A row over the role of auditors in detecting fraud at client companies has taken a fresh turn, with shareholders set to play a significant role in the ongoing drama.
Shareholder advisory body PIRC has warned that it will advise investors to vote against the reappointment of auditors who fail to reject the terms of a consultation looking at the way auditors address fraud.
PIRC’s concern is that the review of current audit guidelines under way by international standard setting bodies is based on a false premise and therefore unlikely to reach the right conclusion.
PIRC says the consultation carried out by the International Auditing and Assurance Standards Board (IAASB) and the International Federation of Accountants (IFAC) is based on the idea that there is an “expectations gap” between public assumptions of what audits do and the actual objectives of a real-life audit. PIRC insists this is incorrect: it’s a “delivery gap” that should be addressed, because in countries like the UK courts and MPs have made it clear that audits should be designed to find fraud.
In a letter to IAASB and IFAC, Alan MacDougall, managing director of PIRC, says the position is so serious that PIRC is considering a recommendation that shareholders vote against auditors if they fail to “publicly repudiate” the consultation document.
Audit standards and fraud
IAASB launched the consultation in September last year after audit firms found themselves caught up in a wave of fraud scandals. The document cites events at Wirecard in Germany, Carillion in the UK, Toshiba in Japan and Steinhoff International as the trigger for a closer look at audit standards and fraud.
The big question at the heart of the document is whether auditors should have “enhanced or more requirements” in relation to fraud and whether it should be “only for certain entities, or in specific circumstances”.
But PIRC is particularly concerned by introductory comments to the consultation made by IAASB chair Tom Seidenstein which suggests the work is designed to “narrow” an expectations gap.
PIRC claims that this sells a “downgrade” of the standards as an “upgrade”, because in the UK, at least, the auditors duties have been laid bare in court. They were illustrated, PIRC says, when Grant Thornton admitted in the High Court that it had “failed in its duty to identify management fraud” at AssetCo during audits that went back to 2009 and 2010. (Grant Thornton lost its appeal last year against damages of £22m for its audit work).
Brydon Review recommendations
Audit’s unhappy relationship with fraud has been in the sights of politicians and regulators alike. Concerned that audit was losing public trust after a series of corporate scandals, the government ordered a series of reviews one of which—the Brydon Report—looked at the content of audits and concluded its approach to fraud should be beefed up.
The Brydon Review proposed that auditors have a new duty to report on what they do to provide assurance of anti-fraud measures at client companies and on the “additional steps” they took to “detect any such fraud”. He also recommended auditors use staff with “forensic accounting” skills.
Perhaps most potent is Brydon’s recommendations is that it be made “clear that it is the obligation of an auditor to endeavour to detect material fraud in all reasonable ways”.
The Financial Reporting Council (FRC), the UK’s audit watchdog, is currently consulting on changes to audit standards to reflect Brydon’s proposal and is yet report its conclusion.
For many no amount of tinkering in audit standards will address the fundamental problem: who employs the auditor. Regulators have consistently concluded that many auditors fail to show enough professional scepticism when inspecting clients. Brydon’s response was to write that one principle of starting an audit should be that auditors use not only “scepticism” but deploy professional “suspicion”.
The outcome of government consultation and the FRC’s work is still to be resolved. The work of auditors in relation to fraud is at the moment uncertain except to say that there will be a greater emphasise on uncovering fraud one way or another.