The Role Of External Auditors In Detecting Corporate Fraud Accounting Essay


This introductory chapter intend to inform the reader on the multiples issues that will be tackled in this paper. So after depicting the chief issues, this chapter will therefore cover the principle of the research, the purposes and aims every bit good as the restrictions encountered, which all will be to the full explored. Finally a reappraisal of the construction of the research will besides be conducted to reason this first portion.

Description of the issue

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External hearers ‘ duties and functions have ever been highlighted by several inquiries such as ‘ Where were the hearers ‘ ( Yuhao Li, 2010 ) in chief fiscal dirts as the Enron matter in 2001, the WorldCom in 2002 and Parmalat in taly in 2003. As these entities stated were really affluent and profitable, when all of a sudden they were declared bankruptcy subsequent to the find of several abnormalities and fraud. Alleyne and Howard ( 2005 ) argue that these sort of corporate catastrophes are frequent and are impacting the duty every bit good as the independency of hearers in observing corporate fraud.

‘Why did non the hearers catch it ‘ this is the first inquiry that arises following a corporate failure. That is why, in relation with the above inquiry and harmonizing to Millichamp and Talor ( 2008 ) , there is a difference called ‘Perception Gap ‘ between the populace and the scrutinizing profession refering the responsibility of an hearer sing the fraud and mistakes sensing. Therefore the hearer responsibility can be seen as the independent scrutiny and look of sentiment over the fiscal statements produced by the entities. It must be done by an appointed hearer in conformity with the relevant statutory duty ( Millichamp and Talor, 2008 ) .

Yuhao Li ( 2010 ) in the instance analysis of the Enron dirt and some others writers such as Koh H. C. and Woo E-S ( 1998 ) ‘the Expection Gap in Auditing ‘ , acknowledged that the populace and stakeholders hold different beliefs about the hearers ‘ responsibility and function but besides about the message stated in the companies ‘ audit studies. So seemingly the public misperceptions are chiefly the major liability issues that scrutinizing profession is confronting. So given these concerns, the external hearers function and responsibility are being misunderstood by the chief portion of the public due to the return and the diverseness of corporate fraud. Therefore this paper targets to turn to the legion issues related to the function and the responsibility of an hearer in peculiar concerning fraud.

Rationale of the research

In the fiscal and scrutinizing country, several literature and researches exist on the important function and responsibility of external hearer in forestalling and observing corporate fraud. Some writers, who stand for investors and those holding involvement in concern, toughly see that a corporate failure is ensuing from either carelessness or even frequently from a deficiency of cognition from hearers. So in other words, most concern failure is due to an audit failure ( Dixon, Woodhead and Sohliman, 2006 ) . Multiples surveies similar to the research stated above are keeping the public belief unchanged, believing that hearers are chiefly responsible for any corporate fiscal dirts. Therefore, farther research over this concern is required in order to convey an efficient attack to answer over this issue. Besides this research will be concentrating on the lone function and responsibility of the external hearers, which is different from old paper on both external and internal hearers. The paper will besides stress on fraud as component of the outlook spread. This will enable separate point of position from corporation ‘s angle and from persons ‘ angle. Therefore the research aims to convey extra part to a well-known land in the major counties with of import stocks exchanges such as the United Kingdom.

1.4.Aims and aims:

This survey will aim to convey a clear and defined overview of the function of the external hearers in the scrutinizing procedure in peculiar their duties sing the corporate frauds. Then the research will be carried out and will be focused on the function and the liabilities of the hearer in fraud sensing. In the interim fraud construct will be explained and detailed to assist to better understand the types of fraud, the ways normally used and every bit good as the different possible culprits.

During all the survey long, some responds will be brought to many inquiries underpinning this paper. Those inquiries may change from related inquiries to the traditional function of hearers to their function and liabilities into corporate fraud. Thus the indispensable inquiries underpinning this survey are:

The importance and effectivity of scrutinizing.

