Audit errors: how to spot them and amend them?

Errors in audits are inevitable, but how these errors are handled can be critical to the integrity of the financial information and the reputation of the accountants involved. For accountants, this challenge carries significant weight — not only does it have the potential to undermine the trust placed in them by their clients, but it can also result in serious legal and regulatory consequences.

In the UK, accountants must navigate a complex landscape of regulatory frameworks, from the Financial Reporting Council (FRC) to HM Revenue and Customs (HMRC), ensuring compliance while also maintaining the highest ethical standards set by professional bodies like the Institute of Chartered Accountants in England and Wales (ICAEW). 

When errors occur, the path to resolution is not merely about correcting numbers on a page but it involves taking comprehensive steps to assess the degree of the error, communicating effectively with clients, addressing the underlying causes, and in some cases, making disclosures to regulatory authorities.

Audit errors can arise for various reasons: misunderstandings of financial reporting standards, weaknesses in internal controls, human error, or even deliberate misrepresentation. Regardless of the cause, once identified, the responsibility falls on the accountant’s shoulders to resolve the issue in a manner that ensures both accuracy and accountability. 

Acknowledge and assess the error

The first and most crucial step when an accountant discovers an audit error is to acknowledge its existence. Ignoring the error or hoping it goes unnoticed is not only unethical but can also lead to serious regulatory issues, reputational damage, and legal repercussions.

Accountants should evaluate the “materiality” of the error. According to UK auditing standards, including those set by the Financial Reporting Council (FRC), materiality refers to whether the error has the potential to influence the decisions of users of the financial statements. Errors could range from minor misstatements to significant inaccuracies that distort the true financial position of the client.

Some questions to consider could be:

– Does the error affect key financial metrics, such as profit, liquidity, or solvency?

– Could the error influence the decision-making of investors, creditors, or other stakeholders?

– Is the error due to fraud or a systemic problem in internal controls?

Communicate with the client

Once the error has been identified and assessed, the next step is to communicate the findings with the client. 

Transparency is critical at this stage, and  accountants have an ethical obligation under the International Ethics Standards Board for Accountants (IESBA) code to act with integrity and professionalism.

When communicating with clients about an audit error, accountants should prioritise several best practices to maintain trust and professionalism. 

First and foremost, timely notification is essential. The accountant should inform the client as soon as the error is discovered, avoiding unnecessary delays that could worsen the consequences or lead to further complications. 

It is also crucial to provide clarity and detail in the explanation. The error should be clearly outlined, along with its potential implications and the proposed steps for correction, ensuring the client fully understands the issue. 

Finally, engaging the client in a dialogue about the error and working together on corrective actions helps preserve the relationship and ensures that the situation is resolved in a way that builds, rather than diminishes, mutual trust.

Correct the error

Once the error has been discussed and understood, the next priority is to correct it. Depending on the nature of the error, there are several ways to approach this:

1. Adjust the financial statements: For errors that affect the current financial period, an immediate adjustment to the financial statements is often the most appropriate action. This should be done in consultation with the client and any relevant internal stakeholders.
2. Restate prior financial statements: If the error relates to prior periods and is deemed material, it may be necessary to restate the previous financial statements. This is more complex, as it requires reissuing corrected versions of the statements and may involve communicating the restatement to shareholders, investors, and regulatory authorities.
3. File amended tax returns (if applicable): In cases where audit errors have tax implications, such as incorrect calculations of taxable income, it may be necessary to file an amended tax return with HMRC. This should be done promptly to avoid penalties and interest for underpaid taxes.
4. Strengthen internal controls: Often, audit errors are a symptom of weaknesses in the client’s internal control systems. As part of the correction process, accountants should recommend improvements to prevent future errors. This could involve changes to accounting processes, additional training for staff, or implementing better accounting software.

Document the error and correction

Accountants must ensure they fully document both the error and the actions taken to correct it. This documentation serves to provide a clear audit trail for any future reviews or investigations, as well as demonstrating compliance with UK auditing standards, especially in case of future audits by regulators like the FRC or HMRC.

The documentation should include a description of the error and how it was discovered, the impact of the error on the financial statements, the process of correcting the error, recommendations for improving internal controls, and communication records with the client regarding the issue.

Inform the relevant authorities

It’s important to remember that in the UK, auditors have a statutory duty to report certain errors, particularly those involving fraud, to the relevant authorities. 

This could include:

– HMRC: For tax-related errors, particularly those that involve incorrect tax filings or underpaid taxes.

– The Financial Conduct Authority (FCA): For public companies where material errors affect financial reporting.

– The Serious Fraud Office (SFO): If the error involves fraud or criminal misconduct.

Failure to notify the relevant authorities when required could lead to penalties, fines, or sanctions from regulatory bodies.

Preventing audit errors requires a combination of proactive and reactive strategies, aimed at both reducing the likelihood of mistakes and addressing them before they escalate. 

One crucial step is to encourage clients to strengthen their internal controls. This includes implementing measures such as segregating duties, conducting regular reconciliations, and maintaining comprehensive documentation procedures, all of which help to catch errors before they develop into larger issues. 

Additionally, ongoing training is vital for both accountants and their clients. Keeping up-to-date with the latest changes in UK accounting and tax laws, as well as staying informed about evolving financial reporting standards, ensures that all parties are well-equipped to prevent misinterpretations and mistakes. 

Finally, emphasising ethics and professionalism is key. Accountants should always adhere to the highest standards of integrity, following guidelines set by the International Ethics Standards Board for Accountants (IESBA) and the UK’s professional accounting bodies. By fostering a culture rooted in ethical responsibility and professionalism, accountants can help prevent errors from being overlooked or intentionally concealed, ensuring transparency and trust in financial reporting.