February 2003

SECPS Member Perceptions of the Exposure Draft on Fraud: The ASB Is on the Right Track, but Will It Make a Difference?

By Linda B. Specht and Petrea K. Sandlin

In 1988, Statement on Auditing Standards (SAS) 53 defined the auditor’s responsibilities for detection of errors and irregularities in a financial statement audit. A successor statement, SAS 82, was released in 1997 to clarify the auditor’s responsibilities regarding client fraud. Despite these efforts, the auditing profession came under increased scrutiny. In 1998, the Public Oversight Board (POB) established the Panel on Audit Effectiveness in re-sponse to SEC concerns regarding the effectiveness of financial statement audits of publicly held companies.

Approximately two years after its appointment, the Panel on Audit Effectiveness reported that financial statement audits were fundamentally sound, but made a number of recommendations. Last year, as a part of its response to the panel’s recommendations, the Auditing Standards Board (ASB) issued an exposure draft, “Consideration of Fraud in a Financial Statement Audit,” intended to supersede SAS 82. The collapse of Enron and the ensuing flood of corporate disclosures regarding accounting improprieties last year led to preliminary SEC recommendations for oversight of the profession. The POB voted to terminate its activities in January 2002 in protest over these recommendations, but the ASB followed its customary procedures for soliciting commentary on the exposure draft, which was recently adopted as SAS 99. Successful implementation of the proposed statement (one that goes beyond mere compliance with documentation requirements) will depend upon CPAs’ perception of the appropriateness of the changes from the guidance offered by SAS 82.

Views of SECPS Members

To learn how SECPS (The AICPA SEC Practice Section) members perceived the changes in the proposed statement, a survey questionnaire was sent to randomly selected members of the SECPS in April 2002. Respondents were asked about their perceptions of the appropriateness of the proposed changes in guidance, and the potential effects of the adoption of the proposed statement on audit planning and performance, public confidence, and regulation.

Appropriateness of proposed changes in guidance. Exhibit 1 illustrates the extent to which respondents agree with the proposed changes in guidance offered by the proposed statement. The aggregated results indicate a general agreement with the ASB’s efforts. More than 80% of the respondents were supportive of the majority of the changes made by the proposed statement. Notable exceptions to this general agreement were the respondents’ relatively negative views regarding two proposed changes:

Although no obvious reason exists for the more negative perceptions of fraud risk assessment and documentation of the auditor’s consideration of fraud, one respondent commented that it was not possible to “audit for specific risks of fraud,” while another respondent expressed the belief that “documentation of these types of issues only serves to aid a plaintiff’s attorney in litigation.” If such sentiments are widely held, it might explain the anomaly with respect to these two areas.

Effect of the adoption of the proposed statement. Despite the general agreement over the appropriateness of the proposed changes, Exhibit 2 indicates significant disagreement about the perceived effects of adoption of the proposed statement. A strong majority (76%) of the respondents agreed that the proposed statement was an appropriate response to the Report and Recommendation of the Panel on Audit Effectiveness. Approximately two-thirds of respondents also believed that adoption of the statement would “result in an increased focus on professional skepticism in the consideration of the risk of fraud in a financial statement audit.” Nonetheless, only half of the respondents believed that it would improve either “audit planning and performance” or “the quality of communications with clients.” Furthermore, three-quarters of the respondents were doubtful that adoption of the proposed statement “would result in a substantial change in the auditor’s performance, and thereby improve the likelihood that auditors would detect material misstatements due to fraud in a financial statement audit.” Respondents were equally pessimistic that adoption would promote Congressional and public confidence in the auditing profession or reduce the likelihood of federal regulation of the auditing profession.

