Auditors and fraud: Auditing defined
Audits and reviews are procedures performed on the financial statements of a company, for the purpose of determining whether the financial statements include any material misstatements. Misstatements are essentially wrong numbers due to numerical errors, fraud, or errors in interpreting the accounting rules. Misstatements are material if they are large enough to make a difference to a user of the financial statements, such as a bank or investor.
Auditors utilize sampling techniques to test certain transactions during the performance of an audit or review, since it would be nearly impossible and too expensive to test every single transaction. The sampling may be aimed at the largest items or the items on the financial statements that pose the most risk of misstatement. If material errors in the financial statements are discovered, the auditors will direct management to correct them.
So how does fraud fit into the idea of material misstatements? Misstatements can be caused by either error or fraud. Auditors have some responsibility for the detection of both errors and frauds that are material, but this responsibility is not absolute. Auditors give “reasonable” assurance that material misstatements have been uncovered, but not total assurance.
Errors are much more likely to be discovered during an audit than are fraud. Fraud schemes are crafted to purposely exploit the accounting system and controls, and therefore it is more difficult for an auditor to find them. Since auditors are not all-knowing beings, the assurance that the financial statements are correct can only be “reasonable” assurance and not total assurance.