The function of the hearer in peculiar in an fiscal environment alterations

The beginning, overview, size and type of corporate fraud

What farther steps should be taken by hearers to guarantee observing corporate fraud

Should scrutinizing move from the ‘archival ‘ attack ( scrutinizing procedure at the terminal of accounting period ) to a lasting auditing where auditing will be processed while corporate is runing.

What changes should be made to guarantee the efficaciousness of scrutinizing.

However, by analyzing these inquiries, this paper will discourse on the basicss issues on scrutinizing particularly hearers function in observing fraud, but will besides convey a presentation of the scrutinizing theory and pattern which are, most of the clip misunderstood. Therefore one of the cardinal aims of this survey will be to demo whether or non that hearers duty were engaged in neglecting to observe the frauds in the past fiscal dirts.

Restrictions and restraints

This survey has encountered some restrictions and restraints. Indeed the research will be intentionally concentrating on the exclusive external hearers as 3rd party appointed to describe to stockholders. This pick is due to the fact that in this research, it was imperative to keep a withdrawal between hearers and directors so that the hearer can non be friend or comparative to any proprietor. It is besides important that he is non keeping any stock in the entity or any pecuniary interest in any other of their subordinates or retentions.

Besides the fraud construct used in the research has been defined as ‘ the act of fraudulence that consequences from deceit of a material fact with cognition of falsify of the representation or with deficiency of sensible land for belief in its truth ‘ ( Association of Chartered Certified Accountants, 1986, P12 ) . The factor Time besides remained every bit restraint as such research requires much longer clip for informations roll uping, seeking and informations analysis intent. Equally good as the clip, the survey has experienced restraint over the hunt of literature because most documents written does non back up the hearer responsibility or function due to the fact that they are subsequent to fiscal dirts.

However the intent of this paper is to reexamine the different sentiments refering the function and the independency or hearers and the effectivity of scrutinizing to observe frauds and mistakes.

1.6. Structure of the research

This research on the function of the hearer in observing corporate fraud will be designed by a 2nd chapter called context in which, different fiscal crisis such as Enron and Parmalat will be analysed. A 3rd chapter will show different literature reappraisal concerning, the function and trust of external hearers at the visible radiation of past dirts every bit good as the nature and different sort of fraud. An consideration will besides be given to the independency of hearers and their related auditing organic structures.

The 4th portion, which is the description of the methodological analysis, used to transport out this survey, will besides include the justification of the employed method every bit good as its restrictions and frogmans restraints confronted when carry oning the research. A 5th portion will therefore summarize the research determination, so construe the legion collected informations. Then finally the 6th portion of the paper will turn to a decision of the survey and the consequences found from it. In this subdivision, a general sum-up will be required including farther research counsel and recommendations.

1.7. Drumhead

The research will underpin on the different inquiries stated in the debut of this research. Therefore in the 2nd chapter ( context ) , an analysis of the environment through which the research has to be related is indispensable.

Chapter 2: Context

The fact of transporting out an audit remains critical and of import for all companies, particularly for public listed companies. It is indispensable for companies that audits are carried out for several grounds. First of all it ensures stakeholders that company is being properly run on their behalf, respectful of company policies and following with the jurisprudence but besides that the investors ‘ money is in safe custodies.

The construct of auditing has been highly developed over the past decennaries, raising some contemplations on scrutinizing as a subject instead than merely a simple pattern. Thus some inquiries have rapidly been raised on the function of the hearers. So to better understand the function of the hearers every bit good as the scrutinizing procedure within a corporate, it is of import to follow a critical attack, as portion of the issue environing the function of the hearers, starts by a misinterpretation of the nature and the function of the hearer. ( Soltani, B. , 2007 ) .

