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  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

    Understanding that auditors allocate greater resources to fraud brainstorming when engagement risk is significant fosters brainstorming of a superior caliber corresponds to stronger regulatory compliance.  Auditors report that engagement teams are holding fraud brainstorming sessions earlier in the audit, document more detailed risk assessments, plan more specific procedures, and retain more documentation.  These characteristics contribute to adequately addressing increased PCAOB regulatory scrutiny.  Additionally, brainstorming sessions are highly regarded when they occur in a face-to-face fashion and are attended by multiple levels of firm personnel—whether that is “core” or “non-core” professionals.  Fraud brainstorming sessions are executed less mechanically (as determined by PCAOB inspectors) by using fewer checklists and increase the amount of time auditors prepare for brainstorming sessions.  

    Citation:

    Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472. 

    Keywords:
    audit planning; engagement risk; field survey; fraud brainstorming; professional skepticism
    Purpose of the Study:

    The purpose of this study is to further understand current fraud brainstorming practices minding regulatory climate and its impression of brainstorming practices.  The authors seek to understand the auditing profession’s existing framework to effectively brainstorm by evaluating audit team characteristics; attendance and communication; structure, timing, effort; and brainstorming quality.  Fraud brainstorming environment is considered with respect to client characteristics; particularly, inherent, fraud, and engagement risks, and if the client is publicly traded or privately held.  The authors refer to the characteristics as “partitions”.  The partitions allow the study to better examine how each characteristic effects the deployment of resources in response to risk levels and trading status. 

                The study poses further exploration into the implementation of Statement of Auditing Standards No. 99 and its effect on fraud brainstorming practices.  Particularly addressing the Public Company Accounting Oversight Board’s report suggesting auditing professionals were “mechanically” addressing fraud-related auditing standards.  SAS 99 sought to blend experienced audit professionals—those with greater client experience—with less-seasoned auditors to brainstorm how a fraud could occur specific to the client.  As part of the brainstorming framework, the study seeks to understand if senior-level auditors (partners and managers) and seniors and staff members, along with “non-core” professionals, cultivate meaningful brainstorming sessions. 

    Design/Method/ Approach:

    The authors collected field data from audits conducted between March 2013 and January 2014, per a survey of 77 audit engagements.  Information pertaining to the client, audit team, and brainstorming sessions were called upon in the survey.  The majority (93 percent) of observations were obtained by two Big 4 firms—7 percent from one non-Big 4 global firm.  Each engagement’s partner received instructions for the distribution of the survey to lead managers and lead seniors on the respective engagement while the partner withheld that the survey was for research purposes.  A total of 75 managers and 73 seniors participated.  

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • Jennifer M Mueller-Phillips
    A Review and Model of Auditor Judgments in Fraud-Related...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.02 Fraud Risk Models 
    Title:
    A Review and Model of Auditor Judgments in Fraud-Related Planning Tasks
    Practical Implications:

    The primary implication of the model based on the literature is that simply because auditors may assess fraud risk at a higher level due to the presence of risk factors, it does not necessarily mean that planned audit procedures designed to address these risks will be effective.  Although being aware of fraud risk is necessary to respond appropriately, being aware of only general risk factors makes it difficult for auditors to formulate possible fraud schemes that a client may perpetrate.  As a result, audit plans designed to respond to general fraud risks tend to increase the extent of testing, but do not alter the nature of the testing in a way that would be more likely to catch fraud.  If auditors identify specific situational cues and are able to generate a plausible fraud scheme as a result, more effective tests that alter the nature of the procedures can be identified and carried out.  Therefore, knowledge of fraud risks via experience or training, particularly for risks specific to a client or industry, will help to allow generation of plausible fraud schemes and the design of effective tests.

    For more information on this study, please contact Jacqueline Hammersley.
     

    Citation:

    Hammersley, J. S. 2011. A Review and Model of Auditor Judgments in Fraud-Related Planning Tasks. Auditing: A Journal of Practice & Theory 30 (4), 101-128.

