Effective methods for detecting fraudulent financial reporting: practical insights from Big 4 auditors

Abstract

PurposeUsing a qualitative grounded theory approach, this study explores the methods experienced external auditors use to detect fraudulent financial reporting (FFR) during standard audits.Design/methodology/approachSemi-structured interviews were conducted with 24 experienced external auditors to explore the methods they used to detect FFR successfully during standard external audits.FindingsThe authors find 58 methods used for FFR detection, out of which the following methods are frequently used and help in detecting more than one type of FFR: (1) specific analytical procedures, (2) positive confirmation, (3) understanding of the client's business and industry, (4) the inspection of specific documents, (5) a detailed analysis of the audit client's anti-fraud controls and (6) investigating tip-offs from suppliers, employees and customers.Research limitations/implicationsBased on the grounded theory approach, the authors theorise that auditors must return to the basics and focus on specific audit procedures highlighted in this study for effective fraud detection.Practical implicationsThe study provides practical guidance, including 58 methods used in audit practice to detect FFR. This knowledge can improve auditors' skills in detecting material misstatements due to fraud. Besides, analytical procedures and positive confirmation helped external auditors in this study detect all forms of FFR, yet they are overlooked in the external audit practice. Therefore, audit firms should emphasise the significance of these audit procedures in their professional audit training programmes. Audit regulators should advise auditors to consider positive confirmation instead of negative confirmation in financial audits to increase the likelihood of FFR detection. Moreover, audit standards (ISA 240 and SAS 99) should explicitly require auditors to conduct a detailed analysis of the client's anti-fraud controls.Originality/valueThis is the first study to identify actual, effective methods used by external auditors in detecting FFR during the ordinary course of an audit.