Relying on accountants alone to detect fraud is a risky proposition.
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By Phil Villegas
Several years ago, there was a great cartoon I came across from Leo Cullum. At the time it truly resonated with me since I was working with a CPA firm and could clearly see firsthand the differences between “accounting” and “accountability”.
While most CPAs, will go to great lengths to tell their clients a reviewed or audited financial statement is not designed to uncover fraud, most dealers will simply hear the word “audit” and will get a false sense of security that all of their transactions are being analyzed.
For a CPA to provide an opinion on a financial statement, they need to ensure that it’s not materially misstated. The term “materiality” is a cornerstone of most engagements. Materiality is the maximum amount by which auditors believe a statement could be misstated, by known or unknown error or fraud, and still not affect the decisions of reasonable financial statement users. For the average dealer, this “materiality” threshold may be in the hundreds of thousands of dollars, meaning that questionable balances or transactions in the tens of thousands of dollars falling below this materiality threshold can go without scrutiny.
Just last month, a U.S. District Judge ruled that a N.Y. dealership group can pursue a malpractice suit against its former accountants for failing to notice that key accounting employees were embezzling millions of dollars over several years. It’s likely in the legal battle to come, the term “Materiality” will be front and center in the accountants’ defense, along with engagement letters that spelled out the limitations and intent of their services. These accountants will likely attempt to demonstrate the dealer’s financial statements were not materially misstated and that the scope of their engagement was not to detect fraud.
Dealers who are truly concerned with fraud should not be expecting their accountants to detect it because there is a very distinct difference between “accounting and accountability”.