EXPLAIN THE RESPECTIVE ROLES AND RESPONSIBILITIES OF MANAGEMENT AND AUDITORS IN THE PREVENTION AND DETECTION OF FRAUD. The primary responsibility for fraud detection lies with management. This arises due to a contractual duty of care. Directors are able to discharge their duty toward prevention and detection of fraud and error in many ways, for example: * Complying with the Combined Code on Corporate Governance * Developing a code of conduct, monitoring compliance and taking action against breaches * Emphasising a strong commitment to fraud prevention.
This involves establishing a culture of honesty and ethical behaviour within the organisation with clearly communicated policies. * Establishing an internal audit function * Having an audit committee The role of the auditor is with assessing the effectiveness of the internal controls. Auditors should appraise the risk of misstatements due to errors and fraud. The role of the auditor in the detection of fraud is appraised within case law, for example: Re Kingston Cotton Mill (1896) – An auditor “is a watchdog not a bloodhound”.
According to Melville (2007), this judgement set the tone for the audit profession for a century.
Auditors were to be passive checkers rather than be proactive in searching out errors, misstatements and fraud. This statement may no longer have the force it once did in the light of ISA 240 The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements. Auditor’s are now expected to recognise at least the possibility that fraud may exist and, consequently, adopt an attitude of professional scepticism in their approach to audit work.
Re Thomas Gerrard & Son (1968) highlighted the negligence of auditor in overlooking fraudulent activities committed by directors.
Auditors relied on stock certificates given to them by the managing director, a person who they trusted. This was supported by the decision in Re Kingston Cotton Mill whereby an auditor is ‘justified in believing tried servants of the company in whom confidence is placed by the company’. It was held that their responsibility was to investigate the matter fully once their suspicions had been aroused. If they had done so, the fraud would have been revealed. This is supported by the content of ISA 240 which requires auditors to follow up anomalies.
Once suspicions have been aroused, tests designed specifically and uniquely to detect and establish the extent of fraud will be performed. Auditor’s should plan and conduct their audit tests to limit the possibility that material fraud and irregularities go undetected. Certain assets such as cash are more susceptible to fraud than others and audit planning should take account of this. Tests are mainly carried out due to the need to assess whether a matter is material before reporting it. If the matte proves to be material, it should be first reported to management (unless management are implicated in the fraudulent activity themselves).
Auditors cannot guarantee the detection of all frauds and errors because they are not able to spend the time searching for frauds as they only analyse a sample. A guarantee cannot be made as auditors provide an opinion. IDENTIFY AND DISCUSS BOTH THE ORGANISATIONAL AND PERSONAL FACTORS WHICH MIGHT CONTRIBUTE TO AN ENVIRONMENT WHERE FRAUD IS MORE LIKELY TO OCCUR. The integrity of the individual and whether they seem to have a strong sense of ethics. Although a difficult characteristic to assess, the behaviour of individuals and their opinions on issues may provide important evidence to assist the auditors in assessing this characteristic.
Personal integrity may well be a key if not the most important factor in keeping a person from committing fraud. There are many cases in which individuals with severe financial or personal pressures and the opportunity to engage in fraudulent activity do not do so because they have a strong personal moral code. Some fraud investigators believe that a strong moral code can prevent individuals from using rationalisations to justify illicit behaviour. Typical rationalisations include: I am only borrowing the money and will pay it back
Nobody will get hurt (perception of fraud as “victimless” crime The company treats me unfairly and owes me Its only temporary until my financial position improves Everybody’s at it!! The extent to which individuals appear to be motivated by greed. Again, a difficult characteristic to assess but the individual’s concern with money and consumer goods may provide some clues about this. If someone starts turning up to work in a brand new Ferrari, they may have won the lottery, or benefited from the demise of a loving relative, or they could be up to no good!! The degree of loyalty exhibited by an individual.
If the individual has been with one firm a long time, this may indicate a certain level of satisfaction with their employment and perhaps reduce the likelihood of them committing fraud. You should, however, also be aware that experienced employees, because they are trusted, might have a greater opportunity to commit fraud. Ernst & Young Survey (2000) found that nearly half of the employees who defrauded their firms had been employed for over five years. Also bear in mind that opportunities to commit fraud can arise when an employee reaches a level of trust in an organisation or when internal controls are weak or nonexistent.
Then the employee if he or she is so motivated will perceive that there is an opportunity to commit fraud, conceal it, and attempt to avoid detection and punishment Also, recent research undertaken by the Wharton School at the University of Pennsylvania suggests that in order to make it to the top ranks of corporate management you of course have to be very self-assured, but this can turn into overconfidence which can lead you to “cross the line” and commit fraud. For example, a senior manager believes that his firm is experiencing only a bad quarter or patch of bad luck.
He believes it is in the best interests of everyone involved – management, employees, customers, creditors and shareholders to cover up the problem in the short term so that these constituents do not misinterpret the current poor performance as a sign of the future. In addition, he is convinced that down the road the company will make up for the current period of poor performance. It is the optimistic executive or overconfident executive who is more likely to have these beliefs. May stretch the rules a little or engage in earnings management ploys, but what if things don’t turn around as expected?
Then he has to make up for the prior period and that requires continuing fraudulent behaviour. There appears to be a belief that overly optimistic executives can turn their firms around before fraudulent behaviour catches up with them, at least according to the US research. Jordan (2002) as cited in Quirke (2008) reaffirms this attitude by quoting a communist era Czech axiom “If you do not steal from the state, you rob your family” Antonio Birritella; “All these funds from the EU were seen as a gift to the Mafia, easy pickings”