Auditors have a duty to follow the scent of fraud

When David Dunckley, the Grant Thornton chief executive, told a committee of MPs last week that auditors examining a company’s books are “not looking for fraud”, his answer met an angry response. If an audit firm is not picking up on fraudulent behaviour, demanded one MP, “what is the point of audit in the first place?” Investors might add, if fraud busting is not the responsibility of auditors, whose is it?

More clarity is needed over such questions in the light of scandals involving companies such as BHS, Carillion and, most recently, Patisserie Valerie, the failed bakery chain — for which Grant Thornton was the auditor. If company accounts that have supposedly been scrutinised by auditors cannot be trusted, the faith of shareholders, employees and the wider public in the corporate system is eroded.

The accountancy profession has long argued that auditors are “watchdogs not bloodhounds”, a phrase first used by Lord Justice Lopes in 1896. Auditors like to say directors bear responsibility for safeguards against fraud. The line between watchdogs and bloodhounds, however, can be too sharply drawn. If auditors pick up a scent of something wrong, they need to follow the bloody trail. As some rival accounting chiefs told MPs last week, auditors ought to be expected to find “material” frauds.

Auditors’ key task is to determine whether a set of accounts gives a “true and fair” picture of a company’s business. They acknowledge they have to carry out what tests they can to determine whether the figures present that true and fair view. Documentary trails for all transactions to support the numbers in the accounts need to be followed. Invoices need to tally with what has been put in the books. The veracity of documents has to be investigated.

Auditors should also put in place procedures and processes that are designed to minimise the chances of fraud slipping through the net — such as checking that stock and assets really exist, and verifying cash balances and borrowings with companies’ bankers.

Such measures may never be enough to catch highly sophisticated deceptions. But if it is later found that fraud was missed because an auditor failed to ask a particular question, it must be determined whether that failure was reasonable under the circumstances. While a company’s internal controls may be primarily the responsibility of the directors, it is an auditor’s job to make sure these are suitably robust.

Some audit veterans complain the reliance on technology to interrogate accounts — even if this ought to be better able to flag up discrepancies — has led to too little time being spent talking to companies and employees. Danger also lies in some other factors. As this newspaper highlighted in a series of reports last year, the very role of auditing is being downgraded by the leading accountancy firms, as advisory services account for a much larger chunk of their income. That leads to the risk of audits being given too little attention.

Last week, in response to concern over such conflicts of interests, two of the “Big Four” accounting firms, PwC and EY, said they would stop providing non-essential consulting services to their UK audit clients in the FTSE 350 index by 2020. KPMG took a similar decision last year, while Deloitte, though it has not yet formally adopted the policy, says it supports it.

If properly implemented, such commitments are welcome. Further changes are on the way after two regulatory probes last year. As long as corporate collapses and frauds such as that at Patisserie Valerie continue to occur, however, the accountancy industry has a long way to go in restoring lost trust.

Letter in response to this editorial comment:

Auditors must review their purpose and scope / From Kevin Ellis, PwC UK, London, UK