    Keywords:
    fraud; risk assessment; hypothesis generation; audit planning.
    Purpose of the Study:

    The PCAOB has expressed concern regarding auditors’ frequent failure to properly adapt their audit plans for fraud risk factors and fraud cues.  Fraud is unique in the audit process in that auditors must plan their audits to address fraud risk, but most auditors have not been on engagements where fraud was discovered, reducing the likelihood that they will assess the risk of fraud effectively from experience.  Much research has been conducted to examine the various aspects of how auditors assess fraud risk and how they react to it.  This paper integrates this research into a qualitative model that shows the relationships between the identified activities of the fraud assessment process and how the related judgments are formed.

    This paper also summarizes auditing research that tests the links in the model, discussing the implications of their findings on these links.  The findings are then related to aspects of the client and situations where certain fraud risk factors may be present and how practitioners should consider these aspects, whether in the process of planning an audit or in training auditors.
     

    Design/Method/ Approach:

    The paper reviews and discusses a large number of research findings in the fraud assessment literature dating back to the early 1990s, synthesizing the results and discussing potential implications of their findings.

    Findings:

    The model can be summarized as follows:

    • Auditors’ knowledge of fraud is based on their experience, ability, and epistemic motivation (the extent to which they develop rich and accurate understandings of situations).
    • Auditors’ knowledge, combined with relevant risk factors identified for the audit, contributes to their ability to generate possible fraud schemes.
    • The generated schemes allow for the assessment of overall fraud risk, which the auditors then use to modify the audit program to detect fraud that may arise from the identified risks.

     

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    A Risk Model to Opine on Internal Control.
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.02 Fraud Risk Models, 06.05 Assessing Risk of Material Misstatement, 07.0 Internal Control, 07.02 Assessing Material Weaknesses, 07.03 Reporting Material Weaknesses 
    Title:
    A Risk Model to Opine on Internal Control.
    Practical Implications:

    The auditor needs a different model for audits of internal control. The auditor needs to apply two different models in an integrated audit, the original model for the opinion on the financial statements and a different model for the opinion on internal controls.

    The author believes standard setters should sponsor research on an appropriate risk model for audits of internal control. Even before the research is completed, the standards could be enhanced in the following ways:
    • indicate that the original audit risk model is intended for use only in financial statement audits, not internal control audits;
    • write standards that consistently use risk terminology and are clear as to which risk they are discussing; and
    • provide guidance on the use of models in integrated audits.

    Citation:

    Akresh, A. D. 2010. A Risk Model to Opine on Internal Control. Accounting Horizons 24 (1): 65-78.

    Keywords:
    audit risk model, inherent risk, integrated audit, internal control, opinion, risk of material misstatement, risk of material weakness
    Purpose of the Study:

    The audit risk model has provided a conceptual framework for audits of financial statements for more than 40 years. Despite practical difficulties in implementation and criticisms of its theoretical foundation, the model has been fairly effective in helping auditors analyze risks and use that analysis to determine the nature, timing, and extent of audit procedures in audits of financial statements. In recent years, some auditors have tried to apply the audit risk model to audits of internal control, usually performed as parts of integrated audits. An integrated audit is an engagement where the auditor provides an opinion on the financial statements and an opinion on the effectiveness of internal control over financial reporting. It is integrated in the sense that the auditor tries to use some of the same procedures to meet both objectives.

    While the audit risk model was designed for audits of financial statements, it was not designed for audits of internal control. Audits of internal control are audits of processes rather than audits of outputs (financial statements). In addition, opinions on internal control do not rely on analytical procedures or on substantive tests of details. Because of this conceptual difference, the author asserts that audit risk model, as originally formulated, does not work as a coherent conceptual framework for audits of internal control. The need for a different risk model for internal control audits is not currently recognized in the auditing standards or in the auditing literature.

    Design/Method/ Approach:

    This article is a commentary.

    Findings:

    For an integrated audit, the auditor would use the two models sequentially. The auditor would use the internal control risk model as a framework to determine the extent of control tests. Then the auditor would use the financial statement audit risk model as a framework to determine the extent of substantive testing.

