The Global Financial Crisis once again raised the spectre of fraud or misstatement in financial reporting, what does this mean for the auditor and the confidence of end users?

Management is in a unique position to perpetrate fraud because it can override established controls that would appear to be operating effectively. Without limiting the scope, some common examples of fraud and misstatement are:

• revenue recognition issues – these continue to be the number-one reason for restating financial statements
• the manipulation of the financial statements through unauthorised journal entries or other so-called top-side adjustments where revenues are recorded against loan accounts or expenses are capitalised
• intentional misstatement of accounting estimates
• the use of complex business structures and sophisticated transactions especially transactions involving special purpose entities or related parties.

It is well established following the release of Australian Auditing Standard ASA 240 “The Auditor’s Responsibility to Consider Fraud in an Audit of a Financial Report” in 2006 that there is now an increased obligation on the auditor to:

• maintain an attitude of professional scepticism recognising the possibility that a material misstatement due to fraud could exist, and to discuss the susceptibility of the entity’s financial report thereon
• identify and assess the risks of material misstatement due to fraud at the financial report level including the entity’s responses thereon
• obtain representations from management of their knowledge of fraud or suspected fraud affecting the entity’s financial report
• evaluate the design of the entity’s related controls to determine whether they have been implemented
• design and perform audit procedures to respond to the risk of management override of controls.

The expanded requirements and guidance provided in the standard improve the likelihood that auditors will detect material misstatements due to fraud in a financial statement audit. Implementation of the standard’s requirements acts to motivate all team members to think about how and where material fraud might occur, which in turn will lead auditors to be more alert for indications of potential material fraud and to carefully consider whether planned audit procedures appropriately respond to identified fraud risks, including the risk of management override of controls. An increased focus on professional scepticism in gathering and evaluating audit evidence should also lead auditors to further challenge evidence that doesn’t make sense and to obtain additional corroboration of management’s explanations or representations concerning material matters.

The successful completion of the audit, having due regard to the auditing standard, will not guarantee that auditors will detect all material misstatements due to fraud. Fraud often is difficult to detect because it involves concealment through falsification of documents or collusion. It should be noted that it is management, which is responsible for the maintenance of adequate accounting records, internal controls, the selection and application of appropriate accounting policies and the safeguarding of the assets of the entity, the audit can only provide reasonable - not absolute - assurance that the financial report is free of material misstatement.


John Zabala, Queensland
jzabala@moorestephens.com.au