The risk of administrative fraud threatens financial statements, and the auditing body warns

The Saudi Organization for Certified Public Accountants (SOCPA) issued a significant warning regarding one of the most serious challenges to the integrity of financial reporting: the risk of fraud resulting from management's circumvention of internal controls. The organization emphasized that this risk is a mandatory consideration for auditors under International Standard on Auditing (ISA) 240, stressing that its pervasive nature and potential impact on financial statements as a whole cannot be assumed to be nonexistent.

Historical context and importance of financial oversight

These warnings come amidst ongoing global and local efforts to enhance governance and transparency in the business sector. Global economic history is replete with stories of major financial collapses of giant corporations like Enron and WorldCom, where the common thread was the manipulation of financial data by senior management through exceeding their authority and circumventing regulatory controls. These incidents resulted in billions of dollars in losses for investors and undermined confidence in financial markets, prompting regulators worldwide to tighten auditing standards. In the Kingdom, the Saudi Organization for Certified Public Accountants (SOCPA) plays a pivotal role in regulating the accounting and auditing profession to ensure adherence to international best practices, thus serving the goals of Saudi Vision 2030 in building a prosperous economy and an attractive and reliable investment environment.

Nature of the danger and its expected impact

The Authority explained in its “Guide to Effective Risk Assessment” that misstatements in financial statements may arise from unintentional error or deliberate fraud, and the fundamental difference between the two lies in “intent.” The position of senior management and their ability to manipulate accounting records or circumvent control procedures designed to prevent fraud provide a unique opportunity to commit fraud that is difficult to detect. The Authority noted that this risk is not limited to a specific area but can extend to various categories of transactions, account balances, and disclosures, making it a comprehensive risk that requires specialized professional handling.

Professional skepticism: the auditor's first line of defense

To address this challenge, the Authority emphasized the need for auditors to maintain “professional skepticism” throughout the audit process. This means not accepting the accuracy of records unconditionally, but rather adopting a questioning mindset and critically evaluating audit evidence. Auditors must consider the possibility of deliberate management misconduct to conceal facts when planning and executing audit procedures. Procedures for detecting unintentional errors may not be sufficient to uncover sophisticatedly planned fraud. This emphasis aims to enhance audit quality and protect the interests of investors and stakeholders who rely on audited financial statements to make their decisions.

It is worth mentioning that the Saudi Organization for Auditors and Accountants recently launched the “Accounting Disclosures” initiative with the aim of enhancing professional awareness of the contents of standards and practices related to audit quality, and highlighting the highly sensitive aspects of financial statements, which contributes to raising the efficiency of auditors and consolidating confidence in financial reports issued in the Saudi market.