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  • 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
    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
    Broadening the Fraud Triangle: Instrumental Climate and...
    research summary posted November 15, 2016 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:
    Broadening the Fraud Triangle: Instrumental Climate and Fraud
    Practical Implications:

    This paper incorporates important organizational theory into the fraud literature by reporting the presence of an instrumental climate when fraud is being perpetrated within an organization. Internal auditors and those charged with governance could adapt this climate measure as a red flag for potential fraud. 

    Citation:

    Murphy, P. R. and C. Free. 2016. Broadening the Fraud Triangle: Instrumental Climate and Fraud. Behavioral Research in Accounting 28 (1): 41-56.

    Keywords:
    organizational climate, instrumental climate, fraud, fraud triangle, rationalization
    Purpose of the Study:

    Many papers focus on investigating organizations in which management’s tone exemplifies high ethical standards, combined with a climate that support and encourages ethical behavior in an effort to examine if this organization is less vulnerable to fraud. However, this paper takes a different approach. It examines the “flip side” of organizations, those that are associated with fraud instead of those associated with preventing fraud. By doing this, the authors also hope to delve into the effectiveness of the fraud triangle. For years, the fraud triangle has been the dominant fraud framework but recently it has been called into question for its narrow interpretation and lack of comprehensiveness. Thus, the goal of this research is not only to identify an organizational climate that exists in the presence of fraud but also to broaden the interpretation of the fraud triangle by explicitly identifying fraud triangle elements related to such a climate. 

    Design/Method/ Approach:

    The authors created and administered a survey to three groups of individuals having fraud experience: (1) prisoners who are incarcerated for committing fraud within an organization, (2) individuals who audited or investigated fraud within an organization, and (3) individuals who witnessed fraud within their organization. 

    Findings:
    • The authors find that 39 percent of the respondents agreed or strongly agreed that an instrumental climate was present when fraud occurred within the organization.
    • The authors find that an instrumental climate is significantly associated with a malevolent work environment and social incentives and pressures.
    • The authors find that the use of externally oriented rationalizations are very common with instrumental climates, especially the claim of helping the company.
    • The authors find that an instrumental climate is not associated with conventional attitude variables (prior history of white-collar crime, character, ethical values of the perpetrator), internally oriented rationalizations (minimizing or ignoring the consequences of the fraud, or entitlement) or individual greed or need. 
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    COMMENTARY FROM THE AMERICAN ACCOUNTING ASSOCIATION’S 2011 A...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.02 Fraud Risk Models, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    COMMENTARY FROM THE AMERICAN ACCOUNTING ASSOCIATION’S 2011 ANNUAL MEETING PANEL ON EMERGING ISSUES IN FRAUD RESEARCH
    Practical Implications:

    When performing brainstorming sessions as mandated by SAS 99, auditors should brainstorm personality traits that may reveal potential fraudsters. Additionally, firms and academics should work to identify characteristics that provide an indication of which individuals are more likely to commit fraud.

    For more information on this study, please contact Sara Melendy.
     

    Citation:

    Brody, R. G., S. R. Melendy, and F. S. Perri 2012. Commentary from the American Accounting Association’s 2011 annual meeting panel on emerging issues in fraud research. Accounting Horizons 26 (3): 513-531.

    Keywords:
    None
    Purpose of the Study:

    During one of the investigative accounting panels at the American Accounting Association’s 2011 annual meeting, panelists discussed various issues related to fraud and fraud research. This article summarizes their discussion, and also draws upon some of the relevant published literature to highlight some of the fraud topics that are still largely unexplored and thus ripe for academic research. Additionally, the purpose of this paper is to (1) critically evaluate the state of current fraud research and provide guidance for future researchers, and (2) examine the publication process for both practitioner and scholarly journals from both an editorial and topical perspective.

    Design/Method/ Approach:

    This paper summarizes and synthesizes information from the American Accounting Association’s 2011 annual meeting and includes existent fraud research.

    Findings:

    There are important misperceptions about the nature of fraudsters. Important among these misperceptions are the following items:
    •    fraud is a one-time offense
    •    fraud is an out-of-character crime
    •    fraudsters are non-violent offenders
     

    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Models, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    Detecting and Predicting Accounting Irregularities: A...
    research summary posted October 20, 2014 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 
    Title:
    Detecting and Predicting Accounting Irregularities: A Comparison of Commercial and Academic Risk Measures
    Practical Implications:

    The results of this study should be useful to research practitioners, regulators, investors, auditors (internal and external), managers, boards of directors, and analysts.  Academic researchers who study fraud or aggressive financial reporting should also be interested in understanding which risk measures have the highest statistical power and construct validity.  One clear advantage of the academic risk measures is that, unlike commercially developed risk measures that are proprietary by nature, researchers know all of the inputs to the academic measures.  On the other hand, studies that need an overall estimate of ex ante financial reporting risk or studies with small or limited sample sizes are likely to benefit the most from using comprehensive, commercially developed risk measures like AGR due to its improved statistical power.

     

    For more information on this study, please contact David A. Wood.

    Citation:

    Price III, R. A., N. Y. Sharp, and D. A. Wood. 2011. Detecting and predicting accounting irregularities:  A comparison of commercial and academic risk measures. Accounting Horizons 25 (4): 755-780

    Keywords:
    Accounting irregularities, detecting fraud, predicting fraud, risk measures, commercial risk ratings
    Purpose of the Study:

    A substantial body of academic research is devoted to developing and testing risk proxies that detect accounting irregularities but the academic literature has paid little attention to commercially developed risk measures.  The authors compare the commercially developed Accounting and Governance Risk (AGR) and Accounting Risk (AR) measures with academic risk measures to determine which best detects financial misstatements that result in: (1) Securities and Exchange Commission enforcement actions; (2) egregious accounting restatements; and (3) shareholder lawsuits related to accounting improprieties.  By making this comparison, the authors provide evidence concerning which metrics among the academic and commercial measures have the greatest ability to detect accounting irregularities and, second, to provide insight on the attribute of superior risk metrics. The authors of this paper also include relatively new academic risk measures that were unavailable for examination in prior studies that compared academic risk measures. 

    Design/Method/ Approach:

    The research sample data is based on the set of firms in Compustat from 1995 to 2008.  Data was obtained from several additional sources, including the Center for Research on Security Prices, Audit Analytics, and Audit Integrity.  The AGR measure is produced commercially by Audit Integrity to estimate the likelihood that reported financial information includes elements that are misleading or fraudulent.  Multivariate logistic regressions were run to test the detective and predictive ability of the measures.

    Findings:
    • The authors find the commercially developed risk measure AGR is useful as a proxy for the risk of accounting irregularities.
    • In comparisons between AGR and academic risk measures, the authors find that AGR performs as well as or better than academic risk measures in all comparisons.
    • The authors find that among the academic risk measures, accrual estimation errors and unexplained audit fees appear to perform the best.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    Does Intent Modify Risk-Based Auditing?
    research summary posted July 16, 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:
    Does Intent Modify Risk-Based Auditing?
    Practical Implications:

    The findings suggest that such sensitization is not merely a main effect” that shifts the risk-to-resource mapping upward. Rather, human intent appears to exert an interactive effect that flattens the risk-to-resource mapping by changing the cognitive mindset of risk from a magnitude-based calculation. For audit practice, the interaction the authors detect relates to the PCAOB’s efforts to differentiate fraud risks from the more general logic that risks should be evaluated based on magnitudes and likelihoods. The study suggests that people are more comfortable conditioning audit resources on risk magnitudes for unintentional reporting risks than for the same risks arising from human intent.

    Citation:

    Kachelmeier, S. J., Majors, T., & Williamson, M. G. 2014. Does Intent Modify Risk-Based Auditing? Accounting Review 89 (6): 2181-2201.

