Abstract: The article discusses the issues related to the increased risk of fraud in business units during the COVID-19 pandemic. The aim of the article was to point out the impact of the pandemic on areas that may be exposed to the embellishment of the presented financial data, as well as to show the increased risk during the audit of the financial statement, which must be taken into account by the statutory auditor when performing the financial audit. Possible solutions were identified, also recommended by the Polish regulator, that may help to sensitise the financial and accounting services to the emergence of fraud in enterprises, and in which areas increased caution should be exercised in the analysis of the presented financial data. It was also pointed out how important a role auditors have in building public trust as ethical leaders. The research methods used in the article were a review of source documents and materials issued by international organizations.
<a href="https://dx.doi.org/10.15611/fins.2022.2.03">DOI: 10.15611/fins.2022.2.03</a>
<p>JEL Classification: M410, M420, M490</p>
<p>Keywords: financial audit, fraud, audit of financialstatements, COVID-19</p>
<h2>1. Introduction </h2>
<p>Currently, the world is experiencing difficulties in doing business
due to the COVID- 19 pandemic. Supply disruptions from global markets,
job losses, problems in continuing operations, personal or
organizational financial difficulties are the daily reality of people
all over the world. Due to the pressures and uncertainties that shape
the current reality, business units are looking for ways to continue
their operations, maintain employment stability, and achieve economic
growth in the long term. These actions may contribute to the search for
illegal or fraudulent solutions. The circumstances created by the
pandemic may give rise to new opportunities to commit fraud (Internet 1,
2020), which, given the situations, may remain undetected for a long
time and thus cause greater and more widespread financial difficulties
for the victims. Yet, “severe crises can be like receding tidal waves,
revealing what was hidden from view” (Poruszanie się wśród podwyższonych
ryzyk…, 2021). This means that it is through the current crisis that
such fraudulent activities that have been hidden for years can come to
light.</p>
<p>The purpose of the article was to indicate the impact of the pandemic
on various areas that may be exposed to an increased risk of fraud
during auditing activities, as well as to identify possible solutions,
also recommended by the Polish regulator (Sprawozdanie finansowe w
czasie pandemii COVID -19…, 2020), that can help sensitise financial and
accounting services to the emergence of fraud in a business entity. With
the adoption by the National Council of Statutory Auditors (Uchwała z
dnia 25 marca…, 2019) of a resolution to introduce a new and improved
Code of Ethics for Statutory Auditors in the language of the
International Code of Ethics for Professional Accountants, auditors have
a tool with which they can play a guiding ethical role in minimising the
extent of fraud. They can also help to signal the appearance of
attempted fraud or fraud that has already taken place and to respond
appropriately, seeking to reduce the impact of such actions on
individual business entities.</p>
<h2>2. Risk of fraud</h2>
<p>One definition of ‘fraud’ states that it is an action undertaken
deliberately to obtain an advantage but at a loss to third parties
(Internet 8, 2020). It can occur in an enterprise at any level of
employment, regardless of position. It can also be collusion between
persons within an enterprise or involving a third party outside the
entity (Internet 2, 2020). Procedures for estimating the risk of fraud
should consider three areas that may convey information that
manipulation may have occurred within an enterprise. These are called
the ‘fraud triangle’ and are presented in Figure 1.</p>
<p>
<img src="/articles/2022/lew-2022-2/media/image1.png" />
</p>
<p><strong>Fig. 1.</strong> The Fraud Triangle
Source: own elaboration based on (Wells, 2006, p. 6).</p>
<p>The first area shown in Figure 1 is the perception by managers or
employees of real or perceived pressure or encouragement that can
provide an opportunity to commit fraud. Another is justifying and
explaining to oneself a fraud that has not really been committed because
"nothing happened", and "it doesn't affect my work that much". Then the
last area, which is most strongly felt nowadays, is the emergence of
circumstances that are conducive to committing a fraudulent act (Hołda,
2020, pp. 48-51).</p>
<p>The COVID-19 pandemic has a negative impact on many areas of life and
work of individuals and whole organizations (Internet 1, 2020).
