Decomposition of Fraud‐Risk Assessments and Auditors' Sensitivity to Fraud Cues*

TLDR

Practitioners and regulators worry that auditors who view management’s attitude as low fraud risk fail to detect high incentive or opportunity risks in overall fraud‑risk assessments. This study tests whether decomposing fraud‑risk assessments into attitude, opportunity, and incentive components improves auditors’ sensitivity to opportunity and incentive cues when management’s attitude signals low fraud risk. The authors discuss and examine potential explanations for the observed pattern. In an experiment with 52 audit managers, decomposing fraud‑risk assessments increased sensitivity to opportunity and incentive cues only when those cues indicated low fraud risk, but had no advantage when cues suggested high fraud risk.

Abstract

Abstract Practitioners and regulators are concerned that when auditors perceive management's attitude or character as indicative of low fraud risk, they are not sufficiently sensitive to high levels of incentive or opportunity risks in their overall fraud‐risk assessments. In this study, we examine whether a fraud‐triangle decomposition of fraud‐risk assessments (that is, separately assessing attitude, opportunity, and incentive risks prior to assessing overall fraud risk) increases auditors' sensitivity to opportunity and incentive cues when perceptions of management's attitude suggest low fraud risk. In an experiment with 52 practicing audit managers, we find that auditors who decompose fraud‐risk assessments are more sensitive to opportunity and incentive cues when making their overall assessments than auditors who simply make an overall fraud‐risk assessment. However, this increased sensitivity to opportunity and incentive cues appears to happen only when those cues suggest low fraud risk. When opportunity and incentive cues suggest high fraud risk, auditors are equally sensitive to those cues whether they use a decomposition or a holistic approach. We discuss and examine potential explanations for this finding.