17.heightened Fraud Risk

Auditing: A Journal of Practice & Theory American Accounting Association
Vol. 30, No. 3 DOI: 10.2308/ajpt-10110

August 2011
pp. 81–101
How Do Audit Seniors Respond to Heightened

Fraud Risk?
Jacqueline S. Hammersley, Karla M. Johnstone, and Kathryn Kadous
SUMMARY: This paper describes how audit seniors modify a standard audit program
in response to heightened fraud risk when cues allow formation of specific hypotheses
about the nature of the fraud. We conduct an experiment in which we manipulate
provision of information about an internal control material weakness. We find that when
fraud risk is heightened by provision of material weakness information, audit seniors’
programs are of lower quality. This occurs because these auditors tend to propose
audit program modifications that are not effective in detecting the fraud, resulting in
programs that are less efficient. We also investigate determinants of higher-quality
audit programs, finding that program quality increases as auditors identify more risk
factors focused on the specific fraud. These results suggest that identifying risk factors
focused on the fraud area is critical to the development of high-quality audit plans, and
thus to fraud detection.
Keywords: audit planning; fraud detection; fraud risk factors; audit seniors; risk
assessments.
INTRODUCTION
A
udit seniors plan, perform, and supervise much of the audit process. For example,
seniors work alone to make any changes to the audit plan in response to fraud risk
factors discussed during the SAS 99 brainstorming session more than one-third of the
Jacqueline S. Hammersley is an Associate Professor at The University of Georgia, Karla M. Johnstone is an

Associate Professor at the University of Wisconsin–Madison, and Kathryn Kadous is a Professor at Emory
University.
We thank Michael Bamber, Kendall Bowlin, Jon Greiner, Jeremy Griffin, Josh Herbold, Bill Kinney, Bill Messier,
Ed O’Donnell, Mark Peecher, Lisa Sedor, Jane Thayer, and Mark Zimbelman, and workshop participants at the
Universities of Missouri and Montana, and participants at the Emory Experimental Brown Bag, the 2008 University
of Kansas Audit Symposium, the 2008 Southeast Summer Accounting Research Conference, the 2008 University of
Illinois Audit Symposium, and the 2009 Auditing Section Mid-Year Meeting for helpful comments, and Ann
Gamble, Jeremy Griffin, Jason Matthews, and Dan Wangarin for their able assistance coding the data. Professor
Hammersley is grateful for research support provided by a Terry-Sanford Research Award. Professor Johnstone
acknowledges support from the University of Wisconsin School of Business Andersen Center for Financial
Reporting.
Editor’s note: Accepted by Ken Trotman.
Submitted: June 2010

Accepted: March 2011
Published Online: August 2011
81
82 Hammersley, Johnstone, and Kadous
time (Bellovary and Johnstone 2007). Through their activities during the audit, seniors filter
and frame the available evidence, profoundly impacting the evidence that is available to
higher-ranking members of the audit team, and, by extension, audit outcomes and the nature of
information available to financial statement users (Ricchiute 1999; Rich et al. 1997). Thus, it
is important to understand how and how well audit seniors perform their critical audit
tasks.
The purpose of this paper is to investigate how and how well audit seniors modify audit
programs to respond to cues that allow them to form specific fraud hypotheses. Several studies have
addressed the general question of whether audit seniors respond to increased fraud risk (Glover et
al. 2000; Johnstone and Bedard 2001; Hunton and Gold 2010). However, the results do not address
whether auditors’ changes to planned procedures are effective because these studies typically use
dependent measures such as total audit hours that do not allow participants to specify how they
would change procedures and/or use cases for which a specific fraud hypothesis cannot be formed.
These studies generally report that auditors increase the extent of planned audit procedures but do
not change the nature of planned audit procedures (Zimbelman 1997; Glover et al. 2000; Glover et
al. 2003). However, it is not clear what change to the nature of procedures should be expected under
these conditions (Hammersley 2011).
Two studies have provided information allowing auditors to develop a specific fraud
hypothesis and have demonstrated that various interventions improve audit planning (Asare and
Wright 2004; Hoffman and Zimbelman 2009). We extend this work by performing a systematic
examination of auditors’ responses to fraud cues, thereby providing evidence about the
effectiveness for fraud detection and efficiency of audit seniors’ risk assessments and risk
responses. Acquiring this evidence is a critical first step in improving auditors’ ability to detect
fraud, because it sheds light on which fraud-related tasks audit seniors do well and which present
particular difficulties. Understanding this distinction is useful for audit firms as they consider
training requirements, task assignments, and the need for review of audit seniors’ work. It also may
be useful to regulators as they develop standards aimed at improving auditors’ risk assessments and
responses (e.g., Public Company Accounting Oversight Board [PCAOB] 2008).
To conduct our examination, we provide senior-level Big 4 auditors with a case describing a
(disguised) company that committed a material revenue cycle fraud, and we ask them to make
revenue cycle audit planning judgments. The fraud involved a channel-stuffing and bill-and-hold
scheme that targeted a small subset of the client’s distributors. Fraud risk cues are woven
throughout the materials and are identical across experimental conditions. Sufficient information is
provided to allow formation of specific, testable fraud hypotheses.
We manipulated whether a material weakness had been discovered in the client’s ongoing
internal controls testing. Auditors were told either that results were not yet available or that so far
one material weakness had been identified related to recording revenue (i.e., the cycle they are
auditing). In the latter case we gave a description of the identified weakness, which was unrelated to
the seeded fraud. Due to the PCAOB’s focus on the importance of internal controls, we expected
that knowledge of a material weakness, particularly when it is in the cycle for which the auditor is
conducting planning, would heighten fraud risk.
We find that auditors who receive information about a material weakness assess both fraud risk
and the need to consult with a risk management partner higher than auditors who receive no
information about a material weakness. However, material weakness information does not cause
auditors to respond more appropriately to fraud risk. Auditors receiving information about a
material weakness do not identify more risk factors focused on the seeded fraud than auditors in the
control condition, nor do they design higher-quality audit programs. In fact, these audit seniors
develop audit programs that are of lower quality than those of auditors in the control condition: they
are no more effective for fraud detection purposes and are more inefficient. In-depth analyses of
Auditing: A Journal of Practice & Theory

August 2011
How Do Audit Seniors Respond to Heightened Fraud Risk? 83
specific audit program modifications show that this latter result occurs because audit seniors modify
the program when the standard procedure is appropriate, and they modify procedures in ineffective
ways when modification is needed. In fact, auditors receiving material weakness information make
significantly more program modifications than auditors in the control condition, but the bulk of
these modifications are indiscriminate increases in sample size, which are ineffective in uncovering
the fraud. Few of the auditors attempt to tailor sample selection or procedures to focus on the
specific risks present.
These results extend prior research by identifying specific areas of difficulty for audit seniors
(i.e., knowing when to use a standard procedure and knowing how to modify a standard procedure)
and by demonstrating that increased audit effort will not necessarily result in increased
performance. Indeed, while prior research shows that auditors know something should be done
in response to fraud cues, our results show that the additional effort often will be ineffective in
identifying fraud.
In additional analyses we find that auditors who identified more risk factors focused on the
seeded fraud developed higher-quality audit programs. This implies that forming specific
hypotheses about what fraud could be present, rather than merely identifying the presence of
higher risk, is necessary for higher performance on audit program modification. Thus, we extend
prior research by demonstrating that the ability to identify relevant fraud risk factors is an important
driver of audit seniors’ fraud detection performance.
PRIOR LITERATURE AND EXPECTATIONS
SAS 99 provides authoritative guidance for auditors’ consideration of fraud in a financial

