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    Financial Statement Fraud: Insights from the Academic...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
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    Title:
    Financial Statement Fraud: Insights from the Academic Literature.
    Practical Implications:

    The research summarized above will provide valuable input to the accounting profession and standard-setters, and there are several areas in which additional research is needed. Despite existing auditing standards and authoritative guidance on an auditor’s responsibility for discovering and reporting financial statement fraud, there remains an expectation gap between what investors believe the auditor’s responsibility should be in detecting financial fraud and what auditors are willing to assume as responsibility in this area.

    Citation:

    Hogan, C. E., Z. Rezaee, J. A. Riley, and U. K. Velury. 2008. Financial Statement Fraud: Insights from the Academic Literature. Auditing: A Journal of Practice & Theory 27 (2): 231-252.

    Keywords:
    audit planning, audit procedures, financial statement fraud, fraud detection, fraud triangle, high-risk audit areas
    Purpose of the Study:

    Over the past several decades, a significant amount of academic research has been focused on fraud in general and financial statement fraud in particular. These studies address the trends, determinants, and consequences of financial fraud, as well as the responsibility for preventing, detecting, and remediating that fraud. To facilitate the development of auditing standards and to inform regulators of insights from the academic auditing literature, the Auditing Section of the American Accounting Association (AAA) has decided to develop a series of literature syntheses for the Public Company Accounting Oversight Board (PCAOB). The authors summarize relevant academic research findings and to offer insights and conclusions relevant to academics, standard setters, and practitioners. They discuss the characteristics of firms committing financial statement fraud, as identified in the literature, and research related to the fraud triangle. The authors then discuss research related to the procedures and abilities of auditors to detect fraud, and how fraud risk assessments impact audit planning and testing. In addition, they discuss several “high risk” areas and other issues as identified by the PCAOB. 

    Design/Method/ Approach:

    Statement on Auditing Standards (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit, states that three conditions are generally present when fraud occurs. These conditions collectively are known as the fraud triangle. The authors reviewed the academic findings related to the presence of these conditions in cases of financial statement fraud. This helps provide a basis for understanding the development of the questionnaires and checklists in SAS No. 82 and SAS No. 99.

    Findings:

    The primary conclusions from the review of the literature on fraudulent financial reporting are as follows.

    • There is a significant amount of literature on the characteristics of fraud firms, providing support for the fraud triangle classifications and the list of “red flags” used in both SAS No. 82 and SAS No. 99.
    • Evidence on the usefulness of checklists as a fraud detection tool is mixed. While there is some research that supports the use of checklists as a decision tool, there is more evidence that suggests the use of checklists is dysfunctional in that auditors fail to expand their thinking beyond the checklist.
    • Research supports a need by auditors to align management incentives to the types of risks that should be evaluated as high.
    • There is evidence that suggests auditors do not make significant adjustments to audit plans as a result of higher fraud risk assessments.
    • Research supports further exploration into the use of additional fraud detection tools such as regression analysis, the use of nonfinancial information, digital analysis, and neural network models.
    • Research supports the identification of revenue recognition, significant or unusual accruals, and related parties as areas with increased risk of fraudulent financial reporting activity.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment