External Audit Case Study

Detection of Fraud in External Audit

Introduction:

Financial statement users such as investors, regulators and other stakeholders expect external auditors to detect frauds in financial reports of organizations. There are various auditing standards and guidelines issued by various regulatory authorities in order to outline responsibilities of an auditor in detecting frauds. Still, we had corporate downfall of companies like Enron(2001) who was awarded by Fortune Magazine as “America’s Most Innovative Company” for six years in a row and others such as WorldCom (2002), Tyco (2002) et cetera. So, questions and allegations started flowing on reliability of the audit reports issued by auditors and the auditor themselves. Then congress passed Sarbanes-Oxley

What is the motive behind fraud? The fraud triangle recognized by Association of Certified Fraud Examiners (ACFE), explains the factors that cause someone to commit occupational fraud. It consists of three components which, together, lead to fraudulent behavior:

1. Perceived financial need (Pressure).

2. Perceived opportunity.

3. Rationalization. This triangle is a result of hypothesis given by Donald Cressey.1

Now let’s see every limb of the triangle as per their order.

1) Pressure: This is said to be the initiator of crime in the first place. This is often said to arise out of need of person who wants to satisfy his needs but cannot do so by legitimate means.

2) Opportunity: The second limb of this triangle points out the methods and means of frauds. This lines out the possibilities and loopholes in the system.

3) Rationalization: Third limb is the reason why most of the fraudster think that whatever they are doing is justified. And that is majority number of fraudster don’t think themselves as

The Center for Audit Quality (CAQ), the trade group for audit firms, issued a brochure on public-company accounting, for clarification as to how auditors function with a particular audit. In which it stated that, auditors consider potential areas of misconduct for a particular company, while deciding the areas of a business to be reviewed. However, the CAQ also clarified that, “because auditors do not examine every transaction and event, there is no guarantee that all material misstatements, whether caused by error or fraud, will be detected.”

Also, PCAOB is trying to come up with a solution to establish financial-reporting fraud center for collecting information on preventing and detecting fraud. This will not only help the auditors to convey their role to investors but will also help investors in obtaining assurance on auditors work. 2 CFO.com Sarah Johnson “What Is the Auditor’s Role in Finding Fraud?” April