Meeting the Challenge through External Audit - Essay Example

Meeting the Challenge through External Audit Research Paper Outline Fraud in business enterprises has become one of the major phenomenons in the industry. The research paper will describe the fraud cases in Canadian organizations as well as the role of external audit to meet the fraud challenges. The reason for selecting this topic primarily rests upon the fact that fraud can cause significant harm to any organization and the capital market. The frauds need to be identified and it is the role of external auditor to recognize any fraud in organization. To prepare the research paper, data has been collected from various secondary sources such as, internet journals and academic websites. The basic premise of the research is to generate an understanding about fraud and role of external audit; how frauds have taken place in Canadian organizations, its impact and the limitations of external audit to face the problems of fraudulent activities. Table of Contents Research Paper Outline 1 Table of Contents 2 Introduction 3 The Duty of External Auditor 4 Fraud in Canadian Organizations 6 Challenges of External Audit 10 Conclusion 13 Introduction Fraud can be defined as a planned activity which is intended to betray other party. It results in sufferance of the victim through loss and accomplishment of any gain by the doer. Fraud is any unlawful act characterized by dishonesty, concealment or breach of faith. However, fraud does not mean any threat of bloodshed or physical force to deceive. It is committed by human beings and organizations to acquire money, assets or services and to evade fee or protect individual or corporate benefits. From the auditor’s viewpoint fraud is the misrepresentation of a company’s financial statement. The misrepresentation can happen because of fraudulent financial statement or embezzlement of asset. A deceptive financial reporting can be realized by the following ways: Exploitation, distortion or modification of accounting data, supporting files, from which the financial statement can be made Deliberate omission of important events, business deals and other data from the financial report Intended misapplication of accounting standards concerning the money amount, classification of transaction, and way of appearance or revelation of data (Thornton, “Managing Fraud Risk: The Audit Committee Perspective”) The Duty of External Auditor The duty of external auditor is to manage the fraud. According to statement on Auditing Standard No. 99 (SAS 99) the external auditor needs to: Collect requisite information to recognize the risks of material misrepresentation Recognize the threat of material misrepresentation Evaluate the risks of fraud React to the consequences of evaluation Examine the audit verification Share any proof of fraudulent activity to interested parties, and File the reflection of auditor regarding fraud (Thornton, “Managing Fraud Risk: The Audit Committee Perspective”). It is the duty of external auditor to identify the fraud and detect any kind of unlawful activity by any organization. In order to detect the risk of misrepresentation the external auditor can apply professional decision and consider the elements of risk which comprises of kinds of risk, importance of risk, probability of the threat, and pervasiveness of the risk. The external auditor’s evaluation does not act like an assurance that no fraud exists in financial report. The audit committee must acquire rational assurance on behalf of the external auditors that organization has taken the requisite steps to secure the assets of the unit. The audit committee needs to verify by proper analysis about the auditor’s vigilance to the likelihood of fraud (Thornton, “Managing Fraud Risk: The Audit Committee Perspective”). According to Companies Act 2006, an organization is required to employ an auditor who makes a report for investors with a view on whether the financial statement provides accurate and real value of company’s financial performance. In fulfilling the task, the auditor should carry out research to generate a view about organization’s adequate reporting. The task of external auditor is concerned with two kinds of fraud which are fake financial statement and misuse of assets. It is expected from the external auditor to maintain professional cynicism with respect to existence of fraud during audit procedure. The external auditor has the authorization to use the organization’s account books and perform enquiry to the board of directors, administration and other personnel to decide whether they know the facts of any actual or suspected fraud activities that can impact of the organization and financial statement. Even though, external auditor may suspect or notice any kind of fraud, he/she at times does not make any determination about the occurrence of the fraud. In case the external auditor has got confirmation of real or alleged fraud, the issue must be reported to proper administration or the board of directors in a timely mode (Fisher & Et. Al., “Fraud Reporting in Listed Companies: A Shared Responsibility”). According to ‘Proceeds of Crime Act 2002’, the external auditor is liable to report suspected fraud based and other cash decontaminating acts to the administrative authorities (Fisher & Et. Al., “Fraud Reporting in Listed Companies: A Shared Responsibility”). In the year 2002, the SAS 99 made mandatory utilization of ‘42 red flags’ in the audit of companies financial report to identify any fraudulent activity. Auditor who does not share information efficiently with the audit committee is prohibited from recording fraudulent incidents to the board. The external auditors must know the degree of fraud identifying utility of each ‘red flag’. The external auditors emphasize the significance of fraud evaluation and identification partially in response to requests by professional entities, supervisory agencies and governments. They rationally defy organization’s use of ‘non-Generally Accepted Accounting Principles’ (Non-GAAP), except organizations and auditors are able to validate that the practice of non-GAAP can provide better calculation of net asset and revenue. Whenever an organization chooses any non-GAAP method, exclusively for reducing the income tax, the external auditors examine for the explanation from the organization about using the non-GAAP mechanism (Shamki, “Internal Audit Responsibilities in Auditing Financial Systems Fraud”). Fraud in Canadian Organizations Canada is unable to evade the recent international phenomenon of the financial fraud scandals. Fraud especially the industrial fraud is an insidious threat of financial system and has possible affect on any enterprise irrespective of the size, or type of industry. The industrial fraud is any deceitful act committed by a worker, administrator, senior manager or proprietor of a company where victim is the company itself. It is also known as internal fraud. According to the report of ‘Association of Certified Fraud Examiners’ (ACFE), 90% of every industrial fraud comprises of asset