statement audit. It identifies several steps that auditors should take when considering fraud,
including: (1) obtaining information necessary to identify risks of material misstatement, (2)
assessing the identified risks after taking into account an evaluation of the entity’s programs and
controls (emphasis added), (3) identifying risk factors that may result in a material misstatement
due to fraud, and (4) responding to the results of the assessment with specific audit procedures and
evidence (AICPA 2002). Our study examines how and how well audit seniors perform the latter
two steps.
As Hammersley (2011) notes, the type of cues present determines the type of changes in
planned audit procedures that can reasonably be made. When only general red flags are present
(i.e., incentive, opportunity, and rationalization risks), auditors are unlikely to be able to specify
hypotheses about how fraud may occur. In this case, auditors likely increase assessed risk, but
will be unlikely to recommend changes to the nature of planned audit procedures. Instead,
auditors are likely to prescribe increases in the extent of testing in response to increased risk
assessments. When the cues allow formation of specific fraud hypotheses, auditors can plan tests
that will determine whether the hypothesized frauds are present. In this case, auditors should be
able to plan changes to the nature of audit procedures; this is the setting in which we focus our
investigation.
Most previous research investigating auditor changes to planned audit procedures examines
whether auditors respond to general red flags, but does not examine whether or how auditors
respond to risk cues that support the generation of specific fraud hypotheses. These studies
generally show that auditors specify increases to planned audit hours and sample sizes, but do not
plan changes to the nature of planned audit procedures. For example, Zimbelman (1997) reports
that decomposing fraud and error risk assessments (i.e., increasing the salience of fraud risk)
increases budgeted hours, but he also reports that perceived audit program strength does not differ
based on the presence of fraud red flags. Glover et al. (2000) report that auditors increase sample

August 2011
sizes and planned audit hours when management has an incentive to misstate the financial
statements and the auditor has minimal corroboration of the explanation for the unexpected
change to the account balance; however, they also report that 40 percent of participants do not
make any changes to planned procedures. Further, Glover et al. (2003) examine whether auditors
are more sensitive to fraud red flags after the implementation of SAS 82, finding that in this time
period auditors indicate a higher need to modify the audit plan, and they budget more total audit
hours when red flags are present than when they are absent. However, they also report no
significant differences in perceived audit program strength based on the presence of red flags,
even though the post-SAS 82 participants’ perceived strength is higher than that of pre-SAS 82
participants.
Evidence from studies examining the effect of red flags on audit program changes cannot
inform the question of whether auditors are able to appropriately specify changes to audit
procedures in response to fraud risk identification unless the red flags allow formation of specific
fraud hypotheses. Two prior experimental studies have examined audit program changes when
auditors could form specific fraud hypotheses. Asare and Wright (2004) report that auditors who
modified a standard audit program create less effective audit plans than auditors who create an
unaided list of the procedures they want to perform. Hoffman and Zimbelman (2009) report that
managers who brainstorm about procedures to perform or engage in strategic reasoning about how
the client could be committing fraud make more effective changes to a standard audit program
compared to managers who are unaided. These studies provide important insights about auditor
performance in fraud detection; however, they do not report detailed analyses of how auditors
respond to identified risks.
Other studies have examined auditors’ judgments captured in the work papers of actual
engagements. These studies report mixed evidence about how effectively auditors in practice
respond to identified risks. Johnstone and Bedard (2001) show that auditors plan an additional
layer of review for prospective clients when they identify even one fraud risk factor. Graham
and Bedard (2003) note that auditors most often add review and inquiry procedures to address
identified fraud risks. Blay et al. (2007) report that auditors plan to collect more external
rather than internal evidence and plan to collect more evidence at year-end rather than at
interim when fraud risk is assessed higher. In contrast, Mock and Turner (2005) report that
audit programs are not modified for the majority of clients in their sample, regardless of the
level of risk assessed.
In sum, there is mixed evidence regarding how and how well auditors are able to identify
relevant fraud risks and design audit programs to detect fraud. We study this issue using a case
in which fraud cues allow formation of specific hypotheses about the nature of the possible
fraud. Thus, our study provides a clear test of whether audit seniors are able to perform these
tasks, and, if not, where they go astray. If auditors are better able to identify relevant risk factors
and create effective programs when awareness of fraud risk is heightened, this would be
consistent with the conclusions of prior studies showing a positive association between risk and
audit effort. However, it is possible that while auditors are better able to identify relevant risk
factors when fraud risk is heightened, they are unable to translate these risk factors into effective
and efficient audit procedures. It is also possible that even when fraud risk is heightened and
auditors recognize the heightened fraud risk, they are still not better able to identify relevant
fraud risk factors or design effective and efficient audit procedures. Given the lack of prior
research in settings in which fraud cues allow formation of specific fraud hypotheses, we
conduct an experiment that enables us to provide descriptive data on the viability of these
alternatives.

August 2011
RESEARCH METHOD
Participants
Fifty-four senior-level auditors with an average of 41.2 months of audit experience participated
in our study during a firm training session for experienced seniors.1 Fifty percent identified
themselves as CPAs.2 Participants’ average self-rated experience with revenue recognition issues
was 4.55 on a scale anchored by 1 (no prior experience), 4 (dealt with on a number of occasions),
and 7 (dealt with this very often). Additionally, they reported working on an average of 2.76
engagements on which a material error was detected and on 0.24 engagements on which material
fraud was detected.
Materials and Procedures

Participants read case information about a hypothetical client and were instructed to design a
revenue cycle audit program for the client. We adapted our materials from Asare and Wright
(2004). Our case included background information on the company; industry analysis; assessments
of management, materiality, and the control environment; an overview of the revenue cycle; and
information about a new marketing strategy the company was employing. The case also contained
current and prior year ratio analyses and summary financial statements. After reading the materials,
participants identified up to five risk factors from the case, judged revenue cycle risks, modified a
standard revenue cycle audit program to respond to the risks, assessed the need to consult with a
risk management partner before finalizing the audit program, and completed a post-experimental
questionnaire containing demographic questions and manipulation checks.
The case contained an embedded revenue cycle fraud reported by the SEC in an Accounting
and Auditing Enforcement Release, thereby providing a valid outcome measure of fraud. The
company had committed revenue fraud via channel-stuffing and bill-and-hold schemes with a small
subset of its distributors. The case contained a description of the new marketing strategy—the
means by which the fraud was committed—including description of questionable sales, credit,
shipping, and other incentives being offered to that small subset of distributors. Financial statements
and financial ratios also indicated likely misstatements consistent with the scheme. We summarize
information provided in the case about the fraud in Appendix A.
Manipulation
We manipulated information provided about a material weakness at two levels: absent (control)
and present.3 Material weaknesses are red flags and are expected to heighten fraud risk. In both
1
There were 67 participants; however, two did not complete the task, one was consistently an outlier in our
analyses, seven failed a manipulation check that asked participants to identify whether they had received
information about a material weakness, and, if so, which transaction cycle it was in, and three failed to answer
the manipulation check. We omit data from these participants, which leaves a final sample of 54 participants.
However, inferences are unchanged if the outlier is included and if data from the ten participants failing or failing
to complete the manipulation check are included in analyses.
2
Our participants’ experience levels are within the range of that of participants in other studies with a similar
focus. For example, Pincus (1989) used auditors with an average of 18 months of experience, while Zimbelman
(1997), Glover et al. (2000), and Wilks and Zimbelman (2004) used auditors with an average of slightly over five
years of experience. The audit firm providing participants assured us that their audit seniors routinely make the
judgments requested in our study.
3
Our full experiment included a third condition in which 33 participants received information about a material
weakness in a different cycle from the one under audit. Results from this ‘‘different cycle material weakness
present’’ condition largely mirror those for the ‘‘material weakness present’’ condition, and so for brevity and
clarity, we report only two conditions.

