Published March 20, 2009

Auditors can do more to deter and detect fraud

By LYNETTE KHOO

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INVESTORS depend on auditors to give reasonable assurance that financial statements are free from material misstatements caused by fraud or error. But that faith has been severely tested of late when cases of fraud left uncovered for years came to light.

Many have started to question the value of an audit opinion. If auditors are unable to uncover fraud earlier or at all, is there any point in having a statutory audit?

Questions such as this emerge whenever there is a rise in fraud cases during bad times. Then comes the same old debate on what an audit should set out to achieve.

Should we expect auditors to act like bloodhounds?

Some argue that while auditors have a duty of care for due diligence, the primary safety nets against fraud still lie with the board of directors and audit committees (ACs).

Singapore Exchange's call on company boards and ACs to raise their vigilance in times of financial turbulence underscored that convention.

Ideally, the board and the AC serve as the watchful pair of eyes to keep a close tab on management.

First line of defence

Some say that internal audit is the first line of defence against poor corporate governance. It has to be independent of management and be accountable to the AC.

The AC plays a critical role in ensuring the integrity of the financial statements through its oversight of the company's financial reporting process, internal controls and the audit function.

But what if directors on the board are less than fully independent, less than well-trained or are simply too busy to be effective overseers?

What if the AC members are less than qualified to understand complex accounting treatment and disclosure requirements? A recent study by the Institute of Certified Public Accountants of Singapore (ICPAS) found that less than half the members on audit committees of listed companies here have formal accounting and financial qualifications and experience.

Corporate governance guidelines also advocate that the ACs review companies' internal controls and risk management systems set up by the management at least annually.

Are the ACs doing so and meeting regularly with key management, internal and external auditors and the company's compliance staff to understand the company's control environment? According to the survey by ICPAS, some 31.9 per cent of the ACs meet fewer than three times a year.

Thus, the reminder issued by the SGX yesterday to boards and ACs of their roles and obligations can't be more timely.

But at the end of the day, the AC and the board still rely on the findings of external auditors on the internal control and weaknesses noted during their statutory financial audits.

Given their expertise, auditors are called upon to ensure integrity in companies' financial reporting. When the effectiveness of the board and the AC is found wanting, auditors' role as a guardian of corporate governance and investors' confidence takes on greater gravity.

The bulletin issued by the Accounting and Corporate Regulatory Authority (Acra) this week has aptly advised auditors to exercise more vigilance and rigour in their audit planning and execution. They now have to consider the higher risks of fraud, inflation of cash, and vigorously test out judgmental estimates such as fair value and goodwill impairment.

They are already doing so. But the current business climate is calling on them to go the extra mile. Watch for inconsistencies, dig deeper, ask the right questions and verify all documentations and sources of replies. In situations where auditors aren't able to give a clean bill of health, instead of walking out, the auditors may have to decide if the basis of the audit qualification warrants an extension of the audit work to probe dodgy issues, make forensic investigations or even get the regulators to step in.

For instance, when the collectibility of receivables is doubtful and results in an audit qualification, it could well be a red flag of potential 'round-tripping' transactions. This was seen in the case of Advance Modules, where such transactions were allegedly used to give the illusion that payment was received for fictitious sales.

Some market watchers felt that it was easier for auditors to walk out rather than bear the risk of 'defaming' a company of fraud or dishonesty unless they were very certain that there are misdeeds. This is unlike in the US, where shareholders can hold a class action against auditors if the latter suspected dodgy issues in a company but failed to inform shareholders.

SGX listing rules and Companies Act do not specifically require companies to explain why its auditors are resigning, though by convention they may provide some reasons when they issue a circular ahead of appointing new auditors at an annual general meeting.

Unanswered question

Companies often end up making boilerplate comments that the resignation is due to a lack of agreement on the fees or rotation. This leaves an important question unanswered. Were there major disagreements between the auditors and the management over the integrity of the financial statements?

Granted, if there is a grand masterplan to defraud and deceive, even the best of professionals can be fooled.

But auditors can do more than express an opinion on financial statements. When internal controls and corporate governance in a company fall short, auditors are the last safety net that would hopefully not fail.