    Future research could determine a more specific model based on how auditors perform these audits. Some research questions include, for example:

    • What models and approaches are currently used in practice? How does current practice compare with the model proposed and other models?
    • Are models useful in providing a conceptual framework for integrated audits?
    • What are the current practices for the auditor’s evaluation of inherent risk? How do those practices compare with risk models?  
    • How do auditors assess design and implementation of internal controls in light of inherent risk without considering operating effectiveness?
    • What are the current practices for the auditor’s evaluation of design, implementation, and operating effectiveness of the control environment? Are those practices adequate to effectively use in a risk model?
    Category:
    Internal Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Material Weaknesses, Assessing Risk of Material Misstatement, Fraud Risk Models, Reporting Material Weaknesses
  • Jennifer M Mueller-Phillips
    A Synthesis of Fraud-Related Research
    research summary posted February 19, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
    Title:
    A Synthesis of Fraud-Related Research
    Practical Implications:

    To facilitate the development of auditing and other professional standards and to inform regulators of insights from the academic literature, the Auditing Section of the AAA decided to develop a series of literature syntheses for the Public Company Accounting Oversight Board (PCAOB). This paper is authored by one of the research synthesis teams formed by the Auditing Section under this program.  The literature review is organized around a model that considers fraud from the perspective of the auditor. The model incorporates the fraud triangle, which auditors include in their assessment of the likelihood of fraudulent financial reporting. In addition, we examine auditors’ processes of assessing the existence and effectiveness of the client’s anti-fraud measures including corporate governance mechanisms and internal controls, and their consideration of possible fraud schemes and concealment techniques. This synthesis should be relevant to regulators, practitioners, and academics.

    Citation:

    Trompeter, G., T. Carpenter, N. Desai, K. Jones, and R. Riley. 2013. A Synthesis of Fraud-Related Research. Auditing: A Journal of Practice & Theory 32 (Supplement 1): 287-321.

    Keywords:
    fraud, auditing, literature review, SAS 99
    Purpose of the Study:

    This paper was prepared as a part of the series of literature syntheses sponsored by the Auditing Section of the American Accounting Association (AAA). As such, this paper integrates and discusses implications of academic research on fraudulent financial reporting, particularly as it applies to the audit. We synthesize academic literature related to fraudulent financial reporting with dual purposes: (1) to better understand the nature and extent of the existing literature on financial reporting fraud, and (2) to highlight areas where there is a need for future research. We examine accounting and auditing research as well as related disciplines including criminology, ethics, finance, organizational behavior, psychology and sociology. We synthesize the research around a model that illustrates the auditors’ approach to fraud. The model incorporates auditors’ use of the fraud triangle (i.e., management’s incentive, attitude, and opportunity to commit fraud), their assessment of the existence and effectiveness of the client’s anti-fraud measures (e.g., corporate governance mechanisms and internal controls), and their consideration of possible fraud schemes and concealment techniques when making an overall fraud risk assessment of the client. The model further illustrates how auditors can incorporate this assessment into an overall strategy to detect fraud by implementing appropriate fraud-detection procedures. We summarize the recent literature of each component and suggest avenues for future research.

    Design/Method/ Approach:

    We organize our literature review around an expanded fraud model that considers fraud from the perspective of the auditor. We review accounting and auditing literature related to fraud as well as approximately 60 journals from various fields including criminology, ethics, finance, organizational behavior, psychology, and sociology. Our purpose is to broaden our perspective of fraud and to gain insights from other disciplines about the dynamics of fraud that may be useful to auditors, standard setters, and academics.

    Findings:
    • The PCAOB finds that auditors have difficulty responding when fraud risk is high. Whether auditors simply fail to respond with appropriate fraud-related audit techniques or whether auditors do not know how to respond with appropriate testing is an important area for future research.
    • Little research has been done in identifying fraud examination tools and techniques that can be used by auditors to detect fraud once initial red flags are identified. Future research is important in this area.
    • Existing research has established the relationship between incentives and earnings management and fraud. Future research could address the extent to which, and the conditions under which, incentives might result in earnings management through aggressive accruals, biases in fair value estimates, and structured transactions.
    • There has been a great deal of literature focused on various aspects of the fraud triangle. However, there is still interest in learning more about the factors that affect the likelihood that an individual will engage in fraud. The fraudster’s assessment of anti-fraud measures, particularly controls, with respect to the probability (perception) of detection is also important.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    Accounting Variables, Deception, and a Bag of Words:...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.02 Fraud Risk Models 
    Title:
    Accounting Variables, Deception, and a Bag of Words: Assessing the Tools of Fraud Detection.
    Practical Implications:

    This paper presents a fraud-detection tool developed based on textual analysis of the MD&A sections in public companies’ annual and quarterly reports. This tool correctly classifies reports into truthful and fraudulent more than 82% of the time. Compared with other fraud-detection approaches documented in prior literature, this tool has the highest predictive power for both annual reports and quarterly reports. Using the tool to analyze a sequence of reports of a company further increases the accuracy of predictions. This paper provides insights for regulators and practitioners in designing fraud-detection tools. As the tool is “trained” using the AAER database, one limitation is the tool may not detect fraudulent reports if the SEC fails to discover certain types of frauds and/or has bias in selecting firms to investigate.     

    Citation:

    Purda, L. and D. Skillicorn. 2015. Accounting Variables, Deception, and a Bag of Words: Assessing the Tools of Fraud Detection. Contemporary Accounting Research 32 (3): 11931223.

    Keywords:
    corporate fraud, financial disclosure, textual analysis
    Purpose of the Study:

    There are many tools developed by academia, audit firms and regulators to detect accounting frauds in the U.S. This paper is to demonstrate that the changes in writing and presentation style in the management discussion and analysis (MD&A) section as captured by a data-generated language tool has high predictive power over frauds. Another purpose of this study is to compare the effectiveness of various fraud-detection tools, including the financial, language-based, and nonfinancial fraud-detection tools, and to analyze the correlations among them. The findings will help investors, regulators and practitioners to select effective tools and use the tools in optimal ways.

    Design/Method/ Approach:

    The authors adopt a bag of word methodology to develop the fraud-detection tool. In contrast to other language-based tools developed through the same methodology, this tool does not use a list of ex-ante identified predictive words. Rather, the authors use data to generate a bag of words. First, the authors extract a sample of annual and quarterly reports for the period from 1999 to 2006 from the EDGAR database. Second, they use the SEC’s AAER bulletins to identify which reports are fraudulent. The truthful and fraudulent reports comprise a database which is used to “train” the tool to identify the subtle relationships between words in the MD&A sections and the fraudulent reports. Third, the authors use the decision tree approach to create a list of top 200 words ranked by their abilities to identify fraudulent reports. Based on the list, they build a model to calculate the probability of truthful reporting for each report.

    Findings:
    • The Receiver Operating Characteristic (ROC) area is a statistic number range from 0 to 1 and is used to assess the overall ability of a model to correctly differentiate truth from false. The ROC area of this tool is 0.89, which is significantly higher than the 0.5 benchmark and is also higher than the ROC areas of alternative fraud-detection tools.  
    • The F-score from Dechow et al. (2011) is the second best fraud-detection tool in terms of the ROC area. The authors find the F-score, a financial-based tool, can be used as complements to their language-based tool.
    • The authors find their tool has an advantage to predict fraudulent interim reports. Through time-series analysis, the authors find a decline in probability of truthful reporting in the two quarters preceding the fraud. They also find including the change in probability significantly increase the predictive power of the model.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    An Examination of the Effect of Inquiry and Auditor Type on...
    research summary posted October 31, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
    Title:
    An Examination of the Effect of Inquiry and Auditor Type on Reporting Intentions for Fraud
    Practical Implications:

    This study implies that there could be a significant relationship between inquiries performed by internal and external auditors and the auditor’s effectiveness in preventing and detecting fraud.  However, because of the many controlled factors in this experiment would not exist in a real world scenario, further research is necessary to assess the validity of these implications. If found to be effective, these inquiries could become a low cost audit tool to identify fraud.

    For more information on this study, please contact Steven E. Kaplan.
     

    Citation:

    Kaplan, S.E., K. Pope, and J.A. Samuels. 2011. An Examination of the Effect of Inquiry and Auditor Type on Reporting Intentions for Fraud. Auditing: A Journal of Practice and Theory. 30 (4): 29-49.

    Keywords:
    Auditor inquiry; reporting intentions; misappropriations of assets; fraudulent financial reporting.
    Purpose of the Study:

    Internal controls are presumably implemented to prevent and detect fraud of all forms. Since internal controls can be very costly and fraud is very difficult to detect and prevent, however, the internal controls of a company tend to be incomplete. Alternatively, evidence shows that the most common form of initial fraud detection comes from company employees. This study analyzes the relationship between auditors and employees and how that relationship can influence the employee’s intentions to report fraud to auditors. The study also examines the effect of different types of fraudulent acts such as, misappropriation of assets and fraudulent financial reporting, on the employee’s reporting intentions.  Specifically, this study aims to develop an understanding of the actions that auditors could take to strengthen an employee’s willingness to report fraud.

    Design/Method/ Approach:

    This study used an experimental approach that entailed providing a hypothetical situation to evening M.B.A. students from a major metropolitan university and analyzing the participant’s responses to issues described in the scenario. Participants were provided with background information of the hypothetical firm as well as with information about a supervisor engaging in fraud. Evidence was collected prior to November 2011. 

    Findings:
    • The term, reporting intention, means one’s likelihood of reporting fraud to an auditor for the purposes of this study. The study found three issues related to reporting intentions among employees who are aware of fraud.
    • First, reporting intentions to an inquiring auditor are much stronger than to a noninquiring auditor.  This evidence implies that auditors can better satisfy their oversight responsibilities by engaging in fraud inquiries with company personnel.
    • Second, reporting intentions of the employee are much higher if reporting to an internal auditor rather than an external auditor.  This evidence implies that employees prefer to use internal channels rather than external ones to report any wrongdoing in the company.
    • Third, the study found that the type of fraud discovered had no effect on either, reporting intentions, inquiry on fraud reporting, or auditor type. This suggests that the aforementioned findings are not contingent on whether the fraud was a misappropriation of earnings or fraudulent financial reporting. 
       
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    An Examination of the Effects of Managerial Procedural...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 14.0 Corporate Matters, 14.02 Corporate Whistle Blowers 
    Title:
    An Examination of the Effects of Managerial Procedural Safeguards, Managerial Likeability, and Type of Fraudulent Act on Intentions to Report Fraud to a Manager.
    Practical Implications:

    This study provides evidence that whistleblowers take report recipient individual differences (i.e., managerial likeability) into account when making reporting decisions. In addition, this is despite that fact that, eventually, the investigation and resolution will involve multiple organizational members. Further, the results highlight the benefits of managerial likeability: employees have higher reporting intentions when faced with a likeable manager than one who is unlikeable.

    Secondly, this study finds that employees have higher reporting intentions when the fraud involves misappropriation of assets as opposed to fraudulent financial reporting, possibly because employees see fraudulent financial reporting as benefiting the organization as a whole, while misappropriation of assets benefits a single employee to the detriment of the organization.

    Finally, the authors suggest that findings indicating that the strength of managerial procedural safeguards to not influence reporting intent could be a result of poor manipulations and need to be further investigated.

    Citation:

    Kaplan, S. E., K. R. Pope, and J. A. Samuels. 2015. An Examination of the Effects of Managerial Procedural Safeguards, Managerial Likeability, and Type of Fraudulent Act on Intentions to Report Fraud to a Manager. Behavioral Research in Accounting 27 (2): 77-94.

