Who Is Responsible for Preventing and Detecting Fraud

...

After the recommendations from the Commission were released, the Auditing Standards Board of the AICPA set out to begin projects that are designed to bridge the gap between the public’s and investors’ understanding of expectation of auditors and what the auditors are responsible for. The expectation gap, according to the author surrounds public understanding of the financial statement responsibilities of the preparers and auditors. The expectation of what the public perceives as the auditors responsibility toward detecting fraud and what the auditor is actually responsible for has long been a differing opinion. In order to address the issue, the Auditing Standards Board (ASD) used its position during that time to address and educate the public’s perception of the auditors’ responsibility, not the manager or providers of the financial information. These responsibilities are discussed in the Statement of Auditing Standards No. 16, “The independent Auditor’s Responsibility for the Detection of error or irregularities.” This standard requires the auditor to look for errors and material irregularities in the financial information that is being presented in financial statements; however the public users of the statements expected more detail auditor responsibilities. (Leary, 1990) The investing public relies on the auditors and to a lesser degree the internal controls of the business to provide reasonable assurance that the financial statements are free from material misstatements. The issue with this belief is that the design and implementation of internal controls is the responsibility of the company’s management. SAS No. 16 requires the auditor, within inherent limitations, to plan audit procedures that are designed to search for errors, unintentional mistakes in the financial information, and irregularities, intentional mistakes made to mislead users of the financial statements, that would have a material effect on the financial statements. In addition and most importantly, SAS No. 16 requires the auditor to conduct the audit with skill and due care. SAS No. 16 also discusses the audit report. It states the audit report “implicitly indicates their belief that financial statements taken as a whole are not materially misstated as a result of errors or irregularities.” (Leary, 1990, p. 244).

Issuing SAS 16 was a good start in helping the public understands the auditor’s responsibility regarding detecting misstatements and fraud; however commentators felt it did not give enough guidance to auditors on how they are to go about detecting errors and irregularities or firmly communicate their responsibility. Because of this the Auditing Standards Board began reconsidering the language of SAS No. 16 to address the concerns of the commentators. The intent is to make the responsibilities of the auditor clearer to the users of the financial statements and the auditors themselves. (Leary, 1990, p. 244).

In addition to addressing auditor’s responsibility in detecting errors, the Accounting Standards Board also wanted to give guidance on auditor’s responsibility on detecting and reporting illegal acts. SAS No. 17, Illegal Acts by Clients was also being reconsidered due to the ambiguity of the language in determining if the auditor was responsible for detecting illegal acts was appropriate. SAS No. 17 illustrates the auditor’s duty to determine if illegal acts have occurred and their obligation to report such illegal acts. This is important as many frauds include illegal acts such as stealing assets and bribing government officials. It is stated in the standard that although the auditor does not specially practice law, the professional training and background should aide the auditor in identifying possible illegal acts that directly affect the financial statements. The standards also states audit procedures should be done that would assist in identifying possible illegal acts and how to report them if any are uncovered. (Leary, 1990, p. 244).

As a result of the reconsiderations of the two standards, No. 16 and No. 17 by the Auditing Standards Board, two new statements were issued in 1988 and became effective for financial statements that were issued after January 1989. These statements changed and clarified the auditor’s responsibility for detecting and reporting material misstatements, illegal acts and irregularities. Firstly, SAS No. 53, “The Auditor’s Responsibility to Detect and Report Errors and Irregularities” (Leary, 1990, p. 245) supersedes SAS 16. SAS 53 requires that the auditor assess the risk that material misstatements may exists and will design audit procedures that will provide reasonable assurance that material misstatements will be detected if present. Secondly, SAS 54, “Illegal Acts by Clients” (Leary, 1990, p. 245) gives similar guidance that is described in SAS 17 in detecting illegal acts, however it includes much of the same requirements stated in SAS 53, meaning the audit procedures should be designed to detect illegal act that may be perpetrated that have a direct and material effect on the financial statements. It is important to note, the ASB does believe it is not feasible to design an audit that will detect all illegal acts done by employees of the company, as detailed in SAS 54. This isn’t because the auditor is incompetent, but rather companies, especially public companies, are subject to laws and regulations that may lead to material consequences if violated. It is the understanding of the ASB that while auditors may have the experience to detect illegal acts perpetrated by employees, they do not have the training to spot violations of all laws and regulations and there is a practical chance these violations will go undetected unless they are specifically pointed out by the company (Carmichael, 2008, p. 41). An example of this is if the company is not in compliance with grants that are provided by a government agency. If it is found, through audit procedures, the company is in violation of one of the requirements; this may not have a direct effect on the financial information, but the auditor should disclose the violation in the footnotes to the statements. (Carmichael, 2008, p. 41).

The ASB’s purpose in issuing these two new standards was to help illustrate to the public and hopefully close the knowledge gap of what the auditor’s responsibility for detecting misstatement is meant to be. (Leary, 1990, p. 245) D.R. Carmichael, the author of the article “The Auditor’s New Guide to Errors, Irregularities and Illegal Acts” further illustrate the differences in SAS 16 and SAS 53. To a non-financially minded person, the differences would be subtle, but to an experience auditor, the differences should be clearer. As stated previously, the main reason for issuing the two separate standards, 16 and 53, the intent of