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During the past 20 years there have been an increasing and non-stopping number of fraud related issues at almost any corporation in the United States. Fortunately with the aid and support of accounting professionals, these fraudulent matters are being reduced with a lot of efficacy and effectiveness. These accounting professionals, also known as auditors, possess certain responsibilities to detect fraud and are being considered as key factors for any organization success at detecting as well as ending fraud. "The attempt to conduct a plan that provides a positive return on the organization's investment is critical to the success of the risk assessment." (Ramos, 2003) Therefore, the subsequent essay will illustrate how the crucial and imperative tasks of external auditors, certified public accountants (CPAs) in the public sector and internal auditors, work together by aiming fraud.
The following document will describe the many responsibilities auditors' have power over in the corporate and legal environment and how these tasks can be properly implemented. In addition, how these auditors' responsibilities are being discussed and utilized in today's workplace will also be discussed. One important aspect that cannot be overruled is the fact that the proficiency, skills and experience auditor possess are keys for any successful achievement.
"Only those organizations that adopt and execute a well-designed approach can ensure identification of fraud risk, which, if left unchecked, can ultimately result in the loss of the organization's assets." (Ramos, 2003)
What is Fraud?
Fraud is considered as an extremely costly problem that affects the general public. The simply, but at the same time complex process of fraud detention, needs to be considered crucial for today's organization. There is an explicit approach called 'fraud examination' that is practically administered "to determine if fraud has occurred and if so to gather evidence of the crime." (Nelson, n.d.) Fraud is also believed as a professional misdeed or crime thus the proper examination of such incidents will practically involve a series of inspections as well as examination of economic and financial reports. Additionally, the act of committing fraud can take many shapes and forms but is mostly difficult to distinguish in view of the fact that fraudsters figure out ways to evade and outwit laws, rules, regulations, policies and procedures." (Nelson, n.d.)
Auditors in order to detect fraud will have to assume certain responsibilities that were practically nonexistent until today, but due to the persistent increase of fraudulent business transactions, these tasks seemed roughly required. Additionally, the auditor is responsible for planning the audit process structure, how is it going to be implemented as well as how the outcomes are going to be analyzed.
Therefore, one of those procedures to detect fraud, called Statement on Auditing Standards (SAS) no. 99, "portrays a process in which the auditor gathers information needed to identify risks of material misstatement due to fraud; assesses these risks after taking into account an evaluation of the entity's programs and controls; and responds to the results." (Ramos, 2003) It is important that management know about the different programs and control about the nature of fraud risk, because it is a way that auditor gathers information to detect fraud, other form to help the auditor it is to seek information about the existence or imagination of fraud.
In other words, the auditor has the responsibility to know how the transaction as a necessary part of financial reporting process is controlled and processed and the auditor has the authority to investigate outside of department in direct relation with the financial reporting process.
The SAS no. 99 gives the auditor the authority to ask when they observed a person in the entity is in fact committing a fraud. Besides this approach allows auditors the right to make different investigations that can help to identify or assess risk of material misstatement due to fraud. Consequently, and according to Ramos (2003), there are different examples of this investigation as illustrated below:
Categorize the existence of the fraud triangle characteristics. (see illustration 1 for more)
Recognize the situations or conditions under which management has or may dominate internal controls.
Understand the business underlying principle for significant unusual transaction.
Value policies and procedures related to revenue recognition.
Understand the policies, procedures and control for recording journal entries or other adjustments.
Illustration 1- The Fraud Triangle Source: Ramos, 2003
SAS no. 99 "will not actually change the auditors' detection responsibility but will strengthen performance requirements." (Ramos, 2003) In other words, SA no. 99 would, without doubts, converse the external auditors' responsibility. Explicitly said, to arrange and execute the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. (Ramos, 2003)
As Ramos (2003) states, "external auditors might consider setting ground rules to help them achieve their objective". These auditors need to remember that inspirations or suggestions are considered a required technique and should be applied with a similar grade of importance as any other audit procedure.