    Keywords:
    managerial procedural safeguards, managerial likeability, fraud, reporting intentions
    Purpose of the Study:

    Because only a fraction of employees who discover fraud actually report it, the authors endeavor to obtain a better understanding of factors influencing individuals' intentions to report fraud, particularly to a non-anonymous recipient such as a manager (as opposed to an anonymous recipient, such as a hotline). The authors predict that reporting intentions to a manager will be influenced by 3 factors:

    • Attributes of the firm (i.e., strong managerial procedural safeguards will result in stronger reporting intentions than will weak managerial procedural safeguards)
    • Report recipient (i.e., a likeable manager will result in stronger reporting intentions than will an unlikeable manager)  
    • Type of fraud (i.e., managers are more likely to report misappropriation of assets than fraudulent financial reporting)

    Results indicate that managerial likeability and the type of fraud, but not managerial procedural safeguards or the interaction with managerial likeability, significantly influence reporting intentions to a manager.

    The authors contend that participants are influenced by managerial likeability because it provides specific information about the manager and acts as a signal about how the manager will likely handle a fraud report. In addition, these results suggest that participants make stronger attributions to a person engaging in misappropriation of assets compared to a person engaging in fraudulent financial reporting.

    Design/Method/ Approach:

    The authors execute a 2 x 2 x 2 between-subjects experiment, engaging 171 professional accountants and managers and randomly assigning each to one of eight experimental conditions. Participants had an average of over 26 years of work experience and almost half (47.5%) reported having had discovered a person of greater authority than themselves engaging in questionable or wrongful behavior. Participants were presented with a scenario in which an employee identifies an apparent fraudulent act by his immediate supervisor and asked about their intentions to report the fraud to a manager.

    Findings:
    • Attributes of the firm: Findings do not indicate that variances in managerial procedural safeguards (strong or weak) impact participant intention to report a fraud.
    • Report recipient: Findings indicate that reporting intentions were significantly higher when the manager was described as likeable (as opposed to unlikeable).
      • The authors suggest that this is because likeable managers are perceived as being more approachable, and will be expected to perform well as a recipient of a fraud report.
    • Type of fraud: Findings indicate that participants have significantly higher reporting intentions when the fraud involves a misappropriation of assets (i.e., employees taking company assets) versus when the fraud involved fraudulent financial reporting (i.e., misreporting financial results or financial position).
      • This, the authors posit, is because misappropriation of assets is seen as benefiting the employee only at the expense of the company and its shareholders, while fraudulent financial reporting might be seen as benefiting the company.
    Category:
    Corporate Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Corporate Whistle Blowers, Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    An Examination of the Legal Liability Associated with...
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 11.0 Audit Quality and Quality Control, 11.01 Supervision and Review – Effectiveness 
    Title:
    An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures
    Practical Implications:

    This study is important to audit practice as it provides an initial view into the effects of outsourcing and offshoring on juror perceptions of the due care exhibited in supervising audit work performance as embodied in assessed damage awards, while also providing perceptions on the expected quality and risk associated with these relationships. The results may be of particular interest to the profession given that this study examines audit work outsourced and/or offshored to India, the country cited as conducting the most outsourced audit work for North American CPA firms. Interestingly, the professional bodies (i.e., NASBA) have chosen not to grant reciprocity of practice for Indian charted accountants (i.e., Mutual Recognition Agreements). India has been denied multiple times while reciprocity has been granted to CPAs/CAs in Australia, Canada, Hong Kong, Ireland, Mexico, and New Zealand (NASBA 2012). The juror perceptions of quality and risk of audit work outsourced offshore, as shown in this study, parallel the concerns expressed by professional bodies.

     

    For more information on this study, please contact Alex Lyubimov.

    Citation:

    Lyubimov, A., V. Arnold, and S.G. Sutton. 2013. An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures. Auditing: A Journal of Practice and Theory 32 (2): 97-118.

