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    Fraudulent Management Explanations and the Impact of...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
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    Title:
    Fraudulent Management Explanations and the Impact of Alternative Presentations of Client Business Evidence
    Practical Implications:

    The study provides evidence that the format of the audit evidence (using the business model evidence versus using the chronological evidence) impacts the level of fraud risk assessment.  This indicates that using the business model provides an advantage in evaluating and assessing the potential risk of fraud.  The advantages of using both forms of evidence may enable auditors to determine the nature, timing and extent of procedures to corroborate management’s explanations for fluctuations beyond the context of fraud.  Therefore, the findings of this study have broader implications, as it can be applied to other audit procedures to ensure that auditors are obtaining sufficient evidence throughout the audit as well as for an assessment of fraud risk.


    For more information on this study, please contact William F. Wright.
     

    Citation:

    Wright, W.F., and L. Berger. 2011. Fraudulent Management Explanations and the Impact of Alternative Presentations of Client Business Evidence.   Auditing:  A Journal of Practice and Theory 30 (2): 153-171.

    Keywords:
    Management explanation, management fraud, risk-based auditing, analytical procedures, information presentation
    Purpose of the Study:

    When planning an audit, auditors perform analytical procedures and inquiries of management regarding any significant fluctuations in the key financial information.  Auditors will assess these significant changes based on these procedures and use the information to assist in planning the nature, timing and extent of audit procedures.  In the context of fraud, the explanations for fluctuations will be based on evidence that either emphasizes the client’s business model or knowledge of the auditor’s chronological presentation of audit evidence.  The chronological presentation of evidence is based on given knowledge of the client’s business, prior year results compared current year information, and other items such as key ratios.  The business model explanation provides linkages between the client’s business strategy and objectives to support the fluctuations.  The use of the chronological information evaluates the comparison of the year over year financial condition and results as well as trend analysis.

    Since auditors use these as audit evidence, the study uses this evidence for generating expectations and for making risk assessments regarding fraud.  The authors hypothesize the following when management provides a fraudulent explanation: 

     

    • There will be a more accurate expectation of the non-fraudulent account balances using the business model versus the chronological method of performance.  If a fraudulent error explanation was not provided as an explanation of the fluctuation, there will not be a difference in the precision of expectations between the two presentation formats.
    • There will be a more effective fraud risk assessment for a significant fluctuation when using the business model versus the chronological method of performance.  If a fraudulent explanation was not provided as an explanation of the fluctuation, there will not be a difference in the fraud risk assessment.
       
    Design/Method/ Approach:

    The authors perform an experiment with 73 participants, 42 of which were auditors who had recently graduated from a Canadian university less than a year before. The remaining participants were graduate students.  The authors used a randomized 2x2 between-subjects design.  The factors that were evaluated included whether management’s explanation was or was not fraudulent as it related to the unexpected fluctuation in sales and the two client business evidence presentation methods:  business model or chronological.

    Findings:
    • As predicted, the study finds that when provided a fraudulent explanation, the users of the business model approach have higher assessment of fraud risk. The auditors realized the inconsistency in management’s explanation when using this approach.
    • When there was no seeded fraud, the business model and the chronological method of audit evidence did not yield any differences in judgment in the auditor’s fraud risk assessment.
       
    Category:
    Audit Quality & Quality Control, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Adequacy of Evidence, Evaluation of Evidence, Fraud Risk Assessment