Who’s on first? Deterring and detecting fraud

When it comes to who is responsible for deterring and detecting fraud, management, audit committees, internal and external auditors don’t always seem to know “who’s on deck.”

When it comes to who is responsible for deterring and detecting fraud, management, audit committees, internal and external auditors don’t always seem to know “who’s on deck.”

The Anti-Fraud Collaboration, which includes the Center for Audit Quality (CAQ), Financial Executives International (FEI), the Institute of Internal Auditors (IIA), and the National Association of Corporate Directors (NACD) in the United States, conducted a survey and roundtable discussion with the key players in the financial reporting supply chain. Each group was asked their expectations of the various players’ roles in the deterrence and detection of financial reporting fraud. I found this interesting because when people talk about the “expectation gap” they generally focus on the gap between what investors think auditors do and what they actually do in an audit. It is evident that the expectation gap also applies to those who work closely with auditors – specifically management, internal auditors and the audit committee.

The auditing standards state the primary responsibility for the prevention and detection of fraud rests with both those charged with governance (the audit committee) and management but this was not borne out in the Anti-Fraud Collaboration survey. While the vast majority of survey respondents indicated that management had primary responsibility for deterring fraud, when it came to detecting fraud audit committee members and internal auditors were more likely to place primary responsibility on the external auditor. In fact, only 2 per cent of the directors surveyed believe they have a primary role in detecting financial reporting fraud. At the same time, 75 per cent of the directors are confident or highly confident of identifying a potential material misstatement of the financial statements due to fraud. This level of confidence about directors is not shared by the other financial reporting chain members. For example, only 46 per cent of auditors are confident or highly confident in directors/audit committee identifying such a misstatement.

Survey respondents were asked “how reasonable is it for us to deter/detect financial reporting fraud?” Of the four groups, management scored themselves the highest – 4.2 (deter) and 3.7 (detect) respectively, with 5 being “very reasonable” and 1 being “not reasonable at all.” Some investors might think that 3.7 is still a low score when it comes to detecting financial reporting fraud. But for me, the low individual scoring by the four groups demonstrates that effective deterring and detecting of fraud depends on all four groups performing their role appropriately, or as stated in the summary:

“complementary parts working together to design, operate, and monitor controls that mitigate the risk of material misstatements related to financial reporting fraud.”

A key conclusion of the roundtable is that to address the expectation gap among financial reporting participants there needs to be open and candid conversation with the internal and external audit functions, management and the audit committee; this would go a long way toward addressing the larger expectation gap between financial reporting participants and the investing public.

Appropriate interactions, including formal and informal communications, among the separate groups in the financial reporting chain can also influence audit quality. Therefore, there seems to me to be a link between the conclusions of the Anti-Fraud Collaboration and enhancing audit quality.

Keep the conversation going… are auditors and audit committees having open and candid conversations about deterring and detecting fraud? Do the conclusions of the Anti-Fraud Collaboration make sense to you?

Post a comment below; or email me directly.

Eric

Conversations about Audit Quality is designed to create an exchange of ideas on global audit quality developments and issues and their impact in Canada.

About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada

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