This introductory chapter intend to inform the reader on the multiples issues that will be tackled in this paper. So after describing the main issues, this chapter will therefore cover the rationale of the research, the aims and objectives as well as the limitations encountered, which all will be fully explored. Eventually a review of the structure of the research will also be conducted to conclude this first part.
Description of the issue
External auditors' responsibilities and roles have always been highlighted by several questions such as ' Where were the auditors' (Yuhao Li, 2010) in main financial scandals as the Enron affair in 2001, the WorldCom in 2002 and Parmalat in taly in 2003. As these entities stated were very wealthy and profitable, when suddenly they were declared bankruptcy subsequent to the discovery of several irregularities and fraud. Alleyne and Howard (2005) argue that these kind of corporate disasters are frequent and are affecting the responsibility as well as the independence of auditors in detecting corporate fraud.
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'Why did not the auditors catch it' this is the first question that arises following a corporate failure. That is why, in relation with the above question and according to Millichamp and Taylor (2008), there is a difference called 'Perception Gap' between the public and the auditing profession concerning the duty of an auditor regarding the fraud and errors detection. Therefore the auditor duty can be seen as the independent examination and expression of opinion over the financial statements produced by the entities. It must be done by an appointed auditor in compliance with the relevant statutory obligation (Millichamp and Taylor, 2008).
Yuhao Li (2010) in the case analysis of the Enron scandal and some others authors such as Koh H. C. and Woo E-S (1998) 'the Expection Gap in Auditing', acknowledged that the public and stakeholders hold different beliefs about the auditors' duty and role but also about the message stated in the companies' audit reports. So apparently the public misperceptions are mainly the major liability issues that auditing profession is facing. So given these concerns, the external auditors role and duty are being misunderstood by the main part of the public due to the recurrence and the diversity of corporate fraud. Thus this paper targets to address the numerous issues related to the role and the duty of an auditor in particular concerning fraud.
Rationale of the research
In the financial and auditing area, several literature and researches exist on the crucial role and duty of external auditor in preventing and detecting corporate fraud. Some authors, who stand for investors and those having interest in business, toughly consider that a corporate failure is resulting from either negligence or even often from a lack of knowledge from auditors. So in other words, most business failure is due to an audit failure (Dixon, Woodhead and Sohliman, 2006). Multiples studies similar to the research stated above are holding the public belief unchanged, thinking that auditors are mainly responsible for any corporate financial scandals. Thus, further research over this concern is required in order to bring an efficient approach to reply over this issue. Also this research will be focusing on the only role and duty of the external auditors, which is different from previous paper on both external and internal auditors. The paper will also emphasize on fraud as element of the expectation gap. This will enable separate point of view from corporation's angle and from individuals' angle. Therefore the research aims to bring additional contribution to a well-known ground in the major counties with important stocks exchanges such as the United Kingdom.
1.4.Aims and objectives:
This study will target to bring a clear and defined overview of the role of the external auditors in the auditing process in particular their responsibilities regarding the corporate frauds. Then the research will be carried out and will be focused on the role and the liabilities of the auditor in fraud detection. In the meantime fraud concept will be explained and detailed to help to better understand the types of fraud, the ways usually used and as well as the different potential perpetrators.
During all the study long, some responds will be brought to many questions underpinning this paper. Those questions may vary from related questions to the traditional role of auditors to their role and liabilities into corporate fraud. Thus the essential questions underpinning this study are:
Always on Time
Marked to Standard
The importance and effectiveness of auditing.
The role of the auditor in particular in an financial environment changes
The origin, overview, size and type of corporate fraud
What further measures should be taken by auditors to ensure detecting corporate fraud
Should auditing move from the 'archival' approach (auditing process at the end of accounting period) to a permanent auditing where auditing will be processed while corporate is operating.
What changes should be made to ensure the efficacy of auditing.
However, by studying these questions, this paper will discuss on the fundamentals issues on auditing especially auditors role in detecting fraud, but will also bring a presentation of the auditing theory and practice which are, most of the time misunderstood. Therefore one of the key objectives of this study will be to show whether or not that auditors responsibility were engaged in failing to detect the frauds in the past financial scandals.
