Fraud refers to the intentional misrepresentation of financial information by management, employees, or third parties. It may involve manipulation of accounts, misappropriation of assets, or deliberate omission of transactions. Although an effective internal control system can reduce the chances of fraud, it cannot eliminate it completely.
This makes the role of an auditor extremely important in detecting and preventing such irregularities.
Manipulation of Accounts in Auditing
Manipulation of accounts involves altering financial records to present a false financial position. This can be done in several ways to mislead stakeholders or conceal fraud.
Common forms of manipulation include omission, falsification, and misclassification of transactions. For example, invoices for purchases or sales may be omitted from accounting records, or false entries may be created to distort financial results.
Stock values may be intentionally inflated or deflated to influence profitability. Similarly, goods sent on consignment may be recorded as actual sales, and goods on a sales-or-return basis may be wrongly treated as completed sales.
There may also be omission of outstanding liabilities or advance payments. In some cases, capital expenditures are incorrectly charged as revenue expenses, or revenue expenditures are treated as capital items. These practices distort the true financial position of the business.
Misappropriation of Assets
1. Misappropriation of Cash
Misappropriation of cash is one of the most common types of fraud. It involves theft or misuse of cash through manipulation of records.
Cash sales may not be recorded, or fictitious allowances and returns may be shown to customers. Miscellaneous receipts, such as scrap sales, may be omitted from records.
Teeming and lading is often used, where money received from one customer is used to cover another customer’s account. Employees may create dummy names or inflate wage sheets to withdraw extra cash.
Other methods include recording fictitious purchases or expenses, omitting credit notes for purchase returns, or using the same voucher multiple times for payment. Personal expenses may also be recorded as business expenses.
Cash in hand may be understated at the time of balancing the cash book, and recoveries of previously written-off bad debts may not be recorded.
2. Misappropriation of Goods
Employees may steal stock or misuse company assets. This type of fraud is harder to detect without proper monitoring.
The management should maintain proper records of stock, purchases, sales, and returns. Strong internal control systems are necessary to safeguard goods.
Auditors can detect such fraud through physical verification and comparison of records with actual stock.
Window Dressing
Window dressing is a technique used to present financial statements in a more favorable way than the actual situation. It involves rearranging or manipulating figures without necessarily changing the underlying records.
This practice is misleading and considered unethical.
Common examples of window dressing include:
- Recording goods sent on sale or return as actual sales
- Collecting debts just before the balance sheet date to improve liquidity
- Arranging long-term loans near year-end to strengthen the financial position
- Charging less depreciation on assets
- Treating revenue expenditure as deferred expenditure
Other methods include recovering loans from employees at year-end and reissuing them after the reporting period, or recording sales to related parties at the end of the year and reversing them later.
Teeming and Lading
Teeming and lading is a method of cash misappropriation where funds received from one debtor are used to cover another debtor’s account.
For example, if debtor “A” pays cash, the cashier may not record it. When debtor “B” makes a payment, it is recorded in “A’s” account instead. Similarly, payments from “C” may be used to settle “B’s” account.
This cycle continues, creating a chain of adjustments that hides the original fraud. Although the example may seem simple, in practice it can become complex, involving multiple accounts and split transactions.
Duties of an Auditor
The auditor plays a crucial role in detecting manipulation and ensuring the accuracy of financial records. He must carefully examine the internal control system, especially for cash transactions.
The auditor should study the internal check system and identify weak points. He must ensure that the cashier does not have authority to record ledger entries.
He should verify counterfoils of receipts with entries in the cash book and pay close attention to dates. Similarly, he should examine paying-in slips, bank statements, and any rough cash books to confirm accuracy.
The auditor should compare cheques received with bank deposits and debtor accounts to detect any splitting or irregularities. He must also review debtor balances to identify overdue accounts.
Special attention should be given to customers who settle accounts in installments or those who previously paid in full but have changed their payment patterns.
The auditor may also request statements directly from debtors and compare them with ledger balances to ensure correctness.
Conclusion
Manipulation of accounts and misappropriation of assets are serious issues that can distort financial statements and harm organizations. While internal controls help reduce risks, they are not sufficient on their own.
The auditor’s role is essential in identifying fraud, verifying records, and ensuring transparency. By applying proper audit procedures and maintaining professional skepticism, auditors can effectively detect and prevent financial irregularities.
See Also: Continuous Audit Definition
