External Auditor - Detection of Fraud

Detection of Fraud

If an external auditor detects fraud, it is his responsibility to bring it to the management's attention and consider withdrawing from the engagement if management does not take appropriate actions. Normally, external auditors review the entity's information technology control procedures when assessing its overall internal controls. They must also investigate any material issues raised by inquiries from professional or regulatory authorities, such as the local taxing authority.

External Audiors' Liability to Third Parties

Auditors may be liable to 3rd parties who are damaged by making decisions based on information in audited reports. This risk of auditors' liability to third parties is limited by the doctrine of privity. An investor or creditor, for instance, can not generally sue an auditor for giving a favorable opinion, even if that opinion was knowingly given in error.

The extent of liability to 3rd parties is established (in general) by 3 accepted standards: Ultramares, restatement, and forseeability.

Under the Ultramares doctrine, auditors are only liable to 3rd parties who are specifically named. The Restatement Standard opens up their liability to named "classes" of individuals. The foreseeability standard puts accountants at the most risk of liability, by allowing anyone who might be reasonably foreseen to rely on an auditor's reports to sue for damages sustained by relying on material information.

While the ultramares doctrine is the majority rule, (to the relief of many new and budding accountants pursuing an auditing career!) the restatement standard is preferred in several states and is growing in popularity. The foreseeability standard will not likely be widely adopted anytime soon because the cost (time and financial) of litigation would be enormous.

CFOs, company accountants, and other employees are NOT afforded the same luxuries of the doctrine of privity. Their material actions and statements open them (and their companies) up to liability from third parties damaged by relying on these statements.

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Famous quotes containing the word fraud:

    Things gained through unjust fraud are never secure.
    Sophocles (497–406/5 B.C.)