    Keywords:
    experimental economics, fraud, intent, risk, risk-based auditing, scale insensitivity
    Purpose of the Study:

    Audit practitioners and regulators have embraced the concept of risk-based auditing, under which auditors expend more resources to address significant risks and fewer resources when risks are lower. In this study, the authors investigate why this reasoning might not apply equally to risks arising from intentional and unintentional sources. In particular, they apply the theory of valuation by feeling to develop the premise that people are more sensitive to the presence of risk than to the magnitude of risk when individuals sense that they could be cheated by others’ intentional actions. If so, risks stemming from willful intent could dampen the mapping from risk magnitudes to desired audit resources, ceteris paribus.

    The research premise speaks to the fundamental possibility that risks stemming from the willful intent of others can trigger a significant response independent of the magnitudes and consequences of such risks. That is, when facing a known intentional risk, valuation by feeling suggests that the desired level of audit resources is relatively invariant to the level of risk. The study seeks a deeper understanding of what risk-based auditing” means from a behavioral perspective. Specifically, if auditors react similarly to high and low levels of intent-based risks, then this propensity would suggest an incremental aversion to intent that goes beyond a strict cost-benefit interpretation of risk-based auditing.

    Design/Method/ Approach:

    The authors design a 2x4 factorial experiment with risk source as a between-participants factor (two levels) and risk magnitude as a within-participants factor (four levels). The authors recruit 83 undergraduate business student volunteers to participate in a one-shot experiment that they program using the ‘‘Z-tree’’ computer architecture for interactive experiments. The evidence was gathered prior to October 2011.

    Findings:

    The primary finding is that the mapping from the level of misreporting risk to the level of audit resources is steeper in the unintentional risk condition than in the intentional risk condition, meaning that auditor-participants are less inclined to back off as risks decline when those risks are from human reporters. Within the intentional risk condition, expenditures are similar to the unintentional risk condition when the level of risk is high, but do not decline as much when risks decline, resulting in a flatter mapping from risk levels to audit resources. At the lowest risk level, average investments in the intentional risk condition even exceed the total amount at risk.

    Within the controlled experiment setting, economically “irrational” behavior occurred, at least from a monetary perspective, insofar as participants expend different amounts to protect themselves from the same magnitudes and probabilities of monetary loss across the intentional and unintentional risk conditions. Accordingly, the findings suggest the possibility that heightened sensitivity to intent-based risks could be dysfunctional if fraud risks are truly low, leading auditors to do too much work. Real-world audit settings, however, cannot provide the strict control the experiment uses to hold the stated risk levels constant.

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    Finding Needles in a Haystack: Using Data Analaytics to...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 06.02 Fraud Risk Models, 08.09 Impact of Technology on Audit Procedures 
    Title:
    Finding Needles in a Haystack: Using Data Analaytics to Improve Fraud Predication
    Practical Implications:

    Data analytics can be used to create fraud prediction models that help auditors improve audit planning decisions. It can also be used to help regulators identify firms for potential fraud investigation. In particular, the SEC is investing resources to develop better fraud risk models and the results of this study could be useful. 

    Citation:

    Perols, Johan L., R. M. Bowen, C. Zimmermann, and B. Samba. 2017. “Finding Needles in a Haystack: Using Data Analytics to Improve Fraud Prediction”. The Accounting Review. 92.2 (2017): 221.

    Keywords:
    fraud; financial statement fraud; data analytics; predictive analytics; data rarity; data imbalance
    Purpose of the Study:

    Financial statement fraud causes organizations to lose an estimated 1.6% of annual revenue. This study examines 3 different methods that use data analytics in an attempt to predict fraud. The methods are as follows:

    • The first method, Multi-Subset Observation Undersampling (OU), addresses the imbalance between the low number of fraud observations relative to the number of non-fraud observations by creating multiple subsets of the original dataset that each contain all fraud observations and different random subsamples of non-fraud observations.
    • The second method, Multi-subset Variable Understampling (VU), addresses the imbalance between the low number of fraud observations relative to the number of explanatory variables identified in the fraud prediction literature by creating multiple subsets of randomly selected explanatory variables.
    • The third method, VU partitioned by type of fraud (PVU), is a variation of the second method that addresses issues associated with treating all fraud cases as homogenous events.
    Design/Method/ Approach:

    The sample contains data from 51 fraud firms. The authors identified fraud firms from SEC investigations that were reported in AAERS from 1998-2005. The objectives of the experiments were to determine how to best implement OU and VU and then to subsequently evaluate their performance against benchmarks. 