    Keywords:
    outsourcing; offshoring; audit quality; litigation risk; juror decision-making; auditor liability; counterfactual reasoning.
    Purpose of the Study:

    Accounting firms have steadily increased the use of outsourcing and offshoring of professional services including independent audit procedures. While firms suggest that the work is of higher quality and similar litigation risk, questions remain as to whether public perceptions may be more negative. The purpose of this study is to examine the effect of outsourcing and offshoring of audit work on juror’s perceptions of auditor legal liability when an audit failure occurs.  More specifically, this paper examines liability associated with an audit failure when work is performed by another office of the same firm or outsourced to a separate firm, and whether the work is performed domestically or in another country.  Theory suggests that outsourcing and offshoring of those outsourced audit procedures has the potential to erode the perceived professionalism of auditors’ work as embodied through decreases in perceptions of work quality, increases in perceptions of associated risk, and ultimately more severe damages assessed against auditors during litigation.

    Design/Method/ Approach:

    An experiment was conducted using a 2 (insource vs. outsource) X 2 (onshore vs. offshore) design. The experiment was delivered through an internet application to facilitate the use of a diverse national sample of jury eligible participants. Participants, representing a broad demographic base, were individuals who were over the age of 18, jury-eligible in the US, had no legal or auditing experience, and not CPA’s. Data were collected over a four-day period in December, 2010.

    Findings:

    Results indicate that choosing to outsource audit work to another audit firm is associated with higher compensatory damages in case of an audit failure.  Furthermore, when this third party audit firm is located in a different country (offshoring), outsourcing leads to significantly higher punitive damages.  Surprisingly, jurors assess higher than expected litigation awards for a failure by another domestic office of the firm for punitive damages. This result suggests that the close proximity in terms of both geography and organizational distance of the domestic office of the firm leads jurors to find the audit failure less understandable. Post hoc analyses indicate that potential jurors perceive that work completed by another domestic office of the firm has the highest expected quality and lowest risk, while work that is outsourced offshore is expected to be lowest quality and highest risk—consistent with proximity theory.

    Category:
    Audit Quality & Quality Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Litigation Risk, Supervision & Review – Effectiveness
  • Jennifer M Mueller-Phillips
    Apology Accepted: The Benefits of an Apology for a Deficient...
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk 
    Title:
    Apology Accepted: The Benefits of an Apology for a Deficient Audit Following an Audit Failure
    Practical Implications:

    The results of this study are important for firms to consider given the recent and historical problem of rising litigation costs. Firms are likely to be targets of lawsuits following the revelation of fraud within a client’s financial statements regardless of whether the firm was complicit in the fraud. Even lawsuits that are settled quickly result in high litigation costs, and the reputational costs to the firm can be just as problematic as the monetary costs. Very few audits are “perfect,” particularly when examined in hindsight. This study suggests that there are benefits to a firm being honest and apologetic about any deficiencies in an audit when the deficiencies do not relate to the fraud itself.

     

    For more information on this study, please contact Jason Rasso.

    Citation:

    Rasso, J. T. 2014. Apology accepted: The benefits of an apology for a deficient audit following an audit failure. Auditing: A Journal of Practice & Theory 33 (1): 161-176.

    Keywords:
    Auditor Litigation, Apology, Reputation
    Purpose of the Study:

    This paper examines the use of an apology for conducting a deficient audit that indirectly leads to an audit failure. Audit failures can be costly to accounting firms in terms of litigation costs and reputational harm. These costs are potentially much higher when the audit failure stems from a deficient audit. The author tests whether the use of an apology containing various components (expression of sympathy, acceptance of responsibility, and/or promise to refrain) is beneficial or harmful to an accounting firm. The results reveal that only the expression of sympathy has an effect on assessments of punishment. However, combining all three apology components leads to a significantly higher perception of the accounting firm’s reputation. This paper is one of very few papers that examines mechanisms that can help protect firm’s reputations.

    Design/Method/ Approach:

    The research evidence is collected in the time period 2011 – 2012. The author collected responses from the general public via Amazon Mechanical Turk. The participants read about the history of an accounting firm, then read a newspaper article identifying a major accounting fraud in which the accounting firm is named as the auditor. The participants then read an apology that contains one, two, or all three of the apology components (one group does not read an apology) and then are asked to rate their support for a lawsuit against the firm, the level of fine they would recommend for the firm, and their perceptions of the firm’s reputation.

