T H E D E T E C T I O N O F F R A U D A S A N A U D I T O B J E C T I V E During the nineteenth century and the early part of the twentieth centuryfraud detection was seen as an important

part of the audit. Although the J o i n t - S t o c k C o m p a n i e s A c t s r e m a i n e d s i l e n t o n t h e s u b j e c t o f f r a u d , t h e Punishment of Frauds Act 1857 strengthened the law against fraud, making itan offence for a director or ofcer of a company to alter falsely a company'sa c c o u n t i n g r e c o r d s i n o r d e r t o d e f r a u d a c r e d i t o r o r s h a r e h o l d e r . T h e judgement in Nichol's Case (1859) stated that it was part of an auditor's dutyto discover fraudulent misrepresentations. Thus, the detection of fraud wasl a i d d o w n a s b e i n g one of the top priorities of an audit and generallyremained so well into the 1920s (Lee, 1986). T h e V i c t o r i a n v i e w o n t h e detection of fraud can be seen from a contemporary comment: `The object of an audit is a two fold one, the detection of fraud where it has been committed,and its prevention by imposing such safeguards, and devising such means aswill make it extremely difcult of accomplishment, even if the inclination is inthat direction' (Bourne, 1887: 330).The decline in the importance of fraud as an audit objective started towardst h e e n d of the nineteenth century. This is reected in the judgement in the Kingston Cotton Mill Case (1896). Auditors did not have to approach their workw i t h t h e f o r e g o n e c o n c l u s i o n t h a t s o m e t h i n g w a s w r o n g , h o w e v e r , o n c e something untoward was discovered, the auditor should investigate it toensure that the error or defalcation was not so material as to affect the v i e w given by the accounts. This case gave rise to the famous saying, `an auditor is awatchdog but not a bloodhound'. In Irish Woollen Co. Ltd. v Tyson and Others (1900), it was held that an auditor is liable for any damages sustained b y a company by reason of falsication which might have been discovered by theexercise of reasonable care and skill in the performance of the audit. So, insteadof having to detect all frauds, it was becoming clear that it was the auditors'duty to exercise reasonable care and skill in the conduct of their work. T H E C O N C E P T U A L B A S I S O F A U D I T I N G The AAA's Committee on Basic Auditing Concepts (1973: 911) i d e n t i e d four conditions which it considered created the demand for an independentaudit of accounting data. These can be summarized as follows:1 The potential or actual conict of interest . T h i s c o n i c t m a y e x i s t b e t w e e n the user of the information and the preparer.2 Consequence

. The user may require the information for decision-makingpurposes; t h e r e f o r e , t h e u s e r n e e d s t o b e c o n d e n t o f t h e q u a l i t y o f t h e accounting information. 93 D E V E L O P M E N T S I N A U D I T I N G A N D A S S U R A N C E 3 Complexity . Th e p r o c e s s e s o f p r o d u c i n g t h e a c c o u n t i n g i n f o r m a t i o n a r e s o complex that the user has to rely on someone else to e x a m i n e i t s quality.4 Remoteness . Even if the user had the ability to reach a conclusion on thequality o f t h e a c c o u n t i n g i n f o r m a t i o n , i t i s u n l i k e l y t h a t t h e u s e r w o u l d have access.This committee considered that `[t]hese four conditions (conict of interest,consequence, complexity, and remoteness) interact in such a way that as theyi n c r e a s e i n t h e i r i n t e n s i t y t h e y m a k e i t b o t h i n c r e a s i n g l y i m p o r t a n t t h a t a n informed, independent conclusion be reached by the user as to the quality of the accounting information being received and increasingly difcult for theuser of the information to reach such a determination without outside assist-ance' (AAA, 1973: 10).In 1993, Pratt and Van Peursem considered that `[a]uditing has developedi n a v e r y p r a c t i c a l w a y o v e r t h e l a s t 3 , 0 0 0 y e a r s , b u t i t i s o n l y i n t h e l a s t 3 0 years that much consideration has been given to the discipline's underlyingt h e o r e t i c a l foundations'. This could be seen to have started in 1961 w i t h Mautz and Sharaf's attempt to formulate a theory of auditing. They intendedt o t r y t o b r i n g t o g e t h e r ` t h e b i t s o f t h e o r y n o w i n t h e l i t e r a t u r e ' ( p . 4 ) , t h e objective being that such a framework would ensure that problems facing theauditor would be dealt with in a rational and consistent manner. Altogether,eight tentative postulates of auditing were formulated by Mautz and Sharaf: 1 F i n a n c i a l s t a t e m e n t s a n d n a n c i a l d a t a a r e v e r i a b l e . 2 Th e r e i s n o n e c e s s a r y c o n i c t o f i n t e r e s t b e t w e e n t h e a u d i t o r a n d the management of the enterprise under audit.3 T h e n a n c i a l s t a t e m e n t s a n d o t h e r i n f o r m a t i o n s u b m i t t e d f o r verication are free from collusive and other unusual irregularities.4 The existence of a satisfactory system of internal c o n t r o l eliminates the probability of irregularities.5 Consistent application of generally accepted principles of account-i n g r e s u l t s i n t h e f a i r p r e s e n t a t i o n o f n a n c i a l p o s i t i o n a n d t h e results of operations.6 I n t h e a b s e n c e o f c l e a r e v i d e n c e t o t h e c o n t r a r y , w h a t h a s h e l d true in the past for the enterprise under examination will hold true in the future.7 W h e n e x a m i n i n g n a n c i a l d a t a f o r t h e p u r p o s e o f e x p r e s s i n g a n independent opinion thereon, the auditor acts exclusively in the capacity of an auditor.8 T h e p r o f e s s i o n a l s t a t u s o f

