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    How Do Audit Seniors Respond to Heightened Fraud Risk?
    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 
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    Title:
    How Do Audit Seniors Respond to Heightened Fraud Risk?
    Practical Implications:

    Less-experienced auditors tend to respond to risk by indiscriminately increasing sample size; when management utilizes a specific scheme to commit fraud, this method is far less effective than tailoring procedures to target a particular sample where fraud is more likely to occur.  The authors suggest that training on recognizing cues that may suggest specific fraud schemes (especially early in an auditor’s career) and when targeting a particular high-risk sample is appropriate (as opposed to simply increasing sample size) would help auditors to recognize when aspects of an engagement imply higher risk of a particular fraud method or scheme and address it properly by targeting their testing to directly address the fraud risk.

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

    Citation:

    Hammersley, J. S., K. M. Johnstone, and K. Kadous.  2011.  How Do Audit Seniors Respond to Heightened Fraud Risk?  Auditing: A Journal of Practice & Theory 30 (3), 81-101.

    Keywords:
    audit planning; fraud detection; fraud risk factors; audit seniors; risk assessments.
    Purpose of the Study:

    A number of studies have looked at methods of improving the assessment of fraud risk and the resulting selection of audit procedures to address this risk.  However, most of these studies use managers, whereas seniors are often responsible for putting together the audit plan.  Although managers review this plan, the initial selection of procedures by seniors can significantly impact the final audit plan.  Therefore, this study examines seniors’ assessment of fraud risk and how they modify a standard audit plan to combat this risk.

    In addition, this study looks at multiple levels of fraud risk. Although all the seniors are given a case based on an actual fraud from an SEC Accounting and Auditing Enforcement Release, some of them are informed that a material weakness in the revenue recognition cycle (although unrelated to the fraud) was detected in the current year in order to determine whether seniors responded to this risk in terms of an elevated risk assessment.  Finally, this study not only investigates the effectiveness of the procedures selected, but also their efficiency; this is able to capture whether the seniors’ procedures may not only be ineffective at catching the fraud, but also inefficient (procedures that add time to the audit, but would not catch the fraud).
     

    Design/Method/ Approach:

    The authors conduct an experiment using seniors from a Big 4 firm.  Evidence was collected prior to 2010.  The seniors were given a case with background and financial information on the company as well as auditing assessments of materiality and the control environment.  The background information included a description of a marketing plan that management was using to fraudulently recognize revenue.  About half of the participants were informed that a material weakness had been identified in the revenue recognition cycle, while the other half were informed that internal controls testing was ongoing, but had not detected anything yet.  All participants were then asked to identify risk factors from the case, judge the revenue cycle risks, modify a standard audit plan to respond to the risks, and assess the need to consult with a risk management partner.

    Findings:
    • Auditors who receive information about a material weakness assess both fraud risk and the need to consult with a risk management partner higher than auditors who receive no information about a material weakness.
    • However, auditors receiving information about a material weakness do not identify more risk factors focused on the fraud than auditors in the control condition.
    • In addition, auditors receiving information about a material weakness develop audit programs that are no more effective for fraud detection purposes but are more inefficient than those who do not receive this information.  This appears to be due to the general implication of risk causing auditors to increase sample size indiscriminately, but not targeting the specific fraud.
    • Auditors who identified more fraud risks were more likely to modify procedures in a way that would have a better chance at detecting the fraud.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment