auditor mindsets and fraud judgment
TRANSCRIPT
Amsterdam Business School
Auditor Mindsets and Fraud Judgment
Master thesis
Name: Thomas Laarman
Student number: 10267166
Thesis supervisor: Prof. dr. V. Maas
Date: August 15, 2016
Word count: 18.244
MSc Accountancy & Control, specialization [Accountancy]
Faculty of Economics and Business, University of Amsterdam
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Statement of Originality
This document is written by student Thomas Laarman who declares to take full responsibility
for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources
other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion
of the work, not for the contents.
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Abstract
The effectiveness of tools that auditors use for assessing fraud risk varies significantly, and this
variation impacts their fraud judgments. This is an alarming observation since it is expected that
in the future the importance of fraud in financial statements will increase relative to error.
Therefore, this thesis investigates whether the effectiveness of tools used by auditors to assess
fraud risk can be improved using mindset theory. Using an experiment, this thesis tests whether
it is beneficial for auditors to change from the current mindset they use when assessing fraud risk
(an implemental mindset) to a potential desirable mindset (a deliberative mindset). The advantage
of the deliberative mindset is that it fosters a broader focus of attention than the implemental
mindset. Furthermore, it promotes the impartial processing of information. Hence, this thesis
expects that a deliberative mindset improves auditors’ fraud judgments. Since the results of this
study provide no support for this expectation, it is suggested that mindset theory is not effective
in improving auditors’ fraud judgments.
Key words: auditors’ mindsets, fraud judgment, fraud risk assessment, SAS No. 99, fraud
checklists.
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Acknowledgements
First of all, I would like to thank prof. dr. V. Maas for the support and feedback on my thesis. I
would also like to thank dr. ir. S. van Triest for providing additional feedback. Lastly, I would
like to thank my family for their mental support.
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Contents
1 Introduction ...................................................................................................................... 7
2 Theoretical background and hypothesis development ................................................... 11
2.1 Fraud.......................................................................................................................... 11
2.1.1 Characteristics of fraud .......................................................................................................... 11
2.1.2 Types of fraud ......................................................................................................................... 12
2.1.3 Fraud triangle .......................................................................................................................... 12
2.1.3.1 Attitude .................................................................................................................................. 14
2.1.3.2 Incentive .................................................................................................................................. 16
2.1.3.3 Opportunity .............................................................................................................................. 18
2.1.4 Summary .................................................................................................................................. 20
2.2 SAS No. 99: Consideration of fraud in a financial statement audit .......................... 21
2.2.1 The role of the auditor .......................................................................................................... 21
2.2.2 Fraud risk assessment tools .................................................................................................. 22
2.2.2.1 Inquiries .................................................................................................................................. 23
2.2.2.2 Analytical procedures .................................................................................................................. 23
2.2.2.3 Fraud checklists ......................................................................................................................... 24
2.2.2.4 Brainstorming ........................................................................................................................... 25
2.2.3 Summary .................................................................................................................................. 26
2.3 Mindsets ................................................................................................................... 27
2.3.1 Characteristics ......................................................................................................................... 27
2.3.2 Implemental mindset, deliberative mindset and hypothesis ............................................ 28
3 Research Methodology ................................................................................................... 30
3.1 Experimental design ................................................................................................ 30
3.2 Sample and procedures ............................................................................................ 30
3.3 Case materials and measures ................................................................................... 32
3.4 Manipulation and variables ...................................................................................... 32
4 Results ............................................................................................................................. 34
4.1 Preliminary analyses ................................................................................................. 34
4.1.1 Variables .................................................................................................................................. 34
4.1.2 Descriptive statistics............................................................................................................... 35
4.1.3 Manipulation evaluation ........................................................................................................ 37
4.2 Hypothesis testing ................................................................................................... 39
4.2.1 Auditor’s mindsets ................................................................................................................. 39
4.3 Additional analyses .................................................................................................. 40
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4.3.1 Regression analysis with interactions................................................................................... 40
4.3.2 Reduced sample test ............................................................................................................... 40
5 Conclusion ...................................................................................................................... 42
References.......................................................................................................................... 44
Appendix 1: Questionnaire Deliberative mindset ............................................................. 48
Appendix 2: Questionnaire Implemental mindset ............................................................ 53
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1 Introduction
From the past, the audit profession has learned how disastrous fraud can be with the collapse of
Arthur Andersen, a firm which once constituted the then Big Five audit firms. In October 2001,
fraud was discovered at a client of Arthur Andersen, namely Enron, a large American energy,
natural resources, and services company. Two months later in December 2001, Enron
succumbed to the effects of the scandal and went bankrupt. Immediately after discovery of the
Enron scandal, Arthur Andersen was investigated for its performance regarding Enron’s
financial statements as well as its suspected role in the scandal. As a result, the audit firm was
convicted in June 2002 of obstruction of justice for destroying Enron related documents in
shredders. This conviction led to the downfall of Arthur Andersen in mid-2002; this downfall
was also brought about by the impact of the scandal and proof of felonious complicity of two
managers of the audit firm, namely Nancy Temple and David Duncan who initiated the
destruction of Enron related documents. In May 2005, the Supreme Court of the United States
decided to reverse the conviction of Arthur Andersen of obstruction of justice, but this came too
late for the audit firm.
The fraud at Enron is only one of the many scandals that have been uncovered in the
early 21st century. All these scandals point to an observation that current accounting and audit
laws and regulations are inadequate. In order to prevent future scandals from occurring, the
aforementioned laws and regulations needed to be rigorously altered. In an attempt to achieve
this objective, the Sarbanes-Oxley Act of 2002 was introduced; this act is an American law that
renews or extends current laws and regulations for all American listed company boards,
management and the audit firms auditing the financial statements of these companies. Also, the
American Institute of Certified Public Accountants (AICPA) introduced the Statement on
Auditing Standards number 99 (SAS No. 99) entitled Consideration of Fraud in a Financial
Statement Audit, and it has been effective from October 2002. The SAS No. 99 and other
standards relating to fraud should be taken very seriously by auditors because fraud detection
and deterrence is a crucial part of an audit (Elliot, 2002; Griffith et al., 2015; Wilks &
Zimbelman, 2004). Moreover, annual reports can now be prepared more reliably due to
innovations in information technology; as a result, the importance of fraud detection in an audit
will increase relative to error detection (Elliot, 2002). On the whole, it can be seen that fraud in
financial statements is a highly important issue that may become even more important in the
foreseeable future. However, the current literature provides mixed results about the effectiveness
of mandatory tools auditors currently use to assess fraud risk.
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In response to this alarming observation, this study aims to expand the current body of
research literature by investigating whether the effectiveness of current tools used for fraud risk
assessments—which are incorporated in SAS No. 99—can be enhanced using mindset theory. A
recent study by Griffith et al. (2015) showed that mindset theory does indeed play an important
role in audits. Their study discovered evidence that a change in mindset can improve auditors’
evaluation of complex estimates (Griffith et al., 2015). Therefore, this thesis uses mindset theory
to determine whether this could also be beneficial in another part of the audit—assessing fraud
risk.
A mindset can be defined as a set of mental processes that establish a general
preparedness to react in a certain way (Freitas et al., 2004; Gollwitzer, 1990). There are two key
characteristics of a mindset: (a) it fosters orientations that are not related to a specific task and
(b) it stays active once it is activated, even after the completion of the original task (Hamilton et
al., 2011). The consequence of the second characteristic is that a mindset affects subsequent and
also separate tasks (Hamilton et al., 2011).
In this thesis, two mindsets—a deliberative mindset and an implemental mindset—are tested to
examine whether a change in mindset leads to a significantly different fraud risk judgment. A
deliberative mindset can be interpreted as mental procedures concerning how a person selects
one goal over other goal alternatives that are available to that person (Gollwitzer et al., 1990). By
contrast, an implemental mindset can be viewed as the steps a person has to take to achieve a
selected goal (Gollwitzer et al., 1990). In other words, a deliberative mindset consists of
procedures focused on analysing and weighing advantages and disadvantages, and an
implemental mindset consists of procedures focused on the timing and sequence of steps that
need to be taken (Gollwitzer et al., 1990). Currently, it is most likely that auditors will adopt a
mindset close to the implemental mindset because assessing fraud risk involves performing the
steps required by the Auditing Standards. However, a deliberative mindset might be more
beneficial to auditors because assessing fraud risk is a unique process in which it is not only
crucial to follow the steps required by the Auditing Standards but also to remain open to
information beyond the steps. A deliberative mindset enlarges the openness of a person’s mind
to incidentally provided information (Gollwitzer & Bayer, 1999; Fujita et al., 2007), and adopting
this mindset could result in the value of the information being evaluated in a better way
(Beckman & Gollwitzer, 1987). Hence, the hypothesis of this thesis is that auditors adopting a
deliberative mindset will judge fraud to be more likely than auditors adopting an implemental
mindset.
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To test this hypothesis, a case-based experiment was carried out in this study. A total of 36
auditors participated in the experiment; they are from one of the Big Four audit firms that
operate in the Netherlands. All participants completed a questionnaire where they are asked to
read a case of a fictitious audit client and a related fraud risk factor checklist completed by a
senior. Subsequently, the participants are asked to provide their judgment about the risk of
material misstatement in the financial statements due to fraud. Before reading this information
and providing a judgment, the participants were first asked to read a different case about a
potential client, a listed construction company that is obliged under Dutch law to choose a new
audit firm for their statutory audit for next year. The participants are asked to imagine that they
work for a Big Four audit firm as an auditor, and that their firm is considering writing a proposal
to win the construction company. After reading the case, one half of the participants are asked to
list three advantages and disadvantages in winning the construction company, and the other half
are asked to list six steps they would take in their attempt to win the construction company. This
was the variable that was manipulated in the experiment; the pros and cons question is used for
activating a deliberative mindset, while the required steps question is used for activating an
implemental mindset.
The results of the experiment provide no support for the expectation of this thesis.
Using a deliberative mindset instead of an implemental mindset does not result in higher fraud
judgments. This implies that mindset theory is not effective in enhancing the effectiveness of
fraud checklists. The findings of this thesis extend the literature in two ways and may be
interesting to both researchers and standard setters. First, the findings suggest that the use of
mindset theory is not effective in enhancing the effectiveness of mandatory tools to assess fraud
risk incorporated in SAS No. 99. Second, the findings of this thesis are inconsistent with the
findings of Griffith et al. (2015). Whereas they do find evidence in their study that suggests
mindset theory is useful in audits, this study finds no evidence. This shows that the usefulness of
mindset theory depends on the task performed in the audit. Therefore, standard setters who are
considering to implement new mindset regulations in specific auditing standards should be
careful when implementing such regulations.
This thesis is subject to several limitations, which could potentially affect the
contributions of the findings. First, the auditors who participated in the experiment all work for
the same Big Four audit firm at one location. These factors may have affected the answers
provided by the participants. Consequently, the generalization of the results is limited. Second,
the use of an already completed fraud checklist in the experiment may also have influenced the
results. Third, the participant’s total time for completing the experiment was not measured.
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Therefore, it remains unclear whether participants in one mindset sample spent significantly
more time on the experiment than participants in the other mindset sample.
This thesis is structured as follows. Chapter 2 provides theoretical background by reviewing
relevant literature about fraud and mindsets, followed by a development of the hypothesis.
Chapter 3 elaborates on the research methodology used in this thesis, while Chapter 4 describes
the results from the case-based experiment. Lastly, Chapter 5 includes a discussion of the
conclusion and the limitations of the study; the chapter also provides directions for future
research.
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2 Theoretical background and hypothesis development
2.1 Fraud
This section explains the concept of fraud using SAS No. 99 and relevant literature. In particular,
this section sheds light on the characteristics of fraud, the types of fraud and the occurrence of
fraud using the fraud triangle.
2.1.1 Characteristics of fraud
Each year companies are required to issue an annual report, which is a report regarding the
company’s activities and position. Usually, this report consists of four financial statements,
including a balance sheet, an income statement, a statement of changes in equity and a cash flow
statement. In addition to these financial statements, the annual report contains a management
discussion and analysis. To minimize the risk of having deviation in the report, companies are
obliged by law to hire an audit firm to audit their annual report. In the event that a company’s
financial statements contain a deviation, this can be due to error or fraud. The basic principle for
evaluating whether a deviation is the result of error or fraud depends on whether the action
which causes a deviation is unintentional or intentional (AICPA, 2002, p. 1721). The AICPA
(2002, p. 1721) states that “fraud is an intentional act that results in a material misstatement in
financial statements that are subject of an audit”. Alternatively, the Dutch institute for auditors
defines fraud as an intentional act or negligence to act involving deception in order to obtain an
advantage, and of which the extent is of such a magnitude that the decisions made based on the
financial statements can be influenced by this deception (NBA, 2010, p. 386). Fraud can be
committed by one or multiple members of management, those charged with governance,
employees or third parties (NBA, 2016).
Although the definition of fraud by the two institutes differs in terms of precision, the
core of both definitions is quite similar. Based on both definitions, this study defines fraud to be
an intentional act by one or multiple individuals involving deception and this act results in a
material misstatement in financial statements that are subject to audit. In this definition, a
material misstatement refers to a misstatement that can influence the decisions made based on
the financial statements, and fraud risk refers to the risk that the financial statements are
materially misstated due to fraud.
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2.1.2 Types of fraud
Two types of misstatements due to fraud are of interest to an auditor when conducting an audit.
Both misstatements result in financial statements that are not presented in all material respects,
in accordance with generally accepted accounting principles (GAAP) (AICPA, 2002, p. 1722).
The first type of misstatement is a material deviation arising from fraudulent financial reporting
(NBA, 2010, p. 391). This type of fraud consists of intentional inaccuracies, deletion of
amounts, or disclosures in the financial statements (AICPA, 2002, p. 1722). According to the
AICPA, this can be achieved using one of the following three methods. The first method
consists of exercising influence on accounting records or accompanying documents from which
the financial statements are compiled (AICPA, 2002, p. 1722). The second method entails
representing information incorrectly in the financial statements or keeping information out of
the financial statements on purpose (AICPA, 2002, p. 1722). The last method involves the
misapplication of GAAP, and this results in inaccuracy with amounts, classification, presentation
or disclosure (AICPA, 2002, p. 1722). The methods for accomplishing fraudulent financial
reporting make it likely that upper management is directly involved in the fraud or is complicit
(Coram et al., 2008, p. 545). Also, public disclosure of a misstatement arising from fraudulent
financial reporting means significant deficiencies in either internal controls, corporate
governance structures, or both (Coram et al., 2008, p. 545).
The second type of misstatement to consider is a deviation arising from misappropriation
of assets (NBA, 2010, p. 391). Examples of misappropriation of assets at the expense of the
company include embezzlement of receipts or theft of assets that belong to the company or
letting a company pay for undelivered goods or services (AICPA, 2002, p. 1722). Furthermore,
misappropriation of assets may also be done in order to deliver benefits to the company, such as
improperly obtaining subsidies (NBA, 2010, p. 391). To cover up misappropriation of assets, the
method of producing incorrect or deceptive records or documents is often used (NBA, 2010, p.
392). Although both types of misstatements are of interest to auditors, auditors considering fraud
during an audit of financial statements seem to pay more attention to the first type of
misstatement (Chadwick, 2000).
2.1.3 Fraud triangle
Multiple studies about fraud risk have used the interaction of three elements to explain why a
person may decide to commit fraud; these elements include attitude, incentive and opportunity
(Cressey, 1973; Albrecht et al., 1984; Loebbecke et al., 1989). These three together are referred to
as the fraud triangle. The first element attitude means that individuals need to have a certain
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attitude that rationalizes their behaviour to commit fraud (Wilks & Zimbelman, 2004, p. 725).
The next element—incentive—is sometimes referred to as the motivation element, and it entails
that a person has an incentive or is motivated to commit fraud because of a perceived pressure
(Wilks & Zimbelman, 2004, p. 724). Lastly, the opportunity element consists of conditions or
situations that create an opportunity for a person to engage in fraudulent activities (Wilks &
Zimbelman, 2004, p. 724).
When all three elements exist in a certain setting, it is likely that fraud can be committed
or has already been committed (Loebbecke et al., 1989, p. 4). Bell and Carcello (2000) found
evidence that is consistent with this assertion. In their study, they developed and tested a logistic
regression model that estimates the probability of fraud, and they have found that a number of
fraud risk factors are associated with fraud. These factors associated with fraud cover all three
elements of the fraud triangle. They include weak internal controls, rapid growth, management
mainly focused on meeting analysts’ expectations, management lying to the auditor or
management not being available often on purpose, ownership status, and a connection between
weak internal controls and management’s aggressive attitude with regard to financial reporting
(Bell & Carcello, 2000, pp. 177-178). A later study by Rezaee provided additional evidence for
the earlier mentioned assertion (2005). He analysed five alleged fraud firms and found evidence
that the fraud triangle elements are present in all these firms (Rezaee, 2005).
By contrast, if one of the elements does not exist, the probability that fraud has occurred
is low, as well as the probability of it happening in the future (Loebbecke et al., 1989, p. 4).
Keeping this in mind, the authors argue that auditors need to examine to what extent the
attitude, incentive and opportunity elements are present. Subsequently, the results of the analysis
are summarized in an overall conclusion (Loebbecke et al., 1989, p. 4). According to the authors,
when one of the elements is absent, the overall conclusion would be that the risk of fraud is
equal to zero. However, the authors also claim that this approach of assessing the likelihood of
fraud has one issue, namely having incomplete information reduces the likelihood of fraud. It
can be the case that incomplete information is available to the auditor, the auditor obtains
incomplete information, or both (Loebbecke et al., 1989, p. 4). Loebbecke et al. (1989, p. 4)
explained this through an example about a firm in which the fraud triangle elements are present
but one of the elements is not recognized by the auditor as present. Normally, this would result
in an overall conclusion that the risk of fraud is equal to zero. To prevent this from happening,
additional work has to be done; this work consists of assessing the robustness and reliability of
the auditor’s performed procedures (Loebbecke et al., 1989, p. 4).
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Wilks and Zimbelman (2004) tested the approach of decomposing the fraud triangle
elements in order to assess the likelihood of fraud, and they then compared it with a holistic
approach. They carried out their study in response to concerns raised by the audit profession
that auditors were too much focused on finding attitude cues that imply a low fraud risk; as a
consequence, both incentive and opportunity cues that imply a high fraud risk were not
sufficiently taken into consideration (Wilks & Zimbelman, 2004, pp. 739-740). They found that
auditors assessing the likelihood of fraud using the approach that decomposes fraud assessments
in situations of low fraud risk are significantly more attentive to incentive and opportunity cues
than auditors using the holistic approach (Wilks & Zimbelman, 2004, p. 740). However, auditors
using the approach that decomposes fraud assessments in situations of high fraud risk are equally
attentive to incentive and opportunity cues as auditors using the holistic approach (Wilks &
Zimbelman, 2004, p. 740).
2.1.3.1 Attitude
In these next three sub-sections, the elements of the fraud triangle are discussed in more detail.
This sub-section concerns the attitude element, which Loebbecke et al. described as a
characteristic found in individuals that allows them to knowingly commit a crime (1989, p. 4).
According to the AICPA, multiple risk factors can lead to an attitude that rationalizes
committing fraud, including
low ethical values or standards;
non-financial management interferes excessively with selecting accounting principles
and determining estimates;
history of violations, allegations and claims;
excessive interest in stock price or earnings by management;
management committing itself to third parties to meet aggressive or unrealistic
expectations;
management not being able to quickly resolve known bugs or weaknesses in internal
controls;
management’s interest in employing unlawful methods to reduce reported earnings for
tax reasons;
number of attempts by management to approve accounting due to immateriality; and
the highly tense relation between the current or predecessor auditor and management
(AICPA, 2002, pp. 1751-1752).
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Furthermore, the AICPA (2002, p. 1753) stated that attitude risk factors related to the
misappropriation of assets are usually not observed by the auditors. However, in the case where
auditors are informed or discover information regarding these attitude risk factors, they should
consider this information when assessing fraud risk due to the misappropriation of assets
(AICPA, 2002, p. 1753).
Multiple studies have looked into this element and investigated factors that may explain
or may affect an attitude that rationalizes criminal behaviour. The first study on this topic
examined the earnings management decisions of managers and auditors (Nelson et al., 2002).
Nelson et al. (2002) investigated whether a difference in precision of accounting standards
affects managers’ attitude to engage in earnings management, and their results indicated that this
is indeed the case. First, they found evidence that managers are more likely to engage in earnings
management with structured transactions when accounting standards are precise; when
accounting standards are imprecise, unstructured transactions are used instead (Nelson et al.,
2002, p. 192). Second, they discovered that auditors are less likely to demand adjustment of
earnings management attempts that are structured when accounting standards are precise; when
accounting standards are imprecise, auditors are less likely to demand adjustment of earnings
management attempts that are not structured (Nelson et al., 2002, p. 192). In addition, managers
were more likely to make earnings-decreasing attempts with unstructured transactions and
imprecise accounting standards (Nelson et al., 2002, p. 193). Moreover, the majority of managers’
earnings management attempts are earnings-increasing (Nelson et al., 2002, p. 193). However,
auditors are more likely to demand adjustment of those attempts, especially if material (Nelson et
al., 2002, pp. 194-195).
Hernandez and Groot (2007) also studied the attitude that managements have towards
committing fraud. However, they approached this topic from a different perspective than
Nelson et al. (2002). Using a large sample of over 5,000 client acceptance and audit continuance
assessments at a Big Four audit firm operating in the Netherlands, they investigated the nature
and degree to which the attitude of management affects fraud risk judgment of audit partners
(Hernandez & Groot, 2007). The findings of the study highlighted that attitude of management
significantly affects auditors’ fraud risk judgment. The ethical conduct of senior management is
considered to be the most important attitude factor for auditors assessing fraud risk of the
attitude factors investigated; this conduct is most strongly associated with higher auditor fraud
risk judgment (Hernandez & Groot, 2007, p. 21). Furthermore, Hernandez and Groot found
that use of aggressive accounting methods, as measured by assessments of revenue recognition
and accounting estimates, also lead to higher auditor fraud risk judgments (2007, p. 33). Lastly,
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they investigated the effects of both auditor-management relationships and senior management
experience and skill on auditor fraud risk judgment. The results showed these factors to be
important in that they affect the overall fraud risk, but these results are only significant for
situations of lower fraud risk levels (Hernandez & Groot, 2007, pp. 33-34).
In contrast to the first two studies mentioned, Gillett and Uddin (2005) specifically
investigate the attitude of one type of manager, the Chief Financial Officer (CFO). The authors
obtained data from 139 CFOs via a survey, and they found that a firm’s size affects a CFO’s
intention to commit financial reporting fraud (Gillett & Uddin, 2005, p. 73). According to the
authors, CFOs of large companies tend to be more likely to commit financial statement fraud
(Gillett & Uddin, 2005, p. 73).
2.1.3.2 Incentive
As mentioned earlier, the incentive element entails that a person has an incentive or is motivated
to commit fraud because of a perceived pressure (Wilks & Zimbelman, 2004, p. 724). The
AICPA listed four incentive risk factors for financial reporting fraud and two for the
misappropriation of assets. The incentive risk factors for financial reporting fraud include the
following conditions: (a) the financial stability or profitability of the company is threatened, (b)
the management is under high pressure to meet expectations of third parties, (c) information is
available that the personal financial position of management or persons charged with governance
is threatened by the company’s performance, and (d) management is under high pressure to meet
targets (AICPA, 2002, pp. 1749-1750). The incentive risk factors for misappropriation of assets
are employees who have personal financial obligations or a negative relation with the company,
and who are able to misappropriate company assets (AICPA, 2002, p. 1752). The current
literature focused on incentive risk factors for financial reporting fraud, and it identified four
perceived pressures which can provide an incentive for a person to commit financial reporting
fraud by illegally managing earnings. These perceived pressures include the need for external
financing, prevention of debt covenant restrictions, compensation scheme and poor business
results.
Using a sample of companies subject to actions by the Securities and Exchange
Commission (SEC) for violating GAAP, Dechow et al. (1996) examined motives for earnings
management. Their results suggested two important motives for earnings management: the
desire to raise external capital at a low cost and the prevention of debt covenant limitations
(Dechow et al., 1996, p. 30).
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Research literature have provided mixed results regarding compensation as a motivation
for engaging in fraudulent financial reporting, but the majority of the studies find a relation
between the two (Beneish, 1999a; Burns & Kedia, 2006; Efendi et al., 2007). The study by
Erickson et al. is an example of a study that contradicts the majority of the research on
compensation and financial reporting fraud (2006). Their study investigated the equity incentives
of executives and financial reporting fraud, and they found no consistent empirical evidence to
suggest that financial reporting fraud is more likely to occur as the total equity incentives of
executives become more sensitive to fluctuations in stock prices (Erickson et al., 2006, p. 140).
Furthermore, the study provided evidence that managements’ sales of stocks and exercises of
stock options are not significantly higher for fraudulent firms compared to non-fraudulent firms
(Erickson et al., 2006, p. 140).
Apart from this study, multiple studies have found a relation between compensation and
fraudulent financial reporting, such as the study by Efendi et al. (2007). Using a sample of firms
that corrected their annual report, they discovered that the probability of a misstated annual
report increases when the Chief Executive Officer (CEO) has a significant amount of stock
options in-the-money (Efendi et al., 2007, p. 703). The term in-the-money means that the current
share price of the share connected to the stock option is below the strike price of the stock
option. This provides the holder of the stock option a possibility to sell the share above its
current share price. Furthermore, the results suggested that irregularities in financial statements
are more likely to occur for companies limited by an interest coverage debt covenant or raising
new external capital (Efendi et al., 2007, p. 703). This finding is consistent with the findings of
the aforementioned study by Dechow et al. (1996). The study by Burns and Kedia showed
similar results with regard to stock options and probability of financial statement fraud (2006).
Specifically, they found that CEO compensation schemes have an impact on the use of
aggressive accounting methods that lead to a restatement of the financial statements (Burns &
Kedia, 2006, p. 63). In particularly, CEOs who have stock option packages which are more
sensitive to share prices are more inclined to engage in financial statement fraud (Burns & Kedia,
2006, p. 63). An earlier study by Beneish examined incentives and sanctions related to earnings
management, and the findings of this study further strengthens the claim that compensation is
related to financial statement fraud (1999a). Their results showed that managers in companies
that opportunistically increase their earnings are more likely to sell their shares and stock options
before public disclosure of the irregularity than managers in control companies (Beneish, 1999a,
p. 454). These findings have suggested that a motivation for managers to overstate earnings is
selling shares and stock options at higher prices (Beneish, 1999a, p. 454). Additional evidence for
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this view has been provided by Denis et al. (2006). They found a significant positive relation
between the probability of fraud and executive stock option incentives (Denis et al., 2006). Their
results have corroborated the view that executive stock option packages lead to an increased
likelihood that executives commit fraud (Denis et al., 2006).
Lastly, Rosner (2003) focused on opportunistic earnings manipulation in poor
performing companies. She examined whether poor performing firms before bankruptcy are
more inclined to engage in earnings manipulation. Her results showed that poor performing
companies have significantly lower cash flows, which is reflected by earnings-increasing
manipulation in non-going-concern years and subsequent reversal in going-concern years
(Rosner, 2003, p. 401).
2.1.3.3 Opportunity
According to Wilks and Zimbelman, the opportunity element consists of conditions or situations
that create an opportunity for a person to engage in fraudulent activities (2004, p. 724). In
section 85 of SAS no. 99, the AICPA listed multiple risk factors that can increase the
opportunity to commit fraud (2002, pp. 1750-1751). The AICPA provided the following as risk
factors that can create an opportunity to commit financial reporting fraud: (a) the nature of the
industry or the company’s operations, (b) insufficient monitoring of management, (c) complex or
unstable organizational structure, and (d) inadequate internal control components (2002, pp.
1750-1751). The literature provided a number of studies that have investigated whether these risk
factors in practice create an opportunity to engage in financial reporting fraud. These studies
have mainly focused on insufficient monitoring of management and inadequate internal control
components as opportunity risk factors.
One of the first studies that focused on these risk factors is the study by Loebbecke et al.
(1989). This study analysed auditors’ experience with material misstatements. In particular, the
authors examined audit partners’ experience with material misstatements of a then Big Eight
audit firm using a survey. The results of the survey indicated that two situations clearly expand
the opportunity to commit fraud: dominated decisions by management and a weak internal
control environment (Loebbecke et al., 1989, p. 20). Using data from 64 Australian firms
obtained through a survey, Rae and Subramaniam have studied the second finding in more depth
(2008). Their results indicated that the probability of fraud occurring is higher in situations
characterized by low Internal Control Procedures (ICP) quality and poor employee perceptions
of organizational justice (Rae & Subramaniam, 2008, p. 119). In other words, a strategy that sets
19
high ethical values within the company and leads to high ICP quality reduces opportunity to
commit fraud (Rae & Subramaniam, 2008, p. 120).
Beasley (1996) specifically investigated whether board composition affects the likelihood
of financial statement fraud and how this occurs. He found that there are fewer outside directors
on boards of fraudulent firms than non-fraudulent firms (Beasley, 1996, p. 463). In fact, adding
outside members to the board leads to more adequate monitoring of management which in turn
reduces the opportunity to commit financial statement fraud (Beasley, 1996, p. 463). This finding
has proven to be consistent with the results of the study by Farber, which has used a control
sample to compare 87 companies classified by the SEC as fraudulent firms—fraudulent because
they were illegally manipulating their financial statements (2005, p. 560). His results also showed
that fraudulent firms have fewer outside members on the board of directors (Farber, 2005, p.
560). Furthermore, he found significant evidence that suggests fraudulent firms have fewer
financial experts on the audit committee and fewer audit committee meetings (Farber, 2005, p.
560). Also, they are less often audited by Big Four audit firms, and they more often have a CEO
who is also the chairman of the board of directors (Farber, 2005, p. 560).
Finally, a couple of studies have paid specific attention to audit committees and financial
statement fraud. Abbott et al. (2004) analysed whether multiple audit committee characteristics
affect the probability of financial statement fraud and how this occurs. Using two samples
consisting of 44 companies alleged of fraud and 44 control companies, the authors found that
audit committee expertise and independence are negatively associated with the likelihood of
fraud (Abbott et al., 2004, pp. 80-83). Further studies that have investigated audit committee
characteristics and the likelihood of financial statement fraud showed that the presence of
financial experts on the audit committee is negatively associated with the likelihood of financial
statement fraud (McDaniel et al., 2002; Bédard et al., 2004).
The AICPA also formulated opportunity risk factors that can increase the likelihood of
misappropriation of assets. This can be a particular characteristic or condition, such as (a) a
process involving a lot of cash; (b) an inventory consisting of small, valuable or highly demanded
items; (c) assets that can easily be converted or the possession of small, marketable fixed assets;
or (d) fixed assets of which identification of ownership is difficult (AICPA, 2002, pp. 1752-
1753). Furthermore, the AICPA mentioned insufficient internal control over a company’s assets
as an opportunity risk factor (AICPA, 2002, pp. 1753). The literature included multiple studies
which examine the relation between internal control over a company’s assets and the likelihood
of misappropriation of assets.
20
The first important study to mention in this respect is the one by Coram et al. (2008).
They focused on the second opportunity risk factor provided by the AICPA—which is
insufficient monitoring of assets—and they measured this factor using the presence of an
internal auditor department (Coram et al., 2008). Many companies have an internal auditor
department to ensure that prior to the audit of the financial statements, there is a low probability
of the second type of misstatement, which is the misappropriation of assets. The authors
examined whether such a department indeed leads to a lower probability of the second type of
misstatement. The results of their study highlighted that companies with an internal auditor
department are better able to detect and self-publish the second type of misstatement than
companies that do not have such a department (Coram et al., 2008, p. 557). In other words, an
internal auditor department is effective in reducing the probability of the second type of
misstatement in the financial statements. This point suggested that the presence of an internal
auditor department can give an auditor an useful indication of a company’s internal control over
assets.
Second, the study by Mustafa and Youssef extended the aforementioned research on
audit committees and financial reporting fraud by looking at whether the financial expertise and
the independence of members in an audit committee affect the probability of misappropriation
of assets (2010, p. 221). They found that an increase in financial expert members and
independent members in an audit committee leads to a decrease in the probability of
misappropriation of assets (Mustafa & Youssef, 2010, p. 221). An important point to note is that
the additional tests showed how independent financial expert members are significantly
negatively associated with the likelihood of misappropriation of assets, but independent
members without financial expertise are not significantly negatively associated with
misappropriation of assets (Mustafa & Youssef, 2010, p. 221). This finding indicated that an
independent member of an audit committee can only reduce the likelihood of misappropriation
of assets if this member has financial expertise (Mustafa & Youssef, 2010, p. 221).
2.1.4 Summary
In summary, fraud can defined as an intentional act by one or multiple individuals involving
deception that results in a material misstatement in financial statements which are subject to
audit. As mentioned, a material misstatement is referred to as a misstatement that can influence
the decisions made based on the financial statements, and fraud risk can be explained as the risk
that the financial statements are materially misstated due to fraud. Two types of material
misstatements due to fraud are of interest to an auditor considering fraud in an audit—the first
21
type is a material deviation arising from financial reporting fraud, and the second is a material
deviation arising from misappropriation of assets. In the literature, the occurrence of these two
material misstatements due to fraud are explained by the interaction of the three elements in the
fraud triangle. These elements are attitude (rationalizes fraudulent activity), incentive (provides
motivation to commit fraud) and opportunity (creates possibility to carry out fraudulent activity).
When all three elements are present in a situation, it is likely that fraud is committed or will be
committed in the future. Many studies have investigated the elements of the fraud triangle; for
each element, these studies have provided a lot of risk factors that are associated with the
likelihood of a material misstatement due to fraud. Many of these risk factors are included in
SAS No. 99. As a result, the risk factors formulated in SAS No. 99 should provide adequate
support to an auditor in assessing the degree to which the elements of the fraud triangle are
present in the company under audit.
2.2 SAS No. 99: Consideration of fraud in a financial statement audit
In elaborating on the concept of fraud, this section explains the role of the auditor with regard to
the consideration of fraud in an audit. Subsequently, the section explores literature that has
investigated the effectiveness of tools which are incorporated into the fraud related standard of
SAS No. 99. This standard has provided guidance on how auditors should assess fraud risk, and
it introduced several tools to support auditors in carrying out a fraud risk assessment.
2.2.1 The role of the auditor
According to International Standard on Auditing (ISA) 200, the role of an auditor consists of
two parts (2009, p. 74). The auditor’s two-part role is “to obtain reasonable assurance about
whether the financial statements as a whole are free from material misstatement, whether due to
fraud or error, and to report on the financial statements, and communicate as required by the
ISAs, in accordance with the auditor’s findings” (ISA, 2009, p. 74). This definition has also been
incorporated into national legislation (NBA, 2010, p. 208; AICPA, 2012, p. 79). Furthermore,
ISA 200 also described that the term reasonable assurance must be interpreted as a high but not
absolute level of assurance since performing an audit has limitations; these limitations lead to the
majority of the audit evidence of the auditor as being compelling but not conclusive (2009, p.
73). This point was confirmed by Ruhnke and Lubitzsch, who found that there is a boundary to
the maximum level of assurance that can be provided based on the audit evidence of the audited
subject matter (2010). The precise meaning of this term has been ambiguous over a long period
22
of time until a definition was finally introduced by the AICPA in 2004 (Roberts & Dwyer, 1998,
p. 572; Christensen et al., 2012, p. 137).
To fulfil the auditors’ role with regard to fraud in a financial statement, an auditor starts
with a fraud risk assessment of the company under audit. The auditor then responds to the
results of the assessment by exercising professional scepticism in collecting and evaluating audit
evidence (AICPA, 2002, p. 1732). Professional scepticism entails that an auditor (a) has a
questioning mind and (b) critically assesses the competency and sufficiency of audit evidence
(AICPA, 2002, p. 1724). The auditor can respond in a number of ways (AICPA, 2002, p. 1732).
For example, the auditor can decide to design additional or other audit procedures for collecting
additional reliable audit evidence substantiating the financial statements or to collect further
confirmation on managements’ explanations and statements on material matters (AICPA, 2002,
p. 1732). Finally, auditors evaluate the audit evidence and report on the financial statements in
accordance with the auditor’s findings. In the case where auditors finds misstatements that are or
may be the result of fraud, they are required to investigate the implications (AICPA, 2002, p.
1745). SAS No. 99 states the follow-up steps that auditors need to take in response to the
outcomes of the investigation (AICPA, 2002, pp. 1745-1748).
2.2.2 Fraud risk assessment tools
According to SAS No. 99, three steps are essential for carrying out an effective fraud risk
assessment (AICPA, 2002, pp. 1725-1732). The first step entails collecting the information
needed for identifying the risks of material misstatement due to fraud (AICPA, 2002, p. 1725).
This essential information about the risk of fraud is collected through inquiry of management
and others persons within the company about the risk of fraud (AICPA, 2002, p. 1726).
Furthermore, several items need to be considered in this step, including (a) the outcomes of the
analytical procedures performed in the planning phase, (b) the fraud risk factors, and (c) other
possible useful information such as the outcomes of brainstorming sessions (AICPA, 2002, pp.
1728-1729). The second step involves processing the collected information and identifying fraud
risks that may lead to a material misstatement (AICPA, 2002, p. 1729). The third and final step
consists of assessing the identified fraud risks; an evaluation of the company’s programs and
controls that tackle the fraud risks also need to be kept in mind (AICPA, 2002, p. 1731).
A number of studies have examined fraud risk assessments. In particular, these studies
have investigated the aforementioned tools in SAS No. 99 that are used for collecting the
required information. The most important studies in this respect are discussed in the next
subsections.
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2.2.2.1 Inquiries
According to Hirst and Koonce, inquiry of client personnel is a frequently used tool by auditors
for developing explanations for unexpected differences in the planning stage of the audit (1996,
p. 463). However, multiple studies have suggested that audit quality could be impaired when this
audit evidence is collected and used by the auditor (Bedard & Biggs, 1991, p. 88; Glover et al.,
2000, p. 42). In response to these findings, Krishnamoorthy and Wright specifically investigated
the value of management inquiry (1999). They provided a framework for auditors that enables
them to assess the value of the evidence collected from management inquiry (Krishnamoorthy &
Wright, 1999, p. 5). The study used three factors which seem to be important in assessing the
value of management inquiry (Krishnamoorthy & Wright, 1999, p. 16). These factors are
management objectivity, management competence and risk of misstatement (Krishnamoorthy &
Wright, 1999, p. 16). First, Krishnamoorthy and Wright found that audit evidence collected
from management inquiry is of high explanatory value only when the audit client is both
objective and competent (1999, p. 16). Second, the possible value of explanations from
management is greatest when the risk of misstatement is high (Krishnamoorthy & Wright, 1999,
p. 16). Third, in the case where financial reporting fraud is suspected and the objectivity of
management is questioned as a result, the value of explanations from management inquiry is low
(Krishnamoorthy & Wright, 1999, p. 16). Finally, when misappropriation of assets is suspected,
the value of explanations from management inquiry can be high, but only if management is
competent to assess the risk of fraud (Krishnamoorthy & Wright, 1999, p. 16). However, it
seems that auditors do not often evaluate managements’ competence in assessing the risk of
fraud (Krishnamoorthy & Wright, 1999, p. 16). Overall, this study suggests that management
inquiry can be a useful tool for collecting audit evidence, but auditors need to exercise much care
in using this audit evidence because the value varies significantly depending on the situation.
2.2.2.2 Analytical procedures
According to the AICPA, analytical procedures consists of comparisons of reported amounts—
or ratios calculated using those reported amounts—to auditors’ expectations (1989, p. 1889). The
difference in complexity of the various analytical procedures is rather great (Green & Choi, 1997,
p. 14). Beneish developed and tested a model in order to predict and detect financial statement
fraud (1999b). The variables of the model consists of reported amounts as well as financial ratios
(Beneish, 1999b, p.25). His results showed that some of the incorporated variables in the model
24
are useful in detecting companies that commit financial statement fraud (Beneish, 1999b, p. 33).
Furthermore, he found that some of the variables have predictive or discriminatory power
(Beneish, 1999b, pp. 33-34). Nevertheless, it should also be noted that the model has a large rate
of classification errors (Beneish, 1999b, p. 34). This is due to the fact that the model captures
both distortions that result from manipulation and distortions that are the result of another
cause, such as material acquisition, a change in the company’s strategy, or a change in the
company’s external environment (Beneish, 1999b, p. 34).
Kaminksi et al. focused specifically on the efficacy of analytical procedures that use
financial ratios to identify fraud risk (2004, p. 26). They compared 21 financial ratios of 79
matched fraudulent and non-fraudulent companies over multiple years (Kaminski et al., 2004, p.
17). They discovered that some of the financial ratios differed significantly between fraudulent
and non-fraudulent companies (Kaminski et al., 2004, p. 26). However, these financial ratios
were not significant across the investigated period of time (Kaminski et al., 2004, p. 26).
Therefore, Kaminski et al. concluded that the efficacy of analytical procedures that use financial
ratios to identify fraud risk is limited (2004, p. 26). Overall, it seems that analytical procedures are
not ineffective, but their contribution is modest.
2.2.2.3 Fraud checklists
In general, auditors make use of standard fraud checklists that are situated around the three
elements of the fraud triangle in order to collect information on the fraud risks factors in the
company under audit (Shelton et al., 2001, p. 25; Mock & Turner, 2005, p. 62). Although such a
checklist is intended to support the fraud risk assessment, the studies are not convinced that
such a checklist is actually beneficial. Early research was conducted by Pincus, who used a field
experiment to investigate the effectiveness of a red flags checklist for assessing fraud risk (1989).
The results of the study showed that the use of a fraud checklist does not significantly affect the
fraud risk assessment in a no-fraud setting (Pincus, 1989, p. 161). Even more importantly, the
use of such a checklist in a fraud setting significantly affects the fraud risk assessment negatively
(Pincus, 1989, p. 161). In the fraud setting, the fraud risk assessments of the participants who did
not use a fraud checklist were about one-third higher than the participants who used a fraud
checklist (Pincus, 1989, p. 161). According to Asare and Wright, it is difficult to generalize these
findings for two reasons (2004, p. 330). First, the study was carried out in a period of time when
auditors were not obliged to take responsibility for assessing fraud risk and detecting fraud
(Asare & Wright, 2004, p. 330). Second, the fraud checklist used in the study was merely one
long list of fraud risk factors; it contained no categorizations of fraud risk factors (Asare &
25
Wright, 2004, p. 330). A related study by Mock and Turner focused specifically on fraud
checklists and fraud risk factors (2005). They found that auditors using a fraud checklist do not
often identify fraud risk factors in addition to the fraud risk factors listed in the fraud checklist;
auditors also tend to tick off more fraud risk factors when the length of the checklist increases
(Mock & Turner, 2005, p. 74). Furthermore, the authors showed that auditors who did not use a
checklist identified more fraud risk factors than auditors who did use a checklist (Mock &
Turner, 2005, p. 74). However, the impact of the last finding on the fraud risk assessment
remains unknown since the authors did not investigate this area in their study.
The study by Asare and Wright extended the scope of research literature by investigating
whether the use of fraud checklists affects the fraud risk assessment while taking into account
the limitations of earlier research (2004). As mentioned in section 2.2.1, auditors currently do
have the responsibility to report that the financial statements are not materially misstated due to
fraud. Furthermore, an updated fraud checklist which categorizes the fraud risk factors is used
(Asare & Wright, 2004, p. 335). The results of the study showed that auditors who do not use a
fraud checklist provide a more accurate fraud risk assessment than auditors who do use a fraud
checklist (Asare & Wright, 2004, p. 341). This point is consistent with the findings of Pincus
(1989). Overall, the research literature has criticized the effectiveness of fraud checklists in
assessing fraud risk rather than confirmed the effectiveness.
