Auditors Are Supposed To Detect Fraud Accounting Essay

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Within the view of the public the auditor's role has given rise to the expectations gap, as it differs from the auditor's own view of the purpose of an audit. The different components of the expectations gap include the reasonableness gap and the performance gap.

To define the gap between society's expectations of the auditor's actual performance can be illustrated within the following diagram:

Society's expectation of auditors

Audit expectation gap

Perceived performance of auditors

Reasonableness gap

Audit expectation gap

Deficient standards

Unreasonable expectations

Deficient performance

Auditors existing duties 2

Auditors existing duties 1

Duties defined by the law and professional promulgations

Duties which are cost-beneficial for auditors to perform

Source: Porter, 1993, p50.

There has always been a misunderstanding and a gap in expectations surrounding the role of the auditor and the meaning of the audit report. This expectations gap has placed emphasis even more over the last ten years, first with the accounting scandals such as Enron's fraudulent accounting and WorldCom, and then with the onset of the financial crisis with the increasing questions of the failure by auditors to foresee the awaiting crisis. These events have also given rise to a crisis within the audit profession itself, causing auditors to seriously examine their own function and how their role could be improved. The result has been in discussion of the future of auditing and their future role as auditors. This discussion has covered many issues that are components of the expectations gap, such as auditor independence, the role of the auditor in detecting fraud, and the meaning and significance of the audit report.

Users of accounts such as company management, investors, creditors and the general public all have their own view of what an auditor should be doing, and of the significance of the audit report. Perpetually their expectations of what the auditor could achieve is set too high, and then resulting in a gap between expectation and reality leads them to question if the value of the audit is in its current form. Company management are asking how it is possible to obtain value for money from an external audit, when it is a legal necessity and that does not necessarily produce worthwhile information, advice or assurance about their financial situation. Investors are asking about the value of the audit report and how far, if at all, it guarantees that all is well within the organisation in which they intend to invest in. Creditors who may have suffered from the accounting scandals and from the financial crisis, are asking how the auditors could have been unaware of the huge financial problems lying just underneath the surface

The qualification of auditors is seen by the investing public as essential, if the audit is to have any meaning. Yet in the early years of the new century, the business world was shaken by scandals such as the Enron collapse, caused at least partly by a lack of audit qualifications. Many large organisations have retained the same auditors for many years, long enough for personal relationships to arise between senior audit staff and company management, which could endanger the ability of the auditor to act in a truly independent manner. There were a lot of pressures for the largest companies to adopt one of the larger auditing firms as their auditors, and there has generally been a trend towards consolidation of audit firms, and therefore a relative lack of competition in the sector. Although auditors may be changed at the time of a company's annual general meeting, a change of auditors is in reality, relatively infrequent and the danger of a lack of audit qualifications remains real.

Although measures were taken following the financial scandals to safeguard audit qualification, by restricting the ability of auditors being able to offer other types of service to their audit clients, these measures were not equally strict in all countries. The measures taken were certainly far stricter in the US with the Sarbanes Oxley Act than in many European countries. For example, in many European countries it has remained possible for the auditors to perform many other services for their audit clients, leading to the possibility of a situation where the auditors are forming an opinion on tax planning transactions taken by their client, on the advice of colleagues from the same audit firm.

There are now many discussions around these measures to ensure the qualification of auditors. These focus on measures such as compulsory rotation of auditors every few years, or a requirement for joint audits to ensure that the relationship between management and the auditors do not get too close. Although such measures might ensure more audit ability, they would also lead to significant inefficiency. Auditors, who deal with the same client year after year, build up expertise with the business that allows them to perform their task more efficiently as the years pass by, and this expertise would potentially be lost. Joint audits would cost much more effort and expense in coordination between the auditing firms, leading to more expense for those firms and for the auditing client.

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The main purpose of an audit from the point of view of the auditor is to ensure that the financial statements of the company give a true and fair view of the transactions during the accounting period under review and that of the assets and liabilities at the balance sheet date. However the public perception is that the detection of fraud should be an important part of the audit and this is another component of the expectations gap.

The auditor's expectation gap results from the difference between the auditor's actual standard of performance and the public's expectations of the auditor's performance, as opposed to the required standard performance. The follow chart will illustrate what many members of the public expect versus existing auditing standards.

Public's Expectations

Auditor's Standard of Performance

Auditors should accept the primary responsibility for the financial statements

Management are responsible for the preparation and presentation of the financial statement in accordance with the Auditing and Assurance Standards Board (AUASB).