August 2011
conditions, we told participants that the audit firm was currently testing the client’s controls
company wide (i.e., testing was incomplete). In the control condition, we also told them that no
results were available yet. In the material weakness present condition, we told them that so far, one
material weakness in recording revenue contracts had been identified (i.e., the cycle under audit).
The material weakness was unrelated to the seeded fraud; this ensures equal information about
fraud across conditions.
Measures
Recognizing the Risk of Fraud
We collected two measures that allow us to test whether material weakness information
influenced assessed fraud risk. Participants assessed both fraud risk for the revenue cycle and the
need to consult with a risk management partner before finalizing the proposed audit program on 11-
point Likert scales. We defined fraud risk as the risk that the client and its management would
intentionally cause the financial statements to be materially misstated.
Responding to Heightened Fraud Risk

Fraud risk factor identification. Participating auditors had two main tasks in the study. First,
they were asked to list up to five important risk factors that came to their attention while reading the
case. We use these listings to analyze the extent to which auditors identify risk factors specific to the
fraud described in the case. To facilitate that determination, we had two research assistants (each
with at least three years of audit experience) code the risk factors into one of six mutually exclusive,
exhaustive categories: (1) related to the seeded fraud, (2) reiterating a material weakness, (3) related
to other revenue cycle issues, (4) related to other (non-revenue, non-control system) risks, (5)
related to other (non-material weakness) control system issues, and (6) participants’ conceptual
errors.4 Coders were blind to experimental condition. Inter-rater agreement was 89.9 percent.
Cohen’s Kappa, a measure of inter-rater agreement over and above that expected by random
agreement, is 0.86, and this is significantly different from zero (p , 0.01). All differences were
mutually resolved by the coders. In the results section we focus our analysis on the number of risk
factors that were coded as related to the seeded fraud.
Modifications to the standard audit program. Participants’ second main task was to modify
a standard revenue cycle audit program for the risks present in the case. The standard audit program
contained 15 audit procedures related to sales and receivables. Participants chose one or more of
five options for each procedure: (1) omit, not applicable; (2) perform standard procedure (random
sample, low to medium risk); (3) increase sample size for high risk; (4) modify to focus (target)
sample; and (5) modify in some other way. When they chose options 4 or 5, they also specified how
they would modify the procedure. We read the modifications to determine whether they were
focused on the fraud. They also were asked to write in any additional procedures needed. An author
and a research assistant who were blind to experimental condition coded the additional procedures
4
We coded risks as related to the seeded fraud if the items made conclusions about the marketing plan’s character
(e.g., ‘‘bill and hold’’ or ‘‘channel stuffing’’) or discussed characteristics of the marketing plan, including the
minimum purchase requirements, incentives offered to distributors (i.e., profit sharing, access to large retail
customers, premier digital frequent-flyer-type program), promissory notes and terms, credit limit increases, and
hiring of freight forwarders and warehouse facilities. We coded risks as reiterating a provided material weakness
if the items noted the presence of the weakness or described the weakness. Other revenue cycle risks include any
items related to revenue but not to controls or the seeded fraud (e.g., revenue trends, changes in sales mix).
Control system risks are any items relating to controls. Other risks include all risk factors not coded into another
risk category (e.g., changing competitive environment, pressure on management, organization of the business).
Errors are conceptual mistakes.

August 2011
written as to whether they would discriminate the presence of the seeded fraud. Inter-rater
agreement is 90.1 percent. Cohen’s Kappa is 0.75, and this is significantly different from zero (p ,
0.01). All coding differences were mutually resolved by the coders.
To evaluate participants’ program modifications, we convened a panel of highly experienced
auditors to specify a benchmark tailored program and write any additional procedures needed that
would be both effective in detecting the seeded fraud and efficient. We measure the degree to which
participants’ programs coincide with this high-quality benchmark program.5 The expert panel was
composed of three auditors (two partners and one senior manager) with an average of 14.4 years of
audit experience, each of whom is responsible for leading the audit practice in his/her office. The
expert panel recommended the standard audit program procedures for three of the fifteen standard
audit program steps, and recommended targeting the sample or changing the standard procedure in
other ways to focus on the fraud for eight other program steps. The expert panel recommended that
the remaining four program steps be omitted because they were not relevant to the client’s
situation.6 In addition to descriptive analyses of the audit programs, we analyze measures of audit
program quality, effectiveness for fraud detection, and inefficiency that are based on the expert
panel’s recommended program.
RESULTS
Recognizing the Risk of Fraud

We first examine whether the presence of material weakness information is associated with
higher fraud risk assessments and higher propensity to consult a fraud specialist. We find that senior
auditors assess fraud risk significantly higher when a material weakness is present (mean = 8.29)
than when it is absent (mean 7.04, F1, 52 = 5.54, p = 0.02).7 Auditors are also more likely to consult
when a material weakness is present (7.39) than when it is absent (5.36, F1, 51 = 10.37, p , 0.01).
A MANOVA model (untabulated) with these two measures as the dependent variables reveals a
significant effect of our manipulation (F2, 50 = 6.20, p , 0.01). Thus, material weakness
information heightens audit seniors’ fraud risk assessments.
Responding to the Risk of Fraud

Fraud Risk Factor Identification
Next, we examine whether audit seniors’ lists of risk factors focus more on the fraud area when
material weakness information is provided. To examine this question, we estimate an ANCOVA
5
To develop the benchmark program, we first provided the expert panel members with the standard audit program.
We told them about the fraud to ensure that they designed the best program for fraud detection. (We are not
interested in comparing audit seniors’ overall performance with that of the expert panel; instead, our purpose is to
use the experts’ program to evaluate the quality of the seniors’ performance for fraud detection.) Each of the
panelists sent their recommended modifications to the standard program to one of the authors. We combined the
collective modifications and distributed the resulting benchmark program to the panelists. They reviewed it a
final time and sent modifications again. We again made changes to reflect the collective modifications, and sent
the final benchmark program to the panelists, upon which all reviewed and approved it.
6
We do not use the standard audit program or the benchmark program from Asare and Wright (2004) for two
reasons. First, we modified their case significantly (we organized the case facts differently, summarized them,
and added a set of financial ratios). Second, we consulted with the firm providing participants to ensure that the
standard program we used was reflective of their standard program. As a result, our standard audit program
contains more steps and uses different response options than Asare and Wright’s, making their benchmark
program incompatible with our instrument. Accordingly, we engaged an expert panel to derive a benchmark
program that was both effective and efficient for our case.
7
All reported p-values are two-tailed.

August 2011
with number of risk factors related to the seeded fraud as the dependent variable, material weakness
condition as the independent variable, and revenue recognition experience as a covariate.8 Table 1,
Panel A contains the ANCOVA and Panel B contains descriptive statistics.
Of the five risk factors audit seniors identified, on average, 1.84 relate to the seeded fraud. The
number of fraud factors does not vary by material weakness information condition (F1, 51 = 1.21, p
= 0.28).9 There are no significant differences across experimental conditions for the other
categories (all p-values . 0.27), except for risk factors focused on the presence of the material
weakness. Audit seniors who received material weakness information wrote 0.47 risk factors
focused on the weakness while those who did not receive this information wrote 0.03 items focused
on this information (F1, 51 = 19.92, p , 0.01). Therefore, audit seniors receiving material weakness
information do not generate more risk factors that are focused on the fraud when awareness of fraud
increases.
As noted above, auditors in the material weakness present condition often used one of their five
risk factors to list the presence of the material weakness. Because we limited their responses, we
investigate whether this affects our conclusions by computing the proportion of fraud risk factors
written to total risk factors written without regard to material weakness risk factors. Our inferences
are unaffected: there are no significant differences in this measure across the levels of our
independent variable (p = 0.56). Material weakness information, despite increasing fraud risk
assessments, does not increase the number of risk factors audit seniors identify that focus on the
seeded fraud.
Changes to the Standard Audit Program

Descriptive analysis. To begin our examination of audit program changes, we present the
standard audit program and the options that auditors were given in the first column of Table 2. The
expert panel’s benchmark program is indicated in bold. Additional columns indicate the percentage
of auditors recommending each particular option and associated modifications (overall and by
experimental condition). Three themes emerge from this table. These themes guide our more
systematic examinations of the fraud detection quality, effectiveness, and efficiency of audit
seniors’ program modifications that follow this section.
First, in situations in which the expert panel recommended tailoring the standard procedure by
targeting the sample or the procedures, audit seniors across experimental conditions appear
reluctant to do so. For example, in the case of confirming receivables (i.e., Receivables Procedure
#1), the expert panel recommended two modifications (i.e., focus the sample on the subset of
distributors in the new marketing strategy and modify the procedure to confirm terms of sales), but
audit seniors correctly tailored this procedure only about 15 percent of the time (5.6 percent plus 9.3
percent). They were far more likely to choose to perform the standard procedure (50.0 percent) or to
recommend increasing the sample size (42.6 percent). Auditors’ overwhelming focus on sending
standard confirmations of balances or increasing the sample size without tailoring the sample or the
content of the confirmation is worrisome, given the available fraud cues.
Second, audit seniors, especially those in the material weakness present condition, appear to
over-rely on increases in sample size, even when doing so is unlikely to be effective. Again
8
Despite random assignment of participants to experimental conditions, we find significant differences across the
material weakness conditions for two demographic measures: number of audits on which material fraud has been
discovered and self-rated revenue recognition experience. We include these variables in our models as controls
when they are significantly correlated with the dependent variable.
9
We also test whether an indicator variable that equals one if a participant included at least one risk factor focused
on the seeded fraud (and equals zero otherwise) is associated with our manipulation. The difference across
conditions also is not significant for this dependent variable (p = 0.14).

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TABLE 1
Fraud Risk Factor Identification
Panel A: ANCOVA Table—Number of Fraud Risk Factors Identified
Source of Variation df MS F p-value
Material Weakness Condition 1 2.06 1.21 0.28
Revenue Recognition Experience 1 9.37 5.49 0.02
Error 51 1.70
Panel B: Descriptive Statistics—Adjusted Least Square Mean (Standard Error)
Material Weakness Condition

Control Present
(n = 26) (n = 28)
Fraud Risk Factors 2.04 1.64
(0.26) (0.25)
Material Weakness Risks 0.03a 0.47a
(0.07) (0.07)
Other Revenue Cycle Risks 0.76 1.00
(0.19) (0.18)
Other Risks 1.91 1.55
(0.24) (0.23)
Other Control System Risks 0.25 0.13
(0.09) (0.08)
Errors 0.00 0.04
(0.30) (0.03)
Total Risk Factors 4.99 4.83
(0.12) (0.12)
Proportion Fraud Risk Factors without 0.42 0.37
regard to MW Risk Factors (0.06) (0.05)
a
Indicates that means are different at p , 0.05 (two-tailed).
Material Weakness Condition is manipulated between participants at two levels. Revenue Recognition Experience is
the amount of experience the auditors have with revenue recognition issues elicited on a scale anchored by 1 (no prior
experience) and 7 (dealt with this very often). Fraud Risk Factors is the number of risk factors written that were coded
as focused on the fraud area. Material Weakness Risks is the number of risk factors written that reiterated the seeded
material weakness. Other Revenue Cycle Risks is the number of risk factors written that focus on revenue cycle risks
that are unrelated to the seeded fraud. Other Risks is the number of risk factors written that focus on the competitive
climate, pressures on management, and the organization of the business. Other Control System Risks is the number of
risk factors written that make conclusions about the internal control system. Errors is the number of items written that
are obvious conceptual errors. Total Risk Factors is the total number of risk factors written; participants were asked to
write five risk factors. The Proportion of Fraud Risk Factors is the proportion of risk factors written that were coded as
focused on the fraud area, without regard to the risk factors written that focused on the material weaknesses used in our
manipulations. We computed this variable as Number of Fraud Risk Factors/(Total Risk Factors Material Weakness
Risk Factors).
focusing on the case of confirming receivables, auditors chose to increase sample size 42.6 percent
of the time across all conditions (60.7 percent when a material weakness was present) rather than
tailoring the procedure as recommended by the expert panel. Given the targeted nature of the fraud
within a limited subset of the distributors, untargeted increases in sample size are unlikely to be

August 2011
TABLE 2
Standard Audit Program, Expert Benchmark Program, and Descriptive Statistics on
Audit Program Changes
Panel A: Standard Audit Procedures—Receivables

Material Weakness
Condition
Overall
Mean Control Present
01. Confirm Receivables [Validity, Recording, Cutoff]
___ omit, not applicable 0.0 0.0 0.0
___ perform standard procedure (random sample, low to medium risk) 50.0 65.4 35.7
___ increase sample size for high risk 42.6 23.1 60.7
___ modify to focus (target) sample, describe the targeting here: 5.6 11.5 0.0
_____________________________________ (0.0) (0.0) (0.0)
___ modify in some other way, describe modification here: 9.3 3.8 14.3
_____________________________________ (1.9) (3.8) (0.0)
02. Test the Allowance for Doubtful Accounts and Bad Debt Expense [Valuation]
_____________________________________ (3.7) (0.0) (7.1)
_____________________________________ (1.9) (3.9) (0.0)
03. Test Allowances for Sales Returns and Discounts [Valuation]
_____________________________________ (0.0) (0.0) (0.0)
_____________________________________ (1.9) (3.9) (0.0)
04. Test Valuation of Foreign Currency Receivables [Valuation]
_____________________________________ (0.0) (0.0) (0.0)
_____________________________________ (0.0) (0.0) (0.0)
05. Test for Prohibited Loans to Executives
_____________________________________ (3.7) (3.9) (3.6)
_____________________________________ (3.7) (0.0) (7.1)
(continued on next page)

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TABLE 2 (continued)
Panel B: Standard Audit Procedures—Sales

