Financial statements communicate the financial position and financial activities of business for a specific period of time. Investors and creditors review the financial statements and evaluate the numbers in order to predict future financial performance.
Investors and creditors want to work with financially viable companies they expect to continue growing in the future. The financial statements are created by company employees who report to company management. The accounting staff report to management and management hold the ultimate responsibility for the numbers reported. As the leaders of the company, management represent the company to outside parties.
As can be seen in the auditor’s report, the Company’s management is responsible for the correctness and completeness of information in the financial statements. But for periods beginning on or after 1 January 2012, management responsibility is expanded to the preparation and fair presentation of financial statements in accordance with accounting standards, and the putting in place of internal controls as management determines necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. This is the result of an application of new Thai Standards on Auditing for the financial period beginning on or after 1 January 2012.
Misstatements in the financial statements can arise from either fraud or error. The distinguishing factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional.
The definition of fraud, described in TSA240 “The Auditor’s Responsibilities Relating to Fraud in An Audit of Financial Statements”, is an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage.
Management is in a unique position to perpetrate fraud because of management’s ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls that otherwise appear to be operating effectively. Due to the unpredictable way in which such overrides can occur,
it is a risk of material misstatement due to fraud and thus a significant risk in the auditor’s view.
The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. It is important that management, with the oversight of those charged with governance, place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to
commit fraud because of the likelihood of detection and punishment. This involves a commitment to creating a culture of honesty and ethical behavior which can be reinforced by an active oversight by those charged with governance. Oversight by those charged with governance includes considering the potential for override of controls or other inappropriate influence over the financial reporting process, such as efforts by management to manage earnings in order to influence the perceptions of analysts as to the entity’s performance and profitability.
The said Thai Standard on Auditing requires an auditor to make inquiries of management to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity, and not limited to:
(a) Management’s assessment of the risk that the financial statements may be materially misstated due to fraud, including the nature, extent and frequency of such assessments.
(b) Management’s process for identifying and responding to the risks of fraud in the entity, including any specific risks of fraud that management has identified or that have been brought to its attention, or classes of transactions, account balances, or disclosures for which a risk of fraud is likely to exist.
(c) Management’s communication, if any, to those charged with governance regarding its processes for identifying and responding to the risks of fraud in the entity.
(d) Management’s communication, if any, to employees regarding its views on business practices and ethical behavior.
Besides answering enquiries, which can be in the form of a questionnaire or interview, management is also required to provide a written representation that;
- It has fulfilled its responsibility for the preparation of the financial statements in accordance with the applicable financial reporting framework, including, where relevant, their fair presentation, as set out in the terms of the audit engagement.
- It has provided the auditor with all relevant information and access as agreed in the terms of the audit engagement.
- All transactions have been recorded and are reflected in the financial statements.
- It acknowledges its responsibility for the design, implementation and maintenance of internal controls to prevent and detect fraud.
- It has disclosed to the auditor the results of management’s assessment of the risk that the financial statements may be materially misstated as a result of fraud.
- They have disclosed to the auditor their knowledge of fraud, or suspected fraud, affecting the entity involving:
- Employees who have significant roles in internal control; or,
- Others where the fraud could have a material effect on the financial statements.
- They have disclosed to the auditor their knowledge of any allegations of fraud, or suspected fraud, affecting the entity’s financial statements communicated by employees, former employees, analysts, regulators or others.
Therefore, do not be surprised if you as the management will be asked by the auditor to answer these kind of sensitive questions this coming audit season. These procedures have been applied internationally since 2009, but only recently applied in Thailand.
Source: Thai Standard on Auditing No. 240 “The Auditor’s Responsibilities Relating to Fraud in An Audit of Financial Statements” effective for audits of financial statements for periods beginning on or after 1 January 2012.