Concideration of fraud in an audit - Research Paper Example

Consideration of Fraud in an Audit INTRODUCTION: The corporate world has recently faced large corporate scandals. These relate to fraudulent activities in an organization which had caused losses of billions of dollars to public. Such scandals include Enron, WorldCom, and Tyco International etc. These scandals have raised concerns and responsibilities of the accounting and auditing bodies all over the world which are now subject to thorough scrutiny. The auditors now owe greater responsibility towards general public and are considered as the savior of their investments. FRAUD Fraud is a word used in broader concepts and approaches. It basically refers to any illegal action characterized by deceit and concealment which isn’t conducted under any violence, force or threat. The aim of every fraudulent activity is an undue advantage which could be institutional or personal. (Flostoiu.2012) Characteristics of Fraud: Fraud results in victim that loses a benefit because of the criminal’s fraud. It is represented by a series of illegal actions and irregularities which are all planned with the intention to deceive. Fraud is also referred to activities which involve concealment of information that was to be revealed by an obligation and intended omission of certain information or documents including misstatements and misrepresentation of information. Fraud also includes falsification of financial situations, corruption and theft. It is always important to distinguish between a fraud and error. The results of both error and fraud could be the same, but fraud is committed intentionally while error happens unintentionally. (Flostoiu.2012) Fraud Triangle Theory: A fraud triangle is a model which discloses the factors found in fraudsters at all levels of organization. This theory researched about the factors that force honest people to commit fraud. These factors could be summed as Pressure/Incentive, Opportunity and Rationalization that put an individual in a position to conduct fraud. (Dorminey, Scott, Kranacher & Riley. 2010) In a Fraud Triangle pressure refers to situations that put mental pressure/incentive on an individual which forces him to commit fraud. These situations could include excessive credit card debts, gambling debts, extended unemployment, family or peer pressures, unbearable expenditures and financial difficulties etc. For an auditor, pressure is difficult to identify in a fraudster as there is no personal interaction with him. (Dorminey, Scott, Kranacher & Riley. 2010) Opportunity as the word suggests, is an instance where the fraudster finds a loophole in the controls which prevent fraud. An employee usually finds a chance where he can commit fraud without being detected. This opportunity for an employee can arise from weak internal controls and inability of frauds being detected, lack of training, weak ethical culture where honesty in doing business isn’t considered a priority and lack of supervision etc. Most opportunities arising situations for fraud include lack of internal controls like segregation of duties not being implemented properly. (Dorminey, Scott, Kranacher & Riley. 2010) Rationalization refers to that state of mind where the fraudster convinces himself that whatever fraud he has committed was either not wrong or even it was wrong it an be corrected later on by returning the money or compensating for it. Another state of rationalization is found when a fraudster convinces himself that he deserves the stolen money. The reason for this rationalization could be the unfair treatment in the organization like a recent promotion or increment not being offered which forces him to believe that has been victimized. (Kassem, Rasha, & Higson, Andrew. 2012) Recent researchers have extended the Fraud Triangle and added a fourth factor to the triangle making it as a diamond. This factor is the capability of the fraudster to conduct fraud. Capabilities include the traits of the fraudster i.e. in presence of the three factors of fraud triangle his capabilities would be sufficient to conduct fraud. This factor was introduced as it was argued that many billion dollars fraud wouldn’t have taken place if the right capability wasn’t possessed by the fraudster like a technical accounting misstatement which no one was able to detect in the financial statement normally. (Kassem, Rasha, & Higson, Andrew. 2012) PREVENTIVE INTERNAL CONTROL MEASURES AND ACTIONS AGAINST FRAUD: Prevention and detection of fraud in an organization should be embedded in an organization’s culture and shouldn’t be considered as a separate activity. There should be internal controls which help in the timely prevention and detection of fraudulent activities. The controls in an organization can be categorized as detective or preventive. Detective controls are ones which are designed to detect an error, misstatement or fraud in an organization. These are important where there are weak procedures and no preventive controls. These include comparing budgets to actual, monitoring performance etc. The preventive controls are the ones that become part of the processes. They are designed to detect an error, misstatement or fraud before the process starts, in this way preventive controls are considered more effective than the detective controls. Whether a control is detective or preventive that depends on the activity that is to be protected against fraud. (Hightower. 