Fraud vs Errors Overview

Fraud vs Errors

• Fraud is defined as an intentional act by one or more individuals, involving deception to gain an unjust advantage.
• Errors are unintentional mistakes.
• The differentiating factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional.

### Types of Errors

• Omission: A transaction is not recorded. This can be partial or total omission.
• Commission: A complete mistake occurs, such as recording the wrong account, amount, or carrying forward incorrect totals.
• Duplication: A transaction is repeated. This does not affect the trial balance.
• Compensating: One mistake cancels another. This can be difficult to identify.

### Types of Frauds

• Misappropriation / Employee Fraud: An employee steals assets or manipulates information for personal gain.
• Management Fraud: Management intentionally misrepresents the financial statements. This can be done for various reasons, including attracting investors, manipulating stock prices, or obtaining loans.

Examples of Misappropriation of Cash

• Suppressing cash receipts: Cash received is not recorded.
• Inflating cash payments: Payments are recorded for a higher amount than actually paid.
• Deferring the recording of cash receipts: Recording of receipts is delayed.
• Inflating the expenses amount: Expenses are recorded at a higher amount than actually incurred.
• Siphoning amount received from customers: Money is withheld from customer payments.
• Giving advances to other employees without proper authorization: Loans are given to employees without proper authorization.

Examples of Misappropriation of Goods

• First goods are misappropriated & then sold: Goods are stolen and then sold by the employee.
• Goods first rejected as inferior & then sold off: Goods are deemed substandard and then sold at a lower price.
• Goods purchased do not reach the godown/factory: Goods are never received at the warehouse or factory.

Other Misappropriation Techniques

• Slicing small amounts from cash receipts: Small amounts of cash are stolen over time.
• Teeming & Lading: Receipts from one customer are used to cover another customer's outstanding balance, and the process is repeated.
• Stealing in small quantities: Known as pilferage, this involves stealing small quantities of goods.

### Management Fraud Techniques

• Recording fictitious journal entries: False transactions are entered to manipulate financial results.
• Inappropriately adjusting assumptions and changing judgments used to estimate account balances: Unrealistic assumptions are used to manipulate balance sheet valuations.
• Omitting, advancing, or delaying recognition in the financial statements of events and transactions that have occurred during the reporting period: Important transactions are hidden or deliberately delayed to manipulate financial results.
• Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements: Relevant information is withheld to distort the financial picture.
• Engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity: Confusing transactions are structured to hide the true financial status.
• Altering records and terms related to significant and unusual transactions: Records of important transactions are changed to manipulate results.

### Management Fraud - "Window Dressing"

• This involves the misuse of managerial authority to manipulate financial statements.
• Management may manipulate financial statements to show higher profits (to attract investors, get higher remuneration, or manipulate stock prices).
• Management can also manipulate financial statements to show higher losses (to obtain tax benefits, pay lower dividends, or purchase shares at a lower price).

### Auditor's Responsibilities

• Primary responsibility for preventing and detecting fraud lies with management.
• Auditors are responsible for obtaining reasonable assurance that financial statements are free from material misstatement, whether caused by fraud or error.

This quiz covers the essential differences between fraud and errors in financial statements. You will learn about various types of errors, such as omissions and commissions, as well as different kinds of fraud, including employee and management fraud. Test your understanding of these critical concepts.