Fraud Risk and Going Concern
Risk
Fraud Risk and Going Concern
Syllabus tag: KASNEB CPA | Advanced Level | CA36 Advanced Auditing and Assurance
1. The auditor's responsibility — ISA 240
Primary responsibility for preventing and detecting fraud rests with management and those charged with governance. The auditor obtains reasonable assurance that the financial statements are free from material misstatement due to fraud or error, maintaining professional scepticism throughout.
Two types of fraud: fraudulent financial reporting (intentional misstatement or omission to deceive users — often involves management override) and misappropriation of assets (theft or misuse of cash, inventory, or other assets).
2. The fraud triangle
Three conditions typically present when fraud occurs: Incentive/Pressure (financial pressure on management — debt covenants, bonus targets; personal financial difficulties); Opportunity (weak controls, complex transactions, management override of controls); Rationalisation (justification — poor ethical culture, "I'll pay it back" attitude).
3. Fraud risk presumptions
Revenue recognition fraud risk is always presumed to exist unless the auditor can rebut it with specific evidence. Response: scrutinise journal entries around year-end, test cut-off, examine unusual revenue transactions. Management override risk is always presumed — it cannot be rebutted. Response: test journal entries (manual, year-end, unusual), review estimates for bias, evaluate business rationale of significant unusual transactions.
4. Reporting fraud
Within the entity: report to management (above the level suspected); if senior management is involved, report to those charged with governance. Outside the entity: normally confidentiality applies, but reporting to a regulator may be appropriate or legally required where there is sufficient public interest.
5. Going concern — ISA 570
Management assesses the entity's ability to continue for at least 12 months from approval of the financial statements. The auditor evaluates that assessment.
Indicators of doubt: financial (net current liability position, negative operating cash flows, approaching debt maturities, significant losses); operating (loss of key staff, loss of major markets, labour difficulties); other (legal proceedings, regulatory action, withdrawal of supplier support).
6. Audit procedures
Review cash flow forecasts, profit forecasts, and sensitivity analyses. Review loan covenants and confirm compliance. Inspect post-balance-sheet events. Obtain written management representations. Assess adequacy of disclosures.
7. Impact on the audit report
Material uncertainty adequately disclosed → unmodified opinion with Material Uncertainty Related to Going Concern section. Going concern basis not appropriate → adverse opinion. Inadequate disclosure of material uncertainty → qualified or adverse opinion depending on pervasiveness.