Fraud- What can the External Auditors do?
Updated: Jan 22
Internal, as well as external auditors, play an important role in uncovering fraud and taking preventive measures to minimize loss due to fraud. An auditor appointed under Section 139 of the Companies Act, 2013 has the responsibility to ensure the company complies with all the relevant laws and regulations and conducts its business fairly. Section 143 of the Act lays down that the auditor shall have access to the books of accounts and vouchers of the company. These are required to dispense the duties as an auditor efficiently as mentioned in the said section. The Act coupled with the rules made thereunder impose the duty on the auditor to report any fraud by or on the company and states the penalty for the failure to do so. However, despite having access to the books of accounts, sometimes the auditors cannot detect fraud. While auditors are required to exercise a reasonable duty of care, there is great controversy about the liability for an auditor’s inability to detect fraud.
REPORTING OF FRAUD
One of the most important provisions to ensure that the assets of the company are safeguarded is Sub-Section 12 of Section 148 of the Companies Act, 2013 which lays an obligation on the auditor who believes that a fraud is being or has been committed against the company to report about the fraud to the Central Government. In addition, the Companies (Audit and Auditors) Amendment Rules, 2015 under Rule 13 lay down that when a statutory auditor has a reason to believe that fraud against the company has been committed which involved individually an amount of one crore rupees or more, the auditor shall report to the Central Government. In case the fraud involves an amount less than rupees one crore, the auditor shall report the same to the Audit Committee as constituted under Section 177 of the Companies Act, 2013, or to the Board within 2 days of the knowledge of the fraud. The Companies (Auditor’s Report) Order 2020 states that the auditor’s report on accounts of the company as maintained under Section 143 of the Act should contain a statement on any fraud by or on the company and nature and amount involved.
Section 143(15) provides for the punishment for default. It states that when an auditor fails to report an offense of fraud as mentioned under Sub-section 12, he shall be punished with fine not less than 1 lakh rupees, which may extend up to 25 lakh rupees.
RESPONSIBILITY OF AUDITORS TO DETECT FRAUD
After the PMC Bank Scam, a lot of questions were raised on the role of auditors. The auditors in that case were found to be wanting in their responsibilities since they could not pick up grave violations committed by the bank. While the auditors were held responsible for default, they claimed that they could not pick up any violations in the guidelines or conditions issued by the RBI.
The primary duty to maintain annual accounts lie with the directors of the company. The duty of safeguarding the assets of the company is upon the management and the auditor relies on the internal controls of the management. The auditor does not conduct the audit with the objective of finding all frauds, because there is an assurance that all types of frauds, omissions, forgery, etc., would be discovered. An auditor, which auditing keeps in mind the possibility of the existence of fraud and the irregularities in the accounts of the company.
One of the reasons why an auditor is unable to detect the fraud is that the process of auditing and the rules thereunder determine whether the financial statements of the company are in place and are free of any material discrepancies. These processes are not aimed at detecting fraudulent activities or preventing the occurrence of fraud.
As per the Auditing and Assurance Standards (AAS), the primary responsibility of the detection of fraud lies with those in charge of the governance and management of the company. Owing to the inherent limitations of an audit, an auditor cannot obtain absolute assurance that material misstatements in the financial statement of the company would be detected, even though the audit is conducted as per the standards laid down in the country. The auditor’s ability to detect fraud depends on multiple factors, like forgery, skillfulness of the perpetrator, and the extent of manipulation. Therefore, imposing liability on an auditor for failure to detect fraud is not reasonable.
ABOUT THE AUTHOR
Arushi Gupta is a 5th-year BA LLB student at DES Law College, Pune University.
They can be contacted at firstname.lastname@example.org
LinkedIn ID: https://www.linkedin.com/in/arushi-gupta-534630192/
DISCLAIMER BY LEGAL ARMOR
We at Legal Armor do not endorse the Authors' views and are in no way responsible for the said views. We are just publishing the Write-ups as blogs with just light editing, and are in no way responsible for any legal claims. Legal Armor shall not be liable for any plagiarized content.