ISA 240 – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements

1 It’s all about expectations

Fraud is nothing new to business world. We have witnessed enormous scandals but one thing remained the same and that is auditors are expected to find fraudulent activity. The question is are they are really responsible as the duty of preparing true and fair financial statements is of management and thus management is responsible but still as auditor is thought to be investigating the matters (which is not really an investigation) users of financial statements expects from auditor to unearth it.

ISA 240 lays down the requirements on:

  1. fraud in auditing
  2. the responsibility of auditor towards it and
  3. dealing with fraudulent activities if found

2 What is Fraud in audit?

It’s a generic philosophy and can be defined in many ways. But in concise manner we can define fraud as:

Intentional act of misrepresentation

In real world misrepresentation may arise due to number of reasons but auditor is interested in those fraudulent activities that have the potential of causing material misstatements in the financial statements. Therefore in case of independent auditor’s audit engagement the following two acts are considered:

  1. Misstatements in the financial statements arising out of fraudulent reporting
  2. Misstatements in the financial statements arising out of misappropriate of assets

2.1 Are misstatements always caused by fraud?

Misstatements are caused either by fraud or error. The factor that separates the two from each other is whether misstatement is a result of intentional or unintentional action. If it is unintentional then most probably its effects are not that deep and might be a one-off event of misstatement caused by human error, carelessness etc. Although  error or errors may cause material misstatements but it is not always the case.

However, if it is intentional then perpetrator will try to cover it up so that it looks normal and is not easily discovered. In the process of dressing up misstatement as true and fair representation will affect many aspects of financial information and that is why fraud will most probably results in material misstatement.

That is why if material misstatement is identified by the auditor as a result of audit procedures auditor considers if it is due to fraud or error and designs the responses accordingly.