    Findings:

    The authors find the following:

    • When the Multi-Subset Observation Undersampling (OU) is used with 12 subsamples it improves fraud prediction by lowering the expected cost of misclassification by more than 10% relative to the best performing benchmark.
    • The Multi-Subset Variable Undersampling (VU) was found to improve fraud prediction in select situations. However, it does not do so reliably.
    • The Multi-Subsets Variable Undersampling by partitioning variables into subsets (PVU) was able to improve fraud prediction and reduce the expected cost of miscalculation by 9.6% relative to the best performing VU benchmark.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Models, Impact of Technology on Audit Procedures Confirmation – Process and Evaluation of Responses
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • Jennifer M Mueller-Phillips
    Fraud dynamics and controls in organizations.
    research summary posted September 16, 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, 06.04 Management Integrity 
    Title:
    Fraud dynamics and controls in organizations.
    Practical Implications:

    The findings have important implications for auditors and other individuals responsible for assessing fraud risk and detecting and preventing fraud. First, for certain types of organizations aggregate fraud levels can vary tremendously over time. Furthermore, the effectiveness of mechanisms to prevent and detect fraud can be contingent on the type of organization and related individual susceptibilities to social influence. Therefore, it may be inappropriate for auditors to evaluate fraud prevention and detection mechanisms in a uniform manner. The results suggest that the same fraud prevention and detection mechanisms implemented in a similar manner in two different organizations cannot be expected to be equally effective without considering the average susceptibilities to social influence of the individuals therein.

    Citation:

    Davis, J. S., and H. L. Pesch. 2013. Fraud dynamics and controls in organizations. Accounting, Organizations & Society 38 (6/7): 469-483.

    Keywords:
    fraud, fraud dynamics, impact of fraud in organizations, fraud risk assessment, management integrity
    Purpose of the Study:

    Fraud has become a popular area of inquiry among accounting academics because of the magnitude of losses (estimated by the Association of Certified Fraud Examiners in 2010 to be US$2.9 trillion worldwide) and requirements imposed on auditors to explicitly address the problem. To date, very little work has attempted to explicitly link individual behaviors in the organization to organizational outcomes within the fraud context. Understanding the individualorganization link is important because a focus on either individual behavior or the organization in isolation turns a blind eye to the social process through which individuals’ behaviors are influenced by the organization as a whole and vice versa. In other words, a narrow focus on individual behaviors or on the organization ignores the organization’s sociology, which can have profound effects on fraud outcomes and the efficacy of fraud prevention mechanisms.

    The authors develop a model of fraud in organizations that allows an evaluation of the relative efficacy of mechanisms designed to prevent fraud while explicitly recognizing the social processes underlying the formation of organizational norms. To develop the model, the authors use a method that is relatively new in accounting research: agent-based modeling (ABM). Designed to study the emergence of macro-level phenomena from micro-level interactions, ABM is well suited to address questions involving organizational outcomes (e.g., a culture of fraud) resulting from the interactions between individuals within an organization and organizational variables. The use of ABM allows the authors to gain insights into fraud even when data in organizations are censored.

    Design/Method/ Approach:

    The authors develop an agent-based model to examine the emergent dynamic characteristics of fraud in organizations. In the model, individual heterogeneous agents, each of whom can have motive and opportunity to commit fraud and a pro-fraud attitude, interact with each other. This interaction provides a mechanism for cultural transmission through which attitudes regarding fraud can spread.

