Evaluating the Intentionality of Identified Misstatements: How Perspective Can Help Auditors in Distinguishing Errors from Fraud

Abstract

Although auditors are responsible for detecting misstatements arising from either error or fraud, the auditing standards require very different audit responses when a misstatement is believed to be the result of an intentional act (AS No. 14, PCAOB 2010a). Specifically, if auditors suspect intentional misstatement, then they should perform additional audit procedures, reassess overall fraud risk and the integrity of management, and communicate potential concerns to the audit committee. Thus, if auditors fail to recognize and respond to information indicating a misstatement was caused intentionally, then audit quality may be impaired. The objective of this study is to investigate whether auditors who consider the perspective of the manager responsible for a misstatement's occurrence are more sensitive to circumstances indicating the misstatement was intentional. Using an experiment with audit managers and senior managers, I find that auditors who consider the client manager's perspective assess the misstatement as significantly more likely to be intentional when circumstances surrounding it indicate high, as opposed to low, fraud risk. In contrast, auditors who do not consider the client manager's perspective do not assess intentionality any differently, regardless of the level of fraud risk.Keywords: perspective taking; fraud risk; fraud detection; misstatement; audit quality. different audit responses than in the case of an isolated error. According to AS No. 14, when auditors believe that a This paper is based on my dissertation completed at the University of South Carolina. I thank my dissertation chair, Scott Vandervelde, for his time and guidance, and my committee members, Marsha Keune, Brad Tuttle, and Douglas Wedell, for their valuable feedback. I am also very grateful to Joel Owens for his assistance in coding data. I appreciate comments received from 11 The wording of the Perspective Taking manipulation is consistent with perspective-taking studies in psychology, which instruct participants to imagine themselves in another's shoes and consider their own thoughts and feelings under the circumstances facing another (e.g., Davis et al. 1996;Galinsky and Moskowitz 2000;Mallett et al. 2008). 12 Furthermore, studies in psychology suggest that perspective taking is an effortful process, which can be inhibited when there are high demands on one's cognitive resources (e.g., Davis et al. 1996). The present study includes substantially more information for participants to evaluate compared to the typical psychology study. Thus, demands on participants' cognitive resources are likely to be greater.

Research Topics in Accounting Fraud in the 21st Century: A State of the Art

“…Hamilton, 2016 [122] The auditor should take into account the client's perspective when preparing the financial statements if he/she suspects that there is an intentional erroneous statement.…”

Wat wetenschappelijk onderzoek ons leert over de fraude-detectievaardigheid van de controlerend accountant

“…Zo moet de accountant bij een opzettelijke fout, het frauderisico opnieuw overwegen en zo nodig aanvullende werkzaamheden uitvoeren voor reeds uitgevoerde aspecten tijdens de jaarrekeningcontrole. Daarnaast dient de accountant de integriteit van het management te heroverwegen en zorgen hierover met de met governance belaste personen bespreken (Hamilton 2016).…”

External Auditors' Judgment and Decision Making: An Audit Process Task Analysis

“…When auditors are prompted to predict management's perspective/actions, auditors change their audit resources allocation decisions by allocating more resources to the low risk account and maintain the same level of resources to the high risk account, compared to nonprompted auditors. Similarly, Hamilton () finds that in settings of elevated fraud risk, auditors that take the perspective of management increase their assessments that a misstatement was intentional. In contrast, auditors that did not take the perspective of management did not differ in intentionality assessments, regardless of the level of fraud risk.…”