Fraud Risk Judgments Research Articles

Fraud risk judgments performance: The role of audit technology, task structure, and auditor competence

This study aims to examine the factors affecting auditor performance in fraud risk judgment, specifically audit technology, task structure, and auditor competence. It explores the interaction effects of audit technology, task structure, and auditor competence on fraud risk judgments performance. Employing a survey method and partial least square analysis responses from 59 state auditors at the Supreme Audit Agency (BPK) Representative Office in Southeast Sulawesi Province. The results indicate that audit technology, task structure, and auditor competence each have a positive and significant impact on fraud risk judgment performance. However, the combined interaction effect of audit technology, task structure, and auditor competence does not significantly influence fraud risk judgments performance. Given these findings, further investigation is warranted to enhance our understanding of these tasks and to refine audit technology specifications for improved fraud risk evaluation.

The Effects of Tone at the Top and Professional Skepticism on Fraud Risk Judgment Among Internal Auditors in Indonesia

Failure of the internal auditors (IAs) to appropriately apply fraud risk judgment could result in audit failure in revealing fraud and scandals. It leads to significant harmful consequences to the IAs’ profession. In carrying out their duties, IAs sometimes have to face top management pressure. Tone at the top becomes essential in creating an ideal working environment for the IAs. Moreover, the lack of professional skepticism has been one factor causing an auditor’s failure to achieve the optimal result in detecting fraud. The findings from 202 respondents revealed that the IAs who have high professional skepticism are more effective in making fraud risk judgments. However, the direct influence of the tone at the top on fraud risk judgment is not statistically supported. This new finding may help professional regulatory bodies and the internal auditing function consider the profile and its necessary environment to elevate fraud risk judgment to regain public trust in the profession.

Mitigating the Dilution Effect in Auditors' Judgments Using a Frequency Response Mode

ABSTRACT This paper investigates the potential of using a frequency response mode to reduce the dilution effect of non-diagnostic evidence on auditors' fraud risk judgments. In two experiments, we test one hypothesis and examine a research question related to the dilution effect where response mode (frequency versus probability) and type of non-diagnostic or irrelevant information are manipulated between-participants. Results of the hypothesis tests show that auditors' fraud risk judgments demonstrate a significantly lower dilution effect when they evaluate diagnostic and non-diagnostic or irrelevant evidence using a frequency response mode, as compared to the probability response mode; this effect is most pronounced when auditors are provided with favorable non-diagnostic or irrelevant evidence. JEL Classifications: M4; M40; M420. Data Availability: Summary data are available from the authors upon request.

Do fine feathers make a fine bird? The influence of attractiveness on fraud‐risk judgments by internal auditors

Independence and objectivity are key principles assumed to underlie internal auditors' fraud‐risk judgments. However, a substantial body of evidence suggests that physical attractiveness of suspects may influence internal auditors' fraud‐risk judgments. In this experimental study we investigated whether internal auditors are susceptible to appearance‐related biases, or whether they correct for them due to their expertise and motivation. A total of 193 internal auditors were presented a misappropriation‐of‐assets scenario in which the attractiveness of a suspect was manipulated. To determine whether professional expertise is associated with increased resilience to appearance‐related biases, their fraud‐risk judgments were contrasted with those acquired from 240 subjects without auditing experience (“naive subjects”). In line with our predictions, attractiveness modulated naive subjects' fraud‐risk judgments, whereas internal auditors did not show any indication for appearance‐related biases. Our findings suggest that internal auditors' experience and motivation may immunize them to the phenomena of physical attractiveness stereotyping and the attractiveness halo effect.

Client Likeability in Auditor Fraud Risk Judgments: The Mitigating Influence of Task Experience, the Review Process, and a “Consider the Opposite” Strategy

SUMMARY Auditors contend with an array of management personalities during the course of an audit engagement. Some clients by their nature are more likeable, while others create a stressful or unpleasant environment. We summarize two related research studies that examine whether and how a client's likeability influences auditors' fraud likelihood judgments. Results indicate that more likeable (dislikeable) clients cause lower (higher) auditor judgments of fraud likelihood. Results also indicate this bias operates indirectly by influencing the evaluation of evidence statements made by the client that relate to management pressures or attitudes rather than operating as a global bias on all evidence. Requiring an explanation for the judgment mitigates this bias, but only for experienced auditors. For inexperienced auditors and experienced non-audit CPAs, a prompt to “consider the opposite” mitigates the bias. These findings suggest that education and training can clarify relevant and irrelevant evidence cues in fraud judgments.

