No abstract

This study examines whether auditors can effectively use nonfinancial measures (NFMs) to assess the reasonableness of financial performance and, thereby, help detect financial statement fraud (hereafter, fraud). If auditors or other interested parties (e.g., directors, lenders, investors, or regulators) can identify NFMs (e.g., facilities growth) that are correlated with financial measures (e.g., revenue growth), inconsistent patterns between the NFMs and financial measures can be used to detect firms with high fraud risk. We find that the difference between financial and nonfinancial performance is significantly greater for firms that committed fraud than for their nonfraud competitors. We also find that this difference is a significant fraud indicator when included in a model containing variables that have previously been linked to the likelihood of fraud. Overall, our results provide empirical evidence suggesting that NFMs can be effectively used to assess fraud risk.

Practitioners and regulators are concerned that when auditors perceive management's attitude or character as indicative of low fraud risk, they are not sufficiently sensitive to high levels of incentive or opportunity risks in their overall fraud‐risk assessments. In this study, we examine whether a fraud‐triangle decomposition of fraud‐risk assessments (that is, separately assessing attitude, opportunity, and incentive risks prior to assessing overall fraud risk) increases auditors' sensitivity to opportunity and incentive cues when perceptions of management's attitude suggest low fraud risk. In an experiment with 52 practicing audit managers, we find that auditors who decompose fraud‐risk assessments are more sensitive to opportunity and incentive cues when making their overall assessments than auditors who simply make an overall fraud‐risk assessment. However, this increased sensitivity to opportunity and incentive cues appears to happen only when those cues suggest low fraud risk. When opportunity and incentive cues suggest high fraud risk, auditors are equally sensitive to those cues whether they use a decomposition or a holistic approach. We discuss and examine potential explanations for this finding.

No abstract

This commentary examines academic research that can assist auditors in detecting and preventing fraudulent financial reporting. We review theoretical and empirical research from game theory, social psychology, judgment and decision making, and auditing to identify improvements in audit practice and promising areas for future research. This review focuses on the strategic fraud setting and suggests modifications in auditing standards that should facilitate auditors' use of strategic reasoning in this setting. We emphasize three critical audit tasks—fraud risk assessment, audit planning, and audit plan implementation—and recommend changes to current auditing standards and identify potential research questions for each task.