On 17th December 2018, the Competition and Markets Authority (CMA) published an update paper outlining serious competition concerns and proposing changes to legislation to improve the audit sector for the benefit of savers and investors alike.

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Week 2b– Errors frauds and unlawful acts

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Expectation gap

The gap between what the public believe that auditors do (or ought to do) and what they actually do.

• a standards gap – where the public believe auditing standards to be different from what they actually are.

• a performance gap – where auditors operate below current standards.

• a liability gap – where the public do not understand to whom the auditor is legally responsible.

Need to

• Educate the public to reduce the standards gap, e.g. the audit report now specifically states the auditor’s responsibilities.

• Improve the quality of audits to reduce the performance gap.

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Non-compliance

Non-compliance with laws and regulations may have a fundamental effect on:

• the operations of the entity (and its ability to continue as a going concern);

• disclosures in the financial statements (most notably provisions and contingencies)

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

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Audit approaches to non-compliance

• obtain a general understanding of the legal and regulatory framework applicable to the entity and the industry, and of how the entity is complying with that framework

• inspect correspondence with relevant licensing or regulatory authorities

• enquire of the management as to whether the entity is in compliance with such laws and regulations

• being alert to the possibility that other audit procedures applied may bring instances of non-compliance to the auditor's attention

• obtain written confirmation from the directors that they have disclosed to the auditors all those events of which they are aware which involve possible noncompliance, together with the actual or contingent consequences which may arise from such non-compliance.

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Auditor’s responses to non-compliance

▪ Understand what has happened

▪ Understand the circumstances in which it has occurred

▪ Gather sufficient other information to evaluate the possible effect on the financial statements

▪ Document their findings

▪ Report their findings to an appropriate level of management (subject to any requirement to report directly to a third party)

▪ Consider modified auditor’s report

▪ In extreme circumstances consider withdrawing from assignment where trust has broken down between management and auditors

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Fraud

Fraud is an intentional act involving deception to obtain an unjust or illegal advantage

Now an offence under Fraud Act 2006

Involves falsification of documents or misapplying accounting policies

Error is unintentional

It is management’s responsibility to safeguard the company’s assets

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Auditor’s responsibilities

ISA 240 The auditor’s responsibility relating to fraud in an audit of financial statements

Must consider risks of fraud as part of planning process, i.e. when carrying out preliminary assessment of controls and procedures.

Consider risk factors and incentives for fraud, e.g. management bonuses on results, poor control environment, pressure to meet unrealistic profit targets.

Two categories

• Fraudulent reporting

• Misappropriation of assets

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Fraudulent reporting

Includes:

▪ Misrepresentation, alteration or falsification of accounting records

▪ Misrepresentation or omission of transactions in records

▪ Intentional misapplication of accounting principles

▪ Misappropriation of assets

Look at possibility of overriding of controls, fictitious journals or adjustment of assumptions and estimates

Aggressive earnings management

Look at revenue recognition (‘mark to market’), accruals & liabilities, provisions and reserves

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

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Procedures

Look at:

▪ Management’s own risk assessment

▪ Internal audit reports

▪ Carry out own risk assessment process – look at vulnerable areas or fraud indicators

▪ Management communications with employees regarding fraud

▪ Management communication with independent directors

Use with Auditing 10e by Alan Millichamp and John Taylor

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© 2012 Cengage Learning EMEA

Consider

Take account of

▪ Management overriding controls

▪ Use of journals by managers to make adjustments

▪ ‘Secret’ or separate funding arrangements

▪ Third parties involvement in transactions or contracts

Auditor should consider audit procedures to evaluate these instances by

▪ understanding client and business

▪ making appropriate enquiries and

▪ testing transactions to evaluate impact on accounts

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Reporting

▪ If fraud is detected auditor should consider impact on accounts

▪ If management is not involved it should be reported to them in the first instance – at a senior level and preferably in writing

▪ If material the auditor’s report might be affected

▪ If management is involved legal advice should be obtained – reporting might be through non execs. Report to shareholders at AGM

▪ Authorities may need to be informed in the case of banking insurance or financial services companies – statutory defence

▪ In extreme circumstances auditors should resign and explain circumstances

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Fraud and the expectation gap

Public expectation that auditors do more than they do with regard to fraud

Need to

• Educate users of financial statements as to roles of auditors and management

• Highlight areas where auditors have relied on management representations

• Most frauds involve management -often at a senior level

• More than half of frauds rare misstated financial reports and don’t involve diversion of funds

• Fraud unlikely to be detected by financial statement audit

Use with Auditing 10e by Alan Millichamp and John Taylor

ISBN 9781408044087

© 2012 Cengage Learning EMEA

Legal liability

• Liable under contract to client – based on Engagement Letter.

• Auditors have to complete audit to best of ability – failure to complete or negligently prepared report will trigger liability.

• Must remain up to date and professionally competent

• If comply with latest auditing standards will not be considered negligent.