Audit claims alleging failure to detect theft and fraud are not new.  However, their frequency and severity are increasing dramatically.  Between 2008 and 2010, the percentage of audit claims alleging failure to detect theft and fraud more than doubled, from 30 percent to nearly two-thirds of all audit claims.  Equally alarming, many claims arising from tax, bookkeeping, compilation and review engagements now include similar allegations.  By 2010, among all claims alleging failure to detect theft and fraud, 24 percent emanated from tax services, 17 percent from compilation and review services, 11 percent from accounting and other services, and 4 percent from investment advisory services. The remaining claims involved audits.¹

Fraud and theft can exist in many forms such as Ponzi schemes intended for personal enrichment or to cover up mismanagement.  The integrity, or “tone at the top” demonstrated by senior management within a company can serve as an indicator of the likelihood that management would commit fraudulent financial reporting and also an indicator of heightened risk of theft or fraud by employees.  Incentives to engage in theft and fraud are heightened during an economic downturn. Employees may feel pressured to engage in fraud to mask substandard financial results, or engage in theft due to personal financial struggles. Employees who believe their jobs will be eliminated or that the business will fail may also be motivated to engage in theft schemes.   

Fraud schemes are more likely to be present in entities lacking a robust internal-control environment, such as a lack of segregation of duties.  Poor segregation of duties within processes (i.e., accounts payable, accounts receivables, cash, payroll processing, etc.) provides opportunities for employees to perpetrate fraud.  A lack of segregation of duties also may arise when a company has an insufficient number of employees.  For example, the opportunity to steal cash and conceal the theft increases if a company does not have separate employees handling cash receipts, preparing deposits and performing bank account reconciliations. Similarly, poor controls over inventory, including company equipment, may be circumvented by employees, leading to possible abuses.

While auditors are well aware of their responsibilities with respect to consideration of fraud and illegal acts in connection with an audit engagement, professional liability claims alleging failure to detect theft or fraud can arise in any type of engagement. It is critical to consider how to best manage the related risks and to exercise professional skepticism in all types of engagements. 

AICPA Professional Liability Program policyholders can click here to access the full version of the article providing an illustration of common scenarios leading to allegations against CPAs and key risk control techniques to adopt in order to reduce risk of facing similar allegations.

November 2011

By Accountants Professional Liability Risk Control, CNA, 333 South Wabash Avenue, 39S, Chicago, IL 60604.

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1 AICPA Professional Liability Insurance Program