For that reason, the following are some examples of attitudes external auditors can implement when performing their tasks and can also be extremely beneficial (Ramos, 2003):
Anticipating or predict questions by labeling them inadequate is one sure way to stifle the contribution of ideas.
Since the world of ideas does not recognize rank, experience or compensation level. Create an environment in which senior team members share information without dominating the discussion and junior members feel secure contributing their own ideas.
A brainstorming session is an intuitive, spontaneous process. Excessive note taking is a barrier to this process.
When individuals become personally invested in an idea, they tend to fight for it as long as possible. There may be a time and a place for battling over the validity of an idea, but a brainstorming session is not one of them.
Certified Public Accountants (CPAs) in public practice
CPAs may be held responsible for a large variety of antifraud and forensic accounting actions and activities including: "investigating suspected fraud, investigating assertions of fraud, developing fraud loss estimates, and many other types of engagements." (AICPA, 2002) Unfortunately, in many cases where CPAs were basically held accountable for missing fraud in financial statements audits, there were many common problems. Sometimes, these auditors simply failed to follow up on signs or indications of fraud, and some other times they seemed excessively trusting of management and accepted explanations for exceptions without verifying that they were true." The many responsibilities CPAs, especially in the public sector, "include but are not limited to fraud detection, investigation, and prevention methods; analysis and techniques; key developments in financial-related fraud; the litigation process; and research tools and aids." (Ramos, 2003)
The American Institute of Certified Public Accountants, also called AICPA, (2002) affirms that "before the Sarbanes-Oxley Act (SOA), the AICPA was responsible through its Auditing Standards Board (ASB) in developing auditing standards that had to be satisfied by public accounting firms." Additionally, it is considered that the Security Exchange Commission (SEC) only "mandated openly traded firms to be audited by public accounting firms to provide reasonable assurance of presentation in conformity with generally accepted accounting principles." (Ramos, 2003) Therefore, in conducting an audit, CPAs firms had to observe generally accepted auditing standards as promulgated by the Auditing Standards Board (ASB).
"One of the most highly publicized statements on fraud auditing standards in recent years was published in early February of 1997. Statement on Auditing Standards (SAB) No. 82, Consideration of Fraud in a Financial Statement Audit, provided guidance to the auditor in the detection of financial statement fraud." (Zikmund, 2008)
In order to be able to properly detect fraud, internal auditors are considered the most reliable in view of the fact that they do not carry "the potential for substantial fines, penalties, and loss" (Zikmund, 2008) that external auditors transmit. Therefore, the internal auditors' responsibilities plays a crucial role in assessing fraud risk and these are mainly focused on fraud risk assessment and alleviation programs. Additionally, "internal auditing is responsible for evaluating whether internal controls are designed to meet their overall objectives."
Additionally, and as stated by Zikmund (2008), "one of the best approaches utilized by internal auditors is called a four-step process that includes evaluating the organization's fraud risks, identifying possible fraud schemes and scenarios, prioritizing identified fraud risks, and evaluating mitigating controls." In other words,
Evaluate the organization's fraud risk factors
Identify possible fraud schemes
Prioritize identified fraud risks
Estimate mitigation controls
In other words, "SAS no. 99 basically requires that auditors confer the probable misstatement in the financial records due to fraud before and during the information-gathering process." (Ramos, 2003) This thinking practice is considered as a required new concept in the auditing field as well as in the adoption process and the goal of firms would need to be focused on deciding how best to implement this requirement in practice.