Material Weakness
Condition
Overall
01. Test Sales Balances [Validity, Completeness, Recording, Cutoff]
_____________________________________ (0.0) (0.0) (0.0)
_____________________________________ (1.9) (0.0) (3.6)
02. Test Sales Returns [Completeness, Recording, Cutoff]
_____________________________________ (0.0) (0.0) (0.0)
_____________________________________ (0.0) (0.0) (0.0)
03. Test Cutoff of Sales [Cutoff]
___ perform standard procedure (random sample, low to medium 37.0 65.4 10.7
risk)
_____________________________________ (1.9) (0.0) (3.6)
_____________________________________ (1.9) (0.0) (3.6)
04. Test Cutoff of Credit Memos [Cutoff]
_____________________________________ (3.7) (0.0) (7.1)
_____________________________________ (1.9) (0.0) (3.6)
05. Test Foreign Currency Sales [Recording]
_____________________________________ (1.9) (0.0) (3.6)
_____________________________________ (0.0) (0.0) (0.0)
(continued on next page)

August 2011
TABLE 2 (continued)
Panel C: Standard Audit Procedures—Sales and Receivables

Material Weakness
Condition
Overall
01. Test Propriety of Revenue Recognition Policies and Procedures—Sales
and Receivables [Validity, Completeness, Recording, Cutoff]
_____________________________________ (3.7) (0.0) (7.1)
_____________________________________ (0.0) (0.0) (0.0)
02. Test Presentation of Sales and Receivables [Presentation]
_____________________________________ (0.0) (0.0) (0.0)
_____________________________________ (3.7) (7.7) (0.0)
03. Test Sales and Receivables Journal Entries Recorded in the General Ledger [Validity, Recording]
_____________________________________ (9.3) (11.5) (7.1)
_____________________________________ (0.0) (0.00) (0.0)
04. Evaluate Business Rationale for Significant Unusual Sales or Receivables Transactions [Validity,
Recording, Valuation]
_____________________________________ (7.4) (3.8) (10.7)
_____________________________________ (0.0) (0.0) (0.0)
05. Test Presentation of Related Party Sales and Receivables [Presentation]
_____________________________________ (5.6) (0.0) (10.7)
_____________________________________ (1.9) (0.0) (3.6)
The expert panel’s recommended options are in bold. Values in the table represent the percentage of participants
recommending that option. For ‘‘modify’’ options, the first value represents the percentage of auditors recommending an
option consistent with the expert panel’s recommendation, and the value in parentheses represents the percentage of
auditors recommending an option inconsistent with the expert panel’s recommendation. Totals for each procedure exceed
100 percent if auditors chose more than one option for each procedure.

August 2011
effective. It appears that auditors correctly recognized that the procedure required a change to
respond to increased risk, but they chose an ineffective response.
Third, although one might expect that audit seniors would be fairly good at identifying
when to apply standard audit procedures, their performance is inconsistent even when the
standard procedure is appropriate. For example, for testing presentation of sales and receivables
(i.e., Sales and Receivables Procedure #2), seniors chose the standard procedure 63.0 percent of
the time; however, for sales cutoff testing and testing sales and receivables journal entries (i.e.,
Sales Procedure #3 and Sales and Receivables Procedure #3), audit seniors chose the standard
procedure recommended by the expert panel only 37.0 and 35.2 percent of the time,
respectively. Thus, identifying when a standard procedure is appropriate is also difficult for
audit seniors.
Fraud detection program quality score. In this section, we examine the relative quality of
auditors’ program modifications at a global level and investigate whether quality differs across
material weakness conditions. Our measure of fraud detection program quality simultaneously
considers the effectiveness (for fraud detection purposes) and the efficiency of participants’
recommended program modifications. To compute this measure, we assign one point for each
program step for which participants chose the same action as the expert panel. We add to this the
number of additional audit procedures written that would discriminate the presence of the seeded
fraud to the points received for program step modifications. No credit is given for ineffective or
inefficient procedures.10 Higher fraud detection program quality scores reflect a higher chance fraud
will be efficiently detected using the modified audit program.
We next estimate an ANCOVA with fraud detection program quality as the dependent variable,
material weakness condition as the independent variable, and experience with fraud as a covariate.
Table 3, Panel A contains the ANCOVA and Panel B contains descriptive statistics for each
element of the fraud detection program quality score.
We find that material weakness condition auditors create lower-quality fraud detection
programs (5.19) than control condition auditors (mean 7.28, F1, 49 = 11.23, p , 0.01). Additional
inspection of Panel B yields three observations. First, auditors write only a small number of
additional effective audit procedures (mean 0.71, not tabulated) and this does not differ by
experimental condition (p = 0.62). Second, for the eight procedures for which the expert panel
recommended modifying the sample to focus on the fraud area, audit seniors’ programs matched the
expert panel recommendation on average only 1.12 times (not tabulated), and material weakness
condition did not affect their relative success (p = 0.43). Third, for the three procedures for which
the expert panel recommended performing the standard procedure, material weakness condition
auditors chose the standard procedure 0.81 times. This is lower than the mean in the control
condition (mean 1.84, F1, 49 = 23.49, p , 0.01). For the four procedures that the expert panel
recommended omitting because the area is not relevant to the client situation, material weakness
condition auditors chose to omit or perform the standard procedure 2.75 times, on average; this is
significantly less than the mean in the control condition (mean 3.39, F1, 49 = 4.87, p = 0.03).11
10
For example, because the fraud was isolated to the new marketing strategy, the expert panel suggested targeting
eight procedures to focus the sample on the distributors included in the program. When the expert panel
recommended targeting, a participant who indicated that the procedure should be performed by increasing the
sample size received no credit for this modification under our fraud detection program quality score, as it is
neither effective nor efficient.
11
The expert panel recommended omitting these procedures because there was nothing in the case that indicated
the procedure is relevant to the client’s situation (e.g., experts omitted testing valuation of foreign currency
receivables because there was no discussion of sales in a foreign currency). However, since the case also did not
explicitly state that the item did not apply to the client’s situation, we accept either ‘‘omit’’ or ‘‘perform the
standard procedure’’ as high-quality answers.

August 2011
Overall, we find that heightened fraud risk does not increase the quality of audit seniors’
programs for fraud detection. Instead, it appears that the opposite is true—audit seniors who receive
material weakness information create lower-quality fraud detection programs than auditors without
such information because they do not more effectively modify the audit program when modification
is appropriate and they perform worse when standard procedures are appropriate. In the following
two sections, we investigate why this occurs by separately examining the effectiveness and
efficiency of audit seniors’ planned programs.12
Audit program effectiveness score. We compute an audit program effectiveness score as the
sum of all procedures for which participants recommended the modifications that the expert panel
labeled as effective for fraud detection, even if they included other inefficient procedures, plus the
number of additional effective procedures written. For example, participants may have recommended
both targeting the sample to focus on the distributors and increasing the sample size on a procedure
for which the panel recommended only targeting the sample. Although this modification would not
increase the program quality score discussed previously, it would count as effective under this
measure. Higher scores indicate more effective audit programs for fraud detection.13
Untabulated results show no difference in the effectiveness of audit programs across material
weakness conditions (means 4.83 and 5.10 for control and material weakness present, respectively;
F1, 49 = 0.24, p = 0.63).14 There are no differences across conditions for procedures for which the
expert panel recommended performing the standard program (p = 0.59) or for those for which the
panel recommended modifying the procedures (p = 0.66). In addition, performance is poor in both
conditions for procedures for which the expert panel recommended changes to target the fraud.
Audit seniors specified an average of only 1.56 effective modifications to these eight procedures.
Audit program inefficiency score. We compute a measure of audit inefficiency as the sum of
all the procedure modifications participants recommended that do not match the procedures
recommended by the panel and the number of additional audit procedures written that would not
provide diagnostic information about the seeded fraud. Higher scores indicate more inefficient audit
programs. We present descriptive statistics concerning this analysis in Table 4.
We find that material weakness present condition auditors produced more inefficient audit
programs (11.04) than control condition auditors (mean 9.12, F1, 49 = 6.26, p = 0.02). This effect is
driven by procedures the expert panel recommended performing as the standard program procedure.
There are no differences across conditions for the procedures that the expert panel recommended
changing or omitting, and there are no differences in additional ineffective procedures listed.15
12
We also examine whether participants’ modifications would effectively address the risks related to the presence
of the material weakness. The material weakness resulted from a lack of communication about changes to sales
contract terms. We considered a response effective for addressing the material weakness if the participant either
wrote an additional audit procedure that required determining whether there were changes to the terms of the
sales contracts or tailored the confirmation procedure to require confirmation of terms of the sale with the
customer (regardless of whether the sample was targeted). We find that participants made very few modifications
that effectively address the material weakness. They averaged 0.11 and 0.14 such modifications in the control
and material weakness present conditions, respectively. Further, material weakness condition participants did not
write significantly more modifications that would address the risks related to the material weakness than no
material weakness condition participants (F1, 52 = 0.09, p = 0.77). Overall, we conclude that participants’
program modifications did not effectively address the risks from the material weakness.
13
We exclude from this computation the procedures that the expert panel recommended omitting because there are
no effectiveness implications for such procedures.
14
Reported test statistics for audit effectiveness, efficiency, and program modifications are based on separate
(untabulated) ANCOVA models with material weakness condition as the independent variable and experience
with fraud as a covariate.
15
We also compute audit inefficiency as the ratio of inefficient procedures to the total number of procedures
specified. Tests using this measure corroborate findings of the main test; that is, audit programs are less efficient
when auditors receive information that increases the awareness of fraud risk ( p , 0.01).

