Errors
Generally errors are the result of carelessness on the part of the person preparing the accounts. During the course of auditing, errors may be detected, though auditing does not ensure detection of all errors. Errors can be described as unintentional mistakes. Errors can occur at any stage in business transaction processing: transaction occurrence, documentation, record of prime entry, double entry record, summarizing process and financial statement production. Errors can be of any of a multitude of kinds: mathematical or clerical or in the application of accounting principles.
Accounting errors, which are possible to be detected through auditing, can be of the following types:
Errors of Omission
When a transaction is omitted completely or partially from the books of accounts, such errors are known as errors of omission. This type of error is not reflected in the trial balance and hence more difficult to detect.
Example
- Omission of purchases from Purchases Day Book.
- Ignoring depreciation on fixed assets completely.
Errors of Commission
When entries made in the books of original entry or ledger are either wholly or partially incorrect, such errors are known as errors of commission. Some of these errors may not affect trial balance.
Example
- Wrong amount recorded in the books of original entry, e.g. sale of goods of Rs. 15,000 recorded as Rs. 1,500 in Sales Day Book. This error will not affect trial balance.
- Posting to the wrong side of an account. In place of debiting, e.g. an amount of Rs. 150 is credited. This error will affect the trial balance.
Compensating Errors
When an error offsets the effect of another error, such errors are known as compensating errors. These errors do not affect the agreement of the trial balance, hence cannot be located by it.
Example
- A debit balance is undercast by Rs. 100 and credit balance is undercast by the same amount of Rs. 100.
- Sales return of Rs. 500 is posted to the Return Inward A/c as Rs. 5,000 and similarly purchase return of Rs. 500 is posted to the Return Outwards A/c as Rs. 5,000.
Errors of Principles
When principles of book-keeping and accountancy are not followed, such an error is known as errors of principles. Such errors may be committed intentionally to understate asset and to over-state liability and to inflate and deflate profit as and when circumstance dictates.
Example
- Treatment of capital expenditure as revenue expenditure, e.g. purchase of machinery treated as purchase of goods.
- Valuation of stock on the basis of wrong principle.
Fraud
Misstatements in the financial statements can arise either from error or from fraud. The term ‘fraud’ is defined in Standards on Auditing (SA)-240 in the following way: “Fraud refers to an intentional act by one or more individuals among management, those charged with governance or third parties, involving the use of deception to obtain an unjust or illegal advantage”.
In other words, the performance of fraud within an entity is the intentional performance by a person or persons including management, other employee or third party, of an action, other than theft, that derives from the entity a benefit to which the person or persons is/ are not otherwise entitled.
The primary objective of an audit of the financial statements of an entity is to form (and communication to the financial statement users) an opinion on management's assertions inherent in the financial statements. This implies that the audit objective includes the detection of misstatements in management's assertions, irrespective of whether or not the misstatements arise from fraud. Auditors argue, however, that bearing in mind they only examine a selection of transactions and that perpetrators of fraud often conceal their fraud, it is not possible to offer reasonable assurance that an audit will detect misstatements arising from fraud. This argument is reinforced by the fact that:
- Fraud often involves the use of sophisticated techniques, such as printing bogus suppliers' invoices and other stationery.
- An employee involved in fraud will often make fraudulent representations to the auditor.
- The fraud may involve collusion between two or more persons.
- The fraud may be perpetrated by a member of management who unbeknown to the auditor overrides internal control procedures.
Nevertheless, auditors identify and assess the risk of material misstatement due to fraud when planning an audit. To do this, auditors obtain a detailed understanding of the nature of the entity's business, the reporting and supervisory responsibilities within the organisation and the types of fraudulent misstatements that are likely to occur.
Whether or not an auditor is responsible for detecting a specific fraud depends on the circumstances. On the one hand, it depends on the complexity of fraud (the greater the complexity, the lesser the responsibility) and on the other hand, it depends on the adequacy of the auditor's planning, performance and judgement (the lesser the adequacy, the greater the responsibility). In many jurisdictions, the final decision rests with the judiciary.
Therefore, fraud means false representation or entry made intentionally or without belief in its truth with a view to defraud somebody. Detection of fraud is considered to be one of the important duties of an auditor. The term ‘fraud’ is used for several sins including:
- Fraud, which involves the use of deception to obtain an unjust or illegal financial advantage.
- Intentional misstatements in or omissions of amounts or disclosures from an entity's accounting records or financial statements.
- Theft, whether or not accompanied by misstatements of accounting records or financial statements.
The following are the main ways in which fraud may be activated:
Embezzlement of Cash
Defalcation of cash is possible irrespective of the size of the business-small or large. The possibility of the misappropriation of cash is small in a small business organisation, where the proprietor has a direct control over the cash receipts and disbursement. The chances are greater in case of large business organisations. There are different methods of misappropriation of cash defalcation, out of which “Teeming and Lading” procedure is usually followed by the employees involved in the misappropriation of cash.
Misappropriation of Goods
Misappropriation of goods is another type of fraud. It may happen that the valuable goods of an organisation may be stolen by the employees or workers. It may also happen that the storekeeper is in collusion with the works manager may sell the goods illegally to some third party. Such frauds are very difficult to locate or identify.
Manipulation of Accounts
Accounts are manipulated through falsification of accounts. These are fraudulent manipulation through accounts and arise generally through passing of false entries with the motive of misappropriating fund slowly and steadily. Unlike misappropriation of cash and goods, this type of fraud is done by sophisticated personnel of an organisation.
