Errors and Frauds: Types, Detection, Prevention and Auditor’s Responsibility Questions

Question 1

Define error in auditing.

Accepted Answer

An **error** is an **unintentional** mistake in recording/classifying accounts due to oversight or negligence.

Question 2

Define fraud in auditing.

Accepted Answer

A **fraud** is an **intentional** act of deception to misappropriate assets or misstate financial results.

Question 3

What is an error of principle?

Accepted Answer

An **error of principle** occurs when accounting principles are violated (e.g., **capital** treated as **revenue**).

Question 4

What is a compensating error?

Accepted Answer

A **compensating error** is when two or more errors **offset** each other.

Question 5

What is lapping?

Accepted Answer

**Lapping** is using receipts from one customer to cover misappropriation of another customer’s receipts.

Question 6

State one fraud red flag.

Accepted Answer

Unusual **period-end journal entries** without proper support can be a fraud red flag.

Question 7

Differentiate between error and fraud (any three points).

Accepted Answer

**Error** is **unintentional** and occurs due to oversight; **fraud** is **intentional** and involves deception.

Differences (any three):
- **Intention**: Error (no intention) vs Fraud (intention to deceive).
- **Examples**: Error (wrong posting) vs Fraud (fictitious sales, lapping).
- **Detection**: Errors are usually easier; fraud is harder due to **management override**.

Question 8

Explain types of errors (any three) with examples.

Accepted Answer

Types of errors (any three):
- **Omission**: transaction not recorded (e.g., invoice not entered).
- **Commission**: wrong recording/posting (e.g., ₹9,500 posted as ₹5,900).
- **Principle**: wrong classification (capital treated as revenue).
- **Compensating**: errors cancel each other.

Always add a short example for full marks.

Question 9

Explain types of frauds with examples.

Accepted Answer

Main types of frauds:
1) **Misappropriation of assets**: theft of cash/inventory (e.g., skimming, lapping, fake vendors).
2) **Fraudulent financial reporting**: manipulating accounts (e.g., fictitious revenue, understating expenses, wrong inventory valuation).

Management fraud is usually more difficult to detect.

Question 10

State common fraud risk factors (any three).

Accepted Answer

Common fraud risk factors (any three):
- weak **segregation of duties**
- unusual **period-end entries**
- frequent cash/inventory shortages
- high staff turnover in accounts
- unusual related-party transactions

These are red flags that require further audit testing.

Question 11

Explain how an auditor detects errors and frauds (brief).

Accepted Answer

Auditor detects errors/frauds by:
- evaluating and testing **internal controls** (test of controls),
- performing substantive procedures like **vouching**, **verification**, and **confirmations**,
- using **analytical procedures** to spot unusual trends, and
- investigating anomalies and red flags with additional evidence.

Question 12

Explain prevention of fraud through internal control (any three measures).

Accepted Answer

Fraud prevention is mainly management’s responsibility through controls like:
- **segregation of duties**
- proper **authorisation** procedures
- physical safeguards for cash/inventory
- periodic **reconciliation**
- supervision/internal audit

Auditor reviews controls and reports weaknesses.

Question 13

Differentiate between errors and frauds with examples and a table/flow.

Accepted Answer

### **Differentiate between Errors and Frauds**

**Errors** are **unintentional** mistakes due to **oversight**, **negligence**, or lack of knowledge. **Frauds** are **intentional** acts of **deception** to misappropriate assets or misstate results.

| Basis | **Error** | **Fraud** |
|---|---|---|
| **Intention** | Unintentional | Intentional |
| **Nature** | Mistake in recording/classification | Deceit/misappropriation/manipulation |
| **Examples** | wrong totalling, wrong posting | fictitious sales, lapping, fake vendors |
| **Detection** | usually easier | harder (especially **management override**) |

```text
No intention → Error
Intention to deceive → Fraud
```

**Conclusion**: In exams, clearly write **intention** as the main basis and add 2–3 examples.

Question 14

Explain types of errors with examples. Add a table.

Accepted Answer

### **Explain types of errors with examples**
Errors are **unintentional** mistakes. Main types:

1) **Error of omission**: transaction not recorded (fully/partly). Example: invoice issued but not entered.
2) **Error of commission**: wrong recording/posting/casting. Example: posting ₹9,500 as ₹5,900.
3) **Error of principle**: violation of accounting principle. Example: capital expenditure treated as revenue.
4) **Compensating errors**: errors cancel each other. Example: one account +₹1,000 and another −₹1,000.

| Type | Key idea | Example |
|---|---|---|
| Omission | not recorded | missing entry |
| Commission | wrong entry | wrong amount |
| Principle | wrong classification | capital vs revenue |
| Compensating | offsets | + and − equal |

Thus, types are explained with clear examples.

Question 15

Explain auditor’s responsibility for detection of fraud. Add a flowchart.

Accepted Answer

### **Auditor’s responsibility for detection of fraud**

Auditor’s duty is to obtain **reasonable assurance** that financial statements are free from **material misstatement** due to **error or fraud**.

**Key responsibilities**:
- Maintain **professional scepticism** throughout the audit.
- Assess **fraud risk** and design procedures accordingly.
- Evaluate **internal controls** and test key controls.
- Perform substantive tests (vouching, verification, confirmations, analytical review).
- When fraud is suspected: increase testing, obtain more evidence, and communicate with those charged with governance.

```text
Understand business → Assess fraud risk → Test controls → Substantive tests
→ Investigate red flags → Conclude materiality → Report/communicate
```

**Important point**: Prevention and detection of fraud is primarily management’s responsibility, but auditor must plan the audit to detect material frauds.

Errors and Frauds: Types, Detection, Prevention and Auditor’s Responsibility

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