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Early detection of error can reduce a company’s losses by a big margin and protect from such instances in the future, but fraud and error detection methodologies are not always fool-proof. This is where the role of auditors comes to the fore. Auditors are always expected to detect discrepancies and irregularities in the company’s financial statements without error because carelessness on the part of the auditor has the possibility of appearing as a manipulation. There are many techniques and procedures that can help with the timely detection of frauds and errors. Here a few generally accepted procedures used while auditing. This knowledge may help you plan and use your resources in a better way.
Types of error
First, we will look into different types of errors that an auditor must be aware of: –
- The error of Principle: This occurs when the entry is not made according to the principles of accounting. It might be a mistake or a manipulative effort to enhance or diminish the financial performance. Examples include improper depreciation, transferring commission to a personal account instead of a business account, wrong accounting of stock, investments, machinery, etc.,treating revenue expenses as capital expenditure, and so on.
- The error of Omission: This happens when a transaction is totally absent from account books. Other examples include the omission of outstanding or balance amount. As expected, the detection of such errors is difficult.
- The error of Duplication: This is another error that is difficult to detect. A purchase transaction or a sale transaction may get recorded more than once. This is only detected after careful verification of all original and duplicate receipts and invoices.
- The error of Commission: These are errors in misreading similar content. For example, writing 25,000 as 2500, or credit into the account of AB company in place of BA company.
- The error of compensation: This is when the expense of an error is compensated with another error. This does not affect the whole trial balance but affects the specifics.
Procedures for error detection
Auditors are expected to perform an audit as per professional standards and guidelines. They cannot guarantee that no fraud exists. However, they can follow these procedures to increase their efficiency: –
- Brainstorming:- An auditing team can gather its members as well as the client’s staff to brainstorm regarding the kind of errors and frauds that may happen or have happened. This may give auditors an outlook of what to expect and consider how the client can commit errors or frauds. Brainstorming sessions are very helpful in the planning of the audit process. Some members may have an idea that other members of the auditing team may not have considered. You can increase the effectiveness of a brainstorming session by adopting certain measures like keeping the agenda clear or using a smaller group for discussions and larger groups for coming up with ideas to narrow your focus.
- Testing:- Testing journal entries is an important procedure. Any error or fraud in the company books can be proof of manipulation of accounts. After understanding the company’s process and protocols, the auditor may choose any particular entry depending on various factors. Entries made by upper management, entries made late in the accounting period, and with less time between subsequent entries or any entry appearing interesting or suspicious may be chosen. Then documents like receipts and invoices can be verified related to the entry.
- Verification:- Unusual transactions of a company may also be a source of error, which is worth verifying. When a company engages in business outside its domain or usual sphere of operations, auditors must examine the causes, purpose, and motive of the business. Once the management of the company gives an explanation, it should be verified with other documentation for irregularities and inconsistencies.
- Estimation:- Another source of accounting errors could be accounting estimates. Accounting estimates are the values assigned to items’ sale or purchase, which have no accurate way of determining value. Examples of estimates include estimating the useful life of an asset, bad debts, and depreciation. Auditors can look for changes in the estimation procedure as recent changes may indicate the possibility of fraud or manipulation. Auditors can also check if, in a certain period, the majority of estimates are either of increasing or decreasing income as this may indicate a possibility of shifting income from one period to another.
While it is important to be vigilant and asking lots of questions for cross-verification of accounts, it is also important to keep in mind the difference between error and fraud. Errors take place when miscalculations and wrong entries are done by mistake. Fraud is when they are done deliberately. It is important to discuss in your team, whether a misstatement comes under the category of error or fraud.
However, if your team concludes that a particular misstatement comes under fraud, you must take necessary steps that include informing senior members of your team and the client team and suggesting the client for a legal counsel to deal with the criminal proceedings.
Suggestions that can be made
In case of error detections, after the completion of audits, the auditor must make suggestions to the client to improve and streamline his operations as an auditor does not have the power to make changes in the business operations. An auditor can ensure that the client follows certain guidelines and standards:-
- Improvements in business’ internal control
- Suggesting ways of fraud prevention
- Suggesting setting up a system of fraud detection including anonymous tip-lines
- Following the accounting principles diligently
- Following the provisions of the companies act
- The profit and loss account and the balance sheet must show the true and fair level of concern
Requirements of an auditor
As an auditor, you also have to follow certain guidelines:
- An auditor must operate as per guidelines of auditing
- Any inconsistency, no matter how minor it appears, must not be overlooked.
- Errors should be made notice of, and frauds should be entered into the audit report.
With this information by your side, you can new easily detect the errors in your accounting records and take corrective actions before any damage occurs.