Even though the survey was conducted in April 2002, before the post-Enron flurry of corporate financial restatements, SECPS members were not convinced that adopting the proposed statement would enhance their abilities to detect fraud or promote public confidence in the profession. Although respondents seemed to believe that the proposed statement is an appropriate response to public and regulatory concerns and that auditors would approach the consideration of the risk of fraud in a financial statement audit with increased professional skepticism, they were evenly divided on whether this will translate into improved audit planning and performance. They clearly do not believe that it will make any real difference in their ability to detect material misstatements due to fraud, to communicate with clients, or to reassure the public about the integrity of the financial statement audit.

Awareness and Familiarity

The survey’s four demographic questions sought to measure respondents’ familiarity with the panel’s report and with the proposed statement, as well as their experience with legal and regulatory proceedings. Their responses are summarized in Exhibit 3.

Nearly two-thirds of respondents had read both the panel’s report (66%) and the proposed statement (64%). A brief summary of the proposed statement with cross-references to the exposure draft was also included with the survey instrument. The results of a statistical analysis suggest that familiarity with the panel’s report and the proposed statement tended to positively influence the respondents’ perceptions of the appropriateness of the proposed statement (i.e., respondents who had read them were more inclined to believe the ASB to be on the right track with the proposed changes).

Survey participants were also asked whether they or their firms had responded to the ASB’s call for comments on the exposure draft of the proposed statement. Because the majority (90%) of respondents did not provide comments to the ASB, the survey results represent perceptual information not available from the comments on the exposure draft.

The final demographic question asked respondents whether their firms had “been subject to the filing of a lawsuit or a regulatory or disciplinary proceeding within the past five years as the result of a financial statement audit.” The fact that most respondents (90%) had not personally borne the brunt of regulatory or legal scrutiny as a result of their financial statement audits suggests this type of negative experience did not significantly influence their opinions about the potential effects of adoption of the proposed statement.

Reserved Optimism

Survey respondents evidently thought that the proposed statement contained changes that need to be made in auditing guidance, and that it was an appropriate response to public concerns regarding the auditor’s role in fraud detection and prevention. They are more pessimistic, however, about the likelihood that adoption of the proposed statement will enhance auditors’ ability to detect fraud, improve communication with clients, promote public and congressional confidence in the auditing profession, or reduce the likelihood of federal regulation.

These findings suggest that auditors remain very much aware of the difficulty of planning and performing an audit that will detect material misstatements due to fraud and cover-up at the highest levels. They also indicate that, at the end of April 2002, auditors were still very much aware of the “expectation gap” that SAS 53 and its successors were intended to remedy. When the ASB issued those standards, as now, the expectation gap was manifested by a crisis of public confidence, calls for federal regulation, and lawsuits against auditors (following the savings-and-loan debacle). After Enron, WorldCom, and a flurry of financial restatements, the expectation gap has not narrowed, but has widened into a chasm that any standard issued by the ASB, regardless of its inherent merit, is unlikely to narrow.

This leaves the auditing profession with a confidence in its standards setters that is not shared by the general public, which sees little reason to put its faith in the ASB, an entity dominated by its once-trusted business advisors. The auditing profession must be re-sponsive to the current ethical and legal climate in order to serve the public interest and to regain the public’s trust. The new fraud standard is one step in that direction, but as one respondent commented, “In reality, the new standard would have had little impact on [Andersen]’s actions and Enron’s collapse.” Neither SAS 99 nor any other standard will alone serve to restore the public’s confidence in the financial statement auditor.

The majority of CPAs have followed the existing pronouncements (including SAS 82) and have served their clients with both expertise and integrity. They must continue to do so as they await the outcome of the current calls for reform. In the meantime, the ASB must move ahead with the assurance that the majority of its constituents believe that it is on the right track and the hope that reform in the area of corporate governance will make the conscientious auditor’s job easier. As one respondent put it, “Fraud results from ineffective management or unethical management … we are not underwriters, we are not insurers, and should not be scapegoats.” One might add, neither should we be collaborators.

Linda B. Specht, JD, CPA, and Petrea K. Sandlin, PhD, CPA, are associate professors at Trinity University, San Antonio, Texas.

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