August 2011
TABLE 3
Fraud Detection Program Quality
Panel A: ANCOVA Table—Fraud Detection Program Quality Score
Source of Variation df MS F p-value
Material Weakness Condition 1 56.54 11.23 , 0.01
Experience with Fraud 1 32.07 6.37 0.02
Error 49 5.04
Panel B: Descriptive Statistics—Adjusted Least Squares Mean (Standard Error)

Control Present
Component Number Possible (n = 25) (n = 27)
Effective Additional Procedures Written NA 0.79 0.64
(0.22) (0.22)
Quality Audit Program Choices when Expert Panel Recommended
Standard Procedure 3 1.84a 0.81a
(0.15) (0.15)
Modify Procedure 8 1.25 0.99
(0.24) (0.23)
Omit Procedure 4 3.39b 2.75b
(0.21) (0.20)
Fraud Detection Program Quality Score . 15 7.28c 5.19c
(0.45) (0.43)
a,b,c
Superscripts of the same letter indicate that means are different at p , 0.05 (two-tailed).
Material Weakness Condition is manipulated between participants at two levels. Experience with Fraud is the number of
times the auditors had been on an audit in the previous five years on which material fraud was discovered. Effective
Additional Procedures Written is the number of additional audit procedures the auditors wrote that would provide
evidence that would discriminate the presence of the seeded fraud. Standard Procedure is the number of times auditors
opted only to perform the standard audit program procedure for the three procedures the expert panel recommended
performing the standard audit program procedure. Modify Procedure is the number of times auditors’ only modification
was to modify the standard audit program procedure to be correctly focused on the fraud area for the eight procedures
that the expert panel recommended modifying in this way. Omit Procedure is the number of times auditors opted to omit
or perform the standard audit program procedure for the four procedures that the expert panel recommended omitting
because the procedures did not relate to the fraud. Fraud Detection Program Quality Score is the number of standard
audit procedures for which auditors chose only the same option (e.g., perform standard, modify, or omit) as the expert
panel, plus the number of effective additional procedures auditors wrote.
Overall, our evidence is consistent with auditors attempting to respond to increased fraud risk when
they receive information that a material weakness is present, but not knowing which procedures to
target or how to respond effectively or efficiently to this risk, and, as a result, producing less
efficient audit plans.
Nature of audit program modifications. Finally, we examine how the number and nature of
audit seniors’ modifications to the standard audit program relate to material weakness condition
(Table 5). We first find that material weakness present condition auditors make significantly more
modifications to the standard program (11.38) than control condition auditors (mean 8.43, F1, 49 =
8.42, p , 0.01). Overall, we find that audit seniors who received information that increases fraud

August 2011
TABLE 4
Audit Inefficiency
Descriptive Statistics—Adjusted Least Squares Mean (Standard Error)
Control Present
Dependent Variable (n = 25) (n = 27)
Ineffective Additional Procedures Written 0.32 0.22
(0.12) (0.12)
Inefficient Standard Audit Program Choices when Expert Panel Recommended
Standard Procedure 1.24a 2.34a
(0.20) (0.20)
Modify Procedure 6.92 7.19
(0.30) (0.29)
Omit Procedure 0.65 1.28
(0.25) (0.24)
Audit Inefficiency Score 9.12b 11.04b
(0.55) (0.53)
Audit Inefficiency Ratio 0.56c 0.68c
(0.03) (0.03)
a,b,c
Superscripts of the same letter indicate differences in cell means at p , 0.05 (two-tailed).
Material Weakness Condition is manipulated between participants at two levels. Ineffective Additional Procedures
Written is the number of additional audit procedures written that would provide evidence that would not discriminate the
presence of the seeded fraud. Standard Procedure is the number of times auditors included inefficient procedure choices
(i.e., other than performing the standard audit program procedure) for the three procedures the expert panel
recommended performing the standard audit program procedure. Modify Procedure is the number of times auditors
included inefficient procedure choices (i.e., other than modifying a standard audit program procedure to be focused on
the fraud area) for the eight procedures that the expert panel recommended modifying in this way. Omit Procedure is the
number of times auditors included inefficient procedure choices (i.e., other than omitting or performing the standard audit
program procedure) for the four procedures that the expert panel recommended omitting because the procedures did not
relate to the fraud. Audit Inefficiency Score is the sum of all the procedure modifications participants recommended that
do not match the procedures recommended by the expert panel and the number of additional audit procedures written that
would not provide diagnostic information about the seeded fraud. Audit Inefficiency Ratio is the proportion of inefficient
procedure choices and additional ineffective procedures written (i.e., inefficient procedures) to total procedure choices,
and additional procedures written.
risk responded by making more changes to the standard program than auditors who did not receive
such information.
Next, we examine the nature of these changes. First, we sum the number of procedures for
which participants chose to increase sample size. Despite the fact that the expert panel indicated that
an untargeted increase in sample size is not effective for any of the audit procedures, audit seniors
chose this option frequently. Material weakness condition auditors chose sample size increases an
average of 7.78 times (out of 15 possible), and this was significantly more often than control
condition auditors (mean 4.87, F1, 49 = 19.69, p , 0.01). Second, we examine audit seniors’
attempts to tailor the sample or the procedures to focus on the fraud area, regardless of the
effectiveness of the attempts. The expert panel suggested that eight procedures required such
tailoring; however, we find that participants did not attempt to tailor samples or procedures very
often. On average, they attempted to tailor 2.59 of the 15 procedures on the audit program (not
tabulated) and tailoring attempts do not differ by material weakness condition (p = 0.61). Thus,
audit seniors responded to heightened fraud risk by increasing sample size, even though an

August 2011
TABLE 5
Audit Program Modifications
Descriptive Statistics—Adjusted Least Squares Mean (Standard Error)