To depict the chief issues around the function of the external hearers in observing corporate fraud, it will be utile to mention to inquiries such as ‘do hearers spend more clip to cover their dorsums than giving helpful information to investors ‘ or ‘where were the hearers? , Critical and general inquiries that arise after fiscal dirts such as Enron in 2001 in the United States of America or the Parmalat matter in Italy. Indeed these sorts of corporate failure are repeated and have exposed some issues sing the duty of the hearers in observing corporate fraud ( Hilton, A. , 2010 ) .

The cost of fraud is progressively impacting many concerns all around the universe. Everybody is affected as a victim of fraud because of the high merchandises costs and besides because of low corporate net incomes. So in order to set an terminal or to cut down this pattern, hearers ( internal and external ) are runing to assist to implement answerability and to put up assurance in fiscal coverage.

Therefore this introductory phase aims to inform the readers on the issues that will be addressed in this paper. The paper will besides cover, the purposes and aims of the research, the used research methodological analysis, the range and restriction of the survey and the literature reappraisal with the proposed chapters.


2.1Overview on Auditing:

First of all, audit will be defined as “ an exercising designed to enable an hearer to show an sentiment whether the fiscal statements are prepared, in all stuff respects, in conformity with an applicable fiscal coverage model ” ( the Institute of Chartered Accountants in England and Wales, 2008, P.6 ) .

So an hearer is the qualified individual who gives a decision whether the fiscal statement of a company ‘shows a true and just position ‘ .

It is of import to cognize that it exists the audit threshold, which is specific to each state or economic country, for illustration in the United Kingdom, all companies harmonizing to the Institute of Chartered Accountants in England and Wales ( 2008 ) are required to be audited except some really little companies and since 2004 freedom were extended to all companies which fulfil the undermentioned standards:

-The concern must be qualified as little company under the 2006 companies act

-The concern ‘s turnover must be less than ?5.6 million

-The company ‘s gross assets ( noncurrent assets and current assets ) must non transcend ?2.8 million.

Basically after the industrial revolution ( 1750-1850 ) , the direction of companies moved from proprietors or exclusive bargainers to directors to do it more professional, hence that where the demand for hearers comes from in order to hold independent hearers from direction to describe to proprietors.

In the United Kingdom the primary intent is to observe frauds and the mistakes. However the general aims of all audit battle will include the undermentioned marks harmonizing to Soltani B. ( 2007 ) :

A cheque up and rating to happen out whether the fiscal statements and the footers have been prepared in conformity of the specified standards

A planetary rating of the effectivity of the internal control systems used for the fiscal coverage during the past accounting period

An rating of the possibility of fraud that could happen within the administration

And eventually it will be indispensable to measure the chance that the organisation will transport on as a traveling concern.

Besides the chief intent of the audit consists in assisting to implement answerability and promote assurance in fiscal coverage. Auditing every bit good stand for a relevant manner for stockholders and stakeholders to assist guarantee that directors and managers are moving in company ‘s best involvement, because managers are chiefly responsible for pull offing the personal businesss of the company on behalf of the stockholders ( Wells, J. T. , 2004 ) .

2.2History of the hearer function refering fraud:

Auditing has gone frontward in the capital market economic system particularly during the past century while its traditional and original intent was to guarantee that honest and accurate accounting have been held in the personal businesss of province, authorities services or others public organic structures. With the clip the construct of scrutinizing has enlarged basically with the economic and industrial developments, since so scrutinizing constructs have expanded conveying more than practical facet to its old 1. Thus a reappraisal of hearers ‘ aims evolution in the clip will be indispensable to appreciate all the contention made round the hearers liabilities ( Soltani, B. , 2007 ) .

2.3Auditors and fraud history:

2.3.1Prior to 1500:

Long clip in the yesteryear, the scrutinizing map was used, for illustration merchandisers were helped by some hearers to back up them in their concern accounting. As that sort of audit was design to command and to verify the responsibility of agents in charge of the trade, so the audit primary map was to forestall and to observe frauds ( Turley and Cooper, 1991 ) .

