WHY DO AUDITORS FAIL TO
DETECT FRAUD?
©Stephen Kwaku Asare, University of Florida
The views expressed in these slides are solely the views of the presenters and do not necessarily reflect the views of the PCAOB, the members of the Board, or the Board's staff.
The PCAOB makes no representation as to the accuracy or completeness of this information.
Overview
Knowledge,
Training and
4-Factor Experience Practical Tips Consultation Dual
Framework needed for Strategy
Fraud
Detection
4-Factor Framework
The audit • the methodology employed to search for and detect
process fraud.
Institutional • includes the regulatory and legal environment
forces
Auditor • include the financial and retention pressures faced by
incentives the auditor
• includes the auditors’ cumulative fraud knowledge
Auditors’ KTE and experience acquired through both formal and
informal learning.
4-Factor Framework
4-Factor Framework
In a recent study, we obtain experiential based
evidence on why auditors rarely detect frauds
from fraud examiners (Asare, Wright and
Zimmerman 2014, JFIA).
• Fraud examiners routinely make causal attributions for an audit
failure that they are investigating, which requires them to focus
• on the effectiveness of the audit process,
• the adequacy of the auditors’ fraud knowledge or training,
• the extent to which an auditor following audit standards could
have detected the fraud and
• the role of auditors’ incentives.
4-Factor Framework
Audit Process
• failing to effectively assess management’s incentives and opportunities;
• Failing to sufficiently modify audit tests as the primary drivers of audit
failures.
Knowledge, training and experience
• Insufficient or Inadequate training;
• Lack knowledge of fraud schemes; and
• Undue trust in management.
Institutional Factors
• They perceive GAAS audits as not sufficiently focused on detecting fraud,
as the primary institutional inhibitor of fraud detection.
Knowledge Training and Experience
Auditors are not effectively trained to detect or recognize fraud.
• One expert noted that fact patterns suggesting that fraud exists (i.e., fraud schemes) are
unfamiliar to many auditors because they have not been trained in this area and because
fraud is a rare event.
Auditors’ lack training in fraud detection methods or fraud investigation
techniques.
Auditors are in constant interactions with management and may develop trust
schema that interfere with their ability to effectively process fraud cues.
• While professional standards highlight the importance of professional skepticism, neither
those standards nor the academic literature have paid adequate attention to the hurdles
inherent in being skeptical of those with whom auditors regularly interact.
KTE needed for Fraud Detection
Understand the The way that Frequency of
conditions that frauds are occurrence of
allow fraud to perpetrated fraud schemes by
occur (fraud schemes) client type
Cues that signal How fraud How fraudsters
that such a schemes reflect in respond to audit
scheme is the financial inquiries
operating reporting process
How to test
hypotheses on How to conduct
various fraud fraud interviews
schemes
Acquiring Fraud KTE
While experience is the best teacher, auditors’
experience seldom teach them fraud detection skills
Formal education and continuing professional education
provide the avenue to acquire fraud knowledge
Alas, most auditing curricula around the country do not
focus enough on providing fraud knowledge
Practical Tips: What Will Not Help
More Skepticism
Detailed Kumbaya
Testing
Fraud
Analysis as
an Oral Auditing
afterthought
or an add on
Practical Tips: What Might Help
Strategic Risk Assessment (ability to identify when companies are in stressful situations)
Better Analytics (better integration of operating data)
Pattern Recognition (anti-line auditing)
Big Data (DNA Coding)
During Interaction Phase
• Are auditors outgunned?
• Victims of past misses (blackmailed?)
• Garden Path
• Verbal and Non-Verbal cues
Consultation
Transform audit engagements to involve forensic specialists
Creates a new work arrangement where the auditor is reliant on
a secondary layer of expertise to fulfill a primary responsibility
while still retaining overall responsibility for the audit outcome
What task sharing, communication and coordination issues arise
in this new work arrangement (Asare and Wright 2014)?
Consultation: Some Preliminary Findings
Forensic specialists’ role in this work arrangement is to clarify how
fraudulent transactions occur, identify idiosyncratic fraud risk and
perform unique fraud procedures (such as document authentication
and entity verification).
There is disagreement among auditors as to whether forensic
specialists should be involved on all audit engagements.
• While some auditors think it is comforting to have the forensic specialist validate
their work, even if it leads to no changes in risks or audit procedures, others think
such required consultations exacerbate the “wild goose chase” effect.
• Nevertheless, current practice appears to require consultation in some target
situations, including incidence of restatements, suspected fraud or scheduled
consultation (e.g., triennially for some public clients).
Consultation: Some Preliminary Findings
The most significant challenges arise in the work arrangement when
the forensic specialists’ task is not targeted or when there is unintended
communication between the forensic specialists and the client
personnel.
auditors and forensic specialists sometimes disagree on what
constitutes immaterial fraud risk, leading to what auditors refer to as
“scope creep” or “wild goose chase.”
There is also the lurking danger that auditors could use the supervisory
controls to direct the forensic specialists to adopt a more client
perspective, with the concomitant erosion in their forensic mindset.
Dual Fraud Reduction Strategy
15
For Clients For Auditors
Make it less likely for
clients to produce Make it more likely for auditors
to design audits that have a
fraudulent preaudit high probability of detecting
financial statements intentional misstatements
Make it more likely for auditors
Make it less likely for to resist client pressure not to
clients to pressure auditor probe and report questionable
to allow biased reporting transactions
