Should External/Internal Auditors Be Responsible for Detecting Client Fraud?

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Yongho Cho

Weekly Memo #1:
Should external/internal auditors be responsible for detecting client fraud?
In 2001 Enron, the seventh largest energy company in 2001, filed for bankruptcy. The event named “Enron Scandal” is considered to be the most shocking incident in American economic history. Bring the country to the edge of disaster, the scandal was basically caused by securities fraud which Enron was charge with. The irrationality of accounting and auditing system encouraged U.S. legislative to respond the scandal, enacting Sarbanes-Oxley Act 2002. SOX Act carried out comprehensive reform of accounting procedures required for publicly held companies, such as promoting and improving the quality and transparency of financial reporting by internal and external auditors.

However, there is a controversial issue of whether auditors should be responsible for detecting client fraud. AU Section 110(Responsibilities and Functions of the Independent Auditor) indicates that “the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” In other words, auditors are not expected to provide absolute assurance financial statements because auditors do not examine every transaction and event. The public, however, expect auditor to guarantee all material misstatements. While users who use the reported financial statements expect all illegal issues such as fraud to be detected, auditors are more likely to consider misstatements in the financial statements reported by management.

Senior editor Sarah Johnson notes in her 2010 article in “the Public Company Accounting Oversight Board (PCAOB) is also trying to close the expectations gap between what investors expect and what auditors do.” Therefore, auditors are not entirely responsible for all kinds of fraud because they provide reasonable assurance. SAS No. 99,...