2。2。Fraud assessment practices

Reviewing key procedures and interviewing audit firm personnel to ascertain how they institutionalized procedures to assess and detect fraud (e。g。, implement the provisions of SAS No。 82), some researchers have analyzed common factors among the clients and their auditors。 Eining et al。 (1997, p。 16) found that “expert systems” help auditors better understand situations entailing varying levels of management fraud risk to develop better subsequent decisions regarding appropriate audit actions。 Bell and Carcello (2000)  used a sample of 77 fraud and 305 non-fraud engagements to develop a logistic regression model to estimate the likelihood of fraudulent financial reporting。 Using the presence (or absence) of such fraud-risk cues as weak internal control, emphasis on meeting earnings, and evasive management, their model was significantly more accurate than a sample of practicing auditors in assessing risk for the 77 fraud observations。 However, the model’s risk assessments for the non-fraud cases were not significantly different from those of the practicing auditors。

Interviewing firm personnel and compared audit manuals and practice aids and from all Big 5 and two second-tier accounting firms regarding their fraud assessment practices, Shelton and Whittington (2001) found that they all sought to incorporate SAS No。 82’s red flag and other provisions into their methodologies, but differed on whether they separated or integrated these procedures with other audit practice aids。 Differences also arose between the firms on when and how they made fraud risk assessments。 Beasley et al。 (2001) reviewed the engagements of alleged SEC audit deficiencies。 As detailed in the 2000 AICPA   ASB

report, “Fraud-Related SEC Enforcement Actions Against Auditors: 1987–1997,” the most common problems were gathering inadequate evidence (80% of the cases); not exercising due professional care (71%); not maintaining an attitude of professional skepticism (60%); not applying GAAP correctly (about 50%); and deficiencies in audit planning (44%)。 Other often cited problems include over-reliance on inquiry, not corroborating management ex- planations, not questioning significant management estimates, deficiencies in confirming receivables, and not recognizing related parties。 Andersen demonstrated many of the above shortcomings in its dealings with Enron。

Enron reveals some of Andersen’s major flaws in their methods of assessing fraud and audit risk, including letting local partners and offices overrule objections from their corporate office assessments of assumed levels of audit risk。 Moreover, Andersen’s lack of clarity and misapplication of its document retention and shredding policies in large measure led to its criminal Obstruction of Justice conviction。

2。3。Fraud recognition theories

Many researchers have asserted that even the use of the most comprehensive set of red flags is insufficient to ensure the detection of financial fraud because auditors often fail to consider such cues within the context of the client’s unique economic and business en- vironment。 They argue that reactive strategies based on past history and experiences do not provide auditors with the forward, predictive approach necessary to detect and defer management from engaging in financial manipulations in today’s dynamic and competi- tive business setting。 For example, the proliferation of stock options as the major form of compensation and the implementation of company-wide ERP systems have opened up new areas vulnerable to management’s inappropriate and self-serving actions。

Matsumura and Tucker’s (1992) experiment supported a direct relationship among fraud prevention, testing and fraud detection。 They found that increasing the auditor’s penalty de- creased fraud, increased detailed tests of balances, and increased fraud detection。 Increasing testing requirements increased audit costs, decreased discretionary testing, increased fraud detection, and decreased fraud occurrence。 With strong internal control, auditors increased tests of transactions and detected fraud more frequently。 Consistent with implications drawn from the professional literature, increasing audit fees resulted in less fraud and more tests of transactions。