Factors Affecting Internal Auditors' Consideration of Fraudulent Financial Reporting during Analytical Procedures

By Church, Bryan K.; McMillan, Jeffrey J. et al. | Auditing: A Journal of Practice & Theory, March 2001 | Go to article overview

Factors Affecting Internal Auditors' Consideration of Fraudulent Financial Reporting during Analytical Procedures


Church, Bryan K., McMillan, Jeffrey J., Schneider, Arnold, Auditing: A Journal of Practice & Theory


Internal auditors serve a vital function in corporate financial reporting. One area where internal auditors play an important role is in the prevention and detection of fraudulent financial reporting. The Standards for the Professional Practice of Internal Auditing states that internal auditors should be alert to the possibility of intentional wrongdoing and should have sufficient knowledge to recognize potential fraud indicators. This research examines whether internal auditors are sensitive to these risk factors.

We provided 127 internal auditors with an unexpected fluctuation in operating income and asked them to list explanations for the fluctuation and to assess the likelihood of fraud. We found that internal auditors were more likely to list fraud explanations when (1) income was greater than expected, and (2) debt covenants were restrictive in a situation where income was greater than expected. We also found that internal auditors assigned a higher likelihood of fraud when (1) income was greater than expected, and (2) when an earnings-based bonus plan was used and debt covenants were restrictive. The practical implication of our findings is that internal auditors did recognize and adjust their consideration of fraudulent financial reporting in the presence of specific fraud indicators. Therefore, internal auditors may serve to deter fraud, and CPAs may want to consult with internal auditors in evaluating and assessing fraud risks.

An examination of factors that affect internal auditors' consideration of fraudulent financial reporting provides important insights into their role in the financial-reporting process. Relatively little academic research has examined the distinct role of internal auditors in this process. Yet, the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (1999) recognizes that internal auditors serve a vital function in corporate accounting and financial reporting. Moreover, external auditors rely on the work of internal auditors in the performance of annual audits, which is a critical aspect of financial reporting (e.g., Schneider 1985; Messier and Schneider 1988). Hence, many groups involved in corporate governance and disclosure (e.g., top management, audit committees, external auditors, government regulators) benefit by a better understanding of internal auditors' judgments, particularly their consideration of fraudulent financial reporting.

According to the Standards for the Professional Practice of Internal Auditing, internal auditors should be alert to the possibility of intentional wrongdoing, including fraudulent financial reporting (IIA 1998, Section 280.01). They are expected to have sufficient knowledge to identify potential fraud indicators (IIA 1998, Section 280.02.2). Internal auditing standards go on to suggest that analytical procedures may be useful in uncovering instances of fraudulent financial reporting and that internal auditors are expected to use such procedures in examining and evaluating information (IIA 1998, Section 420.01).

We investigate internal auditors' consideration of fraudulent financial reporting in an analytical procedures task. Prior research (Church and Schneider 1995; Church et al. 1998) has examined internal auditor behavior in tasks involving analytical procedures. The findings suggest that fraud explanations may be generated to account for unexpected fluctuations in financial data. But in general, empirical evidence on internal auditors' consideration of fraud in accordance with professional standards is scant.

In the experiment reported in this study, internal auditors are provided with an unexpected fluctuation in operating income and asked to list explanations to account for the fluctuation and assess the likelihood of the occurrence of fraud. We find that internal auditors are more likely to list fraud explanations when (1) income is greater than expected, and (2) debt covenants are restrictive, conditioned on income being greater than expected. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Factors Affecting Internal Auditors' Consideration of Fraudulent Financial Reporting during Analytical Procedures
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.