Limitations and constraints
This study has encountered some limitations and constraints. Indeed the research will be deliberately focusing on the sole external auditors as third party appointed to report to shareholders. This choice is due to the fact that in this research, it was imperative to maintain a detachment between auditors and managers so that the auditor cannot be friend or relative to any owner. It is also crucial that he is not holding any stock in the entity or any monetary stake in any other of their subsidiaries or holdings.
Also the fraud concept used in the research has been defined as ' the act of deceit that results from misrepresentation of a material fact with knowledge of falsify of the representation or with lack of reasonable ground for belief in its truth' (Association of Chartered Certified Accountants, 1986, P12). The factor Time also remained as constraint as such research requires much longer time for data collecting, searching and data analysis purpose. As well as the time, the study has experienced constraint over the search of literature because most papers written does not support the auditor duty or role due to the fact that they are subsequent to financial scandals.
However the purpose of this paper is to review the different opinions concerning the role and the independence or auditors and the effectiveness of auditing to detect frauds and errors.
1.6. Structure of the research
This research on the role of the auditor in detecting corporate fraud will be designed by a second chapter called context in which, different financial crisis such as Enron and Parmalat will be analysed. A third chapter will present different literature review concerning, the role and reliance of external auditors at the light of past scandals as well as the nature and different kind of fraud. An consideration will also be given to the independence of auditors and their related auditing bodies.
The fourth part, which is the description of the methodology, used to carry out this study, will also include the justification of the employed method as well as its limitations and divers constraints confronted when conducting the research. A fifth part will therefore summarise the research finding, then interpret the numerous collected data. Then eventually the sixth part of the paper will address a conclusion of the study and the results found from it. In this section, a general summary will be required including further research guidance and recommendations.
The research will underpin on the different questions stated in the introduction of this research. Therefore in the second chapter (context), an analysis of the environment through which the research has to be related is essential.
Chapter 2: Context
2.1. Chapter overview
The complexity of corporations' structure and transactions combined with the industrial concentration have led to the establishment of entities which are larger, so making the corporate governance complex (Dunn, J., 1996). According to Jensen and Meckling (1976) the corporate governance is the set of policies, processes and law that affect the way a corporation is being governed or controlled. Therefore the corporate governance will involve an agency relationship. So Jensen and Meckling argue that an agency relationship could be defined as a contract whereby one or more individuals called principal appoint or engage another person known as agent to perform some services on their behalf. This will include the delegation of some decision-making abilities to the agent.
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However this paper will be based on the role and duty of an auditor in this relationship as they are assigned the task to control and detect fraud and errors. In this multi- relationship, the actual owners of the business require to know whether the management are properly acting in the best interest of the shareholders and not their own.
Thus in the chapter, we will be covering some past financial scandals where the auditing's responsibilities and duty have been highlighted and the related subsequent changes adopted thereafter.in addition the role of the auditors will be analysed in a context of corporate governance. It will also be essential to remind the effect of cultural as well as the legal system impact in the scandals.
2.2. Overview of the BCCI scandal in the United Kingdom
The Bank of Credit and Commerce International, commonly know as BCCI, was set up by a banker from Pakistan called Agha Hassan Abedi in 1972. With the financial help of the major political figures and Sheikhs in the Middle East, the founder was planning to become the biggest bank in the world and also achieve in being a link between developed countries and the third world. Therefore several customers, particularly wealthy clients had confidence in BCCI in managing their investments and deposits. Round four years following its creation BCCI was present in nearly 32 countries worldwide, with their activities concentrated in the United Kingdom but also the Caiman Island (Behind The Closed doors, 1991). The bank was registered in Luxembourg and was using a difficult combination of businesses and subsidiaries in order to avoid regulations. Despite the impossibility to acquire any US bank by a legal way, BCCI had used arguable strategies to buy considerable shares in some American banks. The corporation was secretly using clients' deposits without their knowledge and was covering their poor results and losses by invented deposits and loans. BCCI had also been linked with some others illegal activities such as money laundering, drug trafficking, prostitution management and even the support of terrorism that were all covered with fraudulent records. Surprisingly, BCCI has not been audited in the past as a sole entity. Prior to 1987, the auditing company Ernst & Young was auditing the Luxembourg branch while Price Waterhouse was in charge of the United Kingdom entity as well as the Caiman Island's. Then two years after Price Waterhouse become the only auditing entity, and then discovered the existence of some suspicious loans and false transactions. Thus these suspicions have alerted the bank of England that had decided to carry further investigations, which had led to the discovery of accounts manipulation, fictitious loans and profits, unrecorded deposit liabilities but also some illegal shares repurchasing scheme, and several off-book transactions. In addition investigations, have permitted to detect the existence of falsified audit confirmation and several fraudulent contracts (Kerry, J. and Brown, H., 1992).
