The effect of an intentional strategy and forming expectations on auditors' identification of fraud risks
Simon, Chad Allan
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Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit, requires auditors to identify their clients’ fraud risks and select procedures to address those risks (AICPA 2002). Fraud-related tasks can be difficult because they require auditors to think and act strategically (Wilks and Zimbelman 2004a). It is therefore unclear whether auditors can effectively identify fraud risks and whether identifying relevant fraud risks is enough to allow auditors to identify procedures that will effectively target fraud. I experimentally investigate ways to help auditors identify relevant fraud risks (i.e., identify the ways management is most likely committing fraud). I also examine whether auditors who identify more relevant fraud risks subsequently identify more relevant audit procedures that target an actual fraud. I find that auditors who are prompted to explicitly link a client’s fraud red flags and analytical procedure results to client management’s goals identify a higher number of relevant fraud risks than auditors who are not prompted to link this information to client management’s goals. The process of linking relevant information to management’s goals is consistent with an “intentional strategy” (Dennett 1987) that can potentially help auditors detect fraud (Johnson et al. 1993). Auditors who are prompted to use this approach also identify a higher percentage of relevant fraud risks (i.e., total relevant risks identified / total risks identified). Next, auditors who identify a higher number of relevant risks subsequently identify more relevant audit procedures and a higher percentage of relevant procedures. In contrast, auditors who identify a higher number of irrelevant risks identify a higher number of irrelevant procedures and a lower percentage of relevant procedures. Taken together, these results show the importance of helping auditors effectively identify the specific ways that management is most likely committing fraud, which is consistent with AICPA (2003) guidance. When auditors are able to identify a higher number of relevant fraud risks, they can then identify a higher number of procedures that target fraud. Finally, I find that auditors who identify a higher percentage of relevant procedures are less likely to consult with a forensic specialist.