(upbeat music)
-: There are four key principles or topics
that you need to be very familiar with in regards
to ISA 240.
In ISA 240 part one, we looked at the difference
between fraud and error, including the definition
of fraud and the auditor's responsibilities
in relation to fraud.
In this clip, we will look at the last two key areas,
starting with the difference between fraudulent
financial reporting and misappropriation of assets.
Fraudulent financial reporting relates to the deliberate
misstatements of financial statements.
It is what I like to call Pinocchio's undertaking.
To me, fraudulent financial reporting ultimately
boils down to dishonesty in the financial statements.
So the fraudster is basically pulling the wool
over the eyes of the investors and other stakeholders
who would rely on those financial statements.
Fraudulent financial reporting is basically achieved
using one or more of the three Ms.
That is manipulation of accounting records or documents.
Remember that the financial statements are based
on accounting records and supporting documentation.
So if a fictitious journal entry is processed,
this will ultimately result in a manipulation
of the financial statements.
The second M is misrepresent.
This relates to a distortion of transactions
or events or leaving out certain information,
which would twist facts and mislead users of the
financial statements.
The third M is misapplication.
This one relates to the exploitation of accounting
policies, such that the true state of affairs
are not being reflected,
and users will ultimately be deceived.
Misappropriation of assets relates to assets.
The most common examples of misappropriation of assets
include theft and misuse.
For example, Sam is a truck driver for ABC Movers,
which is a company that transports goods for clients.
The company's closed on weekends,
however without the owner's permission,
Sam uses one of the trucks to provide moving
services at a discounted price.
He obviously pockets the extra cash that he earns.
This is an example of misappropriation of the company's
assets.
Even though Sam did not steal the truck,
he's misusing the asset for personal use
and without permission.
Now let's look at the last key area of ISA 240,
which is the fraud triangle.
ISA 240 paragraph A 25 identifies three
factors which would indicate the possible existence
of fraud.
The first factor is an incentive.
This refers to something that would entice
or encourage a person to engage in fraudulent activities.
The second factor is an opportunity.
This relates to a chance or opening that would
allow for fraudulent activities to occur.
The most common opportunity would be weak
internal controls that would not prevent
or detect fraudulent activities.
The third factor is the ability to rationalise
the wrongdoing.
This refers to the ability to justify or vindicate
one's actions.
For example, one of John's responsibilities
at work includes control over petty cash.
This includes issuing cash, replenishing cash reserves,
and keeping records of all cash issued and to whom.
As he is a trusted senior within the organisation,
no one reviews the petty cash records.
Recently John has been experiencing personal
financial difficulties,
and he started stealing petty cash.
He believes that working extra hours without
claiming overtime would more than compensate
the company for the petty cash that he takes.
The personal financial difficulties that John
has been experiencing are an incentive for him
to engage in fraudulent activities.
The fact that he has full control over petty cash,
and he's responsible for the record keeping
provides him with the opportunity to steal
petty cash and cover up his tracks
by falsifying the petty cash records.
No one checks these records,
and so the controls are ineffective.
He's able to rationalise his wrongdoing
by believing that working overtime without
claiming it would compensate the company
for the stolen cash.
Thus, all three fraud factors are satisfied.
To recap, there are four key areas and learning
points that you should be familiar with in ISA 240.
In this clip, we've focused on the last two points,
which are the differences between fraudulent
financial reporting and misappropriation of assets
as well as the fraud triangle.