HKSA 240, The Auditors Responsibility to Consider Fraud in an Audit of Financial Statements !

ssue"
The important issue of HKAS 240 should be Risk Assessment Procedure,

identification and assessment risk with response Para!raph "0 is a critical issue as re#enue is almost the most si!nificant risk of fraud The e$ample in Appendi$ 2 % Specific Responses from &raudulent &inancial Statement with Re#enue reco!nition, 'n#entor( )uantities and *ana!ement +stimate should be look at The e$ample in Appendi$ , % -ircumstances that indicate the Possibilit( of &raud is a important checklist

CONTENTS
Paragraphs Introduction ....................................................................................................................... 1-3 Characteristics of Fraud..................................................................................................... 4-12 Responsibilities of Those Charged With o!ernance and of "anage#ent...................... 13-1$ Inherent %i#itations of an &udit in the Conte't of Fraud ................................................... 1(-2) Responsibilities of the &uditor for *etecting "aterial "isstate#ent *ue to Fraud............ 21-22 Professional +,epticis#.................................................................................................... 23- 2$ *iscussion &#ong the -ngage#ent Tea#........................................................................ 2(32 Risk Assessment Procedures........................................................................................ 33-.$ Identification and &ssess#ent of the Ris,s of "aterial "isstate#ent *ue to Fraud......... .(-$) Responses to the Ris,s of "aterial "isstate#ent *ue to Fraud....................................... $1-/2 Evaluation of Audit Evidence.......................................................................................... /3/0 "anage#ent Representations........................................................................................... 0)-02 Co##unications With "anage#ent and Those Charged With 1)1 Co##unications to Regulator1 and -nforce#ent &uthorities................................ 1)22 112124 &uditor 3nable to Continue the -ngage#ent............................................................... 1)3-1)$ *ocu#entation.............................................................................................................. 1)(-111 &ppendi' 14 -'a#ples of Fraud Ris, Factors Appendi# 2" $#amples of %ossible Audit %rocedures to Address the Assessed Ris&s of o!ernance................... 03-

'aterial 'isstatement (ue to Fraud Appendi# )" $#amples of Circumstances that !ndicate the %ossibility of Fraud

HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
A, !ntroduction This standard.
/ a b 2. (istin-uishes fraud from error and describes the two t(pes of fraud that are rele#ant to the auditor, that is, misstatements resultin! from misappropriation of assets and misstatements resultin! from fraudulent financial reportin-0 Re.uires the auditor to maintain an attitude of professional skepticism reco!ni1in! the possibilit( that a material misstatement due to fraud could e$ist, notwithstandin! the auditor2s past e$perience with the entit( about the honest( and inte!rit( of mana!ement and those char!ed with !o#ernance0 , Re.uires members of the en-a-ement team to discuss the susceptibilit( of the entit(2s financial statements to material misstatement due to fraud and re)uires the en!a!ement partner to consider which matters are to be communicated to members of the en!a!ement team not in#ol#ed in the discussion0 4 Re.uires the auditor to. a Perform procedures to obtain information that is used to identif( the risks of material misstatement due to fraud0 b 'dentif( and assess the risks of material misstatement due to fraud at the financial statement le#el and the assertion le#el0 and for those assessed risks that could result in a material misstatement due to fraud0 c 3etermine o#erall responses to address the risks of material misstatement due to fraud at the financial statement le#el0 d 3esi!n and perform audit procedures to respond to the risk of mana!ement o#erride of controls0 e 3etermine responses to address the assessed risks of material misstatement due to fraud0 f -onsider whether an identified misstatement ma( be indicati#e of fraud0 ! 4btain written representations from mana!ement relatin! to fraud0 and h -ommunicate with mana!ement and those char!ed with !o#ernance0 i Pro#ides !uidance on communications with re!ulator( and enforcement authorities0

5 Pro#ides !uidance if, as a result of a misstatement resultin! from fraud or suspected fraud, the auditor encounters e$ceptional circumstances that brin! into )uestion the auditor2s abilit( to continue performin! the audit0 and k +stablishes documentation re)uirements

HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
Introduction This standard.
'n plannin! and performin! the audit to reduce audit risk to an acceptabl( low le#el, the auditor should consider the risks of material misstatements in the financial statements due to fraud

/, Characteristics of Fraud
*isstatements in the financial statements can arise from fraud or error The distin!uishin! factor between fraud and error is whether the underl(in! action that results in the misstatement of the financial statements is intentional or unintentional T5o t1pes of intentional #isstate#ents are rele!ant to the auditor2 that is2 #isstate#ents resulting fro# fraudulent financial reporting and #isstate#ents resulting fro# #isappropriation of assets. 0, Fraudulent financial reportin- in#ol#es intentional misstatements includin! omissions of amounts or disclosures in financial statements to decei#e financial statement users &raudulent financial reportin! often in#ol#es mana!ement o#erride of controls that otherwise ma( appear to be operatin! effecti#el( &raud can be committed b( mana-ement o1erridin- controls usin! such techni)ues as. 6 Recordin! fictitious 5ournal entries, particularl( close to the end of an accountin! period, to manipulate operatin! results or achie#e other ob5ecti#es0 6 'nappropriatel( ad5ustin! assumptions and chan!in! 5ud!ments used to estimate account balances0 6 4mittin!, ad#ancin! or dela(in! reco!nition in the financial statements of e#ents and transactions that ha#e occurred durin! the reportin! period0 6 -oncealin!, or not disclosin!, facts that could affect the amounts recorded in the financial statements0 6 +n!a!in! in comple$ transactions that are structured to misrepresent the financial position or financial performance of the entit(0 and

6 Alterin! records and terms related to si!nificant and unusual transactions +$ample 7 &raudulent financial reportin! can be caused b( the efforts of mana!ement to mana!e earnin!s in order to decei#e financial statement users b( influencin! their perceptions as to the entit(2s performance and profitabilit(

HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
2, 'isappropriation of assets in#ol#es the theft of an entit(2s assets and is often perpetrated b( emplo(ees in relati#el( small and immaterial amounts *isappropriation of assets can be accomplished in a #ariet( of wa(s includin!. 6 +mbe11lin! receipts 8for e$ample, misappropriatin! collections on accounts recei#able or di#ertin! receipts in respect of written7off accounts to personal bank accounts90 6 Stealin! ph(sical assets or intellectual propert( 8for e$ample, stealin! in#entor( for personal use or for sale, stealin! scrap for resale, colludin! with a competitor b( disclosin! technolo!ical data in return for pa(ment90 6 -ausin! an entit( to pa( for !oods and ser#ices not recei#ed 8for e$ample, pa(ments to fictitious #endors, kickbacks paid b( #endors to the entit(2s purchasin! a!ents in return for inflatin! prices, pa(ments to fictitious emplo(ees90 and 6 :sin! an entit(2s assets for personal use 8for e$ample, usin! the entit(2s assets as collateral for a personal loan or a loan to a related part(9 *isappropriation of assets is often accompanied b( false or misleadin! records or documents in order to conceal the fact that the assets are missin! or ha#e been pled!ed without proper authori1ation &raud in#ol#es incenti#e or pressure to commit fraud, a percei#ed opportunit( to do so and some rationali1ation of the act a, Fraudulent financial reportin- ma( be committed because mana-ement is under pressure, from sources outside or inside the entit(, to achie#e an e$pected 8and perhaps unrealistic9 earnin!s tar!et % particularl( since the conse)uences to mana!ement for failin! to meet financial !oals can be si!nificant b A percei1ed opportunity for fraudulent financial reportin! or misappropriation of assets ma( e$ist when an indi#idual belie#es internal control can be o#erridden, for e$ample, because the indi#idual is in a position of trust or has knowled!e of specific weaknesses in internal control

c 'ndi#iduals ma( be able to rationali2e committin! a fraudulent act Some indi#iduals possess an attitude, character or set of ethical #alues that allow them knowin!l( and intentionall( to commit a dishonest act

HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
C, %rofessional S&epticism 3Audit %rocedure4
Paragraph 24 The auditor should maintain an attitude of professional skepticism throu!hout the audit, reco!ni1in! the possibilit( that a material misstatement due to fraud could e$ist, notwithstandin! the auditor2s past e$perience with the entit(

(, (iscussion amon- the $n-a-ement Team 3Audit %rocedure4

Para!raph 2; *embers of the en!a!ement team should discuss the susceptibilit( of the entit(2s financial statements to material misstatement due to fraud Para!raph 2< The en!a!ement partner should consider which matters are to be communicated to members of the en!a!ement team not in#ol#ed in the discussion

$, Ris& Assessment %rocedures 3Audit %rocedure4

Para!raph ,, As re.uired by HKSA )05, to obtain an understandin! of the entit( and its en#ironment, includin! its internal control, the auditor performs risk assessment procedures As part of this work the auditor performs the follo6in- procedures to obtain information that is used to identif( the risks of material misstatement due to fraud. 8a9 *akes in)uiries of mana!ement, of those char!ed with !o#ernance, and of others within the entit( as appropriate and obtains an understandin! of how those char!ed with !o#ernance e$ercise o#ersi!ht of mana!ement2s processes for identif(in! and respondin! to the risks of fraud and the internal control that mana!ement has established to miti!ate these risks 6b7 Considers 5hether one or #ore fraud ris, factors are present. 6c7 Considers an1 unusual or une'pected relationships that ha!e been identified in perfor#ing anal1tical procedures. 6d7 Considers other infor#ation that #a1 be helpful in identif1ing the ris,s of #aterial

#isstate#ent due to fraud.

0, HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
F. Inquiries and O tainin! an "nderstandin! of Oversi!#t E$ercised % T#ose C#ar!ed &it# 'overnance (Audit Procedure) ,4 =hen obtainin! an understandin! of the entit( and its en#ironment, includin! its internal control, the auditor should make in)uiries of mana!ement re!ardin!. 8a9 *ana!ement2s assessment of the risk that the financial statements ma( be materiall( misstated due to fraud0 8b9 *ana!ement2s process for identif(in! and respondin! to the risks of fraud in the entit(, ,> The auditor should make in)uiries of mana!ement, internal audit, and others within the entit( as appropriate, to determine whether the( ha#e knowled!e of an( actual, suspected or alle!ed fraud affectin! the entit( 43. The auditor should obtain an understanding of ho5 those charged 5ith go!ernance e'ercise o!ersight of #anage#ent8s processes for identif1ing and responding to the ris,s of fraud in the entit1 and the internal control that #anage#ent has established to #itigate these ris,s. 4$. The auditor should #a,e in9uiries of those charged 5ith go!ernance to deter#ine 5hether the1 ha!e ,no5ledge of an1 actual2 suspected or alleged fraud affecting the entit1. '. Risks of Fraud in Revenue Reco!nition (Audit Procedure) $). "aterial #isstate#ents due to fraudulent financial reporting often result fro# an o!erstate#ent of re!enues 6for e'a#ple2 through pre#ature re!enue recognition or recording fictitious re!enues7 or an understate#ent of re!enues 6for e'a#ple2 through i#properl1 shifting re!enues to a later period7. Therefore2 the auditor ordinaril1 presu#es that there are ris,s of fraud in re!enue recognition and considers 5hich t1pes of re!enue2 re!enue transactions or assertions #a1 gi!e rise to such ris,s. Those assessed ris,s of #aterial #isstate#ent due to fraud related to re!enue

recognition are significant ris,s to be addressed in accordance 5ith paragraphs .( and $1.

0, HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
H, Audit %rocedures Responsi1e to 'ana-ement 71erride of Controls
;? Para!raphs ;"7>2 set out the audit procedures re)uired to respond to risk of mana!ement o#erride of controls Howe#er, the auditor also considers whether there are risks of mana!ement o#erride of controls for which the auditor needs to perform procedures other than those specificall( referred to in these para!raphs ;" To respond to the risk of mana-ement o1erride of controls, the auditor should desi-n and perform audit procedures to" 8a9 Test the appropriateness of 8ournal entries recorded in the !eneral led!er and other ad5ustments made in the preparation of financial statements0 8b9 Re#iew accountin- estimates for biases that could result in material misstatement due to fraud0 and 8c9 4btain an understandin! of the business rationale of si-nificant transactions that the auditor becomes aware of that are outside of the normal course of business for the entit(, or that otherwise appear to be unusual !i#en the auditor2s understandin! of the entit( and its en#ironment

!, $1aluation of Audit $1idence 3Audit %rocedure4

/3. &s re9uired b1 :;+& 33)2 the auditor2 based on the audit procedures perfor#ed and the audit e!idence obtained2 e!aluates 5hether the assess#ents of the ris,s of #aterial #isstate#ent at the assertion le!el re#ain appropriate. /.. The auditor should consider whether anal(tical procedures that are performed at or near the end of the audit when formin! an o#erall conclusion as to whether the financial statement as a whole are consistent with the auditor2s knowled!e of the business indicate a pre#iousl( unreco!ni1ed risk of material misstatement due to fraud >" =hen the auditor identifies a misstatement, the auditor should consider whether such a misstatement ma( be indicati#e of fraud and if there is such an indication, the auditor should consider the implications of the misstatement in relation to other aspects of the

audit, particularl( the reliabilit( of mana!ement representations

0, HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
9, 'ana-ement Representations 3Audit %rocedure4
<0 The auditor should obtain written representations from mana!ement that. 8a9 't acknowled!es its responsibilit( for the desi!n and implementation of internal control to pre#ent and detect fraud0 8b9 't has disclosed to the auditor the results of its assessment of the risk that the financial statements ma( be materiall( misstated as a result of fraud0 8c9 't has disclosed to the auditor its knowled!e of fraud or suspected fraud affectin! the entit( in#ol#in!. 8i9 *ana!ement0 8ii9 +mplo(ees who ha#e si!nificant roles in internal control0 or 8iii9 4thers where the fraud could ha#e a material effect on the financial statements0 8d9 't has disclosed to the auditor its knowled!e of an( alle!ations of fraud, or suspected fraud, affectin! the entit(2s financial statements communicated b( emplo(ees, former emplo(ees, anal(sts, re!ulators or others

K, Communications 6ith 'ana-ement and Those Char-ed :ith ;o1ernance

<, 'f the auditor has identified a fraud or has obtained information that indicates that a fraud ma( e$ist, the auditor should communicate these matters as soon as practicable to the appropriate le#el of mana!ement

<, Auditor =nable to Continue the $n-a-ement

'f, as a result of a misstatement resultin! from fraud or suspected fraud, the auditor encounters e$ceptional circumstances that brin! into )uestion the auditor2s abilit( to continue performin! the audit the auditor should. 8a9 -onsider the professional and le!al responsibilities applicable in the circumstances, includin! whether there is a re)uirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to re!ulator( authorities0 8b9 -onsider the possibilit( of withdrawin! from the en!a!ement0 and 8c9 'f the auditor withdraws. 8i9 3iscuss with the appropriate le#el of mana!ement and those char!ed with

!o#ernance the auditor2s withdrawal from the en!a!ement and the reasons for the withdrawal0 and 8ii9 -onsider whether there is a professional or le!al re)uirement to report to the person or persons who made the audit appointment or, in some cases, to re!ulator( authorities, the auditor2s withdrawal and the reasons for the withdrawal

0, HKSA 240, *The Auditor+s Responsibility to Consider Fraud in an Audit of Financial Statements
', (ocumentation
/0; The documentation of the auditor2s understandin! of the entit( and its en#ironment and the auditor2s assessment of the risks of material misstatement re)uired b( para!raph /22 of HKSA ,/? /0> The documentation of the auditor2s responses to the assessed risks of material

misstatement re)uired b( para!raph ;, of HKSA ,,0 /0< The auditor should document communications about fraud made to mana!ement, those char!ed with !o#ernance, re!ulators and others //0 =hen the auditor has concluded that the presumption that there is a risk of material misstatement due to fraud related to re#enue reco!nition is not applicable in the circumstances of the en!a!ement, the auditor should document the reasons for that conclusion