Concerning the audition question, many reports believe that, the litigious financial reporting and the relation with the auditing entities have eased BCCI t o expand its activities in many countries for nearly 20 years. Also the fact that none of the auditing companies had claimed that there were concerns over the BCCI's reporting did show some lack in the audit process. Also, according to Kerry and Brown (1992), in their report to the Committee on Foreign relations, Price Waterhouse could have warned the stakeholders as they had sufficient information instead of certifying the accounts.
However, based on the fact that the regulatory framework was not clear concerning the role and the responsibilities of the auditors at that particular time and the fact that auditors did not have the relevant tools to detect fraud or irregularities. Auditors' impact may not be retained as the causes of this high level of fraud. Therefore the first step for the regulation of the banking industry was the banking Act 1979. Then with the Building Societies Act 1986 and the Financial services Act1986, auditors have seen their responsibilities increased in detecting fraud. In addition, Price Waterhouse did state that they were confronted to difficulties to access the business information due to the complexity of the business structure and the way that some transactions were covered (Vinten, G., 1992).
2.3.Overview of the Parmalat affair
A decade later, when the auditing profession started to promote confidence in its activities, another case (Parmalat) surged in the financial area especially in Italy.
Parmalat was a multinational Italian Giant, which was operating in the dairy and food industry and was founded in 1961 by Calisto Tanzi. The business was the leading company in the dairy industry and was present in addition of the European market, in China, America and South Africa (Di Meglio, F.,).
The issues have started when, in February 2003 the company CEO, Calisto Tanzi dismissed his Chief Financial Officer. The new Chief Financial officer, just taking position, noticed some irregularities and did not have access to some of the corporate books, probably due to the doubtful transaction with some Cayman based companies. The crisis has become public when the company showing excellent profits figures, failed to pay back their debts and bonds payments. Also, things were serious when the Bank of America had released documents showing nearly 4 billion of Euros belonging to the entities in a bank account. As a confirmation of fraud, a scan machine was found and was repoted to be used to falsify the Bank of America documents (Johnston in Rome, B. and Muspratt, C., 2004).
After investigation, the financial chief told the magistrates that he was under waves of pressure of the CEO, in order to buy several businesses for an over-estimated true value to enable the corporate to settle debts with the banks (Melis, A., 2005).
However, despite the evidence of fraud from the Parmalat executives, the auditing companies Deloitte Touche and Grant Thornton are being sued for £5 billion and a half over their alleged role in the financial crash. The auditing firms had even been accused by parmalat as 'active conspirator'. Then Deloitte, as a defendant, admitted that it is first thanks to Deloitte Italy than the fraud has been uncovered discrediting the parmalat's executives' allegation (Penman, A., and Greenwood, M., 2004).
2.3. Auditors and Corporate Governance:
As stated in the above chapter, corporate governance reforms have played essential role in promoting confidence to auditing after different scandals either in the United Kingdom or in the United States. So in reaction to numerous corporate, auditing and accounting scandals, such as Enron, WorldCom, where investors had lost billion of due to the companies shares' price collapse. The United States had adopted the Sarbanes-Oxley Act in 2002 to enhance the standards. Indeed the bill was intended to create new reform for the public company accounting system but also to set up a crucial investor protection scheme. It had also been called by some expert as a ' Corporate and auditing responsibility Act' due to the content of the texts and the fact that it did follow financial scandals (Bumiller, E., 2002). The reform was also design to address the issues surrounding the auditors' role and independence as well as the financial disclosure standards. Therefore under the SOX (Sarbanes-Oxley), companies' management is required to certify the companies' financial report, and both management and independent auditors are required to certify the business internal control making the responsibilities clear and controllable.
