Auditing - Detection and Prevention of Fraud

The main objective of auditing is to ensure the financial reliability of any organization; detection of fraud is just an incidental object.

Independent opinion and judgement form the objectives of auditing. The job of an Auditor is to ensure that the books of accounts are kept according to the rules stipulated in the Companies Act; an Auditor also needs to ensure whether the books of accounts show a true and fair view of the state of affairs of the company or not.

The following are the three distinct types of fraud −

  • Misappropriation of Cash
  • Misappropriation of Goods
  • Manipulation of Accounts

Misappropriation of Cash

Misappropriation of cash is the easiest way of fraud especially in large business houses where there is limited or no communication between the owner of an organization and the cashier. Following are some of the ways through which embezzlement or misappropriation can be done −

  • Theft of cash receipts and petty cash and showing fictitious payment to workers, creditors, purchases, etc.

  • Showing false payments or excess payments in cash book.

  • By using the Teeming and Lading method, the money received from any customer can be pocketed and the money received from another customer can be shown as money received from the former.

  • Cash sale can be shown as credit sale.

Strict internal control system should be followed in receipts and payments of cash so that the work done by one person should be automatically checked by another person.

Misappropriation of Goods

Misappropriation of goods can be done in the following ways −

  • Goods may be stolen by employees or with the help of employees.
  • By issuing false credit notes to customer on account of goods return.

Detection of misappropriation of goods is more difficult rather than detecting misappropriation of money, especially where management is not much vigilant and sound system of book-keeping, internal control and adequate system of securities are not available. To keep control on the physical verification of goods, reconciliation of physical stock with books and careful checking of sale and purchase is must.

Manipulation of Accounts

Two types of manipulation of accounts are mainly done by top management to mislead some parties for some specific purpose.

  • Showing higher profits − Following are the reasons behind showing higher profit than actual −

    • To obtain credit or to enhance existing credit from financial institutions and also to show credit worthies to suppliers of the company.

    • To maintain confidence of shareholders.

    • To hike the market price of shares of the company and enable the sale of those at higher price, it may be done by declaring higher dividends on shares.

    • To get more commission where commission is calculated on the basis of profit earned.

    • To declare dividend at higher rate.

  • Showing low profits − Following are the reasons behind showing lower profit than actual −

    • To avoid or to reduce Direct Taxes of the company (Income Tax, Wealth Tax).

    • To purchase shares at lower price.

    • To give wrong impression to the other competitors of the business.

Manner of Manipulation of Accounts

Manipulation of accounts may be done in the following ways −

  • Window dressing is a manipulation or miss-representation of financial data in such a way that it seems better than what it actually is. Some of the method of window dressing is given as hereunder.

    • Over valuation of closing stock

    • Under valuation of Liabilities or Over-valuation of assets

    • Purchases and expenses of current year may be deferred to next financial year

    • Charging revenue expenses as capital expenditure

    • Sale and other incomes of preceding year may be shown as income or sale of the current year.

  • Secret reserves of previous years may be used in the current financial year to inflate the profit or secret reserves may be created to suppress the profit of the current financial year.

  • Stock may be under or overvalued. Income and sales may be suppressed or inflated. Expenses and purchases may be suppressed or inflated.