Frauds, laws and materiality

Materiality

The financial reporting framework, states that the auditor is responsible for giving an opinion on whether the financial statements are prepared free from materiality. Materiality refers to the omission or misstatement of information in financial statements that influence the economic decisions of the users.

The auditor has to state whether in his opinion the financial statements are free of material errors such as omissions and misstatements. If the financial statements contain material misstatements they do not show a true and fair view of the accounts which means users are incapable of making reliable decisions.

Whether an item can be classed as material will depend on the size of the item or error.

Fraud 

The major scandals that have affected the accounting profession has typically been as a result of fraud. Since then it has become important for auditors to understand their role in preventing fraud in order to maintain confidence in audit reports. The ISA 240  Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, states that misstatements can arise from either fraud or error. A misstatement is classified as a fraud if the organisation action was intentional.

The auditors role is not actually identifying whether a business is acting in a fraudulent manner but rather the impact of the fraud and error on the accuracy of the financial statements. There are two types of fraud namely:

  • Fraudulent financial reporting – Intentionally misstating accounts to influence the look of the organisations accounts.
  • Misappropriation of Assets – Stealing assets belonging to the company such as cash or inventory.

Role of auditors

Both the internal and external auditors are responsible for preventing and detecting any fraudulent activities and errors. The role of these auditors in this situation is:

Internal Auditor  External Auditor 
Responsible for prevention and detection. Have to consider the risk of misstatements.
Help to contribute to preventing fraudulent actions or errors by assessing effectiveness of control systems. Have to provide reasonable assurance that financial statements are free from misstatement.
May be called to investigate any suspected fraud.