Regarding the United Kingdom, the same approach was adopted, with the publishing of the Cadbury report in 1992 following the BCCI affair and the Polly Peck. Since the Cadbury report become the first step of the UK corporate governance rules represented by the Combined Code. This Combined code or set of principles of good corporate governance, is supervised by the Financial Reporting Council and the Financial Services Authority, in charge of the listed companies at London Stock exchange (Financial Reporting Council, 2010).
Under the respective corporate governance's reforms, whether it is in UK or in the USA, auditors play an important role as they have been given powers to enable them to detect wrongdoings by the entities' management. So auditors are likely to be independent and report on the company objectively. However auditors can only play their role effectively, when they are in a situation of independence in order to comply with corporate governance's regulations (Peel and O'Donnell, 1995).
2.4. Culture and Legal system
The country's culture plays an important role regarding the function of auditing and control. Indeed Nobes and parker (2006) argue that ' culture in any country contains the most basic values that an individual may hold as, It affects the way that individuals would like their society to be structured and how they interact with substructures' (P.25). Therefore the cultural ground in auditing and accounting would be conformed to the same substructures.
Regarding the legal system, two different kind of legal system exist in Europe. Also most of the countries in the world are likely to have their accounting and auditing regulated by these two systems that are the Common Law and the Codified Roman Law (Alexander and Nobes, 2007). Under the common Law approach, there are a restricted number of acts and laws related to the justice or court's interpretation. So the system relied on experiences to set up laws with a minimum legal requirement (Nobes and Parker, 2006). Nobes and parker (2006) argue that the auditing and accounting function in the United Kingdom are based on a similar Principles Based approach, which is as well used in several former English colonies such as the United States and Australia. In the UK, the general framework has been based or the different Company Acts and regulations rules from the auditing and accounting standards setters.
The second type of legal system, known as the Codified Roman system, is based on rules coming from the various ideas of justice and morality as doctrine. So that is the reason why, accounting and auditing have to be conformed to a set of rules like, (Account Plan, or PCG in France for Plan Comptable General). Elsewhere many west European countries seem to have adopted such rules based accounting approach like in Italy or Spain (Bertin, 2001).
The fact of carrying out an audit remains vital and important for all companies, especially for public listed companies. It is essential for companies that audits are carried out for several reasons. First of all it ensures stakeholders that company is being properly run on their behalf, respectful of company policies and complying with the law but also that the investors' money is in safe hands.
The concept of auditing has been extremely developed over the past decades, raising some reflections on auditing as a discipline rather than just a simple practice. Thus some questions have quickly been raised on the role of the auditors. So to better understand the role of the auditors as well as the auditing process within a corporate, it is important to adopt a critical approach, as part of the issue surrounding the role of the auditors, starts by a misunderstanding of the nature and the role of the auditor. (Soltani, B., 2007).
To describe the main issues around the role of the external auditors in detecting corporate fraud, it will be useful to refer to questions such as 'do auditors spend more time to cover their backs than giving helpful information to investors' or 'where were the auditors? , Critical and general questions that arise after financial scandals such as Enron in 2001 in the United States of America, BCCI in the United Kingdom or the Parmalat affair in Italy. Indeed these kinds of corporate failure are repeated and have exposed some issues regarding the responsibility of the auditors in detecting corporate fraud (Hilton, A., 2010).
The cost of fraud is increasingly affecting many businesses all around the world. Everybody is affected as a victim of fraud because of the high products costs and also because of low corporate profits. So in order to put an end or to reduce this practice, auditors (internal and external) are operating to help to enforce accountability and to set up confidence in financial reporting.
Therefore this introductory stage aims to inform the readers on the issues that will be addressed in this paper. The paper will also cover, the aims and objectives of the research, the used research methodology, the scope and limitation of the study and the literature review with the proposed chapters.
2 LITTERATURE REVIEW:
2.1Overview on Auditing:
First of all, audit will be defined as "an exercise designed to enable an auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework" (the Institute of Chartered Accountants in England and Wales, 2008, P.6).
So an auditor is the qualified person who gives a conclusion whether the financial statement of a company 'shows a true and fair view'.