The Influence of Judgment Decomposition on Auditors' Fraud Risk Assessments: Some Trade-Offs

ABSTRACT Auditing standards recommend separate assessments of the likelihood and magnitude of risks (hereafter, LM decomposition). Prior research shows that decomposition can focus individuals on the components of a judgment and make them more sensitive to information. An experiment with 101 experienced auditors shows that LM decomposition leads auditors to be less concerned about high-risk fraud schemes relative to auditors who make holistic risk assessments. Our analyses also show that, relative to those making holistic risk assessments, the correlation between auditors' likelihood judgments and their overall fraud risk judgments and the coherence of their fraud risk judgments are higher for auditors who perform an LM decomposition. Two follow-up experiments with students replicate these findings for higher-risk events, and (unlike the auditor experiment) we also find that LM decomposition results in lower risk judgments for lower-risk issues. We also find that LM decomposition mitigates the influence of affective responses on high-risk judgments.

Do Fine Feathers Make a Fine Bird? The Influence of Attractiveness on Fraud-Risk Judgments by Internal Auditors

Independence and objectivity are the chief principles assumed to underlie internal auditors’ fraud-risk judgments. However, a substantial body of evidence regarding attractiveness stereotyping and the attractiveness halo effect suggests that physical attractiveness of potential suspects may influence internal auditors’ fraud-risk judgments according to the proverb “what is beautiful is good”. In this seminal inter-disciplinary experimental study we investigated whether internal auditors are susceptible to such appearance-related biases, or whether they correct for them due to their expertise and motivation as suggested by the process model of appearance-based stereotyping. 193 internal auditors were presented a misappropriation-of-assets scenario, in which the attractiveness of a suspect was manipulated. To determine whether professional expertise is associated with increased resilience to appearance-related biases, their fraud-risk judgments were contrasted with those acquired from 240 control subjects with no auditing experience. In line with our predictions attractiveness modulated naive subjects’ fraud-risk judgments, whereas internal auditors did not show any indication for appearance-related biases. Our findings demonstrate that internal auditors’ experience and motivation immunize them to the well-documented phenomena of physical attractiveness stereotyping and the attractiveness halo effect – at least when fraud-risk judgments do not involve face-to-face interactions. We propose a two-step procedure to maximize objectivity of internal auditors’ fraud-risk judgments.

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

This study evaluates how the use of alternative fraud model practice aids affects external auditors’ fraud risk judgments. The extant fraud literature, including professional audit standards, focuses almost exclusively on the fraud triangle model (Cressey, 1973) and its components (i.e., pressure, opportunity, and rationalization) to explain the occurrence of fraud. However, the fraud triangle has not been tested empirically relative to other proposed fraud models designed to address the triangle’s limitations. For example, Wolfe and Hermanson (2004) proposed a fraud diamond model that adds individual “capability” to the fraud triangle as a fourth component reflecting the personal skills and attributes needed to recognize and act on fraud opportunities in an organization. A sample of 89 auditors in public accounting participated in a 2×2 experiment with fraud model practice aid type (fraud triangle or fraud diamond) and CEO risk level (low or high) manipulated randomly between subjects in a fraud risk assessment task. The results indicate a significant fraud model type effect, with auditors evaluating fraud risk factors based on a fraud diamond practice aid providing significantly higher (more conservative) fraud risk assessments than auditors evaluating fraud risk factors based on a fraud triangle practice aid. Subsequent factor analysis provides initial support for a revised fraud triangle that includes pressure, opportunity, and a broader capability dimension (that includes rationalization/attitude) as the three formative components.

Mitigating the Dilution Effect of Non-Diagnostic Information on Auditorss Judgments Using a Frequency Response Mode

This paper investigates the potential of using a frequency response mode to reduce the dilution effect of non-diagnostic evidence on auditors’ fraud risk assessments. We test one hypothesis and examine a research question related to the dilution effect where response mode (frequency vs. probability) and type of non-diagnostic information (neutral vs. favorable vs. unfavorable) are manipulated in a between-subjects experiment with professional auditors as participants. Results of the hypothesis test show that auditors’ fraud risk judgments demonstrate a significantly lower dilution effect when they evaluate diagnostic and non-diagnostic evidence using a frequency response mode, as compared to the probability response mode. This effect is most pronounced when auditors are provided with favorable non-diagnostic evidence.