2.3.2Between 1500 and 1850:

With the enlargement of the industrial revolution, scrutinizing besides have been developed due to the fact that even a that period there were a separation between investors or proprietors and the individuals in charge of running the concerns. Few alterations were made for this period and overall the aims of scrutinizing remained the same as the pattern was based on verifying the concern minutess to bring out false operations.

So this phase has settled criterions for accounting pattern that will be expressed subsequently in the British company act 1862 ( Turley and Cooper, 1991 ) .

2.3.3Between 1850 and 1905:

Due to the enlargement of concerns and the separation of ownership and control, it became obvious to happen a proper control system instead than a cheque up of company ‘s records by proprietors. Besides with the constitution of the Society of Accountants in Edinburgh in 1854, which became the Institute of Chartered Accountants of Scotland, it has been recognised that it is of import to be trained and to hold relevant accomplishments for such control map ( Turley and Cooper, 1991 ) .

2.3.4Between 1905 and 1946:

At this period the function of the hearers has evolved due to more complexness in concern. So hearers ‘ responsibility changed toward their capacity to show their assurance and credibleness over fiscal statement instead than attesting paperss and hence doing them clear even though they were non ( Turley and Cooper, 1991 ) .

2.3.5Between 1948 and 1980:

During this period the audit aims have moved from the simple fraud and mistakes sensing to an look of an adept sentiment over the adopted fiscal coverage and fiscal information. Since so hearers will be in charge of verifying recorded information and whether they have been right made, they besides had to look into if minutess in books are in conformity with disclosed information before they eventually expressed their sentiment whether the histories have been prepared sing a ‘True and Fair ‘ position ( Turley and Cooper, 1991 ) .

2.3.6Current state of affairs:

During the twelvemonth ‘s after1980, many fiscal dirts antecedently stated have put the effectivity and the duty of the hearers in cause. However the function of the hearers did non alter profoundly when the fact showed that extension have been brought to the hearers ‘ responsibility. Besides to reenforce their pattern, the fiscal services had imposed a responsibility to describe all frauds suspected or detected. Consequently to alterations, the Auditing Practices Board has issued the statement of scrutinizing criterions 110 related to fraud and mistake ( The Institute of Chartered Accountants In England and Wales, 2008 )


An hearer is in charge to pull decision whether a company ‘s fiscal statements are free from material misstatement that could be due to fraud. Thus the International Standards on Auditing set out hearer ‘s duty regarding fraud through the ISA240 ; which will take history of measuring hazards of stuff misstatement and will besides affect happening out the sensitiveness of the fiscal statements to material misstatement caused by fraud ( the Institute of Chartered comptrollers in England and Wales, 2008 ) .

Fraud is a word which is frequently use to cover a broad scope of illegal Acts of the Apostless, so harmonizing to O’Gara J. D. , ( 2004 ) Fraud is the knowing and illegal act of misrepresentation or of pull stringsing histories. It can be operated for the benefit or to the hurt of the corporate and by individuals inside or outside the organisation. It ‘s besides indispensable to advert that fraud is a deliberate cheating for the satisfaction of an single or group. However in this paper we will merely be concerned by fraud that may be detected by hearers. Actually, we will sort fraud through two dimension which are whether the perpetuated fraud is for or against the organisation and secondly to happen out the category of the blameworthy or culprit.

Sing the type of fraud it could either be:

Corruptness or embezzlement within the concern which instance is a fraud against the concern.

Fraud refering the fiscal coverage which is considered as a fraud for the organisation every bit good as the money laundering.

External fraud against the organisation ( for illustration false cheques or recognition card fraud ) , ( O’Gara, 2004 ) .

And for the culprit it could either be: direction, employee or non-employee. However direction frauds are most of the clip wholly different from employees, as direction will be utilizing positional power instead than taking advantage of internal control failings. Most of the clip fiscal coverage fraud occurs at the top of an organisation and is run up by senior direction the operating direction is more likely to perpetrate graft and corruptness as fraud instead than the others types, whilst administrative directors will travel for asset-misappropriation.