Control Present
(n = 25) (n = 27)
Standard Procedure 0.73a 1.84a
Modify Procedure 3.61b 5.10b
Total Sample Size Increases 4.87c 7.78c
(0.47) (0.45)
Standard Procedure 0.51 0.50
Modify Procedure 1.81 1.80
Omit Procedure 0.12d 0.44d
Total Tailoring Attempts 2.44 2.74
(0.41) (0.40)
Standard Procedure 1.24e 2.34e
Modify Procedure 5.43f 6.90f
Total Standard Audit Program Modifications 7.32g 10.52g
(0.67) (0.64)
Additional Audit Procedures 1.11 0.86
(0.27) (0.26)
Total Audit Program Modifications 8.43h 11.38h
(0.73) (0.71)
a,b,c,d,e,f,g,h
Superscripts of the same letter indicate differences in cell means at p , 0.05 (two-tailed).
Material Weakness Condition is manipulated between participants at two levels. Sample Size Increases measures the
number of times the auditors chose to increase sample size on procedures in the standard audit program. Tailoring
Attempts measures the number of times the auditors attempted to modify the standard audit program to target the sample
or modify in some other way, without regard to the effectiveness of the attempt. Total Standard Audit Program
Modifications is the total of all attempts to modify the standard audit program, without regard to the effectiveness of the
attempt. Additional Audit Procedures measures the number of additional audit procedures the auditors wrote, regardless
of whether the procedure focused on the fraud or would provide diagnostic evidence about the fraud. Total Audit
Program Modifications is the sum of all modifications to the standard audit program plus all additional audit procedures,
regardless of effectiveness.
untargeted increase in sample size is not effective in detecting the seeded fraud, and not by tailoring
standard procedures.
Additional Analysis: Antecedents of Fraud Detection Program Quality
In this section, we examine further two relationships. First, if identifying the presence of risk is
important for superior fraud investigation, we expect that auditors who assess higher fraud risk will
produce higher-quality audit programs. We investigate this by adding fraud risk assessments to the
ANCOVA for fraud detection program quality reported in Table 3. We find that the fraud risk
assessment is not significant (p = 0.20) in the model, with other effects remaining significant as

August 2011
reported in Table 3. This result is not consistent with higher fraud risk assessments being a
sufficient condition for superior performance on the audit program modification task.
Second, we examine whether identifying risk factors specifically focused on the seeded fraud
area is associated with superior audit program modification performance. We investigate this by
adding the number of these fraud risk factors to the ANCOVA for fraud detection program quality
reported in Table 3. We find that fraud risk factor identification is significant (p = 0.01) in the
model, with other effects remaining significant as reported in Table 3. Importantly, program quality
increases with the number of risk factors focused on the fraud area. This suggests that identifying
risk factors focused on the fraud area is critical to the development of high-quality audit plans, and
thus to fraud detection.
CONCLUSIONS
We report results of an experiment that investigates how audit seniors respond to heightened
fraud risk when making audit-planning judgments. We provide all auditors with a case describing a
company with a seeded fraud, and we manipulate the presence of a material weakness in controls.
Our tests employ audit seniors who routinely plan audit work and modify audit programs. We find
that audit seniors assess higher fraud risk when they receive material weakness information, but that
they are unable to capitalize on their recognition of heightened fraud risk by developing
higher-quality audit programs.
The main contribution of our study is that we provide insight into how and how well audit
seniors modify programs in response to heightened fraud risk. We find that a manipulation to
increase assessed fraud risk does not facilitate fraud detection for most audit seniors. In fact, audit
seniors receiving material weakness information produced audit programs that are no more effective
for fraud detection, and are less efficient than those produced by auditors in the control condition.
This occurs because auditors in the material weakness present condition are more likely to modify
standard procedures, and to do so in a way that is not effective (typically by increasing sample size).
Thus, it appears that these auditors recognize high fraud risk and attempt to respond to it, but they
are unable to do so in an appropriate, effective way. Further analysis of the correlates of higher
performance indicates that audit seniors who produce higher-quality programs are those who
identify the most risk factors focused on the fraud.
These results should be helpful to those interested in improving fraud detection and audit
quality, more generally. While our study does not investigate training directly, the results indicate
opportunities for modifying auditors’ training to improve fraud detection. Specifically, while
auditors have apparently learned that increased sample size is one way to respond to risk, they do
not appear to have learned when increased sample sizes will be effective and when targeting of
specific transactions is necessary. Training on the importance of targeting is therefore critical.
Further, the ability to recognize fraud cues appears critical to effective modification of standard
audit programs. Thus, training in recognizing the patterns of risk factors associated with various
fraud schemes may also improve fraud detection.
The study refines our understanding of how auditors respond to heightened fraud risk during
audit planning. Some previous research in the area reports that auditors increase their planned effort
levels (i.e., audit hours and/or sample sizes) in response to indicators of high fraud risk. However,
such research typically either provides fraud risk cues that do not allow auditors to form a specific
hypothesis about the fraud or uses response options (such as hours allocated to an area) that do not
allow examination of the specific actions auditors would take. Increases in budgeted audit hours or
planned sample sizes are often interpreted as appropriate responses; however, while they show that
auditors know something should be done in response to fraud cues, they do not answer the question
of whether they know what should be done. Our finding that audit seniors tend to plan audits that

August 2011
are no more effective and less efficient when fraud risk is heightened indicates that prior
conclusions to the effect that auditors respond appropriately to fraud risk may have in some cases
been premature and more research in this area will be useful.
A limitation of our study is that audits are designed and executed by teams, rather than
individual auditors. Thus, auditors have opportunities to consult with others and to have their work
reviewed before the audit is completed, and we did not allow those opportunities in our study. We
acknowledge that a failure of experienced audit seniors to appropriately respond to heightened fraud
risk will not necessarily result in ineffective audits—if a fraud risk factor is identified and
communicated to superiors, partners and managers may be able to guide seniors in selecting
appropriate procedures. In fact, our participants rated the need for consultation with a risk
management partner higher when fraud risk was heightened, indicating that additional fraud
detection resources are likely to be put in place on these audits. Nonetheless, we believe that fraud
detection would be improved if the experienced seniors who plan, conduct, and supervise much of
the audit work were able to identify specific risk factors and use that knowledge to specify effective
and efficient tests. Such knowledge would enhance their ability to identify new problem areas and
respond to changing risk factors during the audit.
A second limitation is that our study does not specifically examine why audit seniors specify
lower-quality audit plans when fraud risk is heightened. Our results clearly indicate that audit
seniors recommend increased audit effort, but that the specific efforts chosen are ineffective. This
evidence suggests that audit seniors lack the knowledge necessary to create better audit tests when
fraud risk is heightened (see also Asare and Wright 2004). Future research could further examine
the factors that lead to enhancements in auditor performance in this area, including the types of
knowledge needed and the nature of effective training.
REFERENCES
American Institute of Certified Public Accountants (AICPA). 2002. Consideration of Fraud in a Financial
Statement Audit. Statement on Auditing Standards No. 99. New York, NY: AICPA.
Asare, S. K., and A. M. Wright. 2004. The effectiveness of alternative risk assessment and program
planning tools in a fraud setting. Contemporary Accounting Research 21 (2): 325–352.
Bellovary, J., and K. M. Johnstone. 2007. Descriptive evidence from audit practice on SAS No. 99
brainstorming activities. Current Issues in Auditing 1 (1): A1–A11.
Blay, A., L. D. Sneathen Jr., and T. Kizirian. 2007. The effects of fraud and going-concern risk on auditors’
assessments of the risk of material misstatement and resulting audit procedures. International Journal
of Auditing 11 (3): 149–163.
Glover, S. M., J. Jiambalvo, and J. Kennedy. 2000. Analytical procedures and audit-planning decisions.
Auditing: A Journal of Practice & Theory 19 (2): 27–45.
Glover, S. M., D. F. Prawitt, J. J. Schultz, and M. F. Zimbelman. 2003. A test of changes in auditors’ fraud-
related planning judgments since the issuance of SAS No. 82. Auditing: A Journal of Practice &
Theory 22 (2): 237–251.
Graham, L., and J. C. Bedard. 2003. Fraud risk and audit planning. International Journal of Auditing 7 (1):
55–70.
Hammersley, J. S. 2011. A Review and Model of Auditor Judgments in Fraud-Related Planning Tasks.
Auditing: A Journal of Practice & Theory 30 (4).
Hoffman, V. B., and M. F. Zimbelman. 2009. Do strategic reasoning and brainstorming help auditors
change their standard audit procedures in response to fraud risk? The Accounting Review 84 (3): 811–
837.
Hunton, J., and A. Gold. 2010. A field experiment comparing the outcomes of three fraud brainstorming
procedures: Nominal group, round robin and open discussion. The Accounting Review 85 (3): 911–
935.

