Auditors need to Identify & Respond to Financial Statement By Fraud

August 9, 2023

Cases of financial fraud continue to plague the world’s economy and cause significant losses to businesses and the economy. According to the Association of Certified Fraud Examiners, financial statement fraud represented the least common (9%) but most costly source of financial damage in 2022, amounting to a median loss of $593,000.

In addition to financial statement misrepresentations to enhance earnings or to misappropriate assets, tax liability management can be a driving factor behind financial statement fraud, as parties artificially distort their income—whether by manipulation, misrepresentation, or evasion—to reduce their tax obligations.

This interplay between tax reporting and financial statement fraud underscores the importance of robust internal controls, diligent auditing practices, and effective regulatory oversight to detect and prevent fraudulent activities. External auditors play a vital role in the financial reporting framework.

Fraud—in any form—carries a reputational and regulatory risk for companies and audit/advisory firms that exceeds potential gains. As we have seen in the press recently, for professional services firms that includes leaking confidential data obtained from one client to benefit the firm.

Auditors’ Professional Responsibilities

External auditors must identify and respond to the risk of material misstatement in financial statements due to fraud. The external audit of financial statements has been found to reduce median loss of fraud by 33%.

The key professional standards relating to the auditor’s responsibilities are American Institute of Certified Public Accountants AU-C Section 240 and International Standard on Auditing 240. While there may be some differences based on region and terminology, both largely define financial statement fraud as intentional acts of deception, misrepresentation, or omission that lead to material misstatements in financial statements or asset misappropriation.

Each emphasizes the importance of auditors maintaining professional skepticism, exercising professional judgment, and obtaining sufficient evidence to ensure that financial statements are free from material misstatement caused by fraud or error. Together, they state that auditors are required to consider management override of controls, communicate suspected or identified fraud cases to governance bodies and management, and obtain written representations from management regarding knowledge of fraud or suspected fraud.

Continued… Click here for Read more