Should auditors be held more accountable in uncovering financial fraud?
Table of Contents
Currently in the United States, the American Institute of Certified Public Accountants (AICPA) the International Auditing and Assurance Board (IAASB) are the most influential accounting standard boards able to influence fraud detection standard setting in financial reporting. In recent years, there has been a growing trend in financial scandals such as WorldCom, Enron and Madoff that have forever changed the world of financial reporting. These frauds beg the question as to whom to blame. This major issue is what inspired us to come up with the question of: “Should auditors be held more accountable in uncovering financial reporting fraud?”
Though fraud is done by very few people at once, it can represent huge monetary amounts. According to fraud research center, in 2013 alone, eight billion dollars in fraud of investments, securities and commodities will arise. Another alarming fact is that 45% of auditing companies fail to uncover and report fraudulent activity. (Grazioli, Jamal, & Johnson, 2006, p.34) Our research will intend on shedding some light on this matter and explore a variety of possibilities.
In order to answer this question, we must take into consideration many aspects. The first aspect we will be discussing will be based on the techniques of internal, external and forensic accountants available in detecting fraud and their role in preventing it. The second aspect of this report will discuss if auditors should in fact be held accountable. This part will include recent court decision and a brief cost-benefit analysis of the feasibility in having auditors more accountable. And last, a conclusion based on facts and our report.
In most cases, there is a great deal of information asymmetry between the issuers of financial statements and users. Lenders, shareholders, employees, vendors and other users rely heavily on financial statements to make important decisions. Consequently, there is a significant demand for financial statements that are free from material misstatements, especially when the magnitude of the investments users make is considered. The auditor is appointed to verify that such financial statements are free of misstatements, which in turn reduces information risk for the users. Figure 1 presented in the appendix presents in a simple, yet accurate manner the nature of auditing.
As shown, the three-party accountability figure provides the simple relationships that exist between the auditor, the user and management. Auditors provide a conclusion to the users on the information provided by management. What is not presented in the figure is why a conclusion from auditors is necessary. Firstly, mistakes happen. Indeed, humans are not perfect and make honest mistakes. Having accounting experts examine the books as well as the internal controls of a firm will certainly help reduce the occurrence of material misstatements. Secondly, management, which provides the information, may have hidden agendas. This may motivate them to unfaithfully represent information. For instance, from a company perspective, management might want to obtain an important loan to finance their activities. To ensure a low interest rate, they could increase revenues and assets. This does benefit most users of financial statements, but most definitely places great prejudice on the debtor. From a personal standpoint, management might also have incentives to alter their financial statements. For example, in public companies, management’s compensation is often based on performance. As such, there is a risk that they will arrange the financial statements to present them in their favour. Conversely, firms managed by a single owner might try to adjust financial statements to reduce their income tax liability. The presence of auditors verifying the statements might lessen...
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