Professional standards outline the auditor's consideration of material misstatements due to errors and fraud.
a) What responsibility does an auditor have to detect material misstatements due to errors and fraud?
The purpose of assurance engagement is enhancing the reliability of the subject matters. So it is auditor's responsibility to provide a reasonable level to assure the financial report is true and fair.
Financial report is a data assembling which reflect the position of the business. Therefore these users, including investors, managements, shareholders and the other parties can make decision base on the information provided by the financial report. Then the information which impacts on the process of decision making for the uses of the financial report is defined as materiality (Kimmel, Carlon, Loftus, Mladenovic, Kieso, & Weygandt, 2006).
The fairness and trueness of the material is important to the users of financial reports. The major task of auditor is to identify the misstatement in the financial report. By definition, misstatement is a difference between the amounts, classification, presentation or disclosure of a reported financial report item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. There are two kinds of misstatements and they rise from error or fraud respectively (Auditing, Assurance and Ethics Handbook, 2010).
But by the limitation of auditing, financial report audit only provides reasonable assurance instead of total responsibility to the fairness and trueness of the reports. The auditors can assure about whether the financial report is prepared in all material respects in accordance with a financial reporting framework. The reason of the limitation is determined by the nature of financial reporting, the nature of audit procedures and the need for the audit to be conducted within a reasonable period of time and at a reasonable cost (Moroney, Campell, & Hamilton, 2011).
b) What two main categories of fraud affect financial reporting?
By definition, fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage. These two main categories of fraud are financial reporting fraud and misappropriation of assets fraud.
Generally say misappropriation of assets fraud involves some form of theft. Therefore misappropriation of assets fraud will decrease the assets and increase the expenses then it will reduce the owner’s equity of the company (Auditing, Assurance and Ethics Handbook, 2010).
Financial reporting fraud is intentionally misstating items or omitting important facts from the financial report (Moroney, Campell, & Hamilton, 2011). In Cendant case, the fraud is the accounting department manipulating the revenues to meet the expectation of Wall Street analyst. Than the company can have more opportunities to merge other companies. The affect of the financial reporting fraud will increase sales therefore increase the profit of the company. The financial reporting with fraud will indicate the future earning ability to the share market therefore rising the share price in the exchange market.
c) What types of factors should auditors consider when assessing the likelihood of material misstatements due to fraud?
First the auditors should consider the company economical environment to identify whether there are incentives and pressures to commit a fraud (Moroney, Campell, & Hamilton, 2011). CUC is in the travel service industry which is highly competitive. And CUC's revenue has dramatic doubled in the mid-1990s. To merge the other company, the company's profit has to keep increasing to meet the analysts’ expectation. So the managements of CUC have pressures to create more profit by fraud financial figures.
Second the auditors should look into the financial report whether there are opportunities to perpetrate a...