    Findings:
    •  An apology containing only an expression of sympathy is the only version of an apology that results in lower support for a lawsuit and a lower fine recommendation when compared with the group that does not view an apology.
    • There is a steady increase in perceptions of a firm’s reputation that can be seen as more components are added to an apology, with an apology containing all three components yielding the highest perception of the firm’s reputation.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Litigation Risk
  • Jennifer M Mueller-Phillips
    Are Fraud Specialists Relatively More Effective than...
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 10.0 Engagement Management, 10.01 Budgeting and Audit Time Management 
    Title:
    Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk?
    Practical Implications:

    Although both auditors and fraud specialists added non-standard procedures to the audit program, auditors cut the budgets for some standard procedures, making room in the overall audit budget for non-standard additional procedures. In contrast, fraud specialists added standard procedures, but they were not more effective than those selected by auditors, and also provided less budget room for those procedures. The involvement of fraud specialists in planning an audit engagement where fraud risk is present is likely to lead to additional audit effort and cost, possibly without commensurate benefit. However, considering the potential consequences to the auditor of undiscovered fraud, it may be cost-effective to include additional non-standard procedures in an audit program if they improve the probability of discovering a fraud.

    Citation:

    Boritz, J. E., Kochetova-Kozloski, N., & Robinson, L. 2015. Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk? Accounting Review 90 (3): 881-915.

    Keywords:
    audit planning, audit procedures, fraud, specialists
    Purpose of the Study:

    Since the passage of Statement on Auditing Standards (SAS) 99 and the Sarbanes-Oxley Act of 2002, policy-makers and regulators have promulgated additional guidance aimed at improving auditors’ performance in assessing and responding to fraud risks of audit clients. Auditors are expected to address fraud risk through the design of their audit methods and programs and by involving specialists. The authors study whether fraud specialists are relatively more effective than auditors in designing an audit program that will address elevated fraud risk. The goal is to examine whether the expertise of fraud specialists can directly contribute to planning the nature and extent of audit procedures, and whether the mix of procedures that such specialists recommend is likely to be more effective and efficient than the procedures proposed by auditors in a setting where ex ante fraud risk is rated at above a low level. By directly examining fraud specialists’ recommendations for an audit plan under conditions of an elevated fraud risk, the authors seek to clarify whether there are benefits in requesting fraud specialists to participate in audit program design.

    Design/Method/ Approach:

    Participants completed an audit case based on an actual company that had issued fraudulent financial statements. Thirty-two fraud specialists and sixteen auditors completed the case  On average, the fraud specialists were 41 years old, had 12 years of specialized fraud-related experience, and six years of auditing experience. The auditors were, on average, 36 years old, had 13.25 years of auditing experience, but no specialized fraud experience. The evidence was gathered prior to November 2010.

    Findings:
    • In a situation with elevated fraud risk, fraud specialists did not select more procedures from a standard audit program than financial statement auditors; nor were the selected procedures more effective than those selected by auditors. This suggests that the benefits of involving fraud specialists in audit planning do not lie in their ability to identify more effective standard audit procedures.
    • When the risk of fraud is other than low, the fraud specialists proposed more additional procedures than did auditors, and the specialist-proposed additional procedures were marginally more effective, but significantly less efficient, than the additional procedures proposed by auditors. This suggests that involving fraud specialists in audit planning can carry benefits for engagements where fraud risk is not low by helping to identify a larger set of effective procedures than even very experienced auditors are able to do.
    • Fraud specialists increased time budgets to reflect the additional effort that they proposed via extensive non-standard procedures. However, although they proposed significantly more additional procedures than did auditors, their proposed time budget increases for those procedures were significantly lower than adjustments proposed by the auditors. 
    Category:
    Audit Team Composition, Engagement Management, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Budgeting & Audit Time Management, Fraud Risk Assessment, Use of Specialists (e.g. financial instruments – actuaries - valuation)

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