Audit and Fraud: Meaning, Types, Classifications, Advantages & Limitations

Meaning of Fraud 

Fraud in audit is the unlawful and deliberate misstatement of financial statements. It occurs when an organization the information provided in its financial records. It occurs when an entity such as a company or any organisation deliberately falsifies its financial records.

Fraud is a false representation or entry which is made always intentionally with some mysterious objective.

Type of Fraud

These are intentional errors and wanted misrepresentations and failure to disclose the materialistic facts to the transactions in the books of accounts. Such as

Misappropriation of cash 

Cash is the highly exploitation asset in the business, auditor check receipts and payments of cash in order to detect and prevent cash Misappropriation of cash.

Misappropriation of cash by 

1. The theft of cash receipt and petty cash
2. The theft of cheques and other negotiable instruments.
3. Payments made to fictitious creditor or workman.

For Example – 

1. In terms of Sales – Omitting to record sales and pocketing money receive from the customer.
2. In terms of Purchase – Recording fictitious purchase.
3. In terms of Receipt of Cash – Concealing cash received on miscellaneous a/c.
4. In terms of Payment – Misappropriating money shown as wages by entering dummy names of workers therein.

That is why in a big business strict control should be exercise over the receipt and payment of cash. Therefore, there is a system of checking the work of one clerk automatically by another and such system is known in auditing as the system of Internal Check.

Misappropriation of Goods

Fraudulent application of goods by those who handle them e.g., recording purchase of large quantities receiving less quantity and then receiving the balance amount privately.

Proper methods of keeping accounts in regard to purchases and sales, stock, periodical checking of stocks, will help to avoid misappropriation of goods.

Goods can be misappropriated by –

1. By actual theft of stock
2. Auditor is required to do detail checking of stock record, purchase and sale only then this fraud brings to light.

Misappropriation of Accounts

Accounts of an organization can be falsified by making false entries in respect of fictitious sale or purchase. These are the fake evidences produced to auditor in the process of auditing. Such must be identified by the auditor.

This type of fraud is more difficult to discover as it is usually committed by directors or managers or other responsible officials. That is why the auditor should be very careful in detecting such frauds.  He should carry out the routine checking and vouching most carefully and make searching, tactful and intelligent enquiries.

The accounts may be manipulated in a number of ways which are as follows:

1. by not providing any depreciation or less depreciation or more depreciation; or
2. by under valuation or over-valuation of assets and liabilities; or
3. by the utilization of secret reserves during a period when the concern has made less or no profit without disclosing that fact to the shareholders etc.

Classification of Auditing

Classification based on organisational structure & Authority

A business undertaking may be owned, managed & controlled by govt. or private individuals, & may be operated in a corporate form or non- corporate form. The type of audits to be conducted for various organisations, therefore should fall under the following categories.

According to organizational structure of business

Statutory Audit

Audit which is made compulsory under law which lays down or prescribes in definite terms the nature, scope and extent of audit and also the auditor’s qualifications, duties and rights, e.g., in the case of a company including a government company or public sector enterprise/undertaking and other organisations or public corporations governed by special statutes.

Where undertaking is formed under the statute or laws, audit for such undertakings is made compulsory under the statutes that govern them an audit undertaken under any statute or law is called statutory audit.

1. Audit of trust – In some state in India, public trust acts have been enacted which provide for compulsory audit of the accounts of trust by qualified auditors.
2. Audit of other Institutions - Like public corporations, co-operative society, corporate bodies, they also fully recognize the significance of a professional audit which is compulsory in their case too.

Private Audit 

The institutions which are private in nature also get their account auditor by some qualified auditors. Such an audit is not required by law.

There are three types of such institutions

1. Audit of account of sole trader
2. Audit of account of partnership firm
3. Audit of account of other individual and institution

Government Audit

Government maintains a separate department in the name of accounts and audit department which perform the audit of its different department and office. This department is healed by comptroller and auditor general of India who is assisted by different official at various levels.

They are not public auditors and hence cannot be appointed as auditors for public concerns. They work according to the departmental rules and instructions.

Government Audit Objective

1. To verify that the expenditure of the government department is sanctioned in accordance with the rule and regulation of department concern.
2. To ensure that the payment have been made to the right person and they are duly entered in the books on the basis of receipts received from them.
3. To see that the payment has been properly classified as capital and revenue. 
4. To verify the existence and valuation of stores and the stocks.

Internal Audit

Internal audit is the examination of book of account which is conduct by salaried officials of a business known as internal auditor throughout the year.

Internal auditing is the independent appraisal activity within an organisation for the review of the accounting financial and other operations as a basis for protective and constructive services to the management. It deals primarily with accounting and financial matters but it may also properly deal with matter of operating nature.

It is now mandatory for all listed companies and some class of unlisted and private companies to appoint internal auditors. Such auditor cannot be appointed as public auditor or external auditor and hence are expected to know the minor detail of accounting.

