Cognitive Effects of Decomposition on Fraud-Risk Assessments

Abstract

Regulators and the audit profession have always been concerned that auditors may unduly place a strong emphasis on management's attitude or character cues that indicate a low fraud risk to the detriment of opportunity and incentive cues that may be a sign of high fraud risk, and thus assess a lower overall fraud-risk than warranted. This study examines whether decomposing the assessment of fraud can lead to an increased sensitivity in incentive and opportunity risks in comparison to the categorization elicited by the standards. This study also examines what impact decomposition has on fraud-risk assessments when attitude cues indicate high fraud-risk and whether the decision to modify the audit plan and the extent of testing in response to the fraud risk assessment is significantly influenced by a decomposition of the fraud judgment.In an experiment with 90 audit managers, auditors who decompose fraud assessments are significantly more sensitive to variations in incentive and opportunity risks than auditors who only categorize fraud-risk factors. This increased sensitivity is observed in both low and high risk settings. Further, auditor's sensitivity to changes in incentive and opportunity risks are even more heightened when fraud-risk factors related to management's attitude reflect a high risk environment. Finally, auditors who assess fraud with decomposition significantly perceive a higher need to revise audit plans and increase the extent of audit testing than do auditors who make categorization judgments alone.