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    Individual Auditors’ Identification of Relevant Fraud S...
    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, 08.0 Auditing Procedures – Nature, Timing and Extent 
    Individual Auditors’ Identification of Relevant Fraud Schemes

    Simon, C. A. 2012.  Individual auditors’ identification of relevant fraud schemes.  Auditing: A Journal of Practice & Theory 31 (1), 1-16.

    fraud schemes; management’s goals
    Purpose of the Study:

    Previous research has identified that auditors often have difficulty either assessing fraud risk or responding to it properly through effective audit procedures.  This study investigates two methods that are expected to reduce these difficulties. The first method, consideration of management’s goals, is predicted to allow auditors to integrate the effects of these goals with gathered audit evidence (such as analytic procedures) in order to determine whether they are consistent.  The second method, forming expectations independent of client’s current numbers, prevents auditors from “anchoring” their expectations on the current numbers and considering fraudulent activities that contribute these numbers.  In addition, utilizing both methods is predicted to have a joint effect beyond each method’s individual effect, since independently setting expectations after considering management’s goals will result in expectations that are even more likely to reflect consideration of potential fraudulent activity.

    Design/Method/ Approach:

    An experiment was conducted prior to 2011 using auditors with an average of 32 months of experience (most of who were from a single Big 4 firm).  Participants were first given background information about a client (based on an actual fraud investigated by the SEC) followed by fraud red flags that were present or absent and financial ratios for the company’s prior year-end and current year third quarter.  About half of the participants were asked to form expectations before they see the current year-end ratios, while the other half are not asked to form expectations.  Also, half of the participants (randomized differently than for the previous manipulation) were asked to write goals that could lead management to commit fraud, then to list the fraud red flags and analytic results that were consistent with these goals.  Participants then assess overall fraud risk, list potential fraud schemes, then list audit procedures to address the schemes they listed.

    • Auditors who were instructed to focus on management’s goals identified more schemes that were relevant to the fraud (those the SEC noted in its enforcement action)
    • Documenting expectations did not contribute to the identification of relevant schemes
    • Identification of relevant schemes lead to procedures that would be more effective in catching the fraud
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Fraud Risk Assessment