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    Effects of Decomposition and Categorization on Fraud-Risk...
    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 
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    Title:
    Effects of Decomposition and Categorization on Fraud-Risk Assessments.
    Practical Implications:

    The results of the experiment show that auditors who decompose fraud assessments make overall and component fraud-risk assessments that are more appropriate in response to changes in opportunity and incentive cues than auditors who only categorize fraud-risk factors. This study also adds to the body of research that examined the linkage between judgment and decision; more specifically, in fraud judgment. The results of the experiment show that auditors who assess fraud with decomposition perceive a higher (or lower) need to revise audit plans and to increase (or decrease) the extent of testing than auditors who make categorical judgments prior to an overall assessment, in response to increase (or decrease) in fraud risk.

    Citation:

    Favere-Marchesi, M. 2013. Effects of Decomposition and Categorization on Fraud-Risk Assessments. Auditing: A Journal of Practice & Theory 32 (4): 201-219.

    Keywords:
    categorization, decomposition, fraud-risk assessments
    Purpose of the Study:

    Risk assessment is a fundamental part of the audit process. Public Company Accounting Oversight Board (PCAOB) standards highlight auditors’ responsibilities for considering the risk of fraud as a central part of this process. The current auditing standards categorize fraud factors along three dimensions: management’s attitude or character, opportunities, and incentives. Regulators, practitioners, and researchers have all expressed concerns that auditors rely heavily on their perception of management’s attitude when this perception suggests low fraud risk, not realizing the difficulty of accurately perceiving management’s attitude or not understanding the unreliable nature of such perceptions. The potential drawback is that when auditors perceive management’s attitude as indicative of low fraud risk, they may overlook incentive and/or opportunity risks indicative of high fraud risk in overall fraud-risk assessments.

    This study examines two issues related to the decomposition of fraud-risk assessments. First, it investigates whether there is a significant difference in the fraud-risk assessment of auditors who decompose the fraud judgment from that of auditors who merely categorize fraud-risk factors. Second, it examines whether the perceived need to modify the audit plan and the extent of testing in response to the fraud-risk assessment is significantly influenced by the decomposition of the fraud judgment.

    Design/Method/ Approach:

    A total of 60 managers from two of the Big 4 accounting firms in offices throughout Canada and the United States participated in this study. Managers were split evenly over the firms and, on average, had 8.4 years (standard deviation 2.2) of audit experience. The case, using modified WZ materials, was designed to simulate what audit managers review during the planning phase of an audit when assessing fraud risk. The evidence was gathered prior to June 2011.

    Findings:

    The results of this study indicate that auditors who decompose fraud-risk judgments have significantly different fraud-risk assessments than those of auditors who simply categorize fraud cues. When management’s attitude cues are indicative of a low fraud risk, decomposition auditors are significantly more sensitive to changes in incentive and opportunity cues than categorization auditors. Further, auditors who decompose fraud-risk assessments perceive a significantly higher need to revise audit plans and to increase the extent of audit testing.

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment