Efficient Committed Budget for Implementing Target Audit Probability for Many Inspectees

Abstract

Abstract. Strategic models of auditor-inspectee interaction have neglected implementation details in multiple-inspectee settings. With multiple inspectees, the target audit probability derived from the standard analysis can be implemented with sampling plans differing in the budgets committed to support them. Overly-committed audit budgets tie up unneeded resources that could have been allocated for better uses. This paper studies the minimum committed budget required to implement a target audit probability when (i) the audit sample can be contingent on "red flags" due to signals of inspectees' private information (e.g., from self-reporting) and (ii) the number of inspectees is large. It proposes an audit rule called bounded simple random sampling (SRS), which is shown to require no more committed budget to support than two other rules naturally generalized from the one-to-one analysis. When the number of inspectees is large enough, bounded SRS is nearly as good as any efficient audit rule, which demands the lowest committed budget necessary to implement the target audit probability. The results offer insights on how audit sampling plans may be formulated to reduce inefficiency and what budget usage ratios should be expected accordingly. (JEL H26, M42, H72, C72, K34) KEYWORDS: Audit sampling plan, audit budget, tax audit, tax compliance, tax evasion, inspection game, appropriation and rescission.Author's Contacts. Postal: Department of Accountancy, Tilburg University, Warandelaan 2, 5037 AB Tilburg, The Netherlands. Phone: +31 13 466-2489. Fax: +31 13 466-8001. E-mail: andrew.yim@aya.yale.edu .Electronic copy available at: http://ssrn.com/abstract=1401910 Electronic copy available at: http://ssrn.com/abstract=1401910EFFICIENT COMMITTED BUDGET FOR IMPLEMENTING TARGET AUDIT PROBABILITY FOR MANY INSPECTEESAbstract. Strategic models of auditor-inspectee interaction have neglected implementation details in multiple-inspectee settings. With multiple inspectees, the target audit probability derived from the standard analysis can be implemented with sampling plans differing in the budgets committed to support them. Overly-committed audit budgets tie up unneeded resources that could have been allocated for better uses. This paper studies the minimum committed budget required to implement a target audit probability when (i) the audit sample can be contingent on "red flags" due to signals of inspectees' private information (e.g., from self-reporting) and (ii) the number of inspectees is large. It proposes an audit rule called bounded simple random sampling (SRS), which is shown to require no more committed budget to support than two other rules naturally generalized from the one-to-one analysis. When the number of inspectees is large enough, bounded SRS is nearly as good as any efficient audit rule, which demands the lowest committed budget necessary to implement the target audit probability. The results offer insights on how audit sampling plans may be formulated to reduce inefficiency and what budget usage ratios should ...

A Robust Unsupervised Method for Fraud Rate Estimation

“…As it would be cost prohibitive to audit every case for suspiciousness, an optimal “red‐flag” type of auditing strategy is often employed (cf. Dionne, Giuliano, and Picard, 2009; Yim, 2009; Tennyson and Salsas‐Fom, 2002) necessitating an “initial‐screening” sampling process as part of standard business practices. This auditing practice is at high risk of generating a biased sample overrepresenting suspicious cases.…”

Can Strategic Uncertainty Help Deter Tax Evasion? An Experiment on Auditing Rules

“…Such a binary-income setting, or similar discrete-type extensions, are used in many studies (e.g.,Mills and Sansing (2000),Alm and McKee (2004), and some others cited in footnote 4 ofYim (2009)). …”

“…The idea of the bounded rule (i.e., examining up to some …xed number of audits) was …rst studied in a theory paper by Yim (2009). In that paper, the tax authority interacts strategically with taxpayers by choosing an audit capacity without openly committing to it before taxpayers make their reporting choices.…”

“…The reason is that any o¤-equilibrium decisions by subjects taking the tax authority's role will have unpredictable impacts on others taking the taxpayer role, leading to unmanageable complications in comparing the treatment results. Therefore, our experiment is not a strict test of Yim (2009).…”