FRC: Auditors must look for fraud

Haddrill was responding to a letter from Clark in which the secretary outlined the FRC’s priorities transitioning to ARGA. Clark also made reference to Grant Thornton chief executive David Dunckley’s controversial assertion in evidence to the Business, Energy and Industrial Strategy Committee (BEIS) in January that auditors do not look for fraud.

The exchange is illustrative of a gap in expectations. Peter Kyle MP asked Dunckley, “[W]hat measures you take as an auditor when you are undertaking an audit to expose criminal activity going on within companies, and to make sure fraud, should it be happening within a company, is discovered?”

Dunckley replied, “An audit fundamentally gives a reasonable opinion on historic information and does not look for fraud. The market expects that it is doing all those things, so we have that expectation gap that needs to be fixed.”

During the exchange, Dunckley noted he could not speak to the MPs about the current FRC investigation into his firm’s handling of the audit of café chain Patisserie Valerie—the center of a £94 million (U.S. $122 million) accounting misstatement scandal—which is also being investigated by the Serious Fraud Office.

It was revealed in April that Grant Thornton’s audit work on Patisserie Valerie was given a clean bill of health by the FRC, according to The Times newspaper. An FRC spokesperson said its “routine monitoring of audits is designed to ensure the audit was conducted in a satisfactory manner and not to identify aspects such as fraud. The audit of Patisserie Valerie was selected as part of our routine monitoring activity and completed before the company itself identified ‘potentially fraudulent, accounting irregularities.’ ” This lack of insight and enforcement is one of the reasons for the comprehensive review of the FRC, which resulted in its transformation into ARGA.

“We are not looking for fraud. We are not looking at the future. We are not giving a statement that the accounts are correct. We are saying they are reasonable. We are looking in the past, and we are not set up to look for fraud.”

David Dunckley, CEO, Grant Thornton UK

Commenting on the Dunckley confession, Haddrill told MPs in a later hearing, “What I would say to my successor [at ARGA] is, first, there are a number of things that are customer practice within the profession. The Committee discussed one of those last week on this whole question of fraud. The auditor is clearly responsible for pursuing fraud in the company, but there is this mythology that has grown up of, ‘We’re not going to find it,’ and that sort of thing.” He went on to say the future regulator should think not about how the audit profession works now, but where is the public interest and what is the expectation of what the profession is supposed to do.

Dunckley’s view appears not to be unusual in the industry. At the same hearing, KPMG’s U.K. Chairman Bill Michael told MPs, “We are not responsible for the material detection of fraud.” Deloitte U.K. Chief Executive David Sproul added, “The public, perhaps understandably, believe an audit is a guarantee that a company will not fail in the future, and a guarantee that it will find fraud.”

Yet another review of the profession was launched in February this year, again by the BEIS, and led by Sir Donald Brydon. The consultation period for this review will close in June this year. Michael Izza, of the Institute of Chartered Accountants in England and Wales (ICAEW), told MPs he “would be very keen for Sir Donald [Brydon] to explore the expectation gap, with a particular emphasis on fraud.” Setting the extent to which auditors will be responsible for detecting fraud is indeed part of the Brydon remit.

Not all auditors think it is not their job to find fraud. Scott Knight, head of audit at BDO, speaking to MPs at the same hearing as Dunckley, said, “If they [frauds] are sizeable and material then I think you do have to look for them. In a large organisation there will be petty frauds and that is not something an audit is designed to wheedle out. But if they are material to the financial statements and of relevance to the shareholders, then you should be expected to find them.” This exchange caused Dunckley to backpedal somewhat, saying, “When you sign off the audit, you are not signing off to say there has not been a fraud. If there is a fraud that affects the materiality of the accounts, you will want to find it. My point was that the nature of an audit itself is not designed to target fraud necessarily, and there is an expectation from the public that it is.”

Now, there is an expectation not just from the public and investors that auditors will be looking for fraud, but from the new regulator. And the new regulator has been given sufficient enforcement powers to make auditors comply or be heavily fined.