2.2.2.4 Brainstorming
SAS No. 99 introduced a new tool for improving auditors’ fraud judgments, brainstorming,
which is mandatory for every financial statement audit (AICPA, 2002, p. 1724). According to the
AICPA, a brainstorming session should consist of an exchange of ideas among the audit team
regarding (a) the susceptibility of the company’s financial statements to material misstatement
due to fraud, (b) managements’ ability to commit and conceal financial reporting fraud, and (c)
the ways in which assets belonging to the company could be misappropriated (AICPA, 2002, p.
1724). Furthermore, a brainstorming session should emphasize the importance in maintaining a
questioning mind and exercising professional scepticism during the audit (AICPA, 2002, pp.
1724-1725).
Carpenter investigated the effectiveness of fraud brainstorming audit teams using an
experiment in which forty audit teams performed brainstorming sessions; each team consisted of
a staff auditor, a senior and a manager (2007, pp. 1125-1126). First, the results suggested that
fraud brainstorming audit teams come up with more quality fraud ideas than individual auditors
even though the teams may have a fewer number of fraud ideas (Carpenter, 2007, p. 1136).
26
Second, fraud brainstorming audit teams come up with new quality fraud ideas that were not
previously considered by the members of the audit team (Carpenter, 2007, p. 1136). Third, prior
to a fraud brainstorming session, the fraud risk assessments made by audit team members are
significantly lower than their assessments after a brainstorming session, particularly when fraud is
present (Carpenter, 2007, p. 1136). In summary, these findings have suggested that the
effectiveness of financial statement audits can improve when a fraud brainstorming session is
mandatory for performing a financial statement audit.
Brazel et al. found similar results with regard to the effectiveness of audit teams that
performed a fraud brainstorming session (2010). Using data obtained from 179 real audit
engagements, they developed and tested a measure of brainstorming quality (Brazel et al., 2010,
p. 1297). The results of their study showed that fraud risk factors are positively associated with
fraud risk assessments, and the results provided some support that brainstorming quality
moderates these associations (Brazel et al., 2010, p. 1297). Furthermore, in the case where
brainstorming quality is perceived to be higher, fraud risk assessments are more positively
associated with measures of audit procedures; these measures include the nature, timing, and
extent of audit procedures and staff who performs them (Brazel et al., 2010, p. 1297). Overall,
the findings of Brazel et al. suggested that high brainstorming quality seems to improve the audit
team’s consideration of fraud in a financial statement audit by creating a wider set of responses
for the identified fraud risks (2010, pp. 1297-1298). By contrast, a low brainstorming quality
could harm the effectiveness of the financial statement audit because this can result in
insufficient auditing (Brazel et al., 2010, p. 1298). Overall, the studies suggested that a
brainstorming session is an effective tool for auditors assessing fraud risk.
2.2.3 Summary
In summary, the auditors’ role with regard to fraud is to obtain reasonable assurance on whether
the financial statements under audit are free from material misstatement due to fraud. Auditors
cannot obtain absolute assurance because performing an audit has limitations which lead to the
majority of the audit evidence being compelling but not conclusive. To fulfil the auditors’ role,
auditors start with a fraud risk assessment of the company under audit. Typically, a fraud risk
assessment consists of three steps. In the first step, the necessary information is collected to
identify the risks of material misstatement due to fraud. The next step consists of processing the
information and identifying fraud risks that may lead to a material misstatement due to fraud.
The final step involves assessing the identified fraud risks. SAS No. 99 introduced multiple
mandatory tools for carrying out the first step of the fraud risk assessment, including inquiries,
27
analytical procedures, fraud checklists and brainstorming. The studies have provided mixed
results about the effectiveness of these tools. Management inquiry is only effective under certain
conditions, such as when the audit client is both objective and competent (Krishnamoorthy &
Wright, 1999). The effectiveness of analytical procedures is limited but not ineffective (Beneish,
1999b; Kaminski et al., 2004). The studies have criticized the effectiveness of fraud checklists in
assessing fraud risk (Pincus, 1989; Asare & Wright, 2004). Lastly, the literature has shown how
the most recently introduced tool of fraud brainstorming sessions is considered to be promising
(Carpenter, 2007; Brazel et al., 2010).
2.3 Mindsets
The previous section highlights mixed results for the effectiveness of the tools provided in SAS
No. 99. In response, this section discusses the potential of mindset theory in increasing the
effectiveness of these tools. First, the characteristics of mindsets are discussed. Second, two
mindsets are introduced, namely a mindset which reflects the current auditors’ mindset and a
potential desirable mindset. Finally, the hypothesis of this thesis is defined.
2.3.1 Characteristics
A mindset can be defined as a set of mental processes which establish a general preparedness to
react in a certain way (Freitas et al., 2004; Gollwitzer, 1990). Mindsets have been first studied in
the beginning of the 20th century in early experimental studies in psychology (Gollwitzer, 1990,
p. 63). These studies show that carrying out particular tasks activates a set of cognitive operations
(Hamilton et al., 2011, p. 14). Key characteristics of a mindset are that (a) it fosters orientations
that are not related to a specific task, and (b) it remains active when activated, even after
completion of the original task (Hamilton et al., 2011, p. 14). The implication of the first
characteristic is that mindsets impact all phases of decision-making (Griffith et al., 2015, p. 55).
These include the analysis of the problem cues in the task (Gollwitzer, 1993, p. 141), the
information sought (Heckhausen & Gollwitzer, 1987, p. 101; Henderson et al., 2008, p. 408) and
the way in which information is processed and evaluated (Gollwitzer et al., 1990, p. 1119; Taylor
& Gollwitzer, 1995, p. 213). The consequence of the second characteristic is that a mindset also
affects subsequent and separate tasks (Hamilton et al., 2011, p. 14; Freitas et al., 2004, p. 740;
Wyer & Xu, 2010, p. 121).
Mindset theory assumes that situational conditions (e.g. requirements of a certain task)
can switch a person from using one mindset to using a different mindset (Hamilton et al., 2011,
28
p. 14). One point to note is that different mindsets which consist of different sets of cognitive
processes would approach tasks in different ways; in considering this fact, it is difficult for a
person to use more than one mindset at any given time (Hamilton et al., 2011, p. 14). Hamilton
et al. compared this with individuals trying to focus their eyes on a close object and a faraway
object at the same time (2011, p. 14). As a consequence, activating a different mindset than the
current active mindset entails switching away from the current active mindset rather than using a
second mindset (Hamilton et al., 2011, p. 14).
2.3.2 Implemental mindset, deliberative mindset, and hypothesis
In this thesis, the Rubicon model of action phases is used for putting mindsets into perspective.
This model assumes that an action consists of four sequential phases (Heckhausen, 1986). The
pre-decisional phase is the first phase; in this phase, a person’s task is to deliberate and choose
between potential action goals (Gollwitzer, 1990, p. 62). In the second phase, the post-decisional
phase, a person is concerned with the initiation of actions that imply moving towards the
accomplishment of the chosen goal (Gollwitzer, 1990, p. 62). The third is the actional phase
where a person should execute the actions in an efficient way (Gollwitzer, 1990, p. 62). In the
last phase, the post-actional phase, a person evaluates the outcomes of the actions, specifically
whether the chosen goal is accomplished (Gollwitzer, 1990, p. 62). According to Gollwitzer,
carrying out these tasks activates a phase-typical mindset; a set of procedures that support task
accomplishment (1990, p. 62). To analyse mindset effects on auditors fraud risk assessment, this
thesis uses the mindset of the pre-decisional phase (deliberative mindset) and the post-decisional
phase (implemental mindset) because these are most likely to impact auditors’ inferences
(Gollwitzer & Kinney, 1989; Griffith et al., 2015). Furthermore, these mindsets are tested in an
experiment using fraud checklists, which is the most problematic tool of SAS No. 99, as
presented in section 2.2.2.3.
A deliberative mindset consists of procedures focused on analysing and weighing
advantages and disadvantages of goal alternatives, while an implemental mindset consists of
procedures focused on the timing and sequence of steps that need to be taken for accomplishing
the chosen goal (Gollwitzer, et al., 1990, p. 1120). A feature of the deliberative mindset is that it
fosters a broad focus of attention which expands beyond task relevant information (Gollwitzer
& Bayer, 1999; Heckhausen & Gollwitzer, 1987). Fujita et al. investigated this feature, and they
found that using a deliberative mindset results in the mind being more open to processing
incidental information compared to the implemental mindset (2007). Furthermore, Taylor and
Gollwitzer discovered that individuals using a deliberative mindset show fewer positive illusions
29
(i.e. they are more impartial) when processing information than individuals adopting an
implemental mindset (1995). Individuals using an implemental mindset are more biased when
processing information because this mindset stimulates a narrow focus of attention, namely a
focus on directly-related information and selective information processing in support of the
chosen goal (Gollwitzer & Bayer, 1999, p. 406; Heckhausen & Gollwitzer, 1987, p. 116).
Auditors using fraud checklists obtain separate audit evidence for each listed fraud risk
factor. Based on this evidence, they then verify whether the fraud risk factor is present or not. In
the end, they provide an overall fraud judgment based on their findings. This task resembles a
verification task because there needs to be a verification made on whether or not fraud risk
factors exist. Therefore, it is expected that auditors would use a mindset closely linked to an
implemental mindset for this task. As mentioned, this mindset supports individuals in efficiently
completing a task. This implicates that the usage of this mindset when completing fraud risk
checklists leads to auditors focusing on information that is relevant for the risk factors in the
fraud checklist. However, it is likely that this narrow focus limits auditors in considering
information that is not directly relevant to the fraud checklist but might constitute another fraud
risk factor. Mock and Turner found evidence consistent with this assertion (2005). They
discovered that auditors using a fraud checklist do not often identify other potential fraud risk
factors in addition to the fraud risk factors listed in the fraud checklist (2005). This may provide
an explanation for the finding of auditors using a fraud checklist provide significantly fewer
accurate fraud judgments than auditors who do not use a fraud checklist (Pincus, 1989; Asare &
Wright, 2004).
In response, this thesis hypothesizes that switching from an implemental mindset to a
deliberative mindset improves the effectiveness of fraud checklists in assessing fraud risk. Based
on the abovementioned procedures in the deliberative mindset, this thesis expects that auditors
using a deliberative mindset would look beyond the information that is relevant for the fraud
checklist and would process information in a more impartial manner. In this way, auditors
should be able to develop an improved overview of the existing fraud risk factors in the
company under audit. In other words, auditors should be able to provide more accurate fraud
judgments. This point leads to the following hypothesis:
H1: auditors adopting a deliberative mindset will judge fraud to be more likely than
auditors adopting an implemental mindset.
30
3 Research Methodology
3.1 Experimental design
In order to the test the hypothesis, a case-based experiment is conducted. The experiment has a
two by one factorial design; in the experiment, the dependent variable is the participants’
assessment of the fraud risk in a company that is presented in a case scenario. The case provides
information on a fictitious client of the Big Four audit firm which the participant works for. The
information provided consists of (a) the background of the company, its industry, competition,
and its management and (b) a fraud risk factor checklist completed by an audit senior. Based on
the provided information, the participants were asked to give their judgment of the risk material
misstatement due to fraud. Before the participants read the information and gave their judgment,
they were all asked to read a different case about a potential client, a listed construction company
that is obliged by Dutch law to choose a new audit firm for carrying out their statutory audit for
next year. The participants were asked to imagine that they work for a Big Four audit firm as an
auditor and that their firm is considering writing a proposal to win the construction company.
