Evaluating the Intentionality of Identified Misstatements: How Perspective Can Help Auditors in Distinguishing Errors from Fraud

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SUMMARY: Although auditors are responsible for detecting misstatements arising from either error or fraud, the auditing standards require very different audit responses when a misstatement is believed to be the result of an intentional act (AS No. 14, PCAOB 2010a). Specifically, if auditors suspect intentional misstatement, then they should perform additional audit procedures, reassess overall fraud risk and the integrity of management, and communicate potential concerns to the audit committee. Thus, if auditors fail to recognize and respond to information indicating a misstatement was caused intentionally, then audit quality may be impaired. The objective of this study is to investigate whether auditors who consider the perspective of the manager responsible for a misstatement's occurrence are more sensitive to circumstances indicating the misstatement was intentional. Using an experiment with audit managers and senior managers, I find that auditors who consider the client manager's perspective assess the misstatement as significantly more likely to be intentional when circumstances surrounding it indicate high, as opposed to low, fraud risk. In contrast, auditors who do not consider the client manager's perspective do not assess intentionality any differently, regardless of the level of fraud risk.

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