Auditors’ Role in Detecting Fraud
In the case concerning the Kingston Cotton Mill Company in 1896, the judge’s view was that the auditor should be a watchdog not a bloodhound, not suspecting a company’s employees or officers of wrongdoing without reason, but remaining vigilant for any illegal activity. However the public’s perception is that the auditor’s role in detecting fraud should be more active, and here too there is an expectations gap. The investing public, and sometimes also the company management, cannot understand how the auditor could possibly overlook any fraud within the organization, given that the role of the auditor is to examine the transactions performed during the year, and ensure that the assets and liabilities are correctly stated on the balance sheet. This misunderstanding of the auditor's role in detecting fraud is a significant component of the expectations gap.
However from the auditor’s point of view, the detection of fraud is not the main purpose of the audit. The auditor is concerned with ensuring that the financial statements give a true and fair view of the transactions of the company, and of its financial position at the balance sheet date. Much of the fraud that may be committed within a company, while it is substantial in terms of the aggregate amount of money involved, may concern a very small percentage of the company’s turnover and assets, and may simply be immaterial from the point of view of the audit. The auditor will assess the internal controls within the company to form an opinion as to how far they can be relied on in the audit work, and it is the company’s own internal systems that should be picking up signs of fraudulent activity.
Linked to this is the question of the nature of the audit and how it is conducted. Here too there is an expectations gap. The public, and some company directors, may expect that the auditor will go in and review every transaction, checking and cross checking to ensure that all is well. The reality of the audit is very different and may be inexplicable to the public and their high expectations. Rather than examining large numbers of particular transactions, the auditor is likely to be concerned with assessing the internal controls and the internal audit function, to determine the extent to which they can be relied upon by the external auditor. Individual transactions may be examined, but the auditor will be very concerned with walk through tests and statistical sampling, to ensure that the systems are working as they should. The manager, investor or creditor who is expecting forests of green, and brown ticks in books of account and on computer print-outs, will be disappointed with the outcome in terms of colored ink. The image of the auditor as the person who goes through the records with a toothcomb, ensuring that every transaction is examined, is another component of the expectations gap.