The Effects of Auditors' Accessibility to “Tone at the Top” Knowledge on Audit Judgments

ABSTRACT: This study examines how external auditors' accessibility to “tone at the top” knowledge impacts subsequent audit judgments. To examine this relationship, a decision aid is investigated that differentially facilitates the auditors' retrieval of “tone at the top” evidence from memory. Results of an experiment indicate that, holding the client's “tone at the top” constant, the structure of a control environment decision aid influences the auditors' mental representation of the “tone at the top.” Further, favorable “tone at the top” mental representations transfer to induce relatively favorable control environment and fraud risk assessments, and greater reliance on management's explanation for variances detected in analytical procedures. Mediation analyses identify the control environment assessment as a mediator between the influenced mental representation and the subsequent fraud risk and analytical procedure judgments. The results of the paper underscore the importance of how auditors develop their “tone at the top” mental representations, the influence of these mental representations on subsequent audit judgments, and the stage in the audit process where interventions can improve audit quality. Data Availability: Contact the author.

Effects of Decomposition and Categorization on Fraud-Risk Assessments

SUMMARY 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. In an experiment with 60 audit managers, auditors who decomposed fraud-risk judgments have significantly different fraud-risk assessments than those of auditors who simply categorized 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. Finally, auditors who decompose fraud-risk assessments perceive a significantly higher need to revise audit plans and to increase the extent of audit testing.

The Effect of Management Incentives and Audit Committee Quality on Internal Auditors' Planning Assessments and Decisions

We examine the sensitivity of internal auditors' fraud risk assessments and audit effort decisions (i.e., budgeted hours) to variations in management's incentives to intentionally misstate their financial position, and in the quality of a firm's audit committee. Internal auditors are an integral part of an organization's monitoring scheme and it is important to understand how, and how well, their judgments are influenced by factors known to be associated with fraudulent financial reporting. We hypothesize that internal auditors' fraud risk judgments and audit effort decisions will vary with management incentives and quality of audit committee, consistent with documented archival evidence and professional prescriptions. The experimental results, based on responses from 60 internal auditors completing a hypothetical case regarding a potential acquisition target, indicate that internal auditors' fraud risk assessments are responsive to management incentives and variations in the quality of the audit committee. Our results also indicate that internal auditors' budgeted audit hours are sensitive to variations in management incentives to misreport financial information, but are not sensitive to variations in audit committee quality. This latter result implies that internal auditors are aware that stronger audit committees decrease the risk of fraudulent financial reporting, but do not use that knowledge to reduce fraud related work. These results generally hold for a second experiment in which another group of internal auditors was asked to complete the same hypothetical case, but rather than evaluating an acquisition target, they made planning judgments for an audit area of the company in which they were employed. Thus, the results generally hold whether the internal auditors are performing due diligence for a possible acquisition or are auditing their own organization where they may have incentives congruent with organization management, and may have familiarity with the audit committee.

Accountability, the Dilution Effect, and Conservatism in Auditors' Fraud Judgments

This paper investigates the effects on auditors' judgments of being held accountable to superiors in their firm. The specific audit judgment task studied is fraud risk assessment in the presence of both relevant and irrelevant information. Although auditors routinely encounter both relevant and irrelevant information when assessing the risk of fraud, normatively, only the former should affect their judgments. However, prior research (Hackenbrack [1992]) has demonstrated that auditors' fraud risk judgments are influenced by irrelevant information; i.e., they are subject to the dilution effect (Nisbett, Zukier, and Lumley [1981]). Following Tetlock and Boettger [1989], recent auditing research (Messier and Quilliam [1992] and Hackenbrack [1992]) suggests that holding auditors accountable for theirjudgments will exacerbate the dilution effect,

The Relationship Between Materiality Thresholds and Judgments of Fraud Risk

Researchers and practitioners have long debated the arguments in favor of and against providing specific mathematical materiality guidelines in auditing standards. Yet, there is little empirical evidence about the relationship between materiality thresholds and audit risk judgments in the absence of such guidelines. In this study, 152 Big Six managers evaluated materiality and risk for an audit simulation based on an actual case where material fraud was undetected. The auditor subjects were allowed to choose the evidence they would examine before reaching a decision. The major findings of the study are that while auditor materiality judgments differ, these differences were not statistically significantly related to either fraud risk judgments or the amount of evidence the auditors chose to examine before rendering their judgments. This empirical evidence does not support the need for specific quantitative guidance in accounting standards related to materiality. However, other considerations (such as concern for legal liability) could also have an impact on the advisability of providing specific quantitative guidance for setting materiality thresholds.