fraud detection, redress reporting by auditors

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Managerial Auditing Journal Fraud detection, redress and reporting by auditors Harold Hassink Roger Meuwissen Laury Bollen Article information: To cite this document: Harold Hassink Roger Meuwissen Laury Bollen, (2010),"Fraud detection, redress and reporting by auditors", Managerial Auditing Journal, Vol. 25 Iss 9 pp. 861 - 881 Permanent link to this document: http://dx.doi.org/10.1108/02686901011080044 Downloaded on: 08 October 2014, At: 07:38 (PT) References: this document contains references to 43 other documents. To copy this document: [email protected] The fulltext of this document has been downloaded 5032 times since 2010* Users who downloaded this article also downloaded: Rocco R. Vanasco, (1998),"Fraud auditing", Managerial Auditing Journal, Vol. 13 Iss 1 pp. 4-71 Maria Krambia#Kapardis, (2002),"A fraud detection model: A must for auditors", Journal of Financial Regulation and Compliance, Vol. 10 Iss 3 pp. 266-278 Gerald Vinten, Philmore Alleyne, Michael Howard, (2005),"An exploratory study of auditors’ responsibility for fraud detection in Barbados", Managerial Auditing Journal, Vol. 20 Iss 3 pp. 284-303 Access to this document was granted through an Emerald subscription provided by 434496 [] For Authors If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service information about how to choose which publication to write for and submission guidelines are available for all. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.com Emerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of online products and additional customer resources and services. Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation. *Related content and download information correct at time of download. Downloaded by Universiti Teknologi MARA At 07:38 08 October 2014 (PT)

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  • Managerial Auditing JournalFraud detection, redress and reporting by auditorsHarold Hassink Roger Meuwissen Laury Bollen

    Article information:To cite this document:Harold Hassink Roger Meuwissen Laury Bollen, (2010),"Fraud detection, redress and reporting byauditors", Managerial Auditing Journal, Vol. 25 Iss 9 pp. 861 - 881Permanent link to this document:http://dx.doi.org/10.1108/02686901011080044

    Downloaded on: 08 October 2014, At: 07:38 (PT)References: this document contains references to 43 other documents.To copy this document: [email protected] fulltext of this document has been downloaded 5032 times since 2010*

    Users who downloaded this article also downloaded:Rocco R. Vanasco, (1998),"Fraud auditing", Managerial Auditing Journal, Vol. 13 Iss 1 pp. 4-71Maria Krambia#Kapardis, (2002),"A fraud detection model: A must for auditors", Journal of FinancialRegulation and Compliance, Vol. 10 Iss 3 pp. 266-278Gerald Vinten, Philmore Alleyne, Michael Howard, (2005),"An exploratory study of auditors responsibilityfor fraud detection in Barbados", Managerial Auditing Journal, Vol. 20 Iss 3 pp. 284-303

    Access to this document was granted through an Emerald subscription provided by 434496 []

    For AuthorsIf you would like to write for this, or any other Emerald publication, then please use our Emerald forAuthors service information about how to choose which publication to write for and submission guidelinesare available for all. Please visit www.emeraldinsight.com/authors for more information.

    About Emerald www.emeraldinsight.comEmerald is a global publisher linking research and practice to the benefit of society. The companymanages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well asproviding an extensive range of online products and additional customer resources and services.

    Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committeeon Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archivepreservation.

    *Related content and download information correct at time of download.

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  • Fraud detection, redress andreporting by auditors

    Harold Hassink, Roger Meuwissen and Laury BollenDepartment of Accounting and Information Management,

    School of Business and Economics, Maastricht University, Maastricht,The Netherlands

    Abstract

    Purpose The primary research question of this study is to what extent auditors comply withauditing standards once they encounter fraud and whether compliance is associated with particularfraud characteristics (i.e. material versus immaterial fraud, management versus employee fraud,statutory versus voluntary audit and external versus internal fraud) as well as with auditor (experience)and audit firm characteristics (Big Four versus non-Big Four). The study also aims to provide evidenceon the role of auditors in redressing fraud. Redress refers to the auditee taking measures to nullify theconsequences of the fraud, insofar as possible, and to prevent any recurrence of such fraud.

    Design/methodology/approach To gather data on the role of auditors in fraud cases, a surveywas conducted among all audit partners of the top 30 Dutch audit firms. In total, 1,218 audit partnerswere selected and received a postal questionnaire. In total, 326 questionnaires were returned (27 per cent),of which 296 (24 per cent) were usable.

    Findings The results reveal that auditors fail to comply with some important elements of fraudstandards. There are substantial differences among audit firms regarding compliance with therelevant auditing standards. Furthermore, auditors appear to encounter corporate fraud onlyincidentally. About half of the auditors believe they have a significant impact on redressing fraud.

    Research limitations/implications One of the main research findings is that it is difficult forindividual auditors to build up expertise in fraud detection. There appears to be a need for specifictraining programs for auditors to help them to detect fraud, emphasizing the need for mandatoryconsultation with the technical department of the audit firm once red flags indicating fraud arefound. Indeed, this need for change has been addressed by the Dutch professional accountancy bodyNIVRA as a direct result of the findings of this study.

    Originality/value This study extends existing research by investigating the compliance ofauditors with fraud standards and it sheds light on the actual redress experiences of auditors. Itfocuses on the actions taken by auditors or the lack thereof in situations where auditors encounterfraud signals. The study indicates that in the absence of good oversight, auditors have mixedincentives when they are confronted with signals for fraud, resulting in actions that are not always inline with existing regulatory requirements.

    Keywords Auditors, Auditing, Fraud, Professional ethics, Regulation, The Netherlands

    Paper type Research paper

    IntroductionA study on major European business failures revealed that the role of auditors is mostoften questioned and audit firms are most likely to be sued in failures that involvemanagement or employee fraud (Bollen et al., 2005). A widely used explanation for therelatively large number of fraud cases in which the role of the auditor has beenquestioned is the existence of an audit expectation gap, suggesting that society hasunfulfilled expectations concerning the role of the auditor in fraud cases. The potentialcauses of an audit expectation gap have been addressed extensively in existing literature(for an overview, see Nieschwietz et al., 2000). Studies in the area of fraud have mainly

    The current issue and full text archive of this journal is available at

    www.emeraldinsight.com/0268-6902.htm

    Fraud detection

    861

    Received 14 April 2010Reviewed 25 May 2010Accepted 21 June 2010

    Managerial Auditing JournalVol. 25 No. 9, 2010

    pp. 861-881q Emerald Group Publishing Limited

    0268-6902DOI 10.1108/02686901011080044

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  • focused on the extent to which auditors are able to detect fraud and whether society hasunreasonable expectations in this respect (the reasonableness gap). Less attention hasbeen paid to the gap between what can reasonably be expected from auditors once theyencounter fraud signals and what they actually achieve. Following Porter (1993), thispart of the expectations gap may be a result of either the deficiency of standards andregulations with respect to the duties of auditors in fraud situations (the standards gap)or of the (under)performance of auditors regarding existing duties (the performancegap). With respect to the standards gap, the general public may have expectations thatare not reflected in existing auditing standards. Comparing expectations with existingauditing standards could identify opportunities for changing the standards and fornarrowing the standards gap.