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Johnstone, K. M., and J. C. Bedard. 2001. Engagement planning, bid pricing and client response in the
market for initial attest engagements. The Accounting Review 76 (2): 199–220.
Mock, T. J., and J. L. Turner. 2005. Auditor identification of fraud risk factors and their impact on audit
programs. International Journal of Auditing 9 (1): 59–77.
Pincus, K. V. 1989. The efficacy of a red flags questionnaire for assessing the possibility of fraud.
Accounting, Organizations and Society 14 (1/2): 153–163.
Public Company Accounting Oversight Board (PCAOB). 2008. Proposed Auditing Standards Related to
the Auditor’s Assessment of and Response to Risk. Release No. 2008-006. Washington, D.C.:
PCAOB.
Ricchiute, D. N. 1999. The effect of audit seniors’ decisions on working paper documentation and on
partners’ decisions. Accounting, Organizations and Society 24 (2): 155–171.
Rich, J. S., I. Solomon, and K. T. Trotman. 1997. The audit review process: A characterization from the
persuasion perspective. Accounting, Organizations and Society 22 (5): 481–505.
Wilks, T. J., and M. F. Zimbelman. 2004. Decomposition of fraud-risk assessments and auditors’ sensitivity
to fraud cues. Contemporary Accounting Research 21 (3): 719–745.
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APPENDIX A
Fraud Case Summary
The fraud case contained eight pages of information about the client, its industry, the financial
statements, and ratio analysis. Below, we summarize the relevant fraud risk factors from that
material.
Competitive Factors and Conflicting Financial Results
Medical products industry switched from analog to digital products in the last four years;
the client has been slow to change and is behind its competitors.
Analog sales are still 70 percent of client’s revenues, so the emphasis is on the declining
segment of the industry.
Industry sales are slowing: expected increase in 2007 is 5.4 percent after increases of 8.2
percent in 2006 and 12.9 percent in 2005.
The client’s sales, net income, and EPS increased 12 percent, 1.6 percent, and 1.9 percent,
respectively in 2007.
Steady declines in stock share prices since 2005.
Cash provided by operations is down 26 percent from the prior year, and financing
activities are being used to provide new cash.
Ratios show significantly better performance for the client compared to its competitors in
terms of profit margin, current ratio, and inventory turnover, despite the company’s weak
competitive position and a slowdown in the accounts receivable turnover ratio.
Management Pressure to Achieve Targets
Management compensation: base salary (50 percent), earnings-based bonus plan (30
percent), and stock options (20 percent).
Management emphasis on meeting or beating sales and other forecasts: the company has
met or exceeded sales goals for 12 consecutive quarters.

August 2011
The New Marketing Plan and Realizability Issues
In late 2007, management reallocated marketing responsibilities for analog products to

distributors so the company’s direct sales force could focus on sale of digital products.
Previously the client’s analog and digital products had been sold by both the direct sales
force and distributors.
In November 2007, the client launched a new marketing program under which all
distributors were asked to purchase a minimum number of analog systems based on each
distributor’s pro-rata share of sales. About 70 percent of the distributors signed immediately
for large analog orders. Only four distributors did not sign by year-end.
To assist distributors, the program gave them access to large retail accounts previously
served by the direct sales force and gave distributors profit sharing related to the client’s
expanded market share.
The client created a ‘‘Premier Digital’’ program, through which retailers who purchased
analog systems from distributors earned frequent-flyer-type points that could be used to
obtain discounts on digital units.
Participating distributors signed promissory notes for program purchases. The notes
required that all amounts owed to the client, including the November program purchases, be
repaid in six months. Payments coincided with expected product sell-through, and after six
months there was a ‘‘balloon’’ payment for the remaining balances, approximately 70
percent of the November program purchases.
In December 2007, the controller requested credit limit increases for 11 participating
distributors, and management approved the request based on a memo summarizing the
benefits of the marketing plan.
Several distributors had insufficient capacity to store additional products in their
warehouses, so the client hired freight forwarders and warehouse facilities for them.
The marketing program increased revenue and net income by $84 million (4.4 percent) and
$35.2 million (20.2 percent), respectively.

August 2011
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17.heightened Fraud Risk

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Auditing: A Journal of Practice & Theory American Accounting Association

Vol. 30, No. 3 DOI: 10.2308/ajpt-10110

How Do Audit Seniors Respond to Heightened

Jacqueline S. Hammersley is an Associate Professor at The University of Georgia, Karla M. Johnstone is an

Submitted: June 2010

Auditing: A Journal of Practice & Theory

PRIOR LITERATURE AND EXPECTATIONS

SAS 99 provides authoritative guidance for auditors’ consideration of fraud in a financial

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Materials and Procedures

Auditing: A Journal of Practice & Theory

Responding to Heightened Fraud Risk

Auditing: A Journal of Practice & Theory

Recognizing the Risk of Fraud

Responding to the Risk of Fraud

Auditing: A Journal of Practice & Theory

Changes to the Standard Audit Program

Auditing: A Journal of Practice & Theory

Panel B: Descriptive Statistics—Adjusted Least Square Mean (Standard Error)

Material Weakness Condition

Auditing: A Journal of Practice & Theory

Panel A: Standard Audit Procedures—Receivables

(continued on next page)

Auditing: A Journal of Practice & Theory

Panel B: Standard Audit Procedures—Sales

(continued on next page)

Auditing: A Journal of Practice & Theory

Panel C: Standard Audit Procedures—Sales and Receivables

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Panel B: Descriptive Statistics—Adjusted Least Squares Mean (Standard Error)

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Descriptive Statistics—Adjusted Least Squares Mean (Standard Error)

Additional Analysis: Antecedents of Fraud Detection Program Quality

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Auditing: A Journal of Practice & Theory

Competitive Factors and Conflicting Financial Results

Management Pressure to Achieve Targets

Auditing: A Journal of Practice & Theory

The New Marketing Plan and Realizability Issues

 In late 2007, management reallocated marketing responsibilities for analog products to

Auditing: A Journal of Practice & Theory

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