Back Auditor doesn't guarantee the detection of frauds
M. V. Kali Prasad
| M. V. Kali Prasad suggests answers to the November 2004 CA (PE II) paper on auditing |
Audit is an independent examination of the books of account to form and express an opinion whether the financial statements extracted from them show a true and fair view of the state of affairs of the entity. The very definition takes away the responsibility from the auditor to detect frauds and errors. The audit programme is drafted by an auditor with a view to forming an opinion upon the financial statements and not for unearthing of frauds and errors.
Audit procedures are not aimed at detecting frauds or errors. Hence, the procedures are ineffective for detecting an intentional misstatement concealed cleverly by collusion or otherwise by the employees, management or those charged with governance. Therefore, an auditor does not guarantee the detection of all misstatements, either due to fraud or error.
Any misstatement remaining undetected even after the audit is completed does not indicate: Lapses on the part of an auditor; inadequate planning, performance or judgment; absence of professional competence; failure to obtain reasonable assurance; and failure to comply with auditing and assurance standards.
The adequacy of audit procedures in the given circumstances and the suitability of his report based on results of such procedures is the test to determine whether the audit was conducted as per the auditing standards generally accepted in India.
AAS 2 requires the auditor to probe the matter further if he comes across a situation to arouse his suspicion of the existence of a fraud, so as to confirm or dispel it. It implies that the auditor has to be on the look out for such triggers.
The auditor should discuss the possibility of misstatements with his staff at the planning stage itself. Based on past experience and in the context of the particular entity, the team should understand the possibility of misstatements in specific areas and should develop strategies to tackle them. Nature and extent of audit procedures to be carried out and sharing of the results should be well thought of and properly documented.
The auditor should supplement his knowledge of the business with knowledge from discussions with the management about the management's assessment of risk of material misstatements and the control measures taken by them to prevent them.
The auditor should find out how well the management is discharging its responsibilities of accounting and preparation of financial statements. The following matters may be discussed:
The perception of management about the frauds and errors is significant to an auditor. The frequency and the seriousness with which the high-risk areas are perceived by the management indicate how much importance is attributed to them. The management designs accounting and internal control systems keeping in mind the nature and risk they are willing to assume.
Enquiries in these areas help the auditor to determine the risk of misstatements existing in financial statements. The auditor should also enquire of the frauds and errors in the past and how they have been dealt with. Such enquiries help auditors to determine the possibility of misstatements, the management's perception of such frauds and errors and the efficiency of the control systems to detect them. Such enquiries help the auditor to guard himself against employee frauds only. Information on management frauds is unlikely to come out in such enquiries.
Those charged with governance have overall responsibility for systems for monitoring risk, financial control and compliance with law. In case of entities with well-developed corporate governance practices, the auditor should enquire of those charged with governance about the risk of frauds and errors and the adequacy of controls to prevent and detect them. He should also enquire about the competence and integrity of the management.
Such enquiries give an insight to the auditor about the susceptibility of the management fraud. Eliciting individual views of the directors might prove useful.
The following should be discussed with those charged with governance:
Nature, extent and frequency of management's assessment of accounting and control systems to prevent and detect frauds and errors.
Management's reactions to weaknesses in internal control systems identified by internal audit or during a prior period audit.
The entity's control environment and the competence and integrity of management.
The auditor should develop his overall plan based upon his findings during these enquiries, incorporating therein, the procedures he would consider necessary to guard himself against the possibility of material misstatements.
The auditor is under no professional obligation to report frauds or errors to regulatory authorities, except as required specifically by law (such as the IRDA or NBFC) — AAS21.
The auditor should use his judgment to decide whether or not he is required to communicate with the regulatory authorities based on specific circumstances.
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