Lessons From the Past
A number of corporate failures and scandals across the globe have sparked debate between regulators, public policy makers, investors, auditors, and others. While those debates involve questioning the responsibilities of different participants in the financial reporting ecosystem for example:
Toshiba Corporation (2015), Japan Overstated operating profits by more than $1.2 billion in a scandal that began in 2008 and spanned 7 years.
Steinhoff International Holdings NV (2017), South Africa A fraud investigation uncovered billions of dollars of fictitious/ irregular transactions.
Carillion (2018), United Kingdom The company’s collapse left £2 billion owed to its suppliers and £2.6 billion in pension liabilities.
Luckin Coffee (2019), China Fraudulently inflated sales by 2.1 billion yuan (over $300 million), which resulted in the company being delisted from the US Nasdaq exchange.
Wirecard (2020), Germany Filed for insolvency after admitting that approximately $2.6 billion of assets on the company’s balance sheet likely did not exist.
Why focusing on Fraud and Going Concern?
- The public sees audit as part of the solution for preventing corporate failure
- The public demands more responsibilities for auditors in identifying and reporting fraud
- The public believes audit should evolve in way that prevents corporate failure
- Collaboration is needed between all stakeholders of the profession
Current Gap:
The following gap approach suggested by ACCA:
Knowledge Gap: what public thinks auditors do?
Performance Gap: what auditors actually do?
Evolution Gap: what auditors supposed to do, what the public wants auditors to do?
Knowledge gap.
The ‘knowledge gap’ is defined as the difference between what the public thinks auditors do and what auditors actually do. This recognises that the public can sometimes misunderstand audit: for example, a belief that auditors are responsible for preventing corporate failure.
Performance gap.
The ‘performance gap’ is defined as the difference between what auditors actually do and what auditors are supposed to do, given the requirements of auditing standards or regulations. Audit firms have systems and processes that seek to ensure quality in their engagements; in other words, that they comply with the standards and regulations. Audit regulators inspect files of completed engagements to evaluate whether quality is being achieved.
Evolution gap.
The ‘evolution gap’ is defined as the difference between what auditors are supposed to do if they actually follow the requirements of auditing standards and regulation and what the public wants auditors to do. In other words, the evolution gap indicates the areas of the audit where there may be a need for evolution, taking into consideration the general public demand, technological advances and how the overall audit process could be enhanced to add more value in the public interest. Addressing the knowledge and performance gaps is, however, an important first step in determining what needs to evolve in audit. This will help to avoid overregulation and inappropriate developments in auditing standards, when the real problems could be lack of knowledge or poor performance. (Source: ACCA).
Fraud
At a time when entities are under increased pressure, and internal controls may not be operating as planned, the auditor should also consider whether their assessment of risks of material misstatement due to fraud or irregularity needs to be heightened as a result, and additional audit procedures need to be carried out (FRC 2020a). When controls change or don’t operate effectively, the auditor must look at the nature, timing and extent of the audit work and how to deal with these changes. This could also be linked with additional fraud-related risks.
Possible revisions to ISA 240 The auditor’s responsibility for detecting material fraud Some regulator representatives raised concerns about the introduction of ISA 240 and particularly paragraph 5, which notes the inherent limitations of an audit. This paragraph states that while the audit may be properly planned and performed, some material misstatements may not be detected. The regulators argued that this underplays the responsibility that auditors have in detecting material fraud, as it states that fraud may go undetected. Conversely, some participants pointed to the need to be very clear on the limitations of reasonable assurance engagements in order to avoid widening the expectations gap.
Additional focus on non-material fraud requiring additional audit procedures when a nonmaterial fraud is identified had some support from a mixed group of stakeholders. Those who supported this option believed some work needs to be done even if non-material fraud is identified, as it could lead to the discovery of a material fraud. They also referred to cases where non-material fraud was not-material only because the full extent of it had not been uncovered. Also, it could highlight systemic issues, for example with controls in areas of high fraud risk, which, if not addressed, could lead to material fraud. (source: ACCA global publication)
Going Concern
While COVID-19 has forced many businesses to make significant changes to their operations, the impact of the pandemic on entities differs depending on the specific conditions and events as well as management’s plans. The uncertainty brought on by COVID-19 led to the need for some entities to revisit preliminary going concern assessments when considering the potential impact on their future plans. This issue may have been significant for entities that have not been required to prepare detailed assessments before the pandemic.
At the international level, as noted by the IAASB’s Staff Alert on going concern, ‘in completing work related to going concern in the current environment, auditors should focus on all the requirements set out in ISA 570 (Revised), Going Concern, with full consideration given to the entity’s specific circumstances before any conclusions are reached. In completing the work on going concern, the importance of professional scepticism is amplified, particularly when management has determined that current circumstances are not expected to have any material financial impact on the entity and that no material uncertainties related to going concern exist for the entity’ (IAASB 2020b).
Entities were required to reconsider their financial position and resilience in the era of COVID-19, the financial position and resilience of their key customers and their dependency upon them. They also had to consider whether they met the requirements for available government subsidies and, where possible, revisit their operational strategic plans. For example, some managed to switch to online business and adapted to the new normal fairly quickly, while others, owing to the nature of their operation, were not able to do so.
It’s clear that the pandemic carried significant implications for companies, and therefore for their auditors, in the areas of both fraud and going concern. The pandemic highlights the importance of aligning the expectations about the auditor’s responsibilities in these areas, with the expectation of users and other stakeholders of the profession.
Options to explore further on fraud and going concern
- Requiring the use of forensic specialists
- Introduce the concept of suspicious mindset
- Introducing additional quality control review procedures
- Requiring additional audit procedures when non-material fraud is identified
- Expanding the going concern period beyond 12 months
- Introducing other concepts of resilience
- Clarity and consistency regarding material uncertainty related to going concern
- More transparency about fraud and going concern
Roles in the Financial Reporting Ecosystem:
Entity and its management (i.e. preparers): Prepare the financial statements in accordance with the applicable financial reporting framework, also responsible for internal control related to financial statements.
Boards and audit committees: Those charged with governance are responsible for overseeing the strategic direction and obligations related to accountability, including the entity’s financial reporting
External Auditors: Evaluate the company’s financial statements (and sometimes internal controls) in accordance with professional standards, report to users of the financial statements, and report certain matters to those charged with governance.
Governments, regulators, professional bodies, and standard-setters: Establish and enforce legal and other obligations, regulatory requirements, and develop accounting and auditing standards.
Investors, analysts, lenders, consumers, the public, and other stakeholders (financial statements users): Make investment and business decisions based on the financial information available. (source: ACCA)
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