The task given right after presenting this case was used for manipulating the mindset of the
participant in the experiment. One half of the participants were asked to list three advantages
and disadvantages of winning the construction company, while the other half of the participants
were asked to list six steps they would take in their attempt to win the construction company.
3.2 Sample and procedures
In total, 36 auditors from a Big Four audit firm operating in the Netherlands participated in the
experiment. The deliberative mindset condition of the experiment was completed by 18 auditors
and the implemental mindset condition by 18 auditors. At the end of the experiment, the
participants were asked to answer a couple of questions regarding their demographics, namely
their age, gender, function, and years of experience as an auditor. The demographics of the
participants in the experiment are summarized in Table 1. Regarding the profiles of the
participants, a vast majority of them were males. The function of the participants ranged from
Junior Staff to Director, and most of them had multiple years of experience as an auditor.
The experiment was carried out using a questionnaire that was given to the participants.
This questionnaire was available in hard-copy and in an electronic version; most of the
participants completed the electronic version, and only three participants completed the paper
version. Prior to completing the questionnaire, the participants were told that the questionnaire
31
consists of three parts. The first part contains a case of an audit firm rotation with one question,
the second part contains a fraud risk assessment case with one question, and the third part
contains four questions about the demographics of the participant. Furthermore, the participants
were told to keep in mind that this experiment is not a test, and there are no correct or incorrect
answers. Besides these instructions, a consent form was included on the front page, and it
informed the participants about the study, including the purpose, procedures, risks and benefits
of the experiment, the confidentiality of the participants, the contact person, and voluntary
participation in and withdrawal from the experiment.
Table 1
Demographic data of the participants Number of participants (#) Percentage of participants (%)
Participants
Deliberative mindset 18 50
Implemental mindset 18 50
Total participants 36 100
Age
20-25 9 25
26-30 17 47
31-35 6 17
36-40 4 11
Gender
Male 28 78
Female 8 22
Year(s) of experience
as an auditor
0-3 15 42
4-6 8 22
7-9 5 14
10-12 4 11
13-15 3 8
16-18 0 0
19-21 0 0
22-24 1 3
Function
Junior Staff 1 3
Staff 12 33
Senior Staff 5 14
Junior Manager 7 19
Manager 4 11
Senior Manager 5 14
Director 2 6
Partner 0 0
32
3.3 Case materials and measures
In Appendices 1 and 2, the deliberative and implemental mindset condition questionnaires for
the experiment are disclosed. As mentioned earlier, the questionnaire contains two cases in total.
The first case—in combination with a question—is used for activing a deliberative mindset or an
implemental mindset. This case is developed by myself, and it concerns a listed construction
company named Total Sustainable Homes N.V. (TSH N.V.); general information is also
provided about the company’s background, turnover, net income, market position, employees,
contracts and goal for the coming five years. This case is followed by a question about
advantages and disadvantages of winning the construction company or a question about steps to
be taken to win the construction company.
After the first case, the participants were asked to read another case and a fraud risk
factor checklist completed by an audit senior. This case was originally used by Wilks and
Zimbelman (2004). In their study, they used the case together with the checklist to investigate
whether a fraud triangle decomposition of fraud risk assessments (before commenting on the
total the risk of fraud) leads to an increase in auditors’ sensitivity to indications of incentive and
opportunity risks when attitude risks of management suggest that the fraud risk is low (Wilks &
Zimbelman, 2004). To obtain both access to the case and the permission to use it for this thesis,
I contacted the authors by e-mail; Wilks replied my e-mail and sent me the case along with one
cell of their experiment. This cell was a fraud risk factor checklist indicating a low fraud risk; in
this checklist, six of the 40 fraud risk factors were present. These included four incentive risks
and two opportunity risks. This checklist was transformed into a fraud risk factor checklist
indicating a high fraud risk; this was possible using their paper. Three more incentive risks and
four more opportunity risks were marked as present in the case. This present thesis is specifically
interested in situations in which attitude risk is perceived to be low. Therefore, risks that might
have a significant impact on attitude risk are not used for creating a high fraud risk in the case.
Based on the provided information (the case and the completed fraud risk factor checklist), the
participants were asked to assess the risk of material misstatement in the financial statements due
to fraud and provide their judgment.
3.4 Manipulation and variables
The questionnaire contains one independent variable—the auditor’s mindset—which is
manipulated. The manipulation consist of a question that tries to trigger a certain mindset, which
is either a deliberative or an implemental mindset. The manipulation in the experiment, is similar
33
to the one used by Griffith et al. (2015). All participants were asked to read the same case, but
the stated question differed at the end of the case. For the participants who were asked to list
three advantages and disadvantages, a deliberative mindset was activated as the participants were
forced to analyse and weigh pros and cons. For the other participants who were asked to list six
steps, an implemental mindset was activated as they were forced to come up with the steps and
decide on the timing and sequence of the steps.
Subsequently, all the participants were asked to assess the fraud risk after reading another
case and a fraud risk factor checklist completed by an audit senior. A difference between the
fraud risk provided by the participants adopting a deliberative mindset and those adopting an
implemental mindset could suggest that an auditor’s fraud risk judgment is influenced by the
mindset he or she adopts. Moreover, if the participants adopting a deliberative mindset provide a
higher fraud risk than the participants adopting an implemental mindset, this could suggest that
auditors adopting a deliberative mindset judge fraud to be more likely.
The questionnaire consists of one dependent variable: the participants’ assessment of the
fraud risk in a company. The participants were asked to assess the fraud risk in this company on
a rating scale from 1 (indicating a low fraud risk) to 10 (indicating a high fraud risk).
34
4 Results
4.1 Preliminary analyses
In this section, the results of the preliminary analyses, which were performed on the data
obtained from the experiment, are discussed to provide a more complete picture of the data used
in this thesis.
4.1.1 Variables
To test the hypothesis of this thesis, multiple variables were used in both the questionnaire of
the experiment and the statistical analyses. For example, other variables were used aside from a
mindset and a fraud risk judgment variable; some of these other variables include gender and
audit experience. An overview of all variables used is provided in Table 2, which presents a
description and measurement for each variable.
Table 2
Variables: description and measurement
Variable Description Measurement
Mindset The first case contained a
question to activate a
deliberative mindset or a
question to activate an
implemental mindset
0 = Implemental mindset
question in the case
1 = Deliberative mindset
question in the case
Age The age of the participant Ratio
Gender The gender of the participant 0 = Male
1 = Female
Function Function of the participant
within the audit firm
0 = Junior Staff
1 = Staff
2 = Senior Staff
3 = Junior Manager
4 = Manager
5 = Senior Manager
6 = Director
7 = Partner
Experience Year(s) of experience as an
auditor
Ratio
Assessed Fraud Risk The participants’ assessment
of the fraud risk in the second
case
Rating scale from 1
(indicating a low fraud risk)
to 10 (indicating a high
fraud risk)
35
4.1.2 Descriptive statistics
In Table 3, the descriptive statistics of the variables are presented. This table lists the descriptive
statistics for the deliberative and the implemental mindset sample as well as the total sample. The
average age of the participants in the experiment is 29.11 years. Furthermore, 22% of the
participants are female (Mean = 0.22, SD = 0.422). In other words, the vast majority of the
participants are male. Also, the table shows two audit related variables: Function and Experience.
The results show that the function of the majority of the participants varies between Junior Staff,
which is the lowest function, and Manager, which is the fourth highest function (Mean = 2.67,
SD = 1.690). Lastly, the most important variable is Assessed Fraud Risk. As mentioned in Table
2, this variable measures the participants’ fraud risk assessment. The results indicate that the
participants in the deliberative mindset sample provided on average a fraud risk judgment of 7.72
(Mean = 7.72, SD = 1.074). In contrast, the participants in the implemental mindset sample
provided on average a fraud risk judgment of 7.67 (Mean = 7.67, SD = 1.237).
Table 4 presents the Pearson and non-parametric Spearman correlations for the variables
used. According to the Pearson correlation, the switch to a deliberative mindset is insignificantly
correlated with AFR (Pearson r = 0.025, p > 0.05). Furthermore, the non-parametric Spearman
correlation shows that the switch to a deliberative mindset is insignificantly correlated with AFR
(Spearman ρ = -0.074, p > 0.05).
36
Table 3
Descriptive statistics
N Minimum Maximum Mean Median SD
Age Total 36 24 40 29.11 28 4.857
Del. mindset 18 24 40 29.39 28 4.972
Imp. mindset 18 24 40 28.83 27.50 4.866
Gender Total 36 0 1 0.22 0 0.422
Del. mindset 18 0 1 0.33 0 0.485
Imp. mindset 18 0 1 0.11 0 0.323
Function Total 36 0 6 2.67 2.50 1.690
Del. mindset 18 1 6 2.67 2 1.815
Imp. mindset 18 0 6 2.67 3 1.609
Experience Total 36 1 22 6 5 4.980
Del. mindset 18 1 15 6.28 5.50 4.599
Imp. mindset 18 1 22 5.72 5 5.454
AFR Total 36 4 10 7.69 8 1.142
Del. mindset 18 6 10 7.72 8 1.074
Imp. mindset 18 4 9 7.67 8 1.237
Valid N total sample = 36, deliberative mindset sample = 18 and implemental mindset sample = 18
Table 4
Correlations
Mindset Age Gender Function Experience AFR
Mindset
- 0.081
(0.640)
0.267
(0.115)
-0.027
(0.874)
0.113
(0.512)
-0.074
(0.667)
Age
0.058
(0.737)
- -0.485**
(0.003)
0.821**
(0.000)
0.766**
(0.000)
0.191
(0.265)
Gender
0.267
(0.115)
-0.403*
(0.015)
- -0.568**
(0.000)
-0.446**
(0.006)
-0.247
(0.146)
Function
0.000
(1)
0.871**
(0.000)
-0.535**
(0.001)
- 0.907**
(0.000)
0.387*
(0.020)
Experience
0.057
(0.743)
0.848**
(0.000)
-0.367*
(0.028)
0.882**
(0.000)
- 0.388*
(0.019)
AFR
0.025
(0.886)
0.166
(0.333)
-0.211
(0.217)
0.375*
(0.024)
0.306
(0.069)
-
The Pearson correlations are presented below the diagonal.
The non-parametric Spearman correlations are presented above the diagonal.
P-values are presented between brackets (-).
* = Correlation is significant at the 0.05 level (two-tailed).
** = Correlation is significant at the 0.01 level (two-tailed).
37
4.1.3 Manipulation evaluation
In the first part of the questionnaire, the participants were asked a question after reading a case;
this is done in order activate an implemental mindset or a deliberative mindset. In the
implemental mindset sample, only one of the eighteen participants gave three instead of six
steps. By contrast, all eighteen participants in the deliberative mindset sample gave three
advantages and three disadvantages.
To evaluate the responses to the implemental mindset question, the client acceptance
procedures of Hayes et al. are used (2005). In assisting auditors in obtaining new audit clients,
these procedures include the following steps: (a) evaluating a client’s background and reasons for
the audit, (b) checking whether an auditor is able to meet ethical and competence requirements
for the client, (c) determining the need for other professionals, (d) contacting the predecessor
auditor, (e) preparing a client proposal, (f) selecting staff for the audit, and (g) obtaining an
engagement letter (Hayes et al., 2005, pp. 164-185). Table 5 lists the results of the evaluation. An
important point to note is that the results only include procedures that were directly mentioned
by the participants. The results showed that the responses of the participants account for an
average of 44% of client acceptance procedures. This suggests that the participants in the
implemental mindset sample read and answered the question quite critically.
For the evaluation of the responses to the deliberative mindset question, four distinct
categories are used. These categories are financial performance (measured by the words profit and
revenue), reputation (measured by the word reputation), knowledge (measured by the words
knowledge, resources, and experience) and workforce (measured by the words staff and employees). The
reason for choosing these categories is rather straightforward. In order to win and serve clients,
an audit firm needs a number of features, including a good reputation, sufficient knowledge and
qualified employees. Furthermore, financial performance is not only the result of these elements;
it is also a signal to potential clients of an audit firms’ audit quality. An important point to note
here is that in the case where a word is mentioned more than once in an advantage or a
disadvantage, it counts as one word. Furthermore, an advantage or a disadvantage that contains
words from multiple categories can only be used once (e.g. an advantage or a disadvantage that
contains a key word for performance cannot subsequently be used for recording a key word for
another category). The results of the evaluation are shown in Table 6. A distinction is made
between words positively and negatively mentioned. The results show that 39% of the responses of
the participants in the deliberative mindset sample fall in one of the four categories. This also
suggests that the participants in the deliberative mindset sample read and answered the question
quite critically.
38
Table 5
Evaluation responses implemental mindset sample
Procedures Number of times directly mentioned
1. Evaluate clients’ background and reasons
for the audit
16
2. Check whether auditor is able to meet
ethical and competence requirements for the
client
5
3. Determine need for other professionals 3
4. Contact predecessor auditor 3
5. Prepare client proposal 16
6. Select staff for audit 3
7. Obtain engagement letter 1
Total procedures directly mentioned 47
Total steps (18 participants x 6 steps = 108) 108
Total procedures directly mentioned as a
percentage of total steps 44%
Table 6
Evaluation responses deliberative mindset sample
Category Advantage (+) Disadvantage (-)
Performance
- Revenue 7 0
- Profit 1 4
Reputation
- Reputation 5 2
- Name 2 4
Knowledge
- Knowledge 1 0
- Resources 0 4
- Experience 2 0
Workforce
- Staff 2 4
- Employees 3 1
Words mentioned as
advantage or disadvantage 23 19
- Total words mentioned = 23 + 19 = 42
- Total advantages and disadvantages = (3 advantages x 18 participants) + (3 disadvantages x
18 participants) = 108
- Total mentioned words as a percentage of total advantages and disadvantages = (42 / 108) x
100 % = 39%
39
4.2 Hypothesis testing
This following section discusses the results of the test for the hypothesis of this thesis. The
dependent variable AFR is used for testing whether the hypothesis should be rejected or
accepted. The variable AFR provides the results of the participants’ assessment of the fraud risk
in the second case. Furthermore, three independent variables are used, namely mindset, gender
and experience. The latter two variables are included as control variables since they may have an
impact on the dependent variable AFR.
4.2.1 Auditor’s mindsets
According to section 2.3.2, the hypothesis states that auditors adopting a deliberative mindset
will judge fraud to be more likely than auditors adopting an implemental mindset. To test this
hypothesis, a regression analysis was carried out. The results of this regression analysis showed
that there was one outlier (Mahalanobis distance = 12.946, larger than the critical value of 7.81).
This outlier was later removed, and the regression analysis was performed again (n = 36 - 1 =
35). Table 7 presents the results of this regression analysis. The adjusted R-squared shows that
3.6% of the AFR variance is explained by the model. However, the AFR variance explained by
the model is not significant (F = 1.423, p = > 0.05). The table shows that the mindset beta is not
significant (t = 0.011, p > 0.05). Furthermore, both the gender and experience are also not
significant (t = -0.680, p > 0.05; t = 1.408, p > 0.05). Therefore, the hypothesis should be
rejected. Multicollinearity has not affected the analysis since the tolerance of all independent
variables is greater than 0.2 and the VIF is lower than 10.
Table 7
Regression analysis
Model
Unstandardized
Coefficients
Standardized
Coefficients
Collinearity
Statistics
B Standard
error
Beta t-value Significance
level
Tolerance VIF
Intercept 7.283 0.396 18.385 0.000
Mindset 0.005 0.419 0.002 0.011 0.991 0.842 1.187
Gender -0.254 0.530 -0.093 -0.478 0.636 0.744 1.344
Experience 0.083 0.053 0.301 1.570 0.127 0.770 1.299
Adjusted R square: 0.036
F-value: 1.423, significance level: 0.255
Dependent variable: AFR
Independent variables: Mindset, Gender and Experience
40
4.3 Additional analyses
This section provides two additional analyses to check whether the results are robust.
4.3.1 Regression analysis with interactions
The hypothesis is further tested by including two interaction variables as independent variables
to the model. These are mindset times gender and mindset times experience. The results of this
regression analysis are shown in Table 8. The adjusted R-squared shows that -2.4% of the AFR
variance is explained by the model, which means that the model does not fit the data. In other
words, the statistical power is too low to use these results.
Table 7
Regression analysis
Model
Unstandardized
Coefficients
Standardized
Coefficients
Collinearity
Statistics
B Standard
error
Beta t-value Significance
level
Tolerance VIF
Intercept 7.158 0.537 13.327 0.000
Mindset 0.255 0.843 0.112 0.303 0.764 0.220 4.537
Gender -0.267 0.952 -0.098 -0.281 0.781 0.245 4.079
Experience 0.109 0.084 0.398 1.295 0.205 0.319 3.134
Mindset
times
gender
-0.016 1.166 -0.005 -0.014 0.989 0.203 4.926
Mindset
times
experience
-0.045 0.110 -0.177 -0.408 0.686 0.160 6.234
Adjusted R square: -0.024
F-value: 0.844, significance level: 0.530
Dependent variable: AFR
Independent variables: Mindset, Gender and Experience
4.3.2 Reduced sample test
The regression test in section 4.2.1 is performed again, excluding participants who have less than
two years of experience as an auditor. A legitimate reason for this change is that auditors with
less than two years of experience have probably only carried out one fraud risk assessment per
client they serve. Furthermore, it is not likely that they have conducted a complete fraud risk
assessment but rather only an element of it. Lastly, the sample consists of a significant portion of
41
participants with less than two years of experience. Taken together, this may have an impact on
the results in section 4.2.1. For the reduced sample test, seven scores were removed compared to
the original regression analysis (n = 35 - 7 = 28); the results of the reduced sample test are
presented in Table 9. The adjusted R-squared shows that -9.2% of the AFR variance is explained
by the model, which means that the model does not fit the data. In other words, the statistical
power is too low to use these results.
Table 9
Regression analysis
Model
Unstandardized
Coefficients
Standardized
Coefficients
Collinearity
Statistics
B Standard
error
Beta t-value Significance
level
Tolerance VIF
Intercept 7.906 0.418 18.921 0.000
Mindset -0.209 0.400 -0.114 -0.522 0.607 0.842 1.187
Gender -0.066 0.584 -0.026 -0.113 0.911 0.744 1.344
Experience 0.028 0.049 0.121 0.570 0.574 0.770 1.299
Adjusted R square: -0.092
F-value: 0.245, significance level: 0.864
Dependent variable: AFR
Independent variables: Mindset, Gender and Experience
42
5 Conclusion
As mentioned, the numerous fraud scandals in the beginning of the 21st century showed how
accounting and audit laws and regulations were inadequate. In an attempt to prevent future
scandals from happening, the Sarbanes-Oxley Act of 2002 was introduced, and the AICPA also
introduced SAS No. 99 which has been effective from October 2002. However, the current
literature questions the effectiveness of multiple mandatory tools that are incorporated in SAS
No. 99 in assessing fraud risk. Furthermore, multiple studies emphasize the importance of fraud
detection and deterrence in an audit, and it is expected that this area will become even more
important in the future. Therefore, this thesis investigates whether the effectiveness of
mandatory tools incorporated in SAS No. 99 to assess fraud risk can be enhanced using mindset
theory.
According to multiple studies, a mindset can be referred to as a set of mental processes
that establish a general preparedness to react in a certain way. Key characteristics of a mindset
include fostering orientations that are not related to a specific task and remaining active after
completion of the original task. Two mindsets—a deliberative and an implemental mindset—are
tested in an experiment to examine whether a change in mindset leads to a significantly more
accurate fraud risk judgment. The tool used for this experiment is a fraud risk checklist, which
according to the literature is the worst performing tool of SAS No. 99. As mentioned, a fraud
checklist resembles a verification task, and therefore it is expected that auditors will use a
mindset closely linked to an implemental mindset. Usage of this mindset leads to auditors
focusing on information that is relevant for the risk factors in the fraud checklist. However, it is
likely that this narrow focus limits auditors in considering information that may constitute
another fraud risk factor. By contrast, usage of a deliberative mindset fosters a broad focus of
attention that expands beyond task relevant information. Furthermore, auditors using a
deliberative mindset are more impartial in processing information than auditors adopting an
implemental mindset. Therefore, this thesis expects that usage of a deliberative mindset will
improve the effectiveness of fraud checklists. In this thesis, a higher fraud risk assessment is
considered to represent an improved effectiveness of fraud checklists.
The results of the experiment provide no support for the expectation of this thesis.
Using a deliberative mindset instead of an implemental mindset does not result in higher fraud
judgments. This implies that mindset theory is not effective in enhancing the effectiveness of
fraud checklists.
43
The findings of this thesis extend the literature in two ways. Furthermore, these findings
may be interesting to both researchers and standard setters. First, the findings suggest that the
use of mindset theory is not effective in enhancing the effectiveness of mandatory tools
incorporated in SAS No. 99 for assessing fraud risk. This means that mindset theory does not
result in auditors providing more accurate fraud judgments. Second, the findings of this thesis
are inconsistent with the findings of Griffith et al. (2015). Whereas they do find evidence in their
study that suggests mindset theory is useful in audits, this study finds no evidence. This shows
that the usefulness of mindset theory depends on the task performed in the audit. Therefore,
standard setters considering to implement new mindset regulations in specific auditing standards
should be careful when implementing such regulations.
This thesis is subject to several limitations, which could potentially affect the
contributions of the findings. First, the auditors who participated in the experiment all work for
the same Big Four audit firm, and they all work at the same office location. These factors may
have affected the answers provided by the participants. As a consequence, the generalization of
the results is limited. Second, the use of an already completed fraud checklist in the experiment
may also have influenced the results. By contrast, if auditors had been asked to fill out a fraud
checklist themselves and then provide a fraud judgment, the results could be different. Third, the
participant’s total time to complete the experiment was not measured. Therefore, it remains
unclear whether participants in one mindset sample spent significantly more time on the
experiment than participants in the other mindset sample.
