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ACCA Strategic Professional · Advanced Audit and Assurance (International) · Fraud and error

While auditing Saffron Pharma, the auditor identifies that the company is close to breaching a loan covenant and that management has recently changed an accounting estimate to improve profit. How should this be treated under ISA 240?

These are fraud risk factors: covenant pressure gives an incentive and a profit-improving estimate change suggests possible bias. They do not prove fraud, but the auditor must consider them in assessing risks of material misstatement due to fraud and review the estimate for management bias.

  1. AAs fraud risk factors that the team should consider when assessing the risks of material misstatement due to fraud, together with a review of the estimate for management bias.Correct
  2. BAs proof that fraud has occurred, requiring the auditor to withdraw from the engagement.
  3. CAs irrelevant, because fraud risk factors are relevant only when fraud has already been detected.
  4. DAs a matter solely for the tax team to consider.

Explanation

Covenant pressure is an incentive, and a favourable estimate change may indicate bias. Fraud risk factors are events or conditions that indicate incentive, opportunity or rationalisation; they do not prove fraud but must be considered in risk assessment and trigger bias review of estimates. Withdrawal is not automatic.

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