Businesses are experiencing many difficulties because of it, from
financial distress, to the suspension of operations during lockdown and
other countermeasures implemented, to problems with business continuity
and profitability (Chrostowska & Koleśnik, 2021, pp. 9-28). The
desire of businesses to counter this has created both incentives and
pressures to commit fraud. "In addition, the surge in demand for PPE and
prescription drugs has also created incentives for actors to exploit
this demand for quick and illicit financial gain" (Poruszanie się wśród
podwyższonych ryzyk…, 2021).</p>
<p>The business disruptions caused by COVID-19 and the pressures that
arise under them are unprecedented. They may have affected the attitudes
of management and staff operating in the business in question. There may
also have been temptations to consider different ways of maintaining
operations and staffing levels. However, if these ways are fraudulent,
then justifying such decisions may contribute to the appearance or
accumulation of unethical behaviour in the business entity (Kutera,
Hołda, & Surdykowska, 2006, p. 286). This is why it is so important
to realise that maintaining the highest standards of ethical behaviour
nowadays is in the best interest of every company.</p>
<p>The COVID-19 pandemic has created circumstances that encourage the
commission of fraud. The Independent Regulatory Board of Chartered
Accountants (IRBCA) of South Africa examined and issued, in
collaboration with the IESBA, IAASB, and the national ethics
standard-setting bodies of Australia, China, Canada, the US and the UK,
discerned the risks associated with the occurrence of fraud, which
included the following:</p>
<ul><li>
<p>large amounts of funding are made available – all national and
international organizations announced that they are making and will
continue to make large financial aid packages available to offset the
health and economic impact of the pandemic, which can be an attractive
target for people who want to commit fraud;</p>
</li>
<li>
<p>lack of focus of management operating under time pressure – the
pandemic caused management to shift its efforts to crisis management,
which may result in opportunities for misappropriation of assets. There
was a need to make quick decisions in a short period of time, yet this
may result in the neglect of the proper control and application of
procedures, and in a loosening in the area of diligence and
supervision;</p>
</li>
<li>
<p>continuity of internal control effectiveness – management's skills
and flexibility allowed many business units to adopt alternative ways of
working, such as remote working from home. However, these ways can
create challenges to the effectiveness of the pre-existing, internal
control environment;</p>
</li>
<li>
<p>significant market opportunities – the increase in demand for
personal protective equipment (PPE) and therapeutic agents created
significant opportunities for unethical individuals to, among others,
increase dumped prices or sell chemical agents that do not meet safety
standards (Poruszanie się wśród podwyższonych ryzyk…, 2021).</p>
</li>
</ul>
<p>The areas listed are not exhaustive of all the risks that emerged
during the pandemic in business units. However, they do make it clear to
managers and employees that a particular area may require greater
attention and control. The changes that are a consequence of the current
pandemic situation may affect the reliability of information, which in
turn may have an impact on the conclusions to be drawn when preparing,
presenting, and auditing financial statements. In the current situation,
there should be all the more emphasis on auditors, together with those
in the finance and accounting departments, to be inquisitive (i.e. to
make reliable judgements, assess the validity and veracity of
information, make informed decisions and use professional judgement) and
to observe the five fundamental ethical principles set out in the Code,
i.e. integrity, objectivity, professional competence and due diligence,
confidentiality and professional conduct (Uchwała z dnia 25 marca…,
2019). This was strongly emphasised by the President of the IESBA, Dr S.
