Business is the backbone of the Nation’s economy, business entities periodically issue their financial statements. These financial statements should depict a true and fair view of the operations of the business. Accuracy is assured only when there are no errors in the books of accounts. To make sure that the financial statements issued are accurate and complete, the errors if any, should be identified and rectified.

Meaning of Errors:

Errors take place as a result of negligence or lack of knowledge or ignorance of the principles of the books of accounts. Detection of errors is the primary objective of conducting an audit. Errors are generally assumed to be innocent and not intentional.

Reasons:

R.K. Mautz, has classified the reasons and circumstances of errors and he has included fraud in the broad category of errors, the classifications are as follows:

• Ignorance on the part of employees of accounting department, of the generally accepted accounting principles, appropriate account classification of the necessary reconciling subsidiary ledgers and good accounting practices in general.
• Ignorance and carelessness on the part of those doing the accounting work.
• A desire to conceal the effect of misappropriations or embezzlement.
• A tendency of the management to permit bias to influence the interpretation of financial transactions or events in the financial statements.
• An ever present desire to hold taxes on income to the minimum. Organisations try to apply and make their level best strategies to hold taxes to the minimum.

Need to Rectify Errors:

• For the presentation of correct and accurate financial statements.
• To disclose profits of the business with complete accuracy.
• To maintain the state of affairs with complete accuracy so as to improve the goodwill and reputation of the business.
• To present the balance sheet with the true and fair valuation of its assets and liabilities.
• Rectification of errors in time helps to compare the accurate financial statements for future reference.
• Accurate financial statements and compliance within the organisation helps the organisation to expand its horizons and increase its various stakeholders like investors, shareholders, creditors, debtors, employees.
• With a good reputation the company builds a fundamentally strong base which leads to further growth in the goodwill and profitability.

When the trial balance does not agree, the amount of difference detected is transferred to a temporary account known as the "Suspense Account". When all one sided errors are identified and further rectified the suspense account is closed.

Types of Error:

Error of Principle: As the name suggests, these errors take place due to the lack of knowledge of science of book keeping. Transactions are recorded without complying with the accounting principles and the rules. For example, treating capital expenses as revenue and vice versa, treating business expenditure as personal and vice versa, not appropriately providing for depreciation, not appropriately classifying personal, real and nominal accounts.

The error of principle affects the accuracy and reliability of the financial statements presented. In order to make sure that such errors do not occur, the accounts department should be assigned to a duly qualified person who has appropriate knowledge and experience in the field of dealing with accounts.

Error of Omission: This type of error occurs when a particular transaction is omitted from the books of accounts, it is not at all recorded in the books of accounts. The transaction is either partially or completely omitted to be recorded in the books of accounts. Such errors take place due to ignorance or even intentionally. Such errors do not disclose the accurate financial position. It is difficult to detect such an error as the trial balance will tally. For example, acquisition of assets not recorded in the books of accounts, failure to record purchases.

There can be two types of error of omission:

• Error of complete omission which does not affect the agreement of trial balance. In this case, the entire transaction is not recorded in the books of accounts.
• Error of partial omission which affects the agreement of trial balance. This condition is as such where the transaction is given only one effect.

Error of Commission: This type of error indicates that the transaction is recorded but recorded incorrectly. It takes place due to wrong entries or wrong posting of transactions. There exists an error in the way a particular transaction is treated. Error of commission at times does affect the agreement of trial balance. For example:

Amount received from ‘A’ company is shown in ‘B’ company’s account.

• Amount Rupees 850 received maybe recorded as Rupees 580.
• Wrong casting / totalling of the subsidiary books.
• Error in carrying forward, occurs when the amount carried forward is different.

Error of Duplication: As the name suggests, here a particular transaction is recorded twice. Does not affect the agreement of trial balance as the same transactions is treated twice. One has to thoroughly check each and every transaction for the detection of such errors.

Compensating errors: These errors occur when two mistakes of the same amount one on the debit side and the other on the credit side. It is committed in such a way that the net effect of these errors on the debit and credit of accounts is nullified.The total effect or the summation of one or more errors on either side is the same. In this case the trial balance agrees, careful conduct of procedure of audit can only detect such as errors. For example, On August 4, a sum of rupees 4,000 paid to company A is posted as rupees 400 to the debit of A company’s account and on August 10th a sum of rupees 400 paid to company be has been posted as 4000 to the debit of company B’s account.

Errors are further classified as one sided errors and two sided errors. One sided errors affects only one account and affects the agreement of trial balance. Where errors affect two or more accounts on the debit and credit sides, it does not affect the agreement of trial balance.

Meaning of Frauds:

Frauds are considered to be committed intentionally for achieving some alterior motive.

• Frauds refer to intentional misrepresentation of financial information by persons in the management, employees or third parties. It involves manipulation of accounts, suppression of transactions, misappropriation of assets, embezzlement of cash, falsification of accounts, over valuation of assets or liabilities, undervaluation of assets or liabilities.
• Frauds are intentionally done by people in the higher authority. The detection of frauds is one of the primary functions of the auditor.

Types of Fraud:

Embezzlement of Cash: Embezzlement of cash is also known as misappropriation of cash. It is usually committed by theft of cash receipts, petty cash or showing fake payments made to workers, this amount is then further misappropriated. This fraud generally takes place in a smaller concern where there is no proper control over the cash box and is handled either by the owner or any other person.

This can be done either by not accounting for the entire amount received from any data or a smaller amount is shown in the accounts and the difference between the two is and embezzled. Different strategies are used to misappropriate cash like showing purchase of fictitious assets, payments made to dummy workers amount received by the selling of scrap. Any amount received from a debtor is recorded at a lesser value, a few cash transactions may not be accounted. Bad debts recovered may not be shown in the books of accounts.

Temporary Misappropriation of Cash: The temporary misappropriation of cash is referred to as teaming and lading. This method works in such a way that when an amount is received from debtor ‘A ‘ it is not recorded in the books of accounts the amount received is used by the cashier. On the next amount received from debtor ‘B’ is shown that it is the amount receive from ‘A’ and so on.

Nevertheless, before the closure of the books of accounts the money used is paid back and the cash balance is correctly shown. The mechanism is as such that there is only a temporary misappropriation of cash.

However, the auditor should not accept these fraudulent practises being carried out in the organisation. He/she has to compare the date of the money receipts and the date on the transactions written in the books of accounts carefully, by checking the dates of these transactions such frauds can be detected easily.

Misappropriation of Goods: The organisations where the good manufactured or sold are smaller in size and lighter in its weight but are of high value or precious material, such frauds commonly take place. Such good can easily be missappropriated, there should be proper internal control systems and internal check systems prevalent to take into account the number of goods manufactured, sold and their movement. The chain should not have any loop holes for any kind of fraudulent practice to be conducted. Most of the times businesses have a control over the cash than on the goods, which inturn is a wrong policy. Businesses must understand that the goods whether manufactured or work- in- progress represent cash. Goods should not be permitted to leave the premises without the proper permission of some authority. If there are any discrepancies, reasons for the same should be accounted for.

 Goods Manufactured / Work-In-Progress = Cash

The auditor should conduct, at times, surprise verifications of the physical stock with the stock shown in the books of accounts.

Falsification of Accounts: The manipulation of accounts is committed by the top level management to mislead certain parties. The frauds are committed intentionally, which have huge amounts.

The manipulation of accounts is committed by the top level management to mislead certain parties. The frauds are committed intentionally, which have use amounts.The accounts are falsified, fake and incorrect entries are made in the books.The sale of bogus goods, over valuation of closing stock, wrong representation of the profitability of the business or the financial position.In order to avoid income Tax liability the profits may be shown lesser. There can be speculation in the share prices of the company in the stock exchange.

Creation of Secret Reserves: Presenting the financial position worse than it is called creation of secret reserves.It is undertaken to reduce the tax burden or to reduce the probability of new competitors entering in the field.

Window Dressing: Here, the financial position is presented to be better than what it is. This strategy is used to attract more investors and to increase capital

The Risk of Errors and Frauds in Audit:

Internal Control Systems: Weaknesses in the design of internal control systems and non-compliance with the given control procedures lead to the failure of the organisation. The procedures followed are not systematic. This intern affects the working of the organisation and further it’s financial position.

Uncertainty about the Integrity of the Management: Manipulation by the top level management, high rate of employee turn over ratio, changes in the legal advisors, disagreements among the various departments, non-compliance in the preparation of financial statements.

Non-Performance of the Organisation: A particular industry is doing well, as per “The Compound Annual Growth Rate (CAGR)” is considered but the particular company’s performance is poor, heavily dependent on the single line of product, working capital is not well structured, inflated share prices in the stock exchange.

Unusual Transactions: There are unusual transactions which take place within the entity such as excessive payments for certain services, fake payments to dummy workers, showing fictitious assets in the financial statements.

Inappropriate Data: At times, the auditor is not in a place to obtain sufficient data, there is a difference between the figures as per the accounting records and the confirmation received from third parties. Such difference needs further investigation on the part of the auditor before the expression of opinion.

Prevention of Errors and Frauds:

• Strong Internal Control Systems: If the company has and follows the policy of strong internal control systems, the errors can be controlled to a certain extent.
• Check on Internal Staff: The internal management plays an integral role in the state of affairs of the company. There has to be a check on the management, regular functioning and the financial tranactions by a duly authorised peron.
• Assigned Roles: The organisation must delegate the responsiblities to each and every individual as per his/her ability. There should be a clear understanding as to the operational activites among the employees, if the work is assigned strategically there will not be any discrepancies and the work will be done error free.
• Auditing: All the errors cannot be prevented, the organisation must get its financial statements audited by a duly authorised Auditor.
• Tests: Organisations are primarily established with the motive of profit maximisation, one has to make sure that the staff recruited is performing well. The top level management must conduct suprise visits or send persons anonymously to verify the crediblity of the staff appointed. Strict action must be taken for discrepancies, if any.
• Compliance: The financial transactions should proceed under a defied framework, there should noy exist any loopholes. The internal auditors must conduct surprise checks to verify the transactions.