Internal Audit Planning in an Interactive Environment.

Abstract The prevention and detection of resource misappropriation is addressed within a game theoretic model of the internal audit resource allocation problem. This model is used to demonstrate the potential impact of viewing the audit planning problem as a conflict between two strategic actors. Recognizing the multi-person nature of auditing, the auditee and auditor are permitted to endogenously form beliefs about (i.e., anticipate) the other's actions. The importance then to the auditor of being unpredictable becomes apparent within the model. The strategic auditor exploits the interactive nature of the audit setting so as not only to detect, but prevent the occurrence of misappropriations. We show how this strategic approach leads to fundamentally different allocations of resources than those that are arrived at using approaches popular in the internal audit literature. In particular, optimal strategies in an interactive setting may require that identical units receive different allocations of audit resources.