    Although several studies have indicated that auditing standards and regulatorychanges have not resulted in an increase in the auditors ability to detect fraud( Jakubowski et al., 2002; Rezaee et al., 2003) it remains unclear to what extent auditingstandards and regulations have impacted the auditors redress and reporting actions insituations where fraud has been detected. Redress refers to the auditee taking measuresto nullify the consequences of the fraud, insofar as possible, and to prevent anyrecurrence of such fraud. Given the existing standards on the role of auditors in fraudsituations, the existence of a performance gap in this context can be due to severalfactors, including the lack of knowledge or competence on how to act once corporatefraud is detected, lack of care in following protocol or the lack of independence of theexternal auditor, possibly because of conflicting interests. All of these explanationstouch upon auditors professional ethics[1]. Given the sensitive nature of fraud reportingand societys expectations of auditors in this respect, compliance with fraud standards isimportant to auditors and to society.

    The aim of this study is fourfold. The first objective is to present evidence on thevolume and nature of fraud cases detected by auditors. The second objective is todetermine the extent of auditors compliance with auditing standards regarding fraudredress and fraud reporting. The third objective is to study the impact of various contextvariables (i.e. material versus immaterial fraud, management versus employee fraud,statutory versus voluntary audits and external versus internal fraud) as well as auditor(experience) and audit firm characteristics (Big Four versus non-Big Four) on the actionstaken by auditors in fraud situations. Finally, this study provides recommendations onhow the performance of auditors regarding the detection of corporate fraud andcompliance with relevant auditing standards can be improved.

    The two Dutch professional bodies for auditors, NIVRA and NOvAA, commissionedthe study for which the results are presented in this paper. The focus of this study is onthe period 1995-2002. This is a useful period to study auditors compliance withregulations because auditing regulations concerning fraud issues remained unchangedduring this period; after 2002, various changes were implemented. In addition, duringthis period, there was virtually no oversight of audit firms concerning their actions infraud situations; the results of this paper therefore provide a good understanding of thebehaviour and incentives of auditors with respect to fraud situations.

    This study is organised in five sections. First, existing studies on fraud detectionand reporting by auditors will be discussed. After that, the auditors responsibilityregarding fraud detection in the Netherlands in the period 1995-2002 will be described.

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  • Next, the research method of the study will be presented. Subsequently, the empiricalresults of the study will be presented and finally, conclusions will be drawn.

    Auditors and fraudDuring the past couple of decades, a fairly large body of research on auditorsexperiences with fraud has emerged. In their overview study, Nieschwietz et al. (2000)distinguish three branches of empirical research in the field of fraud detection:

    (1) research investigating the environmental conditions related to auditorsdetection of fraud;

    (2) research on auditors assessment of the risk of fraud; and

    (3) research on auditing plans related to detecting fraud.

    In the first type of fraud-related auditing research, the existence of an expectation gapis used to explain the level of lawsuits against auditors in fraud cases (Palmrose, 1991;Bollen et al., 2005). Such lawsuits have introduced the effect of litigation risk intoauditors fraud detection, as a result of which auditors may adjust their audit planningto understate firm performance (Baron et al., 2001). The second type of studies dealswith predictors of fraud and auditors use of fraud cues to assess fraud risk, with orwithout the help of decision aids. The studies on the predictors of fraud haveprovided empirical evidence on the validity of fraud cues by having partners identifyand evaluate fraud cases to determine fraud cues or so-called red flags (Albrecht andRomney, 1986; Loebbecke et al., 1989). The studies on the use of fraud cues arepredominantly based on behavioural decision theory and focus on how auditors assessfraud risk (Hackenbrack, 1992; Zimbelman, 1997; Knapp and Knapp, 2000). Thesestudies have found many factors that affect the ability of auditors to detect fraud(e.g. experience and ethical reasoning), and that auditors generally have difficulty inassessing fraud risk. Furthermore, research in this area has shown that the use of toolsand decision aids improves fraud detection, although auditors typically are veryreluctant to use such aids (Eining et al., 1997). The third type of research concernsauditing plans and procedures and the way they relate to the detection of fraud. Studiesin this area have shown that as a result of changes in auditing standards, auditors maybecome more responsive to fraud risk (Glover et al., 2003; Mock and Turner, 2005),while others found no association between fraud risk assessment and the planning ofmore effective fraud procedures, thus questioning the effectiveness of standardauditing tools in a fraud setting (Asare and Wright, 2004).

    Actions taken by auditors once fraud is detectedAll three research areas mentioned focus on the ability of auditors to detect fraud, butignore the actions taken by auditors once fraud has been detected, and also ignore therole of professional ethics in (refraining from) taking such actions. A study on personalvalues was conducted by Gowthorpe et al. (2002), looking for the predominant ethicalorientation among auditors in New Zealand, and by Arnold et al. (2005) who looked atthe dynamics of auditor decision making in a situation where a clean audit opinion isnot possible. Although these studies do provide insights on professional ethics in thecontext of auditing, they provide little evidence on the ethical aspects of the behaviourof auditors once fraud is suspected or detected. There are a number of (case) studies

    Fraud detection

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  • that provide anecdotal evidence on the response of the auditor once fraud is suspectedor detected; these studies focus on accounting scandals and the auditors role therein(Moriceau, 2004; Melis, 2005). These studies indicate that in some instances auditorswere aware of fraud schemes but were unwilling to address the issue in order not toharm the relationship with the client. Inherent in the nature of these studies, theevidence provided on the behaviour of auditors once fraud is suspected or detected isnevertheless focused specifically on unique fraud cases and consequently may not beapplicable in a broader empirical setting. Overall, the scarce literature on auditorsreactions to fraud situations may suggest that auditors encounter fraud cases veryinfrequently, and that consequently there is no common framework on how to react insuch situations. This issue has increased in importance now that both the auditingprofession and various regulatory bodies have raised the level of standards whichmust be adhered to in the context of fraud.

    Limitations of prior studiesProbably, the foremost limitation for studies in all areas of fraud-related auditingresearch, is the restricted access to data on the actual experiences of external auditorswith fraud detection. Given the sensitive nature of fraud situations and because of therather low frequency of detected fraud cases, most empirical studies in this area useexperimental settings or surveys focusing on auditor perceptions, rather than actualfraud cases as a source of data. The only exceptions are a few empirical studies from the1980s in the USA, in which audit partners are surveyed on actual fraud cases(Romney et al., 1980[2]; Loebbecke et al., 1989[3]). The participants in Romney et al. (1980)were 27 audit partners who detected fraud in a recent audit as well as 36 audit partnerswho did not encounter fraud. By having these partners evaluate their engagement,evidence was collected on red flags indicating frauds. One-third of the 87 red flagsindicated were found to be significant predictors of fraud. These generally pertain topersonal characteristics of management. Loebbecke et al. (1989) surveyed 277 US KPMGaudit partners who detected an average of 3.1 fraud cases in their auditing career. Casesof material fraud appear to be rather rare[4]. Management fraud was detected more oftenthan employee fraud (56 versus 44 per cent), and fraud incidence differed across clientindustries. In addition, material fraud was detected more frequently than immaterialfraud (60 versus 40 per cent). Further conclusions are that a weak control environment,decisions dominated by only a few employees and significant difficult-to-audittransactions are conditions that increase the likelihood of fraud.

