Bloomberg Tax
Aug. 18, 2023, 7:00 AM

Audit Firms Must Equip Their Employees to Detect Financial Fraud

Herbert M.  Chain
Herbert M. Chain
Kreston Global

Detecting and responding to financial fraud is a sum of many parts. At an individual auditor level, there are rigorous professional standards, controls, and engagement strategies that aid in the identification of and response to financial statement fraud.

However, just as a goalkeeper is only as good as the team around them, the individual auditor is the final touchpoint in a far more complex journey within the audit firm. This culture plays an important part in the firm’s quality management system.

The interplay of firm culture and audit quality is addressed in the Public Company Accounting Oversight Board’s recent findings that audit deficiencies were expected to rise for the second year in a row to 40% in 2022, attributed in part to issues that relate to firm culture such as leadership commitment to quality audits, compliance with independence requirements, and in many instances, staff turnover.

Firm culture is an intangible asset that informs employees about behavioral expectations, professional responsibilities, and personal interactions. Various levers, including culture, values, procedures, and training must be aligned to ensure that the firm’s auditors are equipped to effectively address the risk of material misstatement due to fraud.

Professional Skepticism

Professional skepticism is a vital concept for auditors, encompassing a questioning mindset and critical evaluation of audit evidence, and is crucial in identifying and responding to the risks of fraud or material misstatement. Regulators, financial statement users, and the general public expect auditors to uphold professional skepticism throughout the audit process, from planning to reporting.

By maintaining heightened skepticism, auditors approach audits with diligence, actively seeking indicators of fraud and thoroughly examining evidence. It also guides auditors in evaluating management responses, ensuring they are reasonable and supported by evidence. Both “trait” skepticism, a characteristic of individuals, and “state” skepticism, a situational response, play a role in experienced auditors’ behavior.

Firms must consider these differences to enhance professional skepticism, whether through training, awareness, or supervision, to ultimately improve the quality and reliability of financial statement audits.

External vs. Forensic Auditing

Distinguishing between financial statement and forensic auditing is crucial, due to their different objectives, skill requirements, and mindsets.

Financial statement auditing is meant to express an opinion on the fairness and reliability of financial statements. In contrast, forensic auditing investigates fraud suspicions and assumed financial irregularities for legal purposes.

Neutrality is key in financial statement audits, maintaining an unbiased mindset, while presumptive doubt is essential in forensic auditing, questioning evidence for potential wrongdoing. Auditors must balance neutrality and skepticism to stay objective yet vigilant.

Professional Development of Staff

The audit profession emphasizes the concept of “due care,” denoting the level of expertise and diligence expected from auditors during audits. Competence, knowledge, and appropriate supervision are essential to perform effective audits, meaning, for example, that a firm should not have an inexperienced staff member auditing complex and subjective estimates.

A culture of learning and staff development is crucial in equipping professionals to address the risk of financial statement fraud. Training—technical and practical—plays a significant role in enhancing auditors’ ability to identify and respond to fraudulent activities, and it is the duty of audit firms to promote ongoing professional development in support of these skills.

Academic studies have shown that auditors with fraud detection training exhibit greater skepticism, employ sophisticated techniques, and are more likely to detect fraud. Thus, specialized training should be a priority for audit firms to improve fraud detection and response .

Training staff requires a comprehensive approach incorporating technical knowledge and practical skills. Key considerations for an audit firm when designing training programs include:

  • Professional skepticism and critical thinking. Foster a culture of professional skepticism and critical thinking within the firm, train staff to question assumptions, challenge assertions, and adopt a skeptical mindset when evaluating evidence, and provide guidance on evaluating management representations and addressing potential biases or conflicts of interest.
  • Fraud awareness and recognition. Provide training on different types of fraud risks, schemes, red flags, and indicators of potential fraud.
  • Forensic accounting techniques. Adopt, and train staff to use, specialized tools and software for fraud detection and prevention.
  • Internal control evaluation. Teach staff how to assess and evaluate internal controls to identify deficiencies and weaknesses that may increase the risk of fraud.
  • Interviewing and investigation skills. Develop staff’s interviewing skills to effectively gather information and elicit relevant details during fraud discussions with management and boards, and provide training on conducting fraud inquiries, including evidence collection and documentation, even under remote settings.
  • Ongoing professional development. Encourage continuous learning and professional development in the area of fraud detection and support staff in obtaining certifications such as certified fraud examiner or other relevant credentials. Encourage staff to attend relevant conferences, workshops, or seminars on fraud-related topics.

The Role of Technology

Technology is advancing. Data availability is growing. Forensic data capabilities are increasingly being included as part of the audit toolkit, especially if there is a heightened concern about fraud or there have been issues in the past. Likewise, AI-powered systems, including large language models, are increasingly becoming part of the auditor’s toolkit to identify and analyze fraud risks.

To ignore these trends is to ignore reality—putting the firm at risk. Firms should consider how to incorporate these tools and the trained experts into their planning and procedures, and train staff in their use.

Master data analytics. By analyzing transactional data, algorithms can detect unusual patterns, such as unexpected spikes in expenses or revenue, suspicious transactions, or unusual cash flows. Alongside strong analytical skills, proficiency in data visualization tools, statistical analysis techniques, and data mining algorithms is critical for interpreting complex financial information.

Leverage artificial intelligence. AI-powered systems can analyze vast amounts of financial data, identify patterns, and generate valuable insights. Professionals need to develop a strong understanding of AI technologies such as machine learning and natural language processing to leverage these capabilities effectively. However, there are limitations to AI, including inaccurate or biased results, and thus it should be employed and the results analyzed judiciously and carefully.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Herbert M. Chain is deputy technical director at Kreston Global Audit Group and shareholder at Kreston Global member firm Mayer Hoffman McCann P.C.

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