Auditors certify financial statements

An Auditor may express an opinion on the financial statements based on their work.

A clean opinion guarantees the accuracy of financial statements

The auditors obtains reasonable assurance that the financial statements are free from material misstatement

Auditors perform a 100% verification

The auditor performs procedures to obtain audit evidence about the amounts and disclosures within the financial statements. The procedures selected vary according to the judgement of the auditors.

Auditors should give early warning about the possibility of business failure

Only when the auditor has a concern that the entity will be unable to release its assets and discharge its liabilities in the normal course of business. On then will the auditor be required to document:

the specific adverse conditions

management plans to mitigate the adverse conditions

The conclusions on the accounting and disclosure requirement.

Auditors are supposed to detect fraud

The auditor is only required to identify the risks that exist due to the error and fraud that could give rise to the risk of material misstatement in the financial statements.

Internal Auditors Role

The internal audit function, whilst having no direct responsibility with the preparation of financial statements, can provide valuable assistance, for example, in providing advice regarding appropriate accounting treatments for certain transactions. Internal auditors can also assist by reviewing the financial statements, or sections thereof, to ensure they fairly represent transactions or disclosures, and comply with prescribed requirements.

Internal auditors may also assist with the quality assurance of the financial statements and may complement and assist the external audit process. There should be discussions between internal and external auditors regarding the assistance to be provided by internal auditors.

External Auditors Role

Under the Auditor-General Act 2009, the Auditor-General is responsible for the annual external audit of each public sector entity.

The Auditor-General (or delegate) will examine the agency's financial statements in order to express an opinion as to whether they present a true and fair view of the transactions, financial position and cash flows of the agency, and are in accordance with prescribed accounting standards. Section 40(3) of the Auditor-General Act also requires the Auditor-General (or delegate) to express an opinion as to whether:

• all information and explanations have been received, and

• the prescribed requirements in relation to the establishment and keeping of accounts have been complied with in all material respects.

The Auditor-General Auditing Standards identify additional facets of public sector external auditing, including:

• reviewing the probity and propriety of matters associated with the management of public sector agencies, and

• assessing compliance with relevant Acts, regulations, Government policies and other prescribed requirements.

In accordance with the Financial and Performance Management Standard 2009, agencies must agree with the Auditor-General a date that the statements will be given to external auditors.

Agencies should also provide external auditors with a copy of the financial statement preparation timetable that schedules completion dates for tasks .

While external auditors may highlight discrepancies noted in their review of the financial statements, it is not their prime responsibility to identify errors and other discrepancies on behalf of the agency. Agencies must conduct their own quality assurance of the financial statements prior to submission to the Auditor-General.

In the event external auditor does note a material error or discrepancy, the issue will be raised with agency management. Whilst management may elect not to amend the financial statements for errors or other problems identified by the external auditors, where external auditors believe that an uncorrected material misstatement is contained in the financial statements, a modified independent auditor's opinion may be issued.

Accordingly, external auditors and agency management should attempt to reach agreement, where possible, that the effects of those uncorrected financial report misstatements found by the auditor during the audit are immaterial, both individually and in the aggregate, to the financial report taken as a whole.

In conclusion in a society marked by competing worldviews, contradictory institutional structures and an unequal distribution of power, wealth and influence, social practices are inherently unstable and the meaning of audit is subject to negotiation and transformation. Despite their self-regulating status, auditors are not in a sovereign position to determine or change the scope of their responsibilities.

Since auditors are understood and expected to pay meticulous attention to matters such as internal control, accuracy of records, , stock counts, cash counts, bank balances, creditors, debtors, third party evidence and many other items, auditors and others continue to assume that auditors must necessarily be looking for fraud and irregularities.

Reference Listing:

McPhee, I 2007, Administering Regulation, Australian national Audit Office, viewed 14th October 2012 <>

Jubb, C, Topple, S, Schelluch, P, Rittenberg, L and Schweiger, B 2004, Assurance and Auditing Concepts for a changing environment, 2nd edn, Cengage Learning, South Melbourne, Victoria

Gay, G and Simnett, R 2007, Auditing and Assurance services in Australia, 3rd edn, McGraw-Hill Irwin, North Ryde, NSW

Wong, J 2008, Auditing Assurance and Ethics Handbook 2008, Pearson Education Australia, Australia