Practical point view

1. Continuous Audit - A continuous audit is one where auditor or his staff is constantly engaged in checking the account throughout the year or the auditor or his staff attends at regular or irregular interval during the period. Such an audit is necessary only for big business house and not for small ones where accounts can be audited at the close of financial year. 
• Large transaction 
• Limitation of continuous audit – expensive and inconvenience.
2. Cash Audit - The auditor is concerned with the checking of cash transaction. He has to audit entries pertaining to cash receipt and payment with the help of relevant voucher.
3. Cost Audit - It involves the detailed checking of the costing system technique and accounts to verify their correctness and to ensure adherence to the objective of cost accountancy. As company act 2013 has made provision to perform cost audit of certain categories of companies under section 148.
4. Complete Audit  - When an auditor checks each and every transaction total, balance, book of account with the help of relevant vouchers, documents, correspondence etc. it is said to be complete audit but complete audit is neither practicable nor feasible.
5. Partial Audit - When audit is conducted on some of the records and book of a part or whole of the period it is called partial audit. Partial audit may relate to some part of the work for some or whole of the trading period.
6. Interim Audit - An interim audit is that kind which is conducted for a part of accounting year with some interim purpose such an interim purpose may be for example declaration of interim dividend by joint stock company it is conducted between the two-periodical audit.
7. Management Audit - Management audit is an audit conducted to examine all aspect of management in a business. Management audit includes the examination of every activity of business, plans, objectives, means of operation, utilisation of physical resource, organisation pattern, co-ordination of various activity at all levels and control of entire business. The management auditor has to evaluate the overall performance which includes account books too and has to submit a report.
8. Performance Audit - Performance audit is a procedure for analysing the profit and losses of economic activities carried on by the business enterprise, examining the relationship between production and sales and discovering the avenues for maximizing profits. Performance auditor has to evaluate the performance of a concern.
9. Operational Audit - Operational audit is desire to aim at improving the profitability of an industrial enterprise and also at achieving the other organizational objective. It purposes to improve future business operations carried out by the management.
10. Annual or Periodic or Final Audit - It is done at the close of financial or trading period when final accounts are prepared. In such case, the auditor visits his client only once a year and check the account such a form of audit is very much convenient and useful for business house which are small. For big ones, continuous audit is more useful because the work involved in them is voluminous and hence final account cannot be prepared at the close of financial year.
11. Balance sheet Audit - In balance sheet audit, the auditor checks the capital reserve assets and liability etc. given in the balance sheet such checks only those documents which are related to the items given in the balance sheet such an audit is not conducted to check profit and loss and similar other transactions the work of the auditor is confined to the balance sheet alone.

Audit Advantage

For Business

1. Errors and fraud are located very easily at an early date and chances if their further occurrence is reduced to the minimum.
2. Auditing of accounts makes the clerk alert, careful and vigilant, now they are preparing accounts very carefully in future.
3. Loan can easily be borrowed from bank and other money lenders on the basis of properly audited accounts.
4. If the business is a joint stock company its share holder can rely on auditor account and can be sure of their investment being safe with a company.
5. If the business is a partnership firm, then its partner can utilize the audited accounts to settle their dispute in regard to admission, retirement and death of a partner, adjustment of capital etc.
6. If the business is a sole trader, then he can rely well on auditor account and on his accountant who are responsible for the maintenance of account.

For Others

1. The bank or investor can take decision for granting loan to business on the basis of their properly audited accounts.
2. The purchaser of business also uses the audited repost to do the valuation of business
3. Taxation authority can rely on the auditor account for the purpose of imposing sale tax, income tax, wealth tax, expenditure tax et.
4. Audited account of a business can be produced in support of a legal case before the court.

Audit Limitation

1. An auditor has to depend upon books of account and other record presented before him.
2. It is difficult to find the accounts as complete and genuine everywhere. For example, the details about stock in trade.
3. Sometime auditor is influenced by the management reason auditor is appointed by shareholder and director who pay him his remuneration.

Audit & Fraud — Key FAQs

What is audit?

An audit is a systematic examination of financial records, books, and statements of an organization to determine whether they are accurate and fairly presented according to accounting standards and legal requirements. Which includes the checking of transactions, verifying evidence, and forming an independent opinion on financial statements.

What does fraud mean in auditing?

Fraud in auditing refers to the unlawful and deliberate misstatement or falsification of financial information in an organization’s books with the intention to deceive stakeholders. This includes any intentional false entries or concealment of material facts in financial records.

How is misappropriation of cash fraud committed?

Fraud involving cash may occur through: 

• Stolen of cash receipts or petty cash. 
• Stealing cheques or other negotiable instruments. 
• Recording fictitious payments or omitting real receipts.

What is misappropriation of goods?

This type of fraud occurs when goods belonging to the business are stolen or used by employees without proper recording — e.g., recording larger purchases but receiving less quantity and pocketing the difference.

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