This thesis is the second study that addresses the effectiveness of mindset theory in
audits, and the first one that investigates mindsets and fraud judgements. Therefore, further
research is of great importance. First, this thesis is subject to several limitations that harm the
generalizability of the findings. Therefore, future research is needed for investigating a larger
sample consisting of participants from multiple audit firms, and the time participants spend on
their task to provide a fraud judgment needs to be recorded. Second, it is desirable to have future
research on mindsets and the other three tools to assess fraud risk incorporated in SAS No. 99.
These include inquiries, analytical procedures and brainstorming. Third, since it is currently
unclear how long a mindset persists, it is desirable to investigate this in future research. Finally,
future research is needed for investigating the usefulness of mindset theory in performing other
tasks which are part of a financial statement audit.
44
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Appendix 1: Questionnaire Deliberative mindset
Part A: Audit firm rotation
According to Dutch law, companies classified as Organisaties van Openbaar Belang (in
English: public-interest organisations) are obliged to switch auditors after a certain number of
years.
Due to this law on the mandatory rotation of audit firms a listed construction company named
TSH N.V. (Total Sustainable Homes N.V.) – classified as a public-interest organisation – has
to choose a new audit firm to carry out their statutory audit for next year.
TSH N.V. was founded in 1992 by two engineering students. In 2014, TSH N.V’s turnover
was 8.5 billion euro and net income 730 million euro. TSH N.V. is a leader in multiple
segments of the European construction industry including private homes, commercial
buildings and educational buildings. TSH N.V. has multiple offices throughout Europe and
operates globally in more than 37 countries. It currently employs 9,000 people that carry out
about 1,800 building contracts every year. TSH N.V.’s goal for the coming five years is
enhancing their position in current markets and entering new markets.
Imagine that you are working for a Big 4 audit firm as an auditor. Your Big 4 audit firm
considers writing a proposal to win the construction company.
As a consequence, you - as an auditor - are asked to list three advantages and disadvantages
of winning the construction company. Write the three advantages and disadvantages in one
or a few sentences in the table below.
Advantages:
1.
2.
3.
Disadvantages:
1.
2.
49
3.
Part B: Fraud risk assessment case: Oltrak, Inc.
In this part you as an auditor are asked to assess the fraud risk for a client of your audit firm.
First, please read and review the information below. The information consists of (1) company
information and (2) a fraud risk factor checklist completed by an audit senior during the
planning stage. Second, write your judgment in the answer form which is provided at the end
of the text.
Company Background
Oltrak, Inc. (a publicly traded company) is one of the leading global electronic security
companies in the world. Oltrak designs, manufactures, markets, sells and services innovative
electronic products and systems for security and surveillance, industrial video and
professional audio markets worldwide. These products and systems include video monitors,
switchers, quad processors, digital and analog recorders, multiplexers, video transmission
systems, cameras, lenses, observation systems, audio equipment and accessories. Customers
range from single location mom-and-pop businesses to universities and government facilities.
Sales to the professional security markets are through the Company’s channel partners. The
Company has increased sales from $1.8 million in 1987 to $210 million in 2000.
The following financial data have been derived from the consolidated financial statements of
the Company and its subsidiaries (in thousand $).
Year 1996 1997 1998 1999 2000
Net sales 148,977 177,837 196,998 208,200 209,998
Net income
(loss)
1,599 2,401 3,555 3,865 2,972
Total assets 172,510 185,256 196,626 200,350 193,497
Industry/Competition
The Company faces substantial competition in each of its markets. Significant competitive
factors in the Company’s markets include price, quality and product performance, breadth of
product line and customer service and support. Some of the company’s existing and potential
competitors have substantially greater financial, manufacturing, marketing and other
resources than the Company. To compete successfully, the Company must continue to make
substantial investments in its engineering and development, marketing, sales, customer
service and support activities. The Company considers its major competitors to be the CCTV
and access control operations of Sensormatic Electronics Corporation, Burle (part of Philips
Communication & Security Systems, Inc.), Panasonic, Pelco, Lenel, and Interlogics.
Management Background
The management team of Oltrak is made up of the following key individuals:
- President and CEO, George Schultz
- Vice President of Sales and Marketing, Tammy Miller
- Vice President of Operations, Chris Streeter
- Chief Financial Officer, Theo Smith
50
- Controller Fred Beck
Most of the management team has been with Oltrak since Deloitte began auditing the
company five years ago. Over the years, the management team has been very easy to work
with and shown a high level of competence. Furthermore, several sources of information
indicate that the character of the management team is of a high quality, For example, the
partner in charge of this audit has told you that the integrity of upper management is
impeccable. He also commented to you that the CEO is one of the most honourable
businessmen in the community and that he admires his leadership in local community service
organizations such as the United Way. Most people in the business community characterize
Oltrak as begin very supportive of community values and high ideals. This characterization
stems largely from the high ideals of the management team.
Fraud Risk Factor Checklist
Fraud Risk Factor: Present: Yes/No
1. Domineering management behaviour in dealing with the auditor,
especially involving attempts to influence the scope of the auditor's work.
No
2. Significant bank accounts or subsidiary or branch operations in tax-
haven jurisdictions for which there appears to be no clear business
justification.
Yes
3. Unusual rapid growth or profitability, especially compared with that of
other companies in the same industry.
No
4. Excessive interest by management in maintaining or increasing the
entity's stock price or earnings trend.
No
5. An interest by management in pursuing inappropriate means to minimize
reported earnings for tax-motivated reasons.
No
6. Frequent disputes with the current or predecessor auditor on accounting,
auditing, or reporting matters.
No
7. Lack of monitoring of controls, including automated controls and
controls over interim financial reporting (where external reporting is
required).
No
8. Difficulty in determining the organization or individual(s) that control(s)
the entity.
No
9. Known history of violations of securities laws or other laws and
regulations, or claims against the entity, its senior management, or board
members alleging fraud or violations of laws and regulations.
No
10. Formal or informal restrictions on the auditor that inappropriately limit
access to people or information or the ability to communicate effectively
with the board of directors or audit committee.
No
11. Significant related party transactions not in the ordinary course of
business or with related entities not audited or audited by another firm. Yes
12. Perceived adverse consequences on significant pending transactions,
such as business combinations or contract awards, from reporting poor
financial results.
No
13. Nonfinancial management's excessive participation in, or
preoccupation with, the selection of accounting principles or the
determination of significant estimates.
No
51
14. High degree of competition or market saturation, accompanied by
declining margins. Yes
15. A practice by management of committing to analysts, creditors, and
other third parties to achieve aggressive or unrealistic forecasts.
No
16. An ineffective means of communication and support of the entity's
values or ethical standards by management or the communication of
inappropriate values or ethical standards
No
17. Excessive pressure on management or operating personnel to meet
financial targets set up by the board of directors or management, including
sales or profitability incentive goals.
Yes
18. Management's personal guarantee of significant debts of the entity. Yes
19. Ineffective board of director or audit committee oversight over the
financial reporting process and internal control. Ineffective board of
director or audit committee oversight over the financial reporting process
and internal control.
No
20. Operating losses making the threat of bankruptcy, foreclosure, or
hostile takeover imminent.
No
21. Significant, unusual, or highly complex transactions, especially those
close to year end that pose difficult "substance over form" questions. Yes
22. Recurring negative cash flows from operations or an inability to
generate cash flows from operations while reporting earnings and earnings
growth.
No
23. Management failing to correct known reportable conditions on a timely
basis.
No
24. Marginal ability to meet debt repayment or other debt covenant
requirements. Yes
25. Unreasonable demands on the auditor such as unreasonable time
constraints regarding the completion of the audit or the issuance of the
auditor's reports.
No
26. High vulnerability to rapid changes, such as changes in technology,
product obsolescence, or interest rates. Yes
27. Domination of management by a single person or small group (in a
non-owner managed business) without compensating controls.
No
28. Recurring attempts by management to justify marginal or inappropriate
accounting on the basis of materiality.
No
29. Overly complex organizational structure involving unusual legal
entities or managerial lines of authority.
No
30. Significant declines in customer demand and increasing business
failures in either the industry or overall economy. Yes
31. Significant operations located or conducted across international borders
where differing business environments and cultures exist. Yes
32. High turnover rates or employment of ineffective accounting, internal
audit, or information technology staff.
No
33. Significant portions of management's compensation (e.g., bonuses,
stock options) being contingent upon achieving aggressive targets for stock
price, operating results, financial position, or cash flow.
Yes
34. Assets, liabilities, revenues, or expenses based on significant estimates
that involve subjective judgments or uncertainties that are difficult to Yes
52
corroborate.
35. New accounting, statutory, or regulatory requirements that threaten
financial stability or profitability.
No
36. Ineffective accounting and information systems including situations
involving reportable conditions.
No
37. Management has heavy concentration of personal net worth in the
entity.
No
38. Need to obtain additional debt or equity financing to stay competitive-
including financing of major research and development or capital
expenditures.
Yes
39. High turnover of senior management, counsel, or board members. No
40. Profitability or trend level expectations of investment analysts,
institutional investors, significant creditors, or other external parties
(particularly expectations that are unduly aggressive or unrealistic)
including expectations of these external parties created by management in,
for example, overly optimistic press releases or annual report messages.
No
Based on the provided information (case and completed fraud risk factors checklist) what is
the risk of material misstatement in the financial statements due to fraud?
Give your answer on a scale of 1 (low fraud risk) to 10 (high fraud risk). Mark one box
below.
□ □ □ □ □ □ □ □ □ □
Low 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. High
Part C: Information participant
Please enter your demographics in the following fields:
Age:
Gender (Male/Female):
Function:
Year(s) of experience as an auditor:
53
Appendix 2: Questionnaire Implemental mindset
The only difference with Appendix 1 is that in the implemental mindset Part A: Audit firm
rotation contains a different question, which you can see below.
Part A: Audit firm rotation
According to Dutch law, companies classified as Organisaties van Openbaar Belang (in
English: public-interest organisations) are obliged to switch auditors after a certain number of
years.
Due to this law on the mandatory rotation of audit firms a listed construction company named
TSH N.V. (Total Sustainable Homes N.V.) – classified as a public-interest organisation – has
to choose a new audit firm to carry out their statutory audit for next year.
TSH N.V. was founded in 1992 by two engineering students. In 2014, TSH N.V’s turnover
was 8.5 billion euro and net income 730 million euro. TSH N.V. is a leader in multiple
segments of the European construction industry including private homes, commercial
buildings and educational buildings. TSH N.V. has multiple offices throughout Europe and
operates globally in more than 37 countries. It currently employs 9,000 people that carry out
about 1,800 building contracts every year. TSH N.V.’s goal for the coming five years is
enhancing their position in current markets and entering new markets.
Imagine that you are working for a Big 4 audit firm as an auditor. Your Big 4 audit firm
considers writing a proposal to win the construction company.
As a consequence, you - as an auditor - are asked to list six steps you would take in your
attempt to win the construction company. Write the six steps in one or a few sentences in the
table below.
Steps:
1.
2.
3.
4.
54
5.
6.