    Findings:
    • When average susceptibility is low, the number of fraudsters in the organization tends toward a specific level and remains relatively stable over time.
    • When average susceptibility is moderate to high the authors observe a very different pattern in which the number of fraudsters in the organization vacillates over time between extremes; either virtually no one in the organization is a fraudster or virtually everyone is.
    • The impact of mechanisms to prevent fraud is contingent on average susceptibility to social influence within the organization.
    • A reduction in perceived opportunity or the introduction of influential, honest managers (tone at the top) reduces the number of fraudsters, but neither change to their model is effective in eliminating outbreaks of fraud when susceptibility is moderate or high.
    • Allowing honest employees to be more influential than fraudsters has no qualitative effect when susceptibility is low; however, it transforms behavior when average susceptibility is moderate to high, reducing the number of fraudsters to near zero and eliminating fraud outbreaks.
    • Efforts to remove fraudsters can effectively reduce the number of fraudsters to near zero regardless of the level of susceptibility, but such efforts do not eliminate fraud outbreaks when susceptibility is moderate to high.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models, Management Integrity
  • Jennifer M Mueller-Phillips
    Insights for Research and Practice: What We Learn about...
    research summary posted March 2, 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:
    Insights for Research and Practice: What We Learn about Fraud from Other Disciplines
    Practical Implications:

    While other fraud research syntheses focus primarily on research that has been published in accounting journals, this synthesis surveys academic literature from non-accounting publications related to fraud and financial crimes: (1) to better understand the nature and extent of fraud acts; (2) to share with accounting researchers and practitioners ideas, theories, variables, constructs, and research designs used in other fields that might inform anti-fraud research and actions in accounting; and (3) to highlight opportunities for future research. In this review and synthesis of the literature, the authors move beyond the fraud triangle to consider a broader spectrum of factors that researchers and practitioners may consider in an effort to provide a more complete perspective on fraud and related financial crimes.

    For more information on this study, please contact Gregory M. Trompeter.

    Citation:

    Trompeter, G., T. Carpenter, K. Jones, and R. Riley. 2014. Insights for Research and Practice: What We Learn about Fraud from Other Disciplines. Accounting Horizons 28 (4): 769-804.

    Keywords:
    asset misappropriation; fraud; fraudulent financial reporting; literature review
    Purpose of the Study:

    The authors survey academic literature from non-accounting publications related to fraud and financial crimes: (1) to better understand the nature and extent of fraud acts from the perspective of non-accounting research; (2) to share with accounting researchers and practitioners ideas, theories, variables, constructs, and research designs used in other fields that might inform anti-fraud research and actions in accounting; and (3) to highlight opportunities for future research. This project differs from other fraud research syntheses by examining a wider set of theoretical constructs. Indeed, the authors move beyond the fraud triangle and consider the findings of non-accounting research related to broader topics such as theft (by force rather than deception), the role of punishment, and others. Such topics provide insight into financial fraud and have the ability to inform practice and accounting research aimed at prevention, deterrence, and detection of fraud. The scope of the relevant research includes a review of approximately 30 journals that were identified by the Institute for Fraud Prevention in the fields of criminology, ethics, psychology, and sociology.

    Design/Method/ Approach:

    The authors review approximately 30 journals in the fields of criminology, ethics, psychology, and sociology for topics relevant to fraud. They synthesize this research using a framework that incorporates the fraud triangle, but also expands and refocuses one’s thinking about fraud by including additional factors: (1) organizational and societal interventions in the areas of deterrence and prevention, and (2) subsequent detection, investigation, consequences, and remediation of the criminal act once the crime has occurred. 

    Findings:
    • Similar to accounting research, the authors find considerable examination of the fraud triangle in non-accounting research. However, non-accounting researchers have examined neutralizations (justification before the fraud) and rationalizations (justification after the fraud) far more extensively.
    • With respect to anti-fraud measures, extant non-accounting literature offers additional insights into corporate governance and corporate culture, including the role of leadership and globalization.
    • In the area of detection, non-accounting research offers some scoring methodologies that might be helpful in more efficiently using red flags to detect fraud and insights related to interviewing for the detection of deception.
    • Non-accounting research offers insight into the criminal act, concealment, and conversion, well beyond the examination of those issues in accounting research. Nevertheless, the triangle of fraud action (i.e., the act, the concealment, and the conversion) remains largely unexplored.
    • Non-accounting researchers have studied the consequences of fraudulent acts far more extensively than accountants. However, effective investigation, remediation, and other consequences offer abundant opportunities for future research and insights for practice.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models

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