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    SA 240 - The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements

    Introduction

    The auditor is responsible to obtain reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether due to fraud or error. However, due to inherent limitations of an audit, there will be an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the standards. 

    The potential effects of inherent limitations are particularly significant in the case of misstatements resulting from fraud. The risk of not detecting a material misstatement resulting from fraud is higher than risk of not detecting one 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 auditor. 

    SA 240 along with SA 315 are designed to assist the auditor in identifying and assessing the risks of material misstatement due to fraud and in designing procedures to detect such misstatement. 

    With reference to the Fraud the objectives of the auditor are: 

    Toidentify and assess the risks of material misstatement in the financial statement due to fraud vToobtain sufficient appropriate audit evidence about the assessed risks of material 

    misstatement in the financial statements due to fraud

    Torespond appropriately to identified or suspected fraud 

    Related Definitions 

    1. Fraud: An intentional act done by management, those charged with governance, employees (or) third parties, using deception technique, to obtain illegal advantage over the assets of the company. 
    1. Fraud Risk Factor: Events or conditions that motivates or pressurizes to commit fraud (or) provide an opportunity to commit fraud. 
    1. Those charged with Governance: The persons or organizations with responsibility for overseeing the strategic directions of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process. 
    1. Management: Those persons with executive responsibility are termed as management. 

    Types of Fraud

    Types of Fraud 

    Misappropriation of assets 

    Ex: Using company assets Fraudulent Financial Reporting for private purpose 

    • The responsibility for prevention and detection of fraud rests with those charged with Governance and management. 
    • Those charged with governance and management should take necessary preventive steps to prevent fraud. This requires a commitment i.e., to create honesty among employees and ethical behaviour which can be reinforced. 

    Requirements from auditor by SA 240 

    Professional Skepticism 

    • The auditor is responsible for maintaining a professional skepticism throughout the audit in accordance with SA 200, recognizing the possibility that a material misstatement due to fraud could exist.
    • Unless the auditor has reason to believe the contrary, he may accept records and documents as genuine.
    • If he believes that the documents are not authentic or terms in the documents are modified or not disclosed to auditor, then he shall investigate further. He shall inquire with the management and if there are inconsistencies, he shall investigate the inconsistencies. 

    Discussion among the Engagement Team: Auditor (Engagement Partner) shall discuss among the engagement team members, on how and where the entity’s financial statements may be susceptible to material misstatement due to fraud, including how fraud might occur. 

    RiskAssessment Procedures and Related Activities: 

    To obtain an understanding of the entity and its environment, including the entity’s internal controls as required by SA 315 the auditor shall perform the following procedures to obtain information which can be used to identify the risk of material misstatement due to fraud 

    1. Enquiring Management and Others within the Entity: The auditor shall make inquiries of management regarding:
    • Management’s assessment of the risk of material misstatement due to fraud
      • Management’s process for identifying & responding to the risks of fraud in the entity
      • Management’s communication, if any, to those charged with governance, and 
    • Management’s communication, if any, to employees regarding its views on business practices and ethical behaviour
    1. Enquiring those charged with governance 
    • He shall obtain an understanding of how those charged with governance supervise management’s processes. 
    • The auditor shall ask those charged with governance whether they have knowledge of any fraud affecting the entity. 
    1. Unusual or Unexpected Relationships Identified 
    • The auditor shall evaluate whether unusual or unexpected relationship identified in performing analytical procedures.
    • It may indicate risks of material misstatements due to fraud 
    1. Other Information: The auditor shall consider whether any other information obtained by the auditor indicates risks of material misstatements due to fraud 
    1. Evaluation of Fraud Risks Factors 
    • The auditor shall evaluate whether the information obtained, indicated that one or more fraud risk factors are present. 
    • However, fraud risk factor may not necessarily indicate existence of fraud 

    Identification and assessment of the risk of material misstatement due to fraud

    As per SA 315, the auditor shall identify and assess the risks of material misstatement due to fraud at the financial statement level for reporting and at the assertion level for the classes of transactions, account balances and disclosures. 

    In case of revenue recognition area, auditor shall conduct audit based on presumption that there are risks of fraud in revenue recognition. In case the auditor concludes that the presumption is not applicable and accordingly has not identified risk of fraud, he shall document the matter. 

    Conclusion: 

    The auditor is required to identify the risk of material misstatement due to fraud by meeting the requirement of SA 240 and in case the auditor has identified any risk of material misstatement due to fraud, he shall respond to such assessed risk in accordance with SA 330. 

    Further, it shall be noted that inspite of performing duties by Auditor in accordance with all applicable standards and procedures, there will be a potential for not identifying few material misstatements which is unavoidable risk. Hence the auditor cannot give absolute assurance, just he can give a reasonable assurance.

     

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