For many others grounds, direction fraud is under detected, and besides when it ‘s detected most often it remains non prosecuted, that why for internal hearers the primary duty will be acknowledgment and sensing ( O’Gara, J.D. , 2004 ) .

As stated above, external and internal hearer remain different, therefore that is why direction frauds against the concern are highly hard to observe for internal hearers and it s requires farther positions than merely normal accounting. So detecting direction fraud remains the greatest challenge for those internal hearers because of its high impact on the concern frequently even more important than the other types as it is normally an off the books fraud ( O’Gara, 2004 ) .


3.1.1Management fraud:

As mentioned earlier, the country of most direction fraud against the organisation, by and large struggle of involvement, is under reported, because it is the most awkward for a corporation. Harmonizing to John D. O’Gara ( 2004 ) Management fraud could besides affect non direction persons, and we will say below some common characteristic to those frauds:

Chiefly relational fraud, which could be for illustration to deviate corporate net income instead than making minutess, which could be detected by hearers.

The mean direction fraud loss is 8 times the mean employee- fraud loss ( excepting fiscal statement fraud )

The impact of the fraud is important and basically non evident in the records ( income statement or statement of fiscal place of the corporate ) due to the fact that they are off the books.

Besides the culprit is a higher in the corporation so doing him a trusted employee.

Frequently other individuals could ease direction fraud for illustration some confederate specially in command state of affairs.

Besides for most of the clip, deceitful embezzlements happen through deceitful jobbers companies which are typically created for the exclusive intent of fraud without any legitimate concern intent. In some instances the jobbers company is easy identifiable because of the volume of concerns or for its existent place between providers and clients ( Wells, J. T. , 2004 ) .

Some symptoms doing the fraud detectable:

Some symptoms can assist to happen out the on-going fraud state of affairs in corporations such as:

Clear visual aspect of some anomalousnesss in the net income and loss histories, such as amused net incomes.

By and large when there is fraud at the top, we could besides see fraud farther down merely like nutrient concatenation.

There are lifestyle manifestations of the fraud in most instances because persons are engaged in fraud to do their personal concern

The usage of significant jobbers companies, inserted between the corporation and its providers or its clients that are no economic benefit to the corporation.

The alterations that can impact corporation border and which are non supported by external or built-in economic conditions.

Inexplicable bankruptcies or important spreads between market and contract monetary values.

It is of import to advert that a high volume of personal and confidential mail sent to directors or senior directors could besides draw hearers attending ( O’Gara, J. , D. , 2004 ) .

2.4.2FRAUD FOR THE Administration:

Significant deceitful fiscal coverage used to be done and what ‘s surprising is that it does non specially result from a dislocation in the internal accounting control system, but it merely comes as a verification that senior direction uses positional purchase to overmaster their corporate accounting control system. And it has been demonstrated that normally more corporate fraud begins at the top and one issue for the internal audit is the corporate answerability instead than the corporate accounting ( O’Gara, J.D. , 2004 )

So, many inquiries arise to happen out what is the function that internal hearer should play? The internal hearers should be an arm of corporate administration instead than a group of accountants or comptrollers ( Wells, J.T. , 2004 ) .

Some symptoms of fiscal coverage fraud:

Considerable off the book concerns or minutess with related entities particularly when revelation regulation is non decently respected.

Unsupported journal entries peculiarly around period terminal that can hold consequence on the income statement or alterations in the statement of fiscal place such as commissariats, depreciation or stock list rating.

A deficiency of transparence of fiscal statements or alterations in accounting rules to a favorable footing in order to do more benefit or to conceal corporate net incomes

Volatile runing borders assorted with controversial borders which do non fit with the corporate consequences from operations ( O’Gara, J. D. , 2004 )

2.4.3Role of the hearer in look intoing and detection:

In this portion it is of import to do a clear difference between acknowledgment and sensing and between sensing and investigation.