misuse, dishonesty components and deceptive financial statements. The most affected industries in Canada impacted by fraud have been the government administration, retail sector and banking & financial industry. Almost 38.2% fraud happened in private organizations compared to 23.6% in public organizations. Minor companies where number of employees are below 100, comprises of 42.2% of fraud cases. The losses in minor corporations because of fraud is almost 150,000 Canadian Dollar (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). According to evaluation of ACFE, it has been seen that a normal Canadian company losses almost 5% of the yearly income because of fraud each year. For sales of each 100 Canadian Dollars, 5 Canadian Dollars are wasted for fraud. This amount is huge when calculated by considering the highly competitive business environment. The industrial fraud also entails vital indirect expenditure to society and investor with respect to loss of reserves, loss of employment, reduction in stock value, loss of faith in the capital market and audit work (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). Normally frauds take the shape of asset embezzlement, corruption, and deceptive financial report. Among the 90% of the cases, fraud is conducted by asset embezzlement which has accounted for loss of 200,000 Canadian Dollars. 39% of frauds are carried out in the form of corruption which accounts for loss of almost 250,000 Canadian Dollars and the fraud caused by deceptive financial report, accounts for only 11%, but the losses are five times bigger than the asset embezzlement with loss of 1,075,000 Canadian Dollars (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). The following chart will display the fraud cases in Canadian industry: Source: (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). Asset embezzlement comprises of cash as well as non-cash property. Cash is known as major habitually misused asset as it is liquid in nature. The cash can be hoaxed by six fundamental techniques which are billing, payroll, check interference, electronic transfers, expense refund, and cash payment record. Among the six methods, the billing is the most popular method for fraud. About 38.6% cash is stolen by this technique which accounts for loss of 325,000 Canadian Dollars. Check interference and electronic transfer absorb loss of almost 100,000 Canadian Dollars each. About 20% of cash fraud is done by expense refund with loss of almost 18,000 Canadian Dollars (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). The following graph will show the proportion of each technique for fraudulent activities: Source: (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). The financial statements are misrepresented by five techniques which are: providing fictitious revenue, covering the debts and expences, recording false time, inappropriate asset valuation, and inappropriate revelation. Challenges of External Audit Canada follows the principal oriented approach with the exemption of obligatory regulations linked with external audit committee. The companies are required to publicly release the financial report. The collapse of Enron and many other companies such as Adelphia, WorldCom and Tyco were because of the fact that accounting fraud was endorsed as an effort to eradicate the administration misconduct and to reinstate faith in the capital market of the USA. As a participant of capital community of the USA, Canada followed the USA style for strict corporate governance requirement. The principal oriented approach of Canada has been proved to be weak and a failure to prevent the fraudulent activities. Canadian financial market includes far superior percentage of organizations which are strictly held or administered by company owner’s and smaller organizations have limited financial resources to meet the terms of the strict US regulations (Broshko & Li, “Corporate Governance Requirements in Canada and the United States”). The external audit is the most common antifraud measure for preventing fraud. However, there are several challenges for external audit. It can be seen that companies that use external audit faced losses of 198,500 Canadian Dollars where as companies which does not use external audit faced losses of 145,000 Canadian Dollars. The surprise audit has much influence on the fraudulent activities. Companies where surprise audit is conducted face lesser losses compared to other companies where other methods are used. The following graph will show the amount of losses for both types of organizations: Source: (Association of Certified Fraud Examiners & Rivest, “Detecting Occupational Fraud in Canada”). Presently, the challenges for external audit for removing fraud in government as well as private sector are equal. From the above data, it has been seen that in spite of external audit there has been increased fraudulent activities in Canadian firms. The external auditors need to regain the faith of shareholders and other parties and restore the positive expectation about external audit. There is need to establish the faith of public about proper evaluation of asset and accounts of company. The external auditor must react to the shareholders’ demands without conciliating the audit quality (ACCA, “Enhancing External Audit: Learning From The Public Sector”). External auditor has a responsibility to report the real or alleged fraud externally to governing or administrative authorities. It is the auditor’s professional responsibility to preserve the privacy of client statistics. Conclusion In order to make the external audit become successful there is need to extend the span of audit in the private organizations so that audit process can be accomplished effectively. Fraud can destroy the growth of a company as well as have an impact on the economy. It can lead to loss of trust in the capital market and among the shareholders. The external audit can play an important part for preventing the fraudulent activities in Canadian organizations. Better learning and enhancement in the transparency of external audit procedure can help to meet the challenges of fraud efficiently. Works Cited ACCA. “Enhancing External Audit: Learning From the Public Sector”. September 02, 2011. The Association of Chartered Certified Accountants, 2010. Association of Certified Fraud Examiners & Rivest, Dominic P. “Detecting Occupational Fraud in Canada”. September 02, 2011. A Study of its Victims and Perpetrators, 2002. Broshko, Erinn B. & Li, Kai. “Corporate Governance Requirements in Canada and the United States”. September 02, 2011. Canadian Investment Review Forthcoming, 2006. Fisher, Jonathan. & Et. Al. “Fraud Reporting in Listed Companies: A Shared Responsibility”. September 02, 2011. Fraud Advisory Panel, 2010. Shamki, Dhia. “Internal Audit Responsibilities in Auditing Financial Systems Fraud”. September 02, 2011. Business e-Bulletin Vol. 1, Issue 1, pp 25 – 32, 2009. Thornton, Grant. “Managing Fraud Risk: The Audit Committee Perspective”. September 02, 2011. The Audit Committee Guide Series, No Date. Read More