It is important to know that it exists the audit threshold, which is specific to each country or economic area, for example in the United Kingdom, all companies according to the Institute of Chartered Accountants in England and Wales (2008) are required to be audited except some very small companies and since 2004 exemption were extended to all companies which fulfil the following criteria:
-The business must be qualified as small company under the 2006 companies act
-The business's turnover must be less than £5.6 million
-The company's gross assets (noncurrent assets and current assets) must not exceed £2.8 million.
Essentially after the industrial revolution (1750-1850), the management of companies moved from owners or sole traders to managers to make it more professional, therefore that where the need for auditors comes from in order to have independent auditors from management to report to owners.
In the United Kingdom the primary purpose is to detect frauds and the errors. However the general objectives of all audit engagement will include the following targets according to Soltani B. (2007):
A check up and evaluation to find out whether the financial statements and the footnotes have been prepared in accordance of the specified criteria
A global evaluation of the effectiveness of the internal control systems used for the financial reporting during the past accounting period
An evaluation of the possibility of fraud that could occur within the organisation
And finally it will be essential to evaluate the probability that the organization will carry on as a going concern.
Also the main purpose of the audit consists in helping to enforce accountability and promote confidence in financial reporting. Auditing as well represent a relevant way for shareholders and stakeholders to help ensure that managers and directors are acting in company's best interest, because directors are mainly responsible for managing the affairs of the company on behalf of the shareholders (Wells, J. T., 2004).
2.2History of the auditor role concerning fraud:
Auditing has gone forward in the capital market economy especially during the past century while its traditional and original purpose was to ensure that honest and accurate accounting have been held in the affairs of state, government services or others public bodies. With the time the concept of auditing has enlarged essentially with the economic and industrial developments, since then auditing concepts have expanded bringing more than practical aspect to its previous one. Thus a review of auditors' objectives evolution in the time will be essential to appreciate all the controversy made round the auditors liabilities (Soltani, B., 2007).
2.3Auditors and fraud history:
2.3.1Prior to 1500:
Long time in the past, the auditing function was yet used, for example merchants were helped by some auditors to support them in their business accounting. As that kind of audit was design to control and to verify the duty of agents in charge of the trade, so the audit primary function was to prevent and to detect frauds (Turley and Cooper, 1991).
2.3.2Between 1500 and 1850:
With the expansion of the industrial revolution, auditing also have been developed due to the fact that even a that period there were a separation between investors or owners and the persons in charge of running the businesses. Few changes were made for this period and overall the objectives of auditing remained the same as the practice was based on verifying the business transactions to uncover false operations.
So this stage has settled standards for accounting practice that will be expressed later in the British company act 1862 (Turley and Cooper, 1991).
2.3.3Between 1850 and 1905:
Due to the expansion of businesses and the separation of ownership and control, it became obvious to find a proper control system rather than a check up of company's records by owners. Also with the establishment of the Society of Accountants in Edinburgh in 1854, which became the Institute of Chartered Accountants of Scotland, it has been recognised that it is important to be trained and to have relevant skills for such control function (Turley and Cooper, 1991).
2.3.4Between 1905 and 1946:
At this period the role of the auditors has evolved due to more complexity in business. So auditors' duty changed toward their capacity to express their confidence and credibility over financial statement rather than certifying documents and therefore making them clear even though they were not (Turley and Cooper, 1991).
2.3.5Between 1948 and 1980:
During this period the audit objectives have moved from the simple fraud and errors detection to an expression of an expert opinion over the adopted financial reporting and financial information. Since then auditors will be in charge of verifying recorded information and whether they have been correctly made, they also had to check if transactions in books are in accordance with disclosed information before they finally expressed their opinion whether the accounts have been prepared regarding a 'True and Fair' view (Turley and Cooper, 1991).
During the year's after1980, many financial scandals previously stated have put the effectiveness and the responsibility of the auditors in cause. However the role of the auditors did not change deeply when the fact showed that extension have been brought to the auditors' duty. Also to reinforce their practice, the financial services had imposed a duty to report all frauds suspected or detected. Consequently to changes, the Auditing Practices Board has issued the statement of auditing standards 110 related to fraud and error (The Institute of Chartered Accountants In England and Wales, 2008)
2.4DESCRIPTION AND VARIETIES OF FRAUD:
An auditor is in charge to draw conclusion whether a company's financial statements are free from material misstatement that could be due to fraud. Thus the International Standards on Auditing set out auditor's responsibility regarding fraud through the ISA240; which will take account of evaluating risks of material misstatement and will also involve finding out the sensitivity of the financial statements to material misstatement caused by fraud (the Institute of Chartered accountants in England and Wales, 2008).
