the auditor shall report the fraud to the CG within 15 days of reply received from the Board or Audit Committee, as the case may be.
  • In case auditor does not receive any reply within the stipulated period of 45 days, he shall forward his report to the CG within next 15 days.

Fraud and Responsibilities of the Auditor in this Regard – CA Inter Audit Notes

Question 17.
Misstatements in the financial statements can arise from fraud only. [MTP-March 18, Aug. 18, Oct. 18]
Answer:
Statement is incorrect.

  • 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

Question 18.
Teeming and lading is one of the techniques of suppressing cash receipts. [RTP-May 18]
Answer:
Statement is correct.

  • Teeming and Lading is one of the techniques of suppressing cash receipts.
  • Money received from one customer is misappropriated and the account is adjusted with the subsequent receipt from another customer and so on.

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