How Auditors' Responsibilities to Detect Fraud Have Changed Over the Years
Over the past decade or even more, the auditing profession has changed significantly. As Tatum and Munter (1998) state, "bidding and solicitation are now accepted as a way of life." Before there were less cases of fraud thus the auditing process as complex and at the same time extenuating as it is today. "The Securities Litigation Reform Act (SLRA) of 1995 stresses the auditor's responsibility for the detection of fraud; therefore, the difficulty of business transactions and corporation structures has increased significantly." (Tatum and Munter, 1998)
In fact, due to these changes, "the Auditing Standards Board (ASB) has found it necessary in recent months to reexamine existing auditing standards in light of these revolutionary environmental changes in which audits are conducted." (Tatum and Munter, 1998) In other words, accounting professionals would need to adapt to certain new rules and regulations in order to be able to succeed at detecting fraud.
Officially and legally speaking, "it is well thought-out that a fiasco by auditors of any field (internal, external or CPAs) to correctly display and communicate a suitable attitude regarding internal control and the financial reporting process." (Apostolou and Crumbley, 1990)
Consequently, and as Apostolou and Crumbley (1990) detailed, there are precise and extremely reliable indicators that might aid auditors and these include:
Authority of management by a single person or small group without compensating controls such as effective oversight by the board of directors or audit committee.
New accounting, statutory, or regulatory requirements that could impair the financial stability or profitability of the entity.
Organization continuing to employ an ineffective accounting, information technology, or internal auditing staff.
Declining industry with increasing business failures and significant reductions in customer demand.
An ineffective means of communicating and supporting the entity's values or ethics, or communication of inappropriate values or ethics.
Management setting unduly aggressive financial target and expectations for operating personnel.
Nonfinancial management's excessive participation in, or preoccupation with, the selection of accounting principles or the determination of significant estimates.
Previous history of securities law violations or claims against the entity or its senior management alleging fraud or violations of securities laws.
High degree of competition or market saturation, accompanied by declining margins.
In addition, the information required in order to comply with the standards of the SAS no. 99 extend significantly those of the previous standard, known as SAS no. 82, "requiring documentation supporting compliance with substantially all the major requirements of the standard. SAS no. 99 provides a complete, easy-to-understand list of documentation requirements." (AICPA, 2002)
This is practically why auditors in the past were only able to find certain amount of fraudulent transactions but not quite all of them. In contrast, today auditors are authenticating and validating the precision of the many financial records, not essentially looking for fraud, but for reliability only. They design procedures to actively look for fraud in an organization, and when they find it, they dig deeper to find all the evidence and build a case against the perpetrators. According to the standard, today auditors' are required to document (Ramos, 2003):
The results of the procedures performed to further address the risk of management override of controls.
The procedures performed to obtain information necessary to identify and assess the risks of material misstatement due to fraud.
Specific risks of material misstatement due to fraud that were identified and a description of the auditor's response to those risks.
The discussion among engagement personnel in planning the audit regarding the susceptibility of the entity's financial statements to material misstatement due to fraud, including how and when the discussion occurred, the audit team members who participated and the subjects discussed.
If the auditor has not identified improper revenue recognition as a risk of material misstatement due to fraud in a particular circumstance, the reasons supporting that conclusion.
The nature of the communications about fraud made to management, the audit committee and others.
Conditions and analytical relationships that caused the auditor to believe additional auditing procedures or other responses were required and any further responses the auditor concluded were appropriate to address such risks or other conditions.
Figure 1: The Fraud Risks Assessment Process
Unfortunately, fraudulent activities have become more and more frequent in today's economic society. Therefore, the usage and implementation of fraud examination procedures by accounting professionals are being considered as a key to success for a yearned excellent outcome. Auditors' responsibilities today to detect fraud include several well known and victorious procedures, as mentioned above.
These tasks are mainly being performed by accounting professionals, especially external auditors, Certified Public Accountants (CPAs) in public practice as well as Internal Auditors. In other words, fraud examination is today a growing field compared to what it used to be several years ago. The complex act of detecting fraud includes "exciting opportunities since there will always be a need for fraud examiners and as fraud examination techniques evolve and become more scientific, more and more fraud will be uncovered." (Nelson, n.d.)