2009) The companies need to understand the importance and appropriateness of internal controls. There are certain controls which can help in the prevention and detection of error, misstatement or fraud in an organization. For these controls commitment from the organization’s top management is needed and there should be a clear understanding of policies and procedures at all levels of organization. The internal controls in an organization should include segregation of duties. This is an important control that separates the duties and people of one controlling certain processes and the ones keeping record for it. Segregation of duties limits the opportunities for employees to commit frauds; however collusion among employees can override this control. Whistleblowers policy and hotlines should be understood and implemented at all levels and the employee should feel secure enough to report a fraudulent activity in the organization. The organization should also encourage job rotations and mandatory employee vacations. Once a fraud is conducted a person would want to stay to conceal it which can be detected by job rotation or vacations. It also helps in creating backup staff if someone leaves or is unavailable. There should be proper supervision of employees which could prevent fraudulent activities as there would be someone to monitor them. Lastly, there should be a limit set on the access to information; a person should only be allowed access to information and data that is needed to get his job done. In this way unauthorized access can be blocked which will help in prevention of fraud. (Bartlett. 2012) FRAUD IN AN AUDIT Audit is an independent examination of financial statements which is conducted with an aim to give a true and fair view about the integrity of the financial statements. There are various cases of fraud in the companies that relate to fraudulent activities and its misstatement in the financial statements which has caused losses of billions of dollars to the companies. Therefore, it is important for an auditor to consider the potential of frauds and misstatements in the financial statements. (Gramling, Rittenberg & Johnstone. 2010) The misstatements that can occur in financial statements are of two type; first being misstatements arising from fraudulent financial reporting which are intentional misstatements or omissions made in the financial statements to deceive the users of those financial statements. This type of fraud can specifically include manipulation and alteration in the financial records documents, misrepresentation or intentional omission of transactions and events from financial statements and intentional misapplication of accounting standards and principles. The second type of fraud found in the financial statements is the misstatement arising from the misappropriation of assets which includes theft of an asset that causes the financial statements to be materially misstated. This type of fraud can specifically include activities like embezzling receipts, causing entity to pay for personal things, theft of an asset etc. All such fraudulent activities are done by circumventing internal controls and results in misleading financial statements. (Gramling, Rittenberg & Johnstone. 2010) The auditors are required to prevent and detect frauds in an organization. An effective audit function would prevent financial statements through effective and adequate internal control system, performing audit by appropriate functions and procedures and reporting of detected frauds to highest appropriate authority. The auditors should conduct a risk assessment process in the organization in order to identify areas of high risk where there is more potential for fraud to be conducted. During the process the auditor should also keep an eye on the weaknesses in the internal control procedures that he discovers during the audit; these weaknesses should be communicated to the upper management for a sound control system to be implemented in the organization. (Lou,Wang. 2009) CONCLUSION The companies are now in greater pressure by the regulatory authorities to prevent frauds like those occurred in the past. Frauds are the results of weak internal control system in an organization which are unable to detect and prevent fraud and error on a timely basis. There is a continuous need to install systems, policies and procedures that provide a support system against any fraudulent activity in an organization. On the other hand, the auditors (both internal and external) are required to conduct quality audits which involve thorough audit planning, risk assessment at all levels and effective test of controls. Since the auditors are seen as the protectors of shareholder’s investment, they should fulfill their responsibilities effectively and independently with professional skepticism. References Hightower, R. (2009). Internal controls policies and procedures. Hoboken, N.J: Wiley. Kassem, Rasha, & Higson, Andrew W. (2012). The new fraud triangle model. 191.) © Scholarlink Research Institute Journals. Dorminey, J. W., Scott, F. A., Kranacher, M.-J., & Riley, J. R. A. (January 01, 2010). Crimes Beyond the Fraud Triangle: Enhancing Deterrence of Economic. The Cpa Journal, 80, 7, 16. Lou, Y. I., Wang, M.L. (2009). Fraud Risk Factor of the Fraud Triangle Assessing the Likelihood of Fraudulent Financial Reporting. Journal of Business and Economic Research, 7, 2. Bartlett, M. (January 30, 2012). The Fraud Triangle: What to do About Problems That Begins at Home. Credit Union Journal, 16. Flostoiu. S. (2012). The Relationship between Internal Audit and Fraud. Buletin Stiintific, 24-28. Gramling, A. A., Rittenberg, L. E., & Johnstone, K. M. (2010). Auditing. Australia: South-Western Cengage Learning. Read More