Fraud and the accountant: Why be afraid of an opportunity? (Part 1)

By Gunther R. Borris, CPA
Member, MACPA Business Valuation & Litigation Services Committee

What is fraud?

Fraud is the criminal deception intended to financially benefit the deceiver. This means the deception is criminal in nature, must involve a financial benefit, and must be intentionally committed.

In the past, auditors have taken the existence of fraud too lightly, even though the public firmly believed it was the responsibility of the auditor to detect fraud when it existed.

In February 1997, by way of SAS 82, auditors were required to plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement, whether caused by error or fraud. Auditors are required to assess the risk of misstatement due to fraud and are provided guidance regarding their communication about fraud to management, the audit committee and others. Failure to comply with these standards increases the likelihood that auditors will be held accountable in the event fraud is discovered.

I believe auditors are not taking seriously enough the responsibility given by SAS 82. We still have to develop an attitude of expectation of fraud. We must communicate to our clients that management is responsible for the prevention and detection of fraud. They have the responsibility for sound policies and controls that assure accurate financial records.

And how to detect material fraud committed by employees? After all, immaterial fraud committed over lengthy periods of time might become a material fraud!

Is closing our eyes our defense? Should we explain to the public and our clients that discovery of fraud is the responsibility of the client? Is it convincing to say that we check for fraud only when it materially affects the financial statements to which we certify? I do not believe we will be able to convince clients and the public that we are not accountable or our responsibility is, at best, very limited.

In fact, we should be responsible for the discovery of material fraud existing in financial statements and in operations of the business unless we demand that clients install the necessary procedures to prevent material fraud.

I do not believe it is possible for businesses and not-for-profit organizations to eliminate or discover every fraudulent transaction. However, they can substantially reduce the chance of the occurrence of material fraud by properly managing the risk of fraud.

We, the auditors, may question the willingness of clients to install the necessary procedures to reduce the likelihood of the occurrence of material fraud. According to a study by the Association of Certified Fraud Examiners, fraud is estimated to cost the North American economy more than $400 billion annually. This may even be a conservative figure, considering that insurance fraud costs the U.S. industry approximately $120 billion annually and there is additional medical fraud of approximately $120 billion annually.

Furthermore, it is estimated that fraud losses reduce average profits by approximately 5 percent annually. Most of these losses are not discovered or not reported by business.

CPAs generally can assist their clients in installing procedures which, if properly supervised, may prevent material (but not necessarily all) fraud.

These procedures could come under the following headings:

Understanding the Risk of Fraud
Promoting an Ethical Environment
Computer and System Security
Internal Fraud
External Fraud
Financial Statement Fraud
Risk Financing and Fidelity Insurance

It is not very time-consuming for the auditor to review whether management follows and reviews the procedures once installed, and to perform similar tests to those used to measure the effectiveness of management complying with good internal control procedures.

In future articles, the procedures mentioned above will be described in greater detail.

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