On 20 October 2020 the Financial Reporting Council (FRC) launched a consultation on proposed revisions to the UK auditing standard ISA (UK) 240 – The Auditor's responsibilities Relating to Fraud in an Audit of Financial Statements (the Consultation). The proposed changes aim to address concerns that auditors are not doing enough work to detect fraud.

The standard

The ISA (UK) 240 was adopted in the UK in 2004 and is based on the standards issued by the International Auditing and Assurance Standards Board. It is designed to assist auditors in applying standards in relation to the risks of material misstatement due to fraud. Since its adoption 16 years ago, the standard has only received minor amendments.

Effectiveness of audits

Concerns around the inadequacy of audits in identifying fraud was brought into sharp focus following a number of high-profile insolvencies. Insolvency practitioners who are appointed when a company collapses have a duty to investigate the reason for the company's failure. As part of their investigations they often uncover financial irregularities and fraud.

One recent example is the collapse of Patisserie Valerie (PV) where the auditors failed to identify a £94 million shortfall in the accounts. The discrepancy had the effect of significantly overstating the assets and understating the company's liabilities. The Serious Fraud Office subsequently launched a criminal investigation into PV, its officers and its accounting practices and made several arrests. The auditors later admitted they were not looking for fraud.

The Brydon Review (2019) (the Review) looked into the equality and effectiveness of audits. The Review reported last year (the Brydon Report) and made a number of recommendations relating to fraud detection and prevention, including clarifying that an auditor should endeavour "to detect material fraud in all reasonable ways" and that directors "should report on the actions they have taken to fulfil their obligations to prevent and detect material fraud against the background of their fraud risk assessment".

Proposed revisions

The FRC's proposed revisions to ISA (UK) 240 are designed to address some of the issues raised in the Brydon Report, although they do not go as far as many of its recommendations. The Consultation states that changes are designed to increase clarity of auditors' obligations around fraud; enhance the requirements for the identification and assessment of the risks of material misstatement due to fraud and the procedures to respond to those risks. The revisions include:

Clarification that the auditor should obtain reasonable assurance about whether the financial statements are free from material misstatement due to fraud;

An amendment emphasising that the auditor must remain alert for conditions that indicate that a record or document may not be authentic;

A new requirement for the auditor to make enquiries of persons responsible for dealing with allegations of fraud raised by employees or other parties; and

New text emphasising that the auditors' report shall explain to what extent the audit was capable of detecting irregularities including fraud.

The Consultation runs until 29 January 2021. The FRC intends to implement these changes for audits beginning on or after 15 December 2021, with early adoption permitted.

Enforcement action

As economic conditions worsen for many sectors and industries, there is an increased risk of fraudulent accounting practices being used in the hope of avoiding widespread redundancies or insolvency. It is often when a company is in administration however that these accounting irregularities come to light.

Where there is misconduct or a breach of the relevant standards by auditors, accountants, accountancy firms or actuaries, whatever their role, whether in auditing, restructuring or administering a company in insolvency, the FRC may bring enforcement action against them.

FRC investigations can lead to significant fines against individuals and firms, as well as untold reputational damage and the imposition of other non-financial sanctions. Individuals and firms should therefore seek expert assistance as soon as there is any evidence of wrongful accounting and not wait for the FRC to open an investigation into them.