isa 240 (redrafted) - auditors and fraud _ acca qualification _ students _ acca global

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ISA 240 (REDRAFTED) - AUDITORS AND FRAUD

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ThisarticleexaminesthedefinitionsgivenbyInternationalStandardonAuditing(ISA)240(Redrafted)offraudanderror,andthehistoricalexpectationsoftheauditrole.Italsodefinestheextentofauditorresponsibilitiesforthepreventionanddetectionoffraud,includingtheneedforprofessionalscepticismanddiscussionamongtheengagementteam.ThearticlethensummarisesthekeyriskassessmentproceduresrequiredofauditorsbyISA240(Redrafted),andconcludesthatthetraditionalwatchdognotbloodhoundphilosophyregardingtheextentofauditorresponsibilitiesforfrauddetectionisnolongervalidinthecontextoftherequirementsoftheredraftedISA.

Fraudisahighlycontroversialarea,andtheextentofauditorresponsibilityforthepreventionanddetectionoffraudhasgeneratedconsiderablediscussioninrecentyears.Thisarticleaimstosummarisethecurrentextentofauditorresponsibilitiesforfraud,aspertherequirementsofISA240(Redrafted),TheAuditorsResponsibilitiesRelatingtoFraudinanAuditofFinancialStatements.ISA240(Redrafted)wasissuedinDecember2006andiseffectiveforauditsoffinancialstatementsforperiodsbeginningonorafter15December2008.TheInternationalAuditingandAssuranceStandardsBoard(IAASB)ClarityProjectwaslaunchedin2004inordertoencouragegreateruseofitsstandardsandtofacilitatetheprocessoftranslationofstandardsintootherlanguages.ISA240isdescribedbytheIAASBHandbook(reference1)asredraftedbecauseithasbeenrevisedinthepastfewyearsandisnotinneedoffurtherrevisionbytheClarityProject.Asaresult,theclarifiedversionofISA240isthesameastheredraftedversion.SeetheIAASBHandbook,andthesectionBackgroundInformationontheClarityProjectoftheIAASBforfurtherdetails(reference2).

BACKGROUND

ThetraditionalpassivephilosophytowardsauditorresponsibilityforfrauddetectioniswellsummarisedbytheLordJusticeLopesruling,intheUK,giveninthe1896KingstonCottonMillcase(reKingstonCottonMillCompany(No.2)):Anauditorisnotboundtobeadetective,ortoapproachhisworkwithsuspicion,orwithaforegoneconclusionthatthereissomethingwrong.Heisawatchdog,notabloodhound.(Reference3).WatchdogsandBloodhounds(below)givesformaldefinitionsofawatchdogandabloodhound.

Clearly,auditinghaschangedconsiderablysince1896,althoughauditorresponsibilityforfrauddetectionhasremainedalowpriority.Wenowconsidertherequirementsoftherecentlyrevisedauditstandardregardingtheroleoftheauditorandfrauddetection,andthenformaconclusionaboutthecurrentextentofauditorresponsibilityforfrauddetection.

THEDIFFERENCEBETWEENFRAUDANDERROR

Thekeydistinguishingfactorbetweenfraudanderroriswhethertheunderlyingactionthatresultsinamisstatementofthefinancialstatementsisintentionalorunintentional.Thetermfraudisabroadlegalconcept,buttheauditorisconcernedwithfraudthatcausesamaterialmisstatementinthefinancialstatements.ISA240(Redrafted)definesfraudas:Anintentionalactbyoneormoreindividualsamongmanagement,thosechargedwithgovernance,employees,orthirdparties,involvingtheuseofdeceptiontoobtainanunjustorillegaladvantage.ISA240(Redrafted),paragraph11.

Thetwotypesoffraudmostrelevanttotheauditor,accordingtoISA240(Redrafted),aremisstatementsarisingfromfraudulentfinancialreporting,andmisstatementsarisingfromthemisappropriationofassets.Bywayofcontrasttofraud,thetermerrorreferstoanunintentionalmisstatementinfinancialstatements,includingtheomissionofanamountoradisclosure.ISA240(Redrafted)says:Thedistinguishingfactorbetweenfraudanderroriswhethertheunderlyingactionthatresultsinthemisstatementofthefinancialstatementsisintentionalorunintentional.ISA240(Redrafted),paragraph2.

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Theemphasisofthisarticleisonfraud,becausefraudresponsibilitiesaremorecontroversialthanerror.Fraudmayinvolvesophisticatedandcarefullyorganisedschemes,designedtoconcealfraudulentactivity,suchasforgery,deliberatefailuretorecordtransactions,orintentionalmisrepresentationsbeingmadetotheauditor.However,inordertobetterunderstanderror,moreconsiderationofinternalcontroleffectivenessisrequired.

ISA240(REDRAFTED)ANDRESPONSIBILITIESFORFRAUD

ISA240(Redrafted)makesitclearwhohasthemainresponsibilityforthepreventionanddetectionoffraud:Theprimaryresponsibilityforthepreventionanddetectionoffraudrestswithboththosechargedwithgovernanceoftheentityandmanagement.ISA240(Redrafted)paragraph4.

ISA240(Redrafted)alsogoesontostate,however,that:AnauditorconductinganauditinaccordancewithISAsisresponsibleforobtainingreasonableassurancethatthefinancialstatementsasawholearefreefrommaterialmisstatement,whethercausedbyfraudorerror.ISA240(Redrafted),paragraph5.

Hence,boththeentityitselfandtheauditorshaveresponsibilitiesforfraudanderror.Itcouldbesaidthatmanagement,andthosechargedwithgovernance,havetheprimaryresponsibilityforfraudanderror,whereastheauditorhasasecondaryresponsibility.Itisimportant,however,toensurethattheextentofthesesecondaryresponsibilitiesareclearlyunderstood,whichistheareadiscussedintherestofthisarticle.

PROFESSIONALSCEPTICISM

ISA200(RevisedandRedrafted),OverallObjectiveoftheIndependentAuditorandtheConductofanAuditinAccordancewithISAs,requirestheauditortomaintainanattitudeofprofessionalskepticism:Theauditorshallplanandperformanauditwithprofessionalskepticism,recognisingthatcircumstancesmayexistthatcausethefinancialstatementstobemateriallymisstated.ISA200(RevisedandRedrafted),paragraph15.

ISA200(RevisedandRedrafted)describesprofessionalskepticismas:Anattitudethatincludesaquestioningmind,beingalerttoconditionswhichmayindicatepossiblemisstatementduetoerrororfraud,andacriticalassessmentofauditevidence.ISA200(RevisedandRedrafted),paragraph13(l).

ISA240(Redrafted)furtherrequiresthat:Theauditorisresponsibleformaintaininganattitudeofprofessionalskepticismthroughouttheaudit.ISA240(Redrafted),paragraph8.

Professionalskepticismisofkeyimportancetotheaudit,forexamplerequiringauditorstobealertto:

auditevidencecontradictingotherevidenceinformationquestioningevidencereliabilityconditionsthatmayindicatepossiblefraudcircumstancesthatsuggesttheneedforauditproceduresinadditiontothoserequiredbytheISAs.

DISCUSSIONAMONGTHEENGAGEMENTTEAM

ISA240(Redrafted)referstotherequirementinISA315(Redrafted),IdentifyingandAssessingtheRisksofMaterialMisstatementThroughUnderstandingtheEntityanditsEnvironment,thatmembersoftheengagementteamdiscussthesusceptibilityoftheentitysfinancialstatementstomaterialmisstatementduetofraud.ISA240(Redrafted)requiresthat:Thisdiscussionshallplaceparticularemphasisonhowandwheretheentitysfinancialstatementsmaybesusceptibletomaterialmisstatementduetofraud,includinghowfraudmightoccur.ISA240(Redrafted),paragraph15.

Ordinarily,thekeymembersoftheengagementteamshouldbeinvolvedinthediscussion,andtheengagementpartnershouldthenconsiderwhichmattersaretobecommunicatedtothoseintheteamnotinvolvedinthediscussion.Discussionisexpectedtooccurwithaquestioningmind,settingasideanybeliefsheldbytheengagementteammembersthatthemanagementandthosechargedwithgovernancearehonestandhaveintegrity.Interestingly,thisdiscussionisalsoexpectedtoincludeaconsiderationofhowanelementofunpredictabilitywillbeincorporatedintothenature,timing,andextentoftheauditprocedurestobeperformed.

ISA240(REDRAFTED)RISKASSESSMENTPROCEDURES

ISA240(Redrafted)requiresthattheauditorperformsriskassessmentprocedurestoobtaininformationforuseinidentifyingtherisksofmaterialmisstatementduetofraud.Paragraphs17to24ofISA240(Redrafted)outlinetherequiredriskassessmentprocedures,whicharesummarisedintheRiskAssessmentProceduresboxbelow.

CONCLUSION

TheredraftingofISA240hasallowedforatimelyreviewofauditresponsibilitiesrelatingtofraud.It



Lastupdated:22Sep2014

shouldbenoted,however,thatthereareminordifferencesofemphasisbetweentherequirementsofISA240(Redrafted)andthecurrentrequirementsofISA(UKandIreland)240TheAuditorsResponsibilitytoConsiderFraudinanAuditofFinancialStatements,whichbecameeffectiveforperiodscommencingonorafter15December2004.AccordingtoISA240(Redrafted)thedifferencebetweenfraudanderrordependsuponwhetherdeceptionhasbeenused,andthedistinctionbetweentheresponsibilitiesofthosechargedwithgovernanceandauditorsforfraudpreventioncanbedescribedrespectivelyasprimaryandsecondaryresponsibilities.Auditorsarerequired,however,tomaintainanattitudeofprofessionalskepticismthroughouttheaudit,andmembersoftheauditengagementteamarerequiredtodiscussthesusceptibilityoftheentitysfinancialstatementstomaterialmisstatementduetofraud.

ISA240(Redrafted)requiresauditorstoperformriskassessmentprocedurestoobtaininformationforuseinidentifyingtherisksofmaterialmisstatementduetofraud.

Finally,itcanbeconcludedthattodescribetheauditroleasthatofawatchdog,notabloodhoundisnolongervalidinthecontextoftherequirementsoftheredraftedandrevisedISAsthesenegatethetraditionalpassivephilosophytowardsauditorresponsibilityforfrauddetection,markingasignificantshiftawayfromamonitoringroleandtowardstherequirementforaverykeensenseofsmell.

WrittenbyaPaperF8exampanelmember

REFERENCES

1. HandbookofInternationalAuditing,Assurance,andEthicsPronouncements,PartII,IAASB,2008Edition.2. BackgroundInformationontheClarityProjectoftheInternationalAuditingandAssuranceStandardBoard,2008

Edition,pages1to4,inPartIIofHandbookofInternationalAuditing,Assurance,andEthicsPronouncements,IAASB,2008Edition.

3. LordJusticeLopes,TheLawTimes,VolumeLXXIV,CourtofAppeal,11July1896,quotedinSarupD,WatchdogorBloodhound?ThePushandPullTowardsaNewAuditModel,InformationSystemsControlJournal,Volume1,2004.

4.OxfordEnglishDictionary,www.askoxford.com

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