Brydon recommendations: A package of measures around fraud detection and prevention
Following the publication of Sir Donald Brydon’s final report on his Independent Review into the Quality and Effectiveness of Audit, this article summarises his proposal for a package of measures around fraud detection and prevention.
In his report, Sir Donald Brydon has stated that he has found the issue of fraud, and the auditor’s related responsibilities, the most complex and most commonly misunderstood in relation to auditors’ duties.
The issue of fraud is dealt with in International Standard on Auditing (ISA) (UK) 240 (Revised) – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, and requires the auditor to obtain reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
In Sir Donald’s opinion, this message is somewhat ambiguous resulting in a lack of clarity in exactly what is expected of the auditor in relation to fraud. ISA (UK) 240 (Revised) states that it is the directors who are primarily responsible for the detection and prevention of fraud and that it is less likely that the auditor will be able to detect a material misstatement arising from fraud, than one resulting from error, as the former may involve the use of sophisticated methods designed to try to conceal it. It is here, according to Sir Donald, that the confusion arises. There is a gap between what is expected of the auditors in relation to obtaining reasonable (high but not absolute) assurance on the truth and fairness of the financial statements and what is required of them under ISA 240. Users often therefore question why the auditor has been unable to detect a material fraud that has had a significant impact on the financial statements. The auditors’ response that their responsibility only goes as far as providing reasonable assurance that a material misstatement does not exist is not well understood and, in Sir Donald’s opinion, is not satisfactory.
Sir Donald has, therefore, recommended that the proposed new UK Regulator, the Audit Reporting and Governance Authority (ARGA), should amend ISA (UK) 240 (Revised) to make it clear “that it is the obligation of an auditor to endeavour to detect material fraud in all reasonable ways”.
The report also proposes a requirement on directors to “report on the actions they have taken to fulfil their obligations to prevent and detect material fraud against the background of their fraud risk assessment”.
Sir Donald has also recommended that training in forensic accounting and fraud awareness should be included in both the formal training syllabus and continuing professional development provided for those training and practising as financial statement auditors.
In addition, the report contains a proposal to include an explicit statement in the auditor’s report on the work they have performed on the director’s statement of the actions taken by them to prevent and detect material fraud and the appropriateness of this statement. The auditor should also state the steps they have taken in their assessment of the effectiveness of the relevant controls and to detect any such fraud.
A further recommendation is for the proposed new UK regulatory body, ARGA, to maintain a publicly available case study register containing details of past corporate frauds in order that auditors can learn from these examples.
Sir Donald acknowledges in his report that, often, the failure to detect a material fraud is “judged in hindsight in a prejudiced manner”. In order to appropriately assess the culpability of the auditor in such cases, the report recommends the establishment of an Independent Auditor Fraud Panel, which is both impartial and reasonable, to fully investigate the circumstances around the fraud and impose any appropriate sanctions on the auditor.
In Sir Donald’s opinion, the introduction of this package of measures will go a long way towards helping restore confidence in the role of auditors in relation to the detection and prevention of fraud.