Audit must “dial up focus” to detect fraud more effectively

A recent spate of alleged negligence against audit firms has highlighted that the profession must improve trust and do more to detect corporate fraud.

“People expect auditors to do more in this area, and I think that’s a reasonable position to take,” says Mike Suffield, director of professional insights at the Association for Chartered Certified Accountants (ACCA).

“I think it has been the case that there have been big frauds that the auditor should have found and didn’t, and that’s what has led to this lack of trust in the profession.”

Several key cases in recent history help to frame this discussion, with the role KPMG played in the 2018 collapse of government contractor Carillion perhaps the most infamous example.

However, other Big Four firms have found themselves embroiled in similar controversies over the past 12 months.

EY is currently accused of “actively concealed” a six-year fraud from investors during its auditing work for former FTSE 100 healthcare group NMC Health. The amount that was hidden from the group’s balance sheet is reported to be over $4bn.

Meanwhile, PwC has been sued by administrators of luxury car dealership JD Classics. The firm stands accused of failing to spot fraudulent activity which caused losses of more than £41m.

“We don’t believe this claim has merit and will be vigorously defending it,” said PwC in a statement.

Suffield argues that to avoid further controversies occurring auditors’ focus must be sharpened.

“I think there’s scope for them to report publicly on what they’ve done in a clearer fashion. There’s an accountability and transparency side to it which I think could improve.”

Part of this, he suggests, required auditors to enhance the techniques and technologies at their disposal – something that is unavoidable in such a technical profession.

“Technology has developed significantly in recent years to allow both companies themselves and auditors to interrogate data much more quickly, much more effectively and much more comprehensively, so they can identify outliers in datasets that might arouse suspicion.

“It’s a technical area all of its own and therefore it needs investment on the part of both audit firms, but also organisations themselves.”

Similar views are shared by Ed Anderson, partner at law firm Browne Jacobson. He argues that “a lack of necessary professional scepticism” has been the driving force behind past failures to detect fraud, and that the government’s consultation on audit reform goes some way towards addressing this.

“A greater focus on training in this area to change auditors’ skillsets and mindsets and the proposed new standards emphasising its importance are crucial to ensuring that fewer cases go undetected.

“This will help hugely with the proper adoption of the necessary level of professional scepticism.”

The proposal to carve audit from the accounting profession and establish a dedicated professional body is arguably the consultation’s most significant statement of intent in this regard. Its purpose is that, as a standalone profession, audit will be handed the opportunity to become more dynamic and evolved, and ultimately attract better talent.

The audit expectation gap

Audit reform is clearly necessary to improve fraud prevention and detection, but it’s important to acknowledge the distinction between two, says Suffield.

“I think we need to be careful about using the word prevent here – the role of the auditor, for me, is much more around the detection of fraud. I don’t think it’s at all reasonable or even possible to place responsibility on auditors to prevent fraud.”

Suffield and Anderson both refer to this as “the expectation gap” – an age-old dichotomy surrounding the audit industry and the true nature of the auditor’s responsibility.

“Auditors don’t have a public responsibility to prevent fraud as such, and historically that has been part of the audit expectation gap,” says Anderson.

“They are not forensic accountants, who deal with cases of fraud in their daily jobs. Most auditors will never encounter it in their career and have a fundamentally different mindset.”

Both also suggest that the prevention of fraud should predominantly fall to directors and management – another area extensively addressed by the forthcoming audit reforms in the UK.

Broadly influenced by the United States’ Sarbanes-Oxley, the new rules include a series of punitive measures against company directors, including fines, suspensions, revoking of bonuses and dividends, and a series of more stringent reporting requirements.

Suffield also argues that there is a widespread misunderstanding of what auditors do, which in turn leads to excessive and unfair scrutiny in the wake of high-profile corporate fraud cases.

“There’s a perspective that when an auditor signs off on a set of accounts, they’re effectively saying that there certainly isn’t any fraud within the organisation – and that’s not really what they’re there to do,” he says.

“Auditors have got a really important role to play, but absolutely so still do the directors and management and the governance systems and the internal control systems of the organisation. And in many ways, they’re better placed to prevent it happening.”