    The current study expands the Loebbecke et al. (1989) research by not onlyinvestigating the detection of fraud but also by looking at the follow-up of auditors, tobetter understand their redress effectiveness and their resignation behaviour. The studyalso addresses the effect of further characteristics on auditors actions (i.e. materialversus immaterial fraud, management versus employee fraud, statutory versusvoluntary audit and external versus internal fraud) as well as auditor (experience)and audit firm characteristics (Big Four versus non-Big Four). The Big Four/non-BigFour dichotomy is relevant in this context given the argument that larger audit firmshave fewer incentives to behave opportunistically to ensure retention of clients andthus they may provide higher quality audits in comparison with smaller audit firms(DeAngelo, 1981). Overall, consistent evidence is provided that larger audit firmsprovide higher quality audits (Palmrose, 1988; Deis and Giroux, 1992; Krishnan, 2003).

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  • Therefore, Big Four auditors are expected to show a higher level of willingness toredress and report fraud cases.

    Legal contextThis section describes the legal context with respect to the role of auditors in fraudcases in the Netherlands at the time of this study (1995-2002). In this period, Dutchauditors were required by their professional bodies, NIVRA and NOvAA, to complywith two fraud standards:

    (1) the Dutch Auditing Standard 240 fraud and error (further referred to as DAS240); and

    (2) the by-law on reporting on fraud (further BLF)[5].

    DAS 240 was based on the international standard ISA 240 and held the client primarilyresponsible for preventing and detecting fraud. The auditor was not held responsiblefor fraud prevention. DAS 240 specified several issues auditors had to take intoconsideration before and while performing the audit; see also Figure 1 and the Appendix.The BLF extended the scope of ISA 240, by additionally requiring the auditor to informmanagement in writing if he suspected fraud. If it concerned material or managementfraud, he had also to notify the supervisory body in writing. If, after further investigation,fraud was indeed detected, the auditor had to inform management again and redress hadto be demanded. The supervisory body was contacted again if management failed to takereasonable steps to redress the fraud. If the supervisory body failed to take appropriateaction, the auditor had to resign from his engagement. If the engagement concerneda statutory audit, the auditor had to notify a dedicated governmental agency. Hence, inthe window 1995-2002, Dutch auditors had to take the following steps in case fraudsignals appeared while an audit was being performed:

    (1) Inform management in writing when fraud is suspected[6].

    (2) Inform the supervisory body in writing:. in case of management fraud;. in case of material fraud with regard to the financial statements; and. in case the management fails to take reasonable action[7].

    (3) Request redress from management when fraud is detected[8].

    (4) Resign from his engagement when insufficient steps have been taken to redressmaterial fraud[9].

    (5) Notify the relevant governmental agency of the lack of redress in case of astatutory audit[10].

    Research method and sample constructionTo gather information on the role of auditors in fraud cases, a survey was conductedamong all audit partners of the top 30 Dutch audit firms. The professional bodiesNIVRA (2000) and NOvAA provided a database containing the names and addresses ofall audit partners of the top 30 audit firms in The Netherlands. A written questionnairewas used, which had been tested and adjusted in a pilot study[11]. The questionnairecontained three types of questions:

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  • (1) Questions relating to the features of the fraud cases auditors had experienced in

    the period 1995-2002.

    (2) Questions on the reporting and redress of these fraud cases.

    (3) Questions on the perceived role of the auditor in the redress process.

    Figure 1.Outline of audit procedureaccording to DutchAuditing Standard 240and by-law

    Start Inquiries of management andgovernance (ST)Planning discussions with

    audit team (ST)Risk assessment and

    planning of audit (ST)

    Document riskfactors (ST)

    Obtain written statement ofmanagement/governance (ST)

    Finish audit asplanned/issueopinion (GL)

    No

    Informmanagement (BL)

    No Finish audit asplanned/issueopinion (ST)

    NoInform management about mis-statements and sources. Mana-gement might have to adjust

    accounting procedures. Finishaudit as planned. (ST)Yes

    Adjust audit plan andrisk assessment if

    necessary (ST)

    Before the auditDuring the audit

    Redress

    Yes

    YES

    Yes

    Notes: Parts to be found in DAS 240 are tagged with (ST); parts coming from the by-law with (BL)

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  • To improve the response rate and to limit response bias due to the sensitive natureof the subject of the questionnaire, a procedure was designed that fully guaranteedthe anonymity of the individual respondents as well as their audit firms. Theenvelopes, containing a cover letter, the questionnaire and a self-addressed envelope,were mailed by a notary in civil law. The questionnaires were marked with a uniquenumber per audit firm (five categories: four Big Four audit firms and one categorynon-Big Four audit firms) that was known only to the notary. Approximately, threeweeks after mailing the questionnaires, a reminder was sent to every selected auditor(including those auditors who had already responded)[12]. In total, 1,218 partners of thetop 30 Dutch audit firms as measured by revenues were selected. Table I showsthat eventually 326 questionnaires were returned (27 per cent), of which 296 (24 per cent)turned out to be usable[13]. Of the respondents, 49 per cent were partners at a BigFour audit firm, while 43 per cent were partners at a non-Big Four audit firm.The miscellaneous category consists of partners who were affiliated with both aBig Four and non-Big Four audit firm in the window of the study. About 10 per cent ofthe respondents were affiliated with Audit firm A, 8 per cent with Audit firm B, 14 percent with Audit firm C, 20 per cent with Audit firm D and 48 per cent with non-BigFour audit firms. On average, the respondents had 9.9 years of experience as an auditpartner. Exactly, half of the respondents had limited experience as an audit partner(0-10 years). Average (11-20 years) and extensive (20 years) experiences wereexhibited by 38 and 12 per cent of the sample, respectively.

    Three remarks can be made concerning the quality of the collected data. First, theoverall response rate is satisfactory, especially considering the sensitive nature of thetopic. Second, although it cannot be guaranteed that the sample is representative forthe population as a whole, there are no indications of the existence of a non-responsebias. This has been examined by comparing a number of characteristics of the laterrespondents with the characteristics of the early respondents. The rationale here isthat later respondents exhibit some similarities to the non-responding group. t-tests donot indicate significant differences. Third, an inherent risk of a questionnaire is that therespondents give socially desirable answers. This risk has been mitigated as much

    Number of questionnaires sent 1,218Number of questionnaires returned

    Before reminder 216 (18)After reminder 110 (9)Total 326 (27)Number of questionnaires usable for research 296 (24)

    Big Four audit firm 144 (49)Non-Big Four audit firm 127 (43)Miscellaneous 25 (8)Audit firm A 29 (10)Audit firm B 23 (8)Audit firm C 41 (14)Audit firm D 60 (20)Low partner experience (0-10 years) 148 (50)Medium partner experience (11-20 years) 113 (38)High partner experience (20 years) 35 (12)Note: Values within the parenthesis denote percentage

    Table I.Response to

    questionnaires

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  • as possible by making use of the services of a notary in civil law for the mailingprocedure, thereby guaranteeing the anonymity of respondents and audit firms. Also,many questions referred to facts instead of judgments, which increased the probabilityof receiving reliable answers.

    Empirical resultsThe detection of fraudIn the 296 usable questionnaires, a total of 317 detected fraud cases were mentioned,suggesting that on average audit partners of the top 30 audit firms in the Netherlandsdetected 1.07 fraud cases in the period 1995-2002. The low number is consistent withprevious research, although it is still smaller than the number given by Loebbecke et al.(1989), who reported an average of 3.1 cases. However, the time frame investigated inthe current study (eight years) is narrower than the one in Loebbecke et al. (1989).Furthermore, Loebbecke et al. excluded partners who had not encountered fraud(40 per cent of their sample). Translating the findings of Loebbecke et al. to theparameters of the current study suggests that the respondents in the Loebbecke et al.study would have encountered on average 0.76 fraud cases in the eight-year period, whichis more comparable to the empirical findings of 1.07 fraud cases in the current study[14].

    In the remainder of this section, the characteristics of fraud cases mentioned by therespondents will be analyzed in more depth. The analyses will focus on four elements:

    (1) material versus immaterial fraud;

    (2) management versus employee fraud;

    (3) fraud detected during a statutory audit versus voluntary audit; and

    (4) external versus internal fraud.

    Table II summarizes the results.1. Material versus immaterial fraud. Fraud is considered material if it could

    influence the decisions of users of financial statements. The first two columns ofTable II indicate that there are fewer cases of material fraud among the 317 casesdetected than there are cases of immaterial fraud (37 versus 63 per cent). Material fraudwas found more often by respondents of non-Big Four audit firms than by those of BigFour audit firms (46 versus 35 per cent). However, this difference is not statisticallysignificant. There were no significant differences between individual audit firms in theamount of detected material fraud. Respondents indicate that material fraud occursmore often in the services and trade industries than in the manufacturing andnon-profit industries, but again these differences are not statistically significant.Materiality of detected fraud and level of partner experience do not seem to be related.

    2. Management versus employee fraud. Management fraud is committed by membersof top management, while employee fraud is committed by other employees. Table IIreveals that there were more cases of employee fraud than of management fraud(59 versus 41 per cent) among the 317 fraud cases detected. Big Four audit firmsdiscovered relatively fewer cases of management fraud than did non-Big Four auditfirms (37 versus 49 per cent). There is some evidence of a relationship between the type ofaudit firm (A-E) and the proportion of detected management versus employee fraud. Thisrelationship is significant at the 10 per cent level. There turned out to be no significantrelationship between partner experience and detected management and employee fraud.

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    Non

    -pro

    fit

    (%)

    2278

    n.a

    .n

    .a.

    n.a

    .n

    .a.

    n.a

    .n

    .a.

    100

    Partner

    experience

    Hig

    h(2

    0

    yea

    rs)

    (%)

    3862

    3862

    7921

    4258

    *10

    0M

    ediu

    m(1

    0-20

    yea

    rs)

    (%)

    4159

    4258

    8218

    2971

    100

    Low

    (0-1

    0y

    ears

    )(%

    )34

    6640

    6081

    1925

    7510

    0

    Notes:

    Sta

    tist

    ical

    sig

    nifi

    can

    ceat

    :* 1

    0,*

    * 5an

    d*

    ** 1

    per

    cen

    tle

    vel

    s(t

    wo-

    tail

    edte

    st);

    n.a

    .

    not

    avai

    lab

    le

    Table II.Detection of fraud

    Fraud detection

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  • 3. Statutory versus voluntary audit. Most of the 317 fraud cases were detected duringstatutory audits rather than during voluntary audits (81 versus 19 per cent). Non-BigFour audit firms discovered fraud more often during voluntary audits in comparisonwith Big Four audit firms (34 versus 12 per cent). Furthermore, differences were foundamong audit firms with respect to the proportion of fraud cases detected duringstatutory or voluntary audits. For instance, audit partners in audit firm B detected allfraud cases during statutory audits, while in audit firm E only two-thirds of the fraudcases were detected during statutory audits. These differences are significant at the1 per cent level. Finally, partner experience was not related to the detection of fraudduring statutory versus voluntary audits.

    4. External versus internal fraud. In the survey, external fraud was defined as fraudthat predominantly harms external parties, such as the government or customers. Incontrast, internal fraud was described as fraud that primarily harms the company ofthe person who commits fraud. Examples of internal fraud include theft of assets andincorrect claiming of expenses. Table II shows that a large proportion of the 317 casesreported referred to internal fraud rather than external fraud (71 versus 29 per cent).Also, the proportion of detected external versus internal fraud differed between BigFour and non-Big Four audit firms. Big Four audit firms detected external fraud lessfrequently than did non-Big Four audit firms (24 vs 47 per cent) which is significant atthe 1 per cent level. Table II indicates significant differences at the 1 per cent levelamong audit firms in discovering external or internal fraud. In audit firm E, forexample, 43 per cent of all cases of detected fraud concerned external fraud, while inaudit firm B this is only 8 per cent. Finally, more experienced audit partners detectedexternal fraud more often than did less experienced partners (42 versus 29 and25 per cent at the 10 per cent significance level).

    Auditor redress and reporting of fraudThis section focuses on the actions Dutch auditors are required to take once fraud isdetected, according to the auditing standards and regulation as defined above.

    1. Reporting to management. As soon as the auditor detects fraud or receivessignals that could be interpreted as such, the auditor needs to report this tomanagement in writing. The data indicate that the fraud was reported verbally moreoften than in writing (77 versus 48 per cent, see Table III). These per centages add up tomore than 100 per cent, because some fraud cases were reported both verbally and inwriting. As far as reporting verbally to management is concerned, differences amongtypes of fraud, audit firms or levels of audit partner experience were not significant.Still, the results indicate that verbal reports to management were more common for BigFour audit firms (79 versus 72 per cent) and for more experienced partners (87 per centfor extensive experience, 77 and 74 per cent for average and limited experience,respectively). Reporting in writing to management occurred significantly more often incases of material fraud (59 versus 41 per cent for immaterial fraud) and significantlymore often in cases of management fraud (57 versus 41 per cent for employee fraud).Both differences are significant at the 1 per cent level. In cases of statutory audits andin cases of external fraud, respondents indicated that they reported to management inwriting slightly more often, though these differences are not significant. Furthermore,Big Four audit partners reported to management in writing more often than didnon-Big Four audit partners (53 versus 41 per cent). Finally, more experienced audit

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  • Table III.Reporting tomanagement

    100

    Rep

    orte

    d ve

    rbal

    ly24

    577

    Rep

    orte

    d in

    writ

    ing

    152

    48

    Rep

    orte

    d ve

    rbal

    ly10

    533

    Rep

    orte

    d in

    writ

    ing

    99 31

    Red

    ress

    Red

    ress

    not

    requ

    este

    d75 24

    Red

    ress

    requ

    este

    d24

    276

    Not

    redr

    esse

    d15 6

    Red

    ress

    ed22

    794 19

    686

    8031 14

    Res

    igna

    tion

    17 5 4 27

    Exte

    rnal

    not

    ifica

    tion

    No.

    of n

    ot re

    dres

    sed

    15

    37 92 78 70 59 46 39 47 40 28 24 90 76 7 8 83 92 65 78 18 22 13 11 3 43 7

    63 153

    77 82 * 41 59 30 52** 26 47 24 152

    76 8 5 144

    95

    131*

    *91 13 9 4* 2 1 13 8

    41 98 76 74 57 56 43 53 41 21 16 108

    84 11 10 97 90 73 75 24 25 16 12 4 36 11

    59 147

    78 78*

    41 49*

    26 46*

    24 54** 29 134

    71 4** 3 130

    97 123* 95 7 5 1* 1 0 0 4

    81 202

    78 129

    50 98 38 93 36 56 22 198

    77 14 7 184

    93 161

    88 23 13 12 5 n.a.

    n.a

    .

    14

    19 43 73 23 39 7* 12 6* 10 19**

    *32 36 61 0 0 36 10

    0

    31 86 5 14 5 8 n.a.

    n.a

    .

    0

    0 8 1 7 4 3 1

    29 73 78 51 55 30 32 28 30 24 26 69 74 8 12 61 88 48 79 13 21 10 11 3 38 8

    71 172

    77 101

    45 75 33 71 32 51 23 173

    77 7*** 4 166

    96

    148*

    **89 18 11 7*

    * 3 1 14 7

    64 160

    79 107

    53 87 43 81 40 47 23 156

    77 7 4 149

    96 132

    89 17 11 13 6 3 43 7

    25 57 7232

    ***

    41 6* 8 7* 9 23 29 56 71 6 11 50 89 40 10 20 4 5 1 17 6

    16 40 80 28 56 20 40 18 36 14 28 36 72 5 14 31 86 30 97 1 3 4 8 1 20 5

    8 21 88 14 58 17 71 10 42 6 25 18 75 1 6 17 94 16 94 1 6 2 8 1 100 1

    17 42 78 28 52 233

    43 24 44 4 7 50 93 0 0 50 100

    46 92 4 8 3 6 0 n.a. 0

    29 69 75 45 49 6 39 37 40 27 29 65 71 1 2 64 98 51 80 13 20 4 4 1 100 0

    16 45 87 36 69 214

    40 19 37 12 23 40 77 4 10 36 90 32 89 4 11 3 6 n.a.

    n.a

    .

    4

    39 96 77 60 48 24 34 46 37 28 22 97 78 6 6 91 94 83 91 8 9 6 5 n.a.

    n.a

    .

    6

    44 104

    74 56*

    40 2 3034

    ***

    24 35 25 105

    75 5 5 100

    95 81 81 19 19 8 6 n.a.

    n.a

    .

    57 2

    Rep

    orte

    d to

    man

    agem

    ent

    No.

    of a

    ctua

    lly re

    porte

    d in

    the

    tota

    l pop

    ulat

    ion

    Red

    ress

    ed w

    ithou

    t pre

    ssur

    e

    Res

    igne

    d be

    caus

    e of

    frau

    d

    Red

    ress

    ed a

    fter p

    ress

    ure

    Res

    igne

    d be

    caus

    e of

    lack

    of r

    edre

    ss (%

    )

    No.

    of s

    houl

    d ha

    ve

    been

    repo

    rted

    in th

    e sa

    mpl

    e

    Rep

    orte

    d to

    supe

    rviso

    ry b

    oard

    % % % % % % % % % % % % Not

    es: S

    tatis

    tical

    sign

    ifica

    nce

    at: *

    1, *

    *5 an

    d **

    *10

    per c

    ent l

    evel

    s (tw

    o-t

    aile

    d te

    st); a

    the

    data

    on

    redr

    ess a

    re b

    ased

    on

    a su

    bset

    of 3

    09 ca

    ses o

    ut o

    f the

    317

    case

    s; n

    .a.

    dat

    a ar

    e no

    t avai

    labl

    e

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  • partners reported in writing more often than did less experienced partners (69, 48 and40 per cent for extensive, average and limited experience, respectively). No significantrelationships were found between the frequency of written fraud reports tomanagement and the five categories of audit firms (A-E).

    2. Reporting to the supervisory board. At the time the study was performed, auditingstandards explicitly required certain types of fraud to be reported in writing to thesupervisory board: cases of management fraud, cases of material fraud and caseswhere management refuses to redress the fraud. Table III indicates that in 41 per centof the cases of management fraud and in 40 per cent of the cases of material fraud theauditor actually reported to the supervisory board in writing. Reporting verbally to thesupervisory board tended to take place more often in cases of material fraud (39 versus30 per cent for immaterial fraud), in cases of management fraud (43 versus 26 per centfor employee fraud) and in cases of fraud detected during a statutory audit (38 versus12 per cent for voluntary audits). The first difference is not statistically significant;the other two are significant at the 1 per cent level. Verbal reporting to the supervisoryboard was not significantly related to the external/internal dimension. Big Fourauditors reported verbally to the supervisory board more frequently than did non-BigFour auditors (43 versus 8 per cent significant at the 1 per cent level). Differentaudit firms reported verbally to the supervisory board with significantly differentfrequencies: audit firm B reported verbally most often (71 per cent) while audit firmE did so least often (9 per cent). The data indicate that verbal reporting to thesupervisory board is not significantly related to the amount of audit partner experience,although more experience seems to be consistent with more frequent reporting. When itcomes to reporting to the supervisory board in writing, material fraud, managementfraud and fraud encountered during a statutory audit were reported more often thanother types of fraud. Reporting to the supervisory board in writing appears to beunrelated to the external/internal dimension. Big Four audit partners reported moreoften to the supervisory board in writing than did non-Big Four auditors (40 versus9 per cent). Again, differences among the different audit firms were significant at the1 per cent level: audit firm C reported in writing most often (44 per cent) and audit firm Edid so least often (10 per cent). Auditors with high or medium experience issued morewritten reports to the supervisory board than did audit partners with low experience(37, 37 and 24 per cent, respectively, significant at the 10 per cent level).

    3. The redress process. When the auditor has detected fraud and management hasnot yet taken appropriate steps to redress the effects of the fraud, the auditor is requiredto demand that the fraud be redressed, i.e. the consequences of the fraud have to berectified as far as possible and recurrence needs to be prevented. In cases wheremanagement has already taken appropriate action, the auditor does not demandredress but verifies that the actions taken are satisfactory. At the time of the survey,auditing standards required the auditor to demand redress of material fraud. If redresswas not accomplished, the auditor was required to withdraw from the engagement and,when the engagement concerned a statutory audit, report this fact to a centralgovernmental agency[15]. The results show that in 76 per cent of the fraud cases, theauditor demanded the entity to redress the fraud. It is possible that in the remaining24 per cent of the cases the audit client had already taken sufficient measures to redressthe fraud on their own initiative; therefore, in those cases there was no need for theauditor to demand redress. Table III indicates that redress was requested more often

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  • in case of management fraud (84 versus 71 per cent for employee fraud), and frauddiscovered during a statutory audit (77 versus 61 per cent for voluntary audit).Furthermore, demands for redress were significantly related to the audit firm: auditfirm C requested redress in 93 per cent of the cases, while audit firm D did so only71 per cent of the time. Demands for redress were not related to the remainingcharacteristics of fraud or to any other auditor characteristic.

    Of the fraud cases in which redress was requested, redress was accomplished,eventually, in 94 per cent of the cases. Redress more often took place in cases of employeefraud in comparison with management fraud (97 versus 90 per cent) and more oftenin cases of internal fraud than in cases of external fraud (96 versus 88 per cent).Redress effectiveness was not significantly related to fraud materiality and to thestatutory-voluntary audit dimension. Respondents of Big Four audit firms tendedto achieve a higher redress effectiveness than those of non-Big Four audit firms(96 versus 89 per cent), though this difference is not statistically significant. A significantrelationship did exist between redress effectiveness and audit firm: audit firm Cmanaged to achieve redress in all requested cases, while audit firm A achieved redressleast often (86 per cent). Redress effectiveness tended to decline with auditor experience,but this relationship was not significant.

    Furthermore, the auditor can achieve redress with or without putting pressure onthe auditee. Table III reveals that the auditor needed to use pressure more frequently inthe cases involving material fraud (22 versus 9 per cent), management fraud (25 versus5 per cent) and external fraud (21 versus 11 per cent). Also, partners of audit firms Dand E needed to use pressure significantly more often than did partners of other auditfirms. Whether fraud was detected during a statutory or voluntary audit, by a Big Fouror non-Big Four audit partner or by an experienced or less experienced partner did notseem to affect the need for pressure to achieve redress.

    4. Auditor resignation. The auditing standards at the time of the study allowed theauditor to resign from the assignment in case of fraud, but required the auditor toresign if a case of material fraud was not redressed[16]. Results indicated that in17 (5 per cent) of the 317 fraud cases the audit partner resigned. This occurred moreoften in cases of external, management and material fraud than in other fraud cases.Respondents indicated that in three out of these 17 resignations, resignation resultedfrom the fact that redress had not taken place although the fraud was material.The data in Table III, however, suggest that there were actually seven cases of materialfraud that were not redressed by management, and therefore, should have led to theauditors resignation. Consequently, in four cases of non-redressed material fraud, theauditor did not resign despite an obligation to do so.

    5. External reporting of fraud. Finally, auditing standards state that when materialfraud discovered during a statutory audit has not been redressed by the audit clientwithin a reasonable time frame, the auditor is not only required to resign from theengagement, but also to notify the dedicated governmental agency. The 296 respondentsin this study identified seven material fraud cases for the period 1995-2002 that had notbeen redressed, all of which were discovered in the course of a statutory audit. Thismeans that in this sample seven cases should have been reported to the central reportingagency. Given the fact that the initial sample of the top 30 audit firms covers the vastmajority of the population of Dutch auditors who perform statutory audits, the responserate of 24 per cent (which is almost a quarter of the audit partners of the top 30 audit

    Fraud detection

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  • firms) results in an expected number of about 28 cases (7 4) for the entire population,which should have been reported to the government agency[17]. In reality, the agencywas notified only twice in the period 1995-2002, indicating that external reporting offraud is less frequent than might be expected from the results of this study.

    Perceptions of the role of the auditor in the redress processA final issue concerns the audit partners perceptions of their role in the redressprocess. For this analysis, auditors who had not actually detected fraud wereeliminated from the sample (Table IV)[18]. Most auditors who do have experiencewith fraud detection perceived their role in the redress process to be significant(56 per cent). Results also show that perceptions of the role of the auditor in the redressprocess differed between Big Four and non-Big Four auditors; Big Four auditorsperceive their role in the redress process to be limited more often than do non-BigFour auditors (33 versus 17 per cent). In addition, non-Big Four auditors did not havean opinion on their role in redressing fraud more often than did Big Four auditors(24 versus 13 per cent). The influences of the different audit firms and years of auditpartner experience on auditor role perceptions proved not to be significant.

    ConclusionsIn this study, evidence has been presented on the volume and nature of fraud casesdetected by audit partners and the extent of these partners compliance with auditingstandards regarding redress of fraud and reporting fraud to a governmental agency.Also, the study provides evidence on the experiences of auditors requesting redressonce they have encountered cases of corporate fraud.

    The first conclusion to be drawn from this study is that fraud detection by auditors is arelatively rare event; this result is consistent with previous research by Loebbecke et al.(1989). On average, the audit partners in the sample detected 1.07 fraud cases in aneight-year window. Furthermore, non-Big Four auditors seemed to detect the moreserious fraud cases (i.e. management fraud with an external scope) more often than didBig Four auditors. These results indicate that most auditors have insufficient opportunityto build expertise in the area of fraud detection, reporting and redress of detected fraud.

    No/limited role Significant role No opinion

    Total 41 (29) 79 (56) 21 (15)Big Four vs non-Big FourBig Four audit firm 28 (33) 47 (55) 11 (13)Non-Big Four audit firm 7 (17) 24 (59) 10 (24)Big Four audit firmA 3 (16) 14 (74) 2 (11)B 4 (31) 8 (62) 1 (8)C 11 (52) 9 (43) 1 (5)D 14 (35) 19 (48) 7 (18)Experience as a partnerHigh 5 (24) 14 (67) 2 (10)Medium 19 (32) 33 (56) 7 (12)Low 17 (28) 32 (52) 12 (20)

    Note: The values within the parentheses denote percentage

    Table IV.Perceptions of the role ofthe auditor in the redressprocess

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  • The overall conclusion with respect to the redress process is that Dutch auditors do notcomply with certain key elements of the standards. The compulsory written report tomanagement was issued in only 48 per cent of the cases. Also, the written report to thesupervisory board was issued in just 41 per cent of all management fraud cases and in40 per cent of all instances of material fraud. This is more than just a documentationerror. If fraud is not reported in writing, the fraud case may not be included in the auditfile and in case of a file review, the auditor will not be held responsible if his responsewas inadequate.

    Also, data show that the reporting rules were followed more strictly by Big Fourauditors and in cases of material and management fraud. In addition, redresseffectiveness (i.e. whether redress is actually achieved) was lower in cases ofmanagement and external fraud, and pressure was needed in the more serious cases ofmaterial, management and external fraud. This indicates that management was lesslikely to redress a serious instance of fraud than it was to redress a less serious case.When considering the requirement for an auditor to resign when material fraud is notredressed, it turns out that auditors resigned in three out of seven cases. Externalreporting to a governmental agency took place even less often. In the window of thisstudy, the governmental agency was actually notified with regard to two fraudcases[19]. These empirical findings cannot be compared to previous work since thisconcerns a unique feature of the Dutch framework that has not been investigatedpreviously.

    The results of the current study are generally in line with those reported byLoebbecke et al. (1989). As explained above, both studies concluded that auditors rarelyencounter fraud. There are, however, some differences between the current results andthose reported by Loebbecke et al. (1989). In the present study, a much smallerproportion of the total number of fraud cases could be classified as management ormaterial fraud (41 and 37 per cent, respectively) than was the case in Loebbecke et al.(56 and 60 per cent). There are several explanations for these differences. First, thepopulation under investigation differed between the studies. Loebbecke et al. focusedon the USA, while the focus of the current study was on the Netherlands. Institutionaland cultural differences may have an impact on the types of fraud committed and onthe willingness of respondents to provide honest answers. Second, the sample of thecurrent study included partners of the top 30 Dutch audit firms, while Loebbecke et al.focused on a single audit firm. This study provided indications that auditorexperiences with fraud detection do differ across audit firms, thereby providing anexplanation for the observed differences between the two studies. Third, the windowdiffered between the studies. Loebbecke et al. focused on the period prior to 1990, whilethe current study investigated the window 1995-2002. Fourth, the difference in theclassifications of fraud cases as either management or employee fraud may be due toinconsistent interpretations among respondents.