Thomadakis, who stated that "now, more than ever, professional
accountants must focus on the public interest and the ethical
obligations incumbent on them" (Poruszanie się wśród podwyższonych
ryzyk…, 2021).</p>
<h2>3. Audit and increased risk of
fraud</h2>
<p>Conducting audit work in the COVID-19 environment presents unique
challenges. Many business entities have shifted to working remotely,
which has affected financial reporting controls and obtaining reliable
audit evidence (Internet 4, 2020). Health and financial risks have made
people more vulnerable and fearful of whether business units can sustain
their operations and whether they will be able to cope with current
circumstances (Internet 8). This also raises more opportunities for
fraud, which, in turn, results, for the auditor, in an increased risk of
material misstatement of the financial statements (Krajowy Standard
Badania 315 (Z)…, 2019). When auditing financial statements, the auditor
considers factors that can identify risks arising from fraud. Based on
the data they obtain about the entity, they can develop procedures to
reduce the level of these risks to one that will allow them to express
an opinion on the audited area of the financial statements. For this
they can also use the fraud triangle described earlier, by means of
which they can make an identification in each of the three areas
(Internet 8).</p>
<p>As IRBCA points out, the deterioration in the financial situation of
business units, as well as individual employees, may have increased
susceptibility to incentives or pressures to commit fraud. This may be
due to new time constraints, as many employees work remotely in an
attempt to reconcile home and work responsibilities, or due to
downsizing, where employees have to perform additional responsibilities
in addition to their duties. The pandemic raises more opportunities for
incentive proposals for illicit profit (Internet 8). Employees may feel
pressure from new time constraints as more workers work remotely from
home and struggle to balance work with other responsibilities.
"Financial difficulties may create additional pressures. Management may
feel pressure to alter or distort an entity's financial performance and
position in order for it to achieve its objectives, avoid bankruptcy or
foreclosure, maintain its customer base, obtain financing in the form of
debt or equity, or qualify for government assistance" (Poruszanie się
wśród podwyższonych ryzyk…, 2021). Auditors must increase their
vigilance for the occurrence of such situations in business entities and
focus even more strongly on the important audit area that accounting
records are becoming. Similarly, they should approach the area of
auditing accounting estimates because all estimates are associated with
a certain degree of uncertainty, which may cause subjectivity (Internet
2). This, in turn, creates a need for judgement on the part of
management, which may lead to unintentional or intentional bias on the
part of management. If it is intentional, management bias is inherently
deceptive (Internet 8).</p>
<p>In contrast, modifications to internal controls required by the
pandemic situation have created more opportunities for fraudulent
financial reporting or misappropriation of assets. The auditor should
pay particular attention to opportunities for management to circumvent
these controls (Krajowy Standard Badania 265…, 2019) , if only because
remote working has a significant impact of not being able to control and
verify areas that were previously under control. Another possibility of
fraud to emerge is changing supply chains. Other third parties emerge
who are not a trusted source of supply, and as a consequence may cause
an increased risk of fraud. Another area in which the auditor should
look is financial assistance from government and local authorities.
There may be a desire to manipulate the data shown in the financial
statements in order to obtain a positive verification of an unlawful
application for funding activities during a pandemic (COVID-19: Aspekty
etyczne oraz rozważania dotyczące niezależności…, 2022). The auditor
should also be aware that the audit evidence they obtain during the
audit engagement may be different from what they previously obtained
(Internet 1). This may be due to different sources of their acquisition,
access to information, or their use, which in turn, may result in that
evidence not being as useful or reliable as the evidence used previously
in their work. "This may result in other challenges in relation to
assessing the usefulness and reliability of information" (COVID-19:
Aspekty etyczne oraz rozważania dotyczące niezależności…, 2022). Remote
working has also increased the risk to data security as it makes
business units vulnerable to <em>cyber-attacks</em> (Internet 9), and
the shift of management's attention to the more pressing needs of the
business, such as financial and operational matters, rather than
focusing on compliance issues, may have resulted in a weakening of
internal controls. This is why it is so important for the auditor to
consider significant changes that have occurred in internal control
during the period, particularly in terms of fraud risk factors. Changes
in control procedures may indicate an increased risk of material
misstatement due to fraud, which affects the auditor's design and the
conduct of further audit procedures (Internet 8). The COVID-19 pandemic
has meant that fraudulent activities can be ‘justified’ as helping an
individual survive or for personal gain due to financial deterioration.
