Fraud and Risk Assessment

Research Prospectus Project

Assignment u010a
Verneshia D. Cody
March 18, 2011

Fraud and Risk Assessment

Occurrences of fraud at organizations such as Enron and WorldCom have sensitized the
public accounting profession to the devastating effects of fraud on all stakeholders, including
employees, investors, creditors, companies and auditors. Fraud detection has historically been
one of the objectives of the auditing profession, and it became an even higher priority after these
highly publicized scandals. (Alon & Dwyer, 2010)
In 2002, the fraud guidance was expanded by the Statement of Auditing Standards (SAS)
No. 99 (AICPA, 2002) to reinforce to auditors the need to maintain professional skepticism and
overcome the tendency of over-reliance on client representation. SAS No. 99 includes a
brainstorming requirement, which mandates an audit team to discuss the potential for material
misstatement due to fraud and encourages the auditors to share client information and
experiences in order to develop a better understanding of fraud possibilities (Ramos, 2003).
Before SAS No.99 the fraud risk assessment was typically performed by a senior on the

engagement (Shelton, et al., 2001). With the inception of SAS No. 99, key members of the audit
team, from the lead partner or manager to the new staff, meet during the planning stage to
exchange ideas and brainstorm how management could conceal fraudulent financial reporting or
misappropriation of assets (Beasley and Jenkins, 2003).
The Public Company Accounting Oversight Board (PCAOB, 2007) has emphasized that
detection of fraud is an important objective of an audit and an important focus of the board.
PCAOB reminds auditors to be diligently focused on their responsibilities to detect fraud and has
urged auditors to take the requirements of SAS No. 99 (AICPA, 2000) seriously. SAS No. 99
introduces a new audit procedure that must be performed on every engagement: a brainstorming
session. Members of the audit team must meet to exchange ideas about how and where they
believe the entitys financial statements may be susceptible to material misstatements due to
fraud and to discuss how management could perpetrate and conceal fraudulent financial
reporting or misappropriate assets.
Auditors have to find a way to determine if fraud risk assessment is more likely to be
detected through a group brainstorming session or more likely during an individual
brainstorming session with decision aid material. The purpose of this paper is to investigate
brainstorming sessions with individuals and groups to determine which has a better influence on
fraud risk assessment with and without using decision aid material.
Osborne (1957) presented group brainstorming as a means of increasing creativity in idea
generation. This creativity was suggested to occur because of the advantages of a large pool of
ideas, from the mutual simulation of ideas and from the production of new ideas by combining or
changing ideas already generated. (Trotman, Simnett & Khalifa, 2009)
Multi-person decision-making is common in auditing but most work has been focused on
individual judgments (Arnold, et. al, 2000). While decision aids have been shown to benefit
individual decision-making, findings have not been consistent with groups. Arnold et al. (2000)

found that decision support systems may in fact impede a groups decision quality during
materiality assessment risk. In contrast, Bamber et al, 1996 found that groups using a group
support system demonstrates higher acceptance of group decisions and undertook a more
thorough analysis in a disclosure decision.
Decision aid reliance is defined as the extent of use of aid by the participants (Rose,
2002). For this investigation, based on Hampton (2005), a seven-point Likert scale (ranging from
strongly disagree to strongly agree) was developed to evaluate users reliance on the decision aid.
Three different measures were used to obtain the information on the extent of decision aid usage.
There are two independent variables: individuals and groups. The two dependent variables would
be: decision aids and without decision aids are better needed to influence fraud risk assessment.
In this investigation, we are trying to determine if individuals or groups have a better influence
on risk assessment with or without using decision aid material.
The Auditing Standards Board issued SAS No. 99 because new
guidance was needed
to improve the likelihood that auditors would detect fraudulent financial
reporting (AICPA
2003). In essence, SAS No. 99 requires auditors to consider during planning
how an issuers financial statements might be susceptible to material
misstatement due to fraud and how management could perpetrate and
conceal fraudulent financial reporting. Audits must include a brainstorming
session during planning that reinforces that detection of fraud is an essential
element of the audit (AICPA, 2002; PCAOB, 2007). Auditors must document
the fraud risks identified during this brainstorming session and respond with
modifications to the audit plan that address the identified risks. This includes

changes to the audit program and appropriate skepticism during evidence

evaluation.
Fraud risk assessment and fraud detection are