Continuing his recent efforts at clarifying the views of the Office of the Chief Accountant (“OCA”) on various topics, in an October 11, 2022 statement Acting Chief Accountant Paul Munter emphasized the SEC’s focus on auditor responsibility for fraud detection. The October 2022 statement follows others issued in June 2022, December 2021, and October 2021, which discussed the role auditors serve and the manner in which auditors and audit firms engage with their clients. (See our prior posts here and here.) This latest statement expands on the use of the “fraud lens” and “professional skepticism” as an underpinning for auditors’ engagements with clients, which could foreshadow greater auditor scrutiny in the months ahead.
Emphasizing the significant losses investors suffer each year due to fraud, Mr. Munter cites Association of Certified Fraud Examiners’ estimates that organizations lose 5% of revenue to fraud each year. Given this magnitude of estimated fraud and consistent with the OCA’s focus on high quality financial reporting for the protection of investors, Mr. Munter underscores the importance of the auditors’ required “focus on the consideration of fraud in the audit.” Application of this “fraud lens” affords auditors “with a significant opportunity to support investor protection by helping to identify and address the precursors of financial reporting fraud so that more material misstatements due to fraud are detected by independent auditors.”
Mr. Munter then commented on “recently observed shortcomings,” which may have prompted the release of the statement. These included “not communicating fraud risks to audit committees” and other observations on the performance of audits, such as insufficient journal entry testing and revenue recognition as potential fraud risks. Mr. Munter also highlighted recent enforcement actions against audit firms and personnel for allegedly “ignoring red flags and contradictory information and failing to obtain sufficient audit evidence.”
Offering reminders for auditors, Mr. Munter highlighted PCAOB auditing standards on identifying and responding to fraud risk, which “include having a questioning mind when discussing the potential for material misstatements due to fraud among key engagement team members,” and how it “require[s] auditors to set aside any prior beliefs about management’s honesty and integrity.” Going further, Mr. Munter states that the “the mindset of ‘trust but verify’ may represent potential bias if it is anchored in the belief that management is honest and has integrity. Such a mindset may interfere with an auditor’s ability to effectively evaluate signs of fraud when evaluating misstatements or to objectively challenge evidence provided by management.” Taken together, Mr. Munter summarizes that “[a]uditors should avoid any assumptions of honesty, be mindful of potential unconscious biases, and apply the appropriate level of professional skepticism.”
What It Means For Public Companies
As auditors design and implement their third quarter review and year-end audit plans, they presumably will bear in mind Mr. Munter’s recent statements directed toward audit firms, including the October 2022 statement. For public company management teams, audit committees, and boards, the October 2022 statement would be worth considering as they navigate the busy close process. Mr. Munter’s latest reminder to focus on professional skepticism is likely best met with a focus on early, clear, and consistent communication with the audit firm. Advance planning and thoughtful organizational meetings will continue to be the hallmark for well-executed close processes and the OCA’s statements serve to underscore that approach.