This can manifest itself in different ways and occur at different levels
within the entity, from top management to rank-and-file employees.
Therefore, the auditor, in performing their audit engagement, should
continually review whether their procedures would allow them to identify
material misstatements in this regard (Internet 6).</p>
<h2>4. Planning and conducting the
audit</h2>
<p>When planning and performing an audit engagement, the auditor should
always consider the risk that financial statements contain material
misstatements due to fraud. Although the audit has been properly planned
and conducted in accordance with the applicable Polish law, there is
always a risk that some material misstatements will not be detected
(Krajowy Standard Badania 200…). In the current situation, some risk
factors for fraud may have been amplified, and while the auditor may
have completed the risk identification and assessment before the audit
commenced, as circumstances change, he or she should continually
consider whether the previous findings remain the same or whether
further redesign is needed. This may result in changes in how audit
procedures are designed and performed for particular groups of
transactions, account balances, or disclosures (Internet 6). During the
pandemic, more often than not, the information the auditor receives may
be in a different format than before. This may result in the need for
additional or different procedures to determine whether the information
to be used as audit evidence by the auditor is relevant and reliable and
will allow the auditor to express an opinion on whether the financial
statements are, in all material respects, prepared in accordance with
the applicable financial reporting framework (Krajowy Standard Badania
200…).</p>
<p>Therefore, regular and adequate communication with management and
supervisors becomes so important, as events and changes that occur are
dynamic and can have a significant impact on the audit. In addition,
there may be a need to modify the opinion in the auditor's report. This
situation requires that the circumstances that led to such a situation
be presented to those who supervise the entity (Krajowy Standard Badania
705 (Z)… ).</p>
<p>In turn, MSB 570 Krajowy Standard Badania 570 (Z) w brzmieniu
Międzynarodowego Standardu Badania 570 (Zmienionego) Kontynuacja
działalności, Załącznik nr 1.24 do uchwały Nr 3430/52a/2019 Krajowej
Rady Biegłych Rewidentów z dnia 21 marca 2019 r. sets out communication
requirements when events or conditions are identified that may cast
significant doubt on the entity's ability to continue as a going concern
(Internet 5). In contrast, ISA 701 requires the auditor to communicate
to supervisors those matters that the auditor has identified as key
audit matters (Krajowy Standard Badania 701…).</p>
<p>To properly plan and conduct an audit of financial statements,
professional scepticism becomes all the more necessary (Krajowy Standard
Badania 200…). Having a critical mind, being alert to conditions that
may indicate risks from fraud or contradictory audit evidence, and
conducting a critical evaluation of the evidence gathered, becomes even
more relevant and important (Poruszanie się wśród podwyższonych ryzyk…,
2021). The auditor must not forget that the current times are conducive
to an increased risk of violating laws and regulations. This may be due
to regulations that are often unclear and opaque, and short deadlines
for submissions, but also due to accidental or intentional breaches of
the law.</p>
<h2>5. Conclusion</h2>
<p>The impact of COVID-19 has a significant global impact on individual
business entities and global markets, which are currently characterised
by dynamic volatility and possible material uncertainty. In such
unpredictable circumstances, auditors of affected entities should focus
on the potential effects on reports used to communicate audit opinions
to interested recipients (Internet 5). As the IRBCA team and its
collaborating bodies rightly point out, the responsibilities caused by
the COVID-19 pandemic can be overwhelming, but at the same time they can
also be inspiring. This time of crisis is an opportunity for auditors to
be seen and admired as ethical leaders. The skills they possess and the
values they hold at work can bring about positive change. Remaining
alert to threats to compliance with fundamental principles can cause a
reconsideration of the safeguards and expectations of a reasonable and
informed third party. Reminding others of the risks and helping to
identify these areas will, in the long run, contribute to the long-term
retention and success of the business units and clients that employ them
(Internet 5).</p>
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