Are your systems and controls up to date? Is it time to review your company procedures?
After a succession of very public accounting scandals in recent years, Sir Donald Brydon, chairman of the London Stock Exchange, is to look into this. Sir Donald Brydon is to lead a government-commissioned review into just how far auditors should go in detecting company fraud.
He may want to talk to a forensic accountant or two along the way. As the closest people you get to the police in the financial world, it’s a forensic accountant’s day job to investigate fraud and other financial irregularities. We could give Sir Brydon some insights into what investigating fraud is really like and the differences compared to an audit (many forensic accountants start out as auditors).
Companies often dread the auditors coming in, finding the whole experience rather inconvenient and intrusive. But if Sir Brydon concludes that auditors should be more responsible for detecting company fraud, the annual audit could get a whole lot more intrusive. Sticking with the police analogy for a moment – would it be like the police turning up on your doorstep and looking to see whether they can find any evidence that a crime has been committed, regardless of whether there was any suspicion that one has?
The expectation gap
There’s an obvious gap between the current scope of an audit and the public’s view of what an audit should do. We’re not surprised by the confusion. In our experience, many have confused audits with accounting investigations, but there’s a big difference between the two.
Perhaps the key difference is the concept of materiality. This threshold applies to an audit but doesn’t really exist in the forensic world. A forensic investigation usually has a much narrower focus than an audit but will view things in greater detail and with a higher degree of scrutiny and professional skepticism.
Auditors often have to rely on the representations of a company’s directors and/or senior management and where there is no suspicion of fraud or other financial wrong doing it is reasonable to do so. As the work of a forensic accountant is likely to end up in front of a regulator or a court of law, we are expected if not duty bound to check that what we have been told is supported by other documentary evidence.
These differences inevitably mean that a forensic investigation would be much more intrusive and costly than an audit. Both the time and monetary costs of an annual forensic accounting investigation would be prohibitive for most businesses and unjustifiable where there’s no suspicion of fraud or error.
Investigation versus detection
Let’s also be clear that there’s a big difference between the investigation and detection of corporate fraud. It’s very difficult, even for forensic accountants, to detect fraud. Investigations more often than not result from whistleblower allegations or other suspicions of fraud. The same way police investigations start with evidence or suspicion that a crime has been committed.
Some of the bigger forensic accounting firms can use whizzy analytical tools and techniques on a company’s financial data to detect potential anomalies or abnormal patterns – these may indicate fraud. In an increasingly data intensive and digital world, this may be one of the ways forward and would at least give the auditors a starting point.
Prevention is better than cure
It will be interesting to see what conclusions are drawn from Sir Brydon’s review later in the year and whether the gap between audit and forensic accounting narrows as a result. In the meantime, we shouldn’t overlook the very important role a company’s own directors, senior management and staff play in the prevention and detection of fraud. A company’s own corporate governance procedures should go a long way in addressing and reducing the risk of fraud being committed in the first place. The recent succession of public accounting scandals suggest that corporate governance procedures could be doing more too.