So chronologically fraud acknowledgment happens foremost because at that measure hearer becomes cognizant of fraud possibility so followed by sensing when he determines the chance of fraud ( O’Gara, J.D. , 2004 ) .

Normally it is better when fraud acknowledgment happens earlier so hearers could hold more clip to run deep probe s through corporate fiscal statement.

Probes constitute a separate phase from sensing in the fraud concatenation as they will be concerned by:

Verifying stock lists and look intoing bank rapprochements, besides corroborating receivables

When detected, pay attending to fraud life circle to happen out the continuance and the mechanism

Determine the true individuality or any jobbers company and besides do himself available for employees that could convey more information than expected

Using corporate resources carefully and discreetly to obtain information

Interviewing employees, but in this state of affairs the order does matter because it is advised to maintain premier suspect for to stop and non to allow them cognize about any anterior information from others employees interview ( O’Gara, J.D. , 2004 ) .

After look intoing phase when fraud is found so it will be clip to describe it in conformity of the Auditing criterions.

Besides an hearer should hold these qualities stated below harmonizing to the Institute of Chartered Accountants in England and Wales ( 2008, P75 ) :

“ Accountability


Objectivity and independency




Clear, complete and effectual communicating


Supplying value ”

Fraud is a major cost for corporation, that why hearers are runing to bring out typical fraud that could impact corporations. And besides hearers are truly close to corporations than any other advisor to seek to assist them and to extinguish fraud.

However scrutinizing besides has certain restrictions that affect it on its manner to look into and track fraud.



The chief intent of this portion is to expose the methodological analysis used to gain this research. It will besides detail the different stairss including the range and restriction of the paper.

3.2Methodology used:

The methodological analysis employed in this paper can be divided in two parts. In the first, it will be inquiry to detail the effectual function of the hearer every bit good as an account of fraud and its different types. The 2nd portion will include a reappraisal of the duties of hearers based on the old fiscal dirts such as BCCI, WorldCom or Enron in the United States of America.

However this research will affect both a primary and a secondary research

The aim is to decently specify the duties and liabilities of the hearer in a primary research. Then in a secondary one, due to legion researches covering with the subject, it will be indispensable so to compare the current function and liabilities of the hearers with the declared behavior of the hearers which were related to the past fiscal dirts.

Besides a full account will be given sing the fraud to better understand the range of the research.

3.3Justification of the methodological analysis used:

This portion is intended to warrant the pick of the current research methodological analysis, so it important to state that this survey has been established to reply some inquiries such as:

Are scrutinizing important in the in the corporate capital markets?

Can hearers efficaciously detect or prevent all frauds, what farther alterations could be suggested?

These inquiries are discussed in a context of extended alterations in the capital market every bit good as the subsequent complexness brought into the corporate fiscal coverage ‘s.

3.4Scope and Restrictions:

This portion gives an overview of the issues encountered during the research. So first, it is of import to advert that the usage of both primary and secondary informations brings some jobs. Thus the secondary informations were basically used due to the clip and stuff restraints. However, if non decently interpreted, such informations use may do mistake.

Besides this paper will be chiefly concentrating on the function of external hearers in fraud sensing refering the major fiscal dirts in Europe peculiarly in the United Kingdom.

But besides due to the importance of some dirt like Enron in the United States of America, this survey will include analysis based on such instance.

As good the range of this research might be different to another paper in term of period, as a research made after Enron or Parmalat instance might be different from a research made before.

3.5Research Timetable:

Research Activity











Topic pick and specifying research country

Literature hunt and critical analyses

Proposal entry

Conducting and transcribing interviews

Analyzing and discoursing consequences

Write up

Dissertation entry


This paper highlights the effectual function and map of scrutinizing in a hard context such as fiscal dirts like Enron, BCCI or Parmalat. Besides it is important to specify the boundary lines of hearers ‘ function in fraud sensing every bit good as the range of the scrutinizing procedure within the corporate.

However this survey ‘s concluding words and recommendations will be based on farther research and the following findings.


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