Abstract No company, regardless of size or business, is immune to fraudulent financial reporting. The inescapable fact is that normal business activities introduce incentives and opportunities that can lead to fraudulent financial reporting (Treadway 1987). SAS No. 53 (AICPA 1988a) states that the auditor has the responsibility to plan the audit to provide reasonable assurance that the financial statements do not contain material irregularities. This paper reports the results of two studies wherein practicing auditors assessed the risk of fraudulent financial reporting associated with certain indicators (sometimes called red-flags). In the first study, 21 auditors with three years' experience indicated the extent to which 16 independent fraud-related situations would increase a company's exposure to fraudulent financial reporting. There was substantial disagreement about the amount of fraud-risk associated with the situations presented. The second study investigates one source of the disagreement (experience with different sized clients) observed in study one. Thirty-two auditors with three years' experience rated the relative fraud-risk indicated by eight of the 16 situations used in study one. Four of the situations were incentives to commit fraudulent financial reporting and four were opportunities that allow such frauds to occur. The auditors assigned predominantly to the audits of large companies placed more emphasis on the opportunities than the auditors assigned predominantly to the audits of small companies. Reasons cited for this result relate to the differences in control structures between large and small companies and the effect such differences have on auditor perceptions of the importance of opportunities when making fraud-risk assessments. The results add to the understanding of how audit experiences influence audit judgment and have implications for the design of fraud-risk engagement tools, assignment of audit personnel, and audit staff training.
Karl Hackenbrack (Mon,) studied this question.