Decomposition of Fraud‐Risk Assessments and Auditors' Sensitivity to Fraud Cues*

Abstract

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.

Corporate Fraud and Managers’ Behavior: Evidence from the Press

“…Jeffrey Cohen et al (Wilks and Zimbelman, 2004) or, in short, the fraud triangle. These elements were first identified by Sutherland (1949) and developed by Cressey (1953, p. 30).…”

The effect of alternative fraud model use on auditors’ fraud risk judgments

“…Finally, although the empirical fraud literature reflects strong interest in understanding and improving auditors' fraud-related judgments (e.g., Asare and Wright, 2004;Wilks and Zimbelman, 2004;Carpenter, 2007;Hogan et al, 2008;Kochetova-Kozloski et al, 2011;Johnson et al, 2013;Trompeter et al, 2013), it reflects an almost exclusive focus on the fraud triangle as a basis for evaluating auditor fraud detection performance.…”

“…Given the importance of top management fraud risk (Bell and Carcello, 2000;Wilks and Zimbelman, 2004;Beasley et al, 2010;Norman et al, 2010), we manipulate CEO risk level (high or low) to evaluate the extent that fraud model effects depend on the level of top management risk at the client.…”

Different Approaches to Fraud Risk Assessment and Their Implications on Audit Planning

“…In the decomposition fraud risk assessment method, besides the traditional audit risk assessment model, the fraud risk is broken down into sub elements of the fraud triangle; the risk of incentives or pressure, the risk of rationalization or attitude, and finally the risk of opportunities to commit fraud (Wilks and Zimbelman, 2004;Favere-Marchesi, 2013). Srivastava et al (2009) proposed a further consideration in addition to the three previously mentioned components of the fraud triangle.…”

“…On the other hand, the decomposition approach requires less cognitive effort than the holistic decision. Wilks and Zimbelman (2004) examined how the fraudtriangle decomposition affects overall fraud risk assessment. Instead of using long standardized fraud checklists, they recommended to split the risk assessment along the components of the fraud-triangle.…”