Real Examples of Why Financial Statement Audits Cannot Detect All Fraud: Insights from an Expert Witness in Major Fraud Cases

Abstract

Auditors are expected by the public and to find all financial statement fraud, even though Generally Accepted Auditing Standards (GAAS) have long held that auditors may not be able to detect all frauds. In this article, we use examples from the experience of an expert witness in numerous major fraud cases where auditors were sued for not detecting fraud to illustrate situations in which auditors can, and cannot, reasonably be expected to detect fraud. We discuss factors that can make fraud nearly impossible to discover even when a competent GAAS audit is performed. We also discuss factors that were present when auditors should have detected fraud.

Keywords: Expectations gap, fraud examination, hindsight bias, financial statement fraud auditor negligence

JEL Classification: M49, K22