    Given the sensitive nature of reporting fraud and societys expectations of auditors inthis respect, compliance with audit standards on fraud detection and reporting is a keyissue in auditors professional ethics. Most existing studies in this area have focused onthe question of the extent to which auditors are able to detect fraud, implicitly focusingon the fact that society may have unrealistic expectations in this matter. However, theevidence provided in this study suggests that in cases where the auditor has detectedfraud, relevant procedures and regulations are not fully complied with.

    Fraud detection

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  • There may be several causes for the finding of non-compliance in the current study.Possibly, auditors may decide not to comply with the standards because they faceconflicts of interest, or because they are careless or for efficiency reasons, or it might bethey are not fully aware of what the standards require. With regard to this latterpossibility, respondents claimed that they hardly ever detect fraud, and therefore, didnot build up experience with responding to actual fraud cases in line with auditingstandards. This increases the probability that they fail to do so when fraud occurs.Compare this situation to that of airline pilots. The likelihood that an average airlinepilot will be confronted with a near crash in his career is extremely low. Since theyshould nevertheless know how to deal with such situations, aviation authorities requireairline pilots to be trained in the procedures for handling near crash situations in flightsimulators. Auditors, however, often do not train for similar rare events and as aconsequence they do not build up expertise in finding and dealing with corporatefraud. Existing studies have indicated that changes in auditing standards andregulatory changes have not resulted in an increase in auditors ability to detect fraudor in an improvement of audit effectiveness in discovering fraud (Jakubowski et al.,2002; Rezaee et al., 2003). Our results suggest that a lack of knowledge among auditorsabout the details of such standards and regulations may have further limited theireffect on auditors demands for redress and on their reporting actions in fraud cases. Inaddition to increasing educational efforts, this finding may also lead to the conclusionthat in cases of fraud, the audit team should be expanded to ensure the availability ofspecific expertise that may be available at the technical department of the audit firm.However, as mentioned, auditors may also decide not to comply with the standardsbecause they face conflicts of interest, or because they are careless or for efficiencyreasons, in addition to the lack of knowledge or specific training with regard todetecting and responding to fraud.

    As a direct result of the outcomes presented here, the Dutch professional bodyNIVRA took several steps. First, all Dutch auditors have been obliged to take a specialcourse on fraud standards, to make sure that they are well aware of the lateststandards regarding corporate fraud. In addition, existing fraud regulations have beenamplified with respect to the consultation of experts, to encourage the engagementteam to use the expertise of specialists to address potential fraud situations.Furthermore, regulations concerning the reporting of fraud have been strengthened.Previously, the auditor was required to report fraud cases to the supervisory body onlyin cases of management or material fraud, but under the new standards all cases offraud must be reported. Furthermore, under the new standards, the auditor shouldconsider resigning from the engagement not only in material cases but also in all caseswhere management fails to take reasonable steps to redress fraud. These changesshould limit the number of situations in which auditors are exempted from takingactions as laid down in standards relating to fraud situations, making what can beexpected from the auditor in fraud-related situations more transparent for auditors aswell as for the general public.

    As with all other studies on the occurrence of fraud, this research suffers from aninherent limitation. The sensitive nature of the subject and the tendency of auditpartners to protect themselves and their firms may lead to socially desirable answers.There may also be a non-response bias. These risks were mitigated as far as possibleby using a notary in civil law as an intermediary in the data-collection process

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  • to guarantee anonymity of the respondent. Also, specific non-response tests wereperformed. Nevertheless, further research on the role of auditors in fraud cases remainscrucial. In future research, it would be interesting to distinguish the power of suchfactors as:

    . auditors lack of knowledge or competence on how to act once corporate fraud isdetected;

    . lack of care for following protocol; and

    . the external auditors lack of independence.

    Moreover, it would be interesting to investigate in more detail the characteristics ofthose cases of detected fraud where existing standards were not complied with. Moredetailed analyses of real-life fraud cases can offer unique opportunities for improvingcurrent fraud standards.

    Notes

    1. Professional ethics concerns the moral issues (e.g. fraud reporting) that arise because of thespecialist knowledge that professionals attain, and how the use of this knowledge should begoverned when providing a service to the public (Chadwick, 1998).

    2. In a later study, Albrecht and Romney (1986) used the same dataset to extend this research.

    3. The dataset used in Loebbecke et al. (1989) consisted only of fraud cases. Several laterstudies have used the same dataset, expanding it with a set of non-fraud cases (Bell et al.,1991; Hansen et al., 1996; Bell and Carcello, 2000).

    4. Loebbecke et al. (1989) distinguished between management fraud and defalcations, privatelyheld or publicly held companies, fraud materiality, client industries, deceptive actions, levelsof client personnel involved, audit areas, auditing procedures first indicating the fraud andnumber of prior audits of the client.

    5. Currently, the responsibilities of auditors in the Netherlands with regard to corporate fraudare set in the Audit Firms Supervision Act (2006), the Decree on the Supervision of AuditFirms (2006) and Audit Standard COS 240 The auditors responsibility to consider fraud inan audit of financial statements. This is a slightly different situation compared to themoment the survey in this study was conducted. The current requirements are essentiallythe same as the requirements in the situation before 2006 except for the fact that someresponsibilities are now set in a national act instead of in professional standards.

    6. See DAS 240 and BLF, now: COS 240.93a.

    7. See DAS 240 and BLF, now: COS 240.95b.

    8. See DAS 240 and BLF, now: BTA 37.1.

    9. See BLF Art. 3, now: COS 240.103. Note that COS 240.130 requires the auditor to considerresigning whereas BLF Section 2 requires the auditor to resign.

    10. See BTA, COS 240.102a.

    11. The questionnaire is available from the auditors upon request.

    12. Every received self-addressed envelope was opened by the notary in civil law in the absenceof the researchers; the date was put on the questionnaire and the questionnaire was markedby the notary with a new code per auditing firm. This procedure made it possible for theresearchers to compare fraud experiences among auditing firms while still guaranteeing the

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  • anonymity of the respondents and of the auditing firm involved. After recoding theself-addressed envelopes, the notary destroyed the coding table.

    13. With respect to non-response bias, a number of characteristics of early versus laterespondents have been tested. The corresponding t-tests have not indicated any significantdifferences between both groups.

    14. To compare the findings, the average number of fraud cases reported by Loebbecke et al.was multiplied by 0.6, resulting in an average of 1.86 fraud cases per audit partner. To adjustfor the larger time frame of Loebbecke et al., we divided this number by the average auditingexperience of 19.5 years of the partners sampled in this research and then multiplied thisnumber by eight years, which is the window of the current study. After these adjustments,the number of fraud encounters per audit partner in the Loebbecke et al. study is about 0.76,which is more in line with the findings of the present study (1.07 fraud cases).

    15. Note that in the current auditing standards in this situation the auditor only has to considerwithdrawing from the engagement but nevertheless he must report to a centralgovernmental agency.