t h e i n d e p e n d e n t a u d i t o r i m p o s e s c o m - mensurate professional obligations. (Mautz and Sharaf, 1961: 42) 94 C O R P O R A T E F I N A N C I A L R E P O R T I N G Lee (1972) developed Mautz and Sharaf's work by categorizing a u d i t i n g postulates into three divisions, to form `justifying', `behavioural' and `functional' postulates. Sherer and Kent (1983: 19) described this categorization as` a r a t i o n a l a n d c o m p r e h e n s i v e b a s i s u p o n w h i c h t o b a s e a n e x a m i n a t i o n o f auditing theory'. The justifying postulates set out the reasons for the existenceof the external audit function. Gwilliam (1987: 45) describes these justifyingpostulates as `the most signicant extension of the postulate approach'. Thiswas because Mautz and Sharaf were more concerned with whether an auditwas in fact feasible, and not with whether it was necessary.Lee's justifying postulates (1972: 536) can be summarized as follows:1 W i t h o u t a f o r m a l a u d i t , t h e a c c o u n t i n g i n f o r m a t i o n contained in a com-pany's nancial statements lacks credibility to be u s e d c o n d e n t l y b y external users.2 T h e m o s t i m p o r t a n t r e q u i r e m e n t o f t h e e x t e r n a l a u d i t i s t o i n c r e a s e t h e credibility of the nancial statements.3 Th e b e s t w a y t o e n h a n c e t h e c r e d i b i l i t y o f t h e n a n c i a l s t a t e m e n t s i s b y means of the external audit.4 I t i s a s s u m e d t h a t t h e c r e d i b i l i t y o f t h e n a n c i a l s t a t e m e n t s c a n b e established by the external audit process.5 Users of the nancial statements are not able to satisfy themselves as to thecredibility of the accounting information in the nancial statements.The behavioural postulates support the assumption that the external auditorcan enhance the credibility of the nancial statements. Therefore, the assump-t i o n s ( L e e , 1 9 7 2 : 5 6 6 0 ) a r e t h a t : 1 The audit is not impeded by unnecessary conicts of interest between theexternal auditor and company management.2 The work of the external auditor is not impeded by any unreasonable legalrestrictions.3 Th e a u d i t o r i s i n d ep e n d e n t b o t h m e n t a l l y and physically.4 T h e a u d i t o r h a s s u f c i e n t s k i l l a n d e x p e r i e n c e t o c a r r y o u t t h e d u t i e s required.5 T h e a u d i t o r i s a c c o u n t a b l e f o r t h e q u a l i t y o f t h e w o r k p e r f o r m e d a n d t h e opinion expressed thereon.T h e functional postulates relate to the actual work performed by t h e auditor (Lee, 1972: 603):1 I t i s a s s u m e d t h a t t h e r e i s s u f c i e n t r e l i a b l e e v i d e n c e a v a i l a b l e t o e n a b l e the external auditor to carry out an audit within a reasonable time and at areasonable cost. 95 D E V E L O P M E N T S I N A U D I T I N G A N D A S S U R A N C E 2 The accounting information in the nancial statements, largely due to theexistence of internal controls, is free of major fraud and error.3 Th e r e exists generally accepted and recognized accounting concepts a n d bases which, when used consistently, result in a true and fair presentationof the accounting information in the nancial statements.F l i n t

(1988: 9) considered there was `a place for theory to explain t h e responsibility of the audit function and the basis of its evolution, and to assistin resolving the unanswered questions which have been posed not a theory built up on a piecemeal basis from a series of solutions to particular questions, b u t a set of comprehensive propositions making up an overall theory fromw h i c h t h e s o l u t i o n s t o a l l t h e s e q u e s t i o n s c a n b e d e r i v e d ' . Flint's basicpostulates view the audit in its wider setting and c a n b e s u m m a r i z e d a s follows:1 A r e l a t i o n s h i p o f a c c o u n t a b i l i t y e x i s t s . 2 An audit is required because the subject matter is too remote, too complexor too important.3 The distinguishing characteristics of audit are independence, and freedomfrom investigatory and reporting constraints.4 T h e subject matter for audit `is susceptible to verication by e v i d e n c e ' ( p . 3 1 ) . 5 The standards for accountability can be set and actual performance can bec o m p a r e d b y k n o w n c r i t e r i a ` t h e p r o c e s s o f m e a s u r e m e n t a n d c o m - parison requires special skill and the exercise of judgement' (p.32).6 `The meaning, signicance and intention of nancial and other statementsand data which are audited are sufciently clear that the credibility whichi s g i v e n t h e r e t o a s a r e s u l t o f a u d i t c a n b e c l e a r l y e x p r e s s e d a n d c o m - municated' (p. 38).7 ` A n a u d i t p r o d u c e s a n e c o n o m i c o r s o c i a l b e n e t ' ( p . 3 9 ) . F l i n t ( 1 9 8 8 ) v i e w e d a u d i t a s ` a s o c i a l c o n t r o l m e c h a n i s m f o r s e c u r i n g accountability': `The onus is on auditors and audit policy-makers constantlyto seek to nd out what is the societal need and expectation for independenta u d i t a n d t o e n d e a v o u r t o f u l l t h a t n e e d w i t h i n t h e l i m i t s o f p r a c t i c a l a n d economic constraints, remembering at all times that the function is a dynamic,n o t a s t a t i c o n e' (p. 17).Although the Companies Acts set out the responsibilities of t h e a u d i t o r , they do not specify, in any great detail, how they are to be accomplished. Therst UK auditing pronouncement ( General Principles of Auditing ) was issued in1 9 6 1 . T h i s w a s t h e r s t o f t h e Statements of Auditing , which were replaced b y t h e Auditing Standards and Guidelines during the 1980s. Following the 96 C O R P O R A T E F I N A N C I A L R E P O R T I N G