Fraud is a word which is often use to cover a wide range of illegal acts, then according to O'Gara J. D., (2004) Fraud is the intentional and illegal act of deception or of manipulating accounts. It can be operated for the benefit or to the detriment of the corporate and by persons inside or outside the organization. It's also essential to mention that fraud is a deliberate cheating for the satisfaction of an individual or group. However in this paper we will only be concerned by fraud that may be detected by auditors. Actually, we will classify fraud through two dimension which are whether the perpetuated fraud is for or against the organization and secondly to find out the class of the culpable or perpetrator.
Regarding the type of fraud it could either be:
Corruption or misappropriation within the business which case is a fraud against the business.
Fraud concerning the financial reporting which is considered as a fraud for the organization as well as the money laundering.
External fraud against the organization (for example false checks or credit card fraud), (O'Gara, 2004).
And for the perpetrator it could either be: management, employee or non-employee. However management frauds are most of the time completely different from employees, as management will be using positional power rather than taking advantage of internal control weaknesses. Most of the time financial reporting fraud occurs at the top of an organization and is run up by senior management the operating management is more likely to commit bribery and corruption as fraud rather than the others types, whilst administrative managers will go for asset-misappropriation.
For many others reasons, management fraud is under detected, and also when it's detected most frequently it remains not prosecuted, that why for internal auditors the primary responsibility will be recognition and detection (O'Gara, J.D., 2004).
As stated above, external and internal auditor remain different, thus that is why management frauds against the business are extremely difficult to detect for internal auditors and it s requires further perspectives than just normal accounting. So detecting management fraud remains the greatest challenge for those internal auditors because of its high impact on the business often even more significant than the other types as it is usually an off the books fraud (O'Gara, 2004).
2.4.1FRAUD AGAINST THE ORGANIZATION:
As mentioned earlier, the area of most management fraud against the organization, generally conflict of interest, is under reported, because it is the most embarrassing for a corporation. According to John D. O'Gara (2004) Management fraud could also involve non-management individuals, and we will states below some common characteristic to those frauds:
Mainly relational fraud, which could be for example to divert corporate profit rather than doing transactions, which could be detected by auditors.
The average management fraud loss is 8 times the average employee- fraud loss (excluding financial statement fraud)
The impact of the fraud is significant and essentially not apparent in the records (income statement or statement of financial position of the corporate) due to the fact that they are off the books.
Also the perpetrator is a higher in the corporation so making him a trusted employee.
Frequently other persons could facilitate management fraud for example some accomplice specially in bidding situation.
Also for most of the time, fraudulent misappropriations happen through fraudulent middlemen companies which are typically created for the sole purpose of fraud without any legitimate business purpose. In some cases the middlemen company is easily identifiable because of the volume of businesses or for its real position between suppliers and customers (Wells, J. T., 2004).
Some symptoms making the fraud detectable:
Some symptoms can help to find out the ongoing fraud situation in corporations such as:
Clear appearance of some anomalies in the profit and loss accounts, such as diverted profits.
Generally when there is fraud at the top, we could also see fraud further down just like food chain.
There are lifestyle manifestations of the fraud in most cases because individuals are engaged in fraud to make their personal business
The use of substantial middlemen companies, inserted between the corporation and its suppliers or its customers that are no economic benefit to the corporation.
The changes that can affect corporation margin and which are not supported by external or inherent economic conditions.
Inexplicable bankruptcies or significant gaps between market and contract prices.
It is important to mention that a high volume of personal and confidential mail sent to managers or senior managers could also pull auditors attention (O'Gara, J., D., 2004).
2.4.2FRAUD FOR THE ORGANISATION:
Significant fraudulent financial reporting used to be done and what's surprising is that it does not specially result from a breakdown in the internal accounting control system, but it just comes as a confirmation that senior management uses positional leverage to overpower their corporate accounting control system. And it has been demonstrated that usually more corporate fraud begins at the top and one issue for the internal audit is the corporate accountability rather than the corporate accounting (O'Gara, J.D., 2004)
So, many questions arise to find out what is the role that internal auditor should play? The internal auditors should be an arm of corporate governance rather than a group of controllers or accountants (Wells, J.T., 2004).
Some symptoms of financial reporting fraud:
Considerable off the book businesses or transactions with related entities especially when disclosure rule is not properly respected.
Unsupported journal entries particularly around period end that can have effect on the income statement or changes in the statement of financial position such as provisions, depreciation or inventory valuation.
A lack of transparency of financial statements or changes in accounting principles to a favourable basis in order to make more benefit or to hide corporate profits
Volatile operating margins mixed with controversial margins which do not match with the corporate results from operations (O'Gara, J. D., 2004)
2.4.3Role of the auditor in investigating and detecting:
In this part it is important to make a clear difference between recognition and detection and between detection and investigating.
So chronologically fraud recognition happens first because at that step auditor becomes aware of fraud possibility then followed by detection when he determines the probability of fraud (O'Gara, J.D., 2004).
Usually it is better when fraud recognition happens earlier so auditors could have more time to run deep investigation s through corporate financial statement.
Investigations constitute a separate stage from detection in the fraud chain as they will be concerned by:
Verifying inventories and checking bank reconciliations, also confirming receivables
When detected, pay attention to fraud life circle to find out the duration and the mechanism
Determine the true identity or any middlemen company and also make himself available for employees that could bring more information than expected
Using corporate resources carefully and discreetly to obtain information
Interviewing employees, but in this situation the order does matter because it is advised to keep prime suspect for to end and not to let them know about any prior information from others employees interview (O'Gara, J.D., 2004).
After investigating stage when fraud is found then it will be time to report it in accordance of the Auditing standards.
Also an auditor should have these qualities stated below according to the Institute of Chartered Accountants in England and Wales (2008, P75):
Objectivity and independence
Clear, complete and effective communication
Fraud is a major cost for corporation, that why auditors are operating to uncover typical fraud that could affect corporations. And also auditors are really close to corporations than any other adviser to try to help them and to eliminate fraud.
However auditing also has certain limitations that affect it on its way to investigate and track fraud.
The main purpose of this part is to expose the methodology used to realise this research. It will also detail the different steps including the scope and limitation of the paper.
The methodology employed in this paper can be divided in two parts. In the first, it will be question to detail the effective role of the auditor as well as an explanation of fraud and its different types. The second part will include a review of the responsibilities of auditors based on the previous financial scandals such as BCCI, WorldCom or Enron in the United States of America.
However this research will involve both a primary and a secondary research
The objective is to properly define the responsibilities and liabilities of the auditor in a primary research. Then in a secondary one, due to numerous researches dealing with the topic, it will be essential then to compare the current role and liabilities of the auditors with the stated behaviours of the auditors which were related to the past financial scandals.
Also a full explanation will be given regarding the fraud to better understand the scope of the research.
3.3Justification of the methodology used:
This part is intended to justify the choice of the current research methodology, so it crucial to say that this study has been established to answer some questions such as:
Are auditing crucial in the in the corporate capital markets?
Can auditors effectively detect or prevent all frauds, what further changes could be suggested?
These questions are discussed in a context of extensive changes in the capital market as well as the subsequent complexity brought into the corporate financial reporting's.
3.4Scope and Limitations:
This part gives an overview of the issues encountered during the research. So first, it is important to mention that the use of both primary and secondary data brings some problems. Thus the secondary data were essentially used due to the time and material constraints. However, if not properly interpreted, such data usage may cause error.
Also this paper will be mainly focusing on the role of external auditors in fraud detection concerning the major financial scandals in Europe particularly in the United Kingdom.
But also due to the importance of some scandal like Enron in the United States of America, this study will include analysis based on such case.
As well the scope of this research might be different to another paper in term of period, as a research made after Enron or Parmalat case might be different from a research made before.
Topic choice and defining research area
Literature search and critical analyses
Conducting and transcribing interviews
Analysing and discussing results
This paper highlights the effective role and function of auditing in a difficult context such as financial scandals like Enron, BCCI or Parmalat. Also it is crucial to define the borders of auditors' role in fraud detection as well as the scope of the auditing process within the corporate.
However this study's final words and recommendations will be based on further research and the next findings.