    16. See also BLF.

    17. Of the total population of top 30 audit partners in The Netherlands, about a quarterparticipated in this study. Of approximately 130,000 audits in The Netherlands in the period1995-2002, about 1,250 instances of fraud would have been detected. In 1,000 of these casesredress would have been requested by the auditor, of which 940 cases would have beenredressed eventually. Therefore, in 60 cases, no redress would have taken place, of which28 cases would have been material fraud detected during a statutory audit. In 16 of theseinstances, the auditor would have resigned, and 28 cases would have been reported to theexternal reporting agency.

    18. The reason for this removal was that only 15 per cent of this group had an opinion on theauditors role in fraud redress; eight partners considered their role to be small, and15 partners considered their role to be significant. The remaining 132 auditors who had noexperience with fraud detection did not have an opinion on the auditor role in the redressprocess.

    19. Under the old requirements, it was mandatory for auditors to report the fraud to thegovernmental central reporting agency (BLF, Section 3) while under the current legislationthis is mandatory according to the Audit Firms Supervision Act, Article 26.

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    Arnold, D.F. Sr, Bernardi, R.A., Neidermeyer, P.E. and Schmee, J. (2005), Personal versusprofessional ethics in confidentiality decisions: an exploratory study in Western Europe,Business Ethics: A European Review, Vol. 14 No. 3, pp. 277-89.

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    Glover, S.M., Prawitt, D.F., Schultz, J.J. Jr and Zimbelman, M.F. (2003), A test of changes inauditors fraud-related planning judgments since the issuance of SAS no. 82, Auditing:A Journal of Practice & Theory, Vol. 22 No. 2, pp. 237-51.

    Gowthorpe, C., Blake, J. and Dowds, J. (2002), Testing the bases of ethical decision-making:a study of the New Zealand auditing profession, Business Ethics: A European Review,Vol. 11 No. 2, pp. 143-56.

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    Krishnan, G.V. (2003), Audit quality and the pricing of discretionary accruals, Auditing: AJournal of Practice & Theory, Vol. 22 No. 1, pp. 109-26.

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    Farrell, B.J. and Cobbin, D.M. (2000), An analysis of the ethical environment of the internationalaccounting profession, Business Ethics: A European Review, Vol. 9 No. 1, pp. 20-30.

    Farrell, B.J. and Cobbin, D.M. (2001), Global harmonisation of the professional behaviour ofaccountants, Business Ethics: A European Review, Vol. 10 No. 3, pp. 257-66.

    Ferguson, M.J. and Majid, A. (2003), To sue or not to sue: an experimental study of factorsaffecting Hong Kong liquidators audit litigation decisions, Journal of Business Ethics,Vol. 46 No. 4, pp. 363-74.

    Kerler, W.A. III and Killough, L.N. (2009), The effects of satisfaction with a clients managementduring a prior audit engagement, trust, and moral reasoning on auditors perceived risk ofmanagement fraud, Journal of Business Ethics, Vol. 85 No. 2, pp. 109-36.

    Krishnan, J. and Krishnan, J. (1997), Litigation risk and auditor resignations, AccountingReview, Vol. 72 No. 4, pp. 539-60.

    Lee, H.Y., Mande, V. and Ortman, R. (2004), The effect of audit committee and board of directorindependence on auditor resignation, Auditing: A Journal of Practice & Theory, Vol. 23No. 2, pp. 131-46.

    Majid, A., Gul, F.A. and Tsui, J.S.L. (2001), An analysis of Hong Kong auditors perceptions ofthe importance of selected red flag factors in risk assessment, Journal of Business Ethics,Vol. 32 No. 3, pp. 263-74.

    Pratt, J. and Stice, J.D. (1994), The effects of client characteristics on auditor litigation riskjudgments, required audit evidence, and recommended audit fees, Accounting Review,Vol. 69 No. 4, pp. 639-56.

    Raghunandan, K. and Rama, D.V. (1999), Auditor resignations and the market for auditservices, Auditing: A Journal of Practice & Theory, Vol. 18 No. 1, pp. 124-34.

    Shu, S.Z. (2000), Auditor resignations: clientele effects and legal liability, Journal of Accounting& Economics, Vol. 29 No. 2, pp. 173-205.

    Tatum, K.W. (2008), Analysis of international standards on auditing, AICPA ProfessionalStandards, Vol. 1, AICPA, Durham, NC, Appendix B.

    Wilks, T.J. and Zimbelman, M.F. (2004a), Decomposition of fraud-risk assessments andauditors sensitivity to fraud cues, Contemporary Accounting Research, Vol. 21 No. 3,pp. 719-45.

    Wilks, T.J. and Zimbelman, M.F. (2004b), Using game theory and strategic reasoning conceptsto prevent and detect fraud, Accounting Horizons, Vol. 18 No. 3, pp. 173-84.

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  • AppendixDAS 240The main points were as follows. Before starting the audit as such, auditors are required to carryout a pre-assessment, evaluating and documenting the likelihood of financial misstatements andthe presence of risk factors indicating an increased potential for fraud, and making inquiries tobetter understand the company, its procedures and its management. Based on thispre-assessment, the audit procedure should take into account the estimated level of inherentand control risk, and may have to be adjusted or expanded if circumstances are encountered thatmay indicate material misstatement. While conducting the audit, a written representation frommanagement should be requested including a statement that management feels obliged to detectand deter the occurrence of fraud, and that the auditor has been informed about all relevant fraudcases. If material errors are detected, the auditor should report this to management and may,again, have to revise the audit procedures based on the new information. At the same time, theintegrity of management should be reconsidered, especially if there are indications ofmanagement fraud. If there is fraud or an indication of fraud and the auditor believes that it istherefore not possible to continue the audit, he should consider reporting to the entity (or, in somecases, to regulatory authorities) or withdrawing from the engagement. The auditor needs toterminate his appointment if the audit is impeded by any restrictions or limitations imposed bythe client, and should inform the appropriate level of management and the supervisory bodyabout his reasons for doing so.

    BLFThe main points were as follows. The BLF came into force in 1994 and remained unchangedthroughout the period under study (1995-2002). Both the AS 240 and the Supervision of AuditorsAct (Wet toezicht accountantsorganisaties or WTA) were modified after this study wascompleted. These regulations now contain the main points of the BLF, which then ceased to existas a separate auditing standard. However, there is one exception to the BLF, and that concernsthe provision that auditors must notify the supervisory body if management refuses toredress the detected fraud. This step is not covered, either by the WTA or the accompanyingDecree on the Supervision of Auditors (Besluit toezicht accountantsorganisaties, or BTA).The BTA requires that the competent government authority be notified when the audit clientfails to redress the fraud (whether this concerns management or the supervisory body), thusomitting the intermediate step of informing the supervisory board.

    Abbreviations:

    BLF Dutch by-law on reporting on fraud.

    BTA Dutch decree on the supervision of audit firms, 2006.

    COS Dutch audit and other standards (as of 2007).

    DAS Dutch Auditing Standards (until 2007).

    ISA International standard on auditing.

    Corresponding authorHarold Hassink can be contacted at: [email protected]

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  • This article has been cited by:

    1. Anna Gold, W. Robert Knechel, Philip Wallage. 2012. The Effect of the Strictness of ConsultationRequirements on Fraud Consultation. The Accounting Review 87:3, 925-949. [CrossRef]

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