How the distinction works
The distinction becomes critical when the auditor identifies a misstatement and must decide how to respond. ISA 240.35 requires the auditor to evaluate whether a misstatement is indicative of fraud.
If an error: evaluate under ISA 450 and add to the misstatement schedule.
If fraud: ISA 240.38 requires communication to management, ISA 240.40 to governance, and ISA 240.36 requires the auditor to reconsider the fraud risk assessment for the entire engagement.
Governed by: ISA 240 paragraph 11 (definitions of fraud); ISA 450 paragraph 4(a) (definition of misstatement)
Key Takeaways
- The difference between error and fraud is intent; the financial effect can be identical.
- Fraud triggers ISA 240 obligations including communication to governance and possible reporting to regulators.
- Errors require evaluation under ISA 450 but do not trigger ISA 240's fraud-specific procedures.
- When the auditor cannot determine whether a misstatement is error or fraud, they must treat it as potential fraud.
Worked example: Lindström Engineering Oy
Finnish engineering company, FY2024, revenue €65M, IFRS.
Misstatement 1 (error): €145K supplier invoice recorded in wrong period. Clerk confirms late processing. No intent identified.
Misstatement 2 (suspected fraud): €89K credit note issued 28 December with no underlying return, complaint, or contractual basis. Sales director authorised without supporting correspondence. Team extends credit note testing, finds two more unsupported credit notes (€52K). Total suspected fraud: €141K.
Error vs fraud comparison
| Dimension | Error | Fraud |
|---|---|---|
| Definition | Unintentional misstatement (ISA 450.4(a)) | Intentional act involving deception (ISA 240.11) |
| Intent | Absent | Present |
| Governing standard | ISA 450 | ISA 240 |
| Communication | Management | Management + governance + possibly regulator |
| Effect on risk assessment | May indicate control deficiency | Requires reassessment of fraud risk |
What reviewers get wrong
- Teams skip the ISA 240.35 evaluation, recording every misstatement on the ISA 450 schedule without asking the intent question.
- Teams classify a misstatement as error because the perpetrator said it was a mistake. ISA 240.A9 notes that determining intent is difficult; if characteristics suggest fraud, treat as suspected fraud regardless of management's explanation.
Related terms
Related reading
Frequently asked questions
What is the difference between an error and fraud in auditing?
Intent. An error is an unintentional misstatement; fraud is an intentional act involving deception. The financial effect can be identical, but the auditor's obligations differ significantly under ISA 240 and ISA 450.
What should the auditor do when they cannot determine if a misstatement is error or fraud?
ISA 240 requires the auditor to treat it as potential fraud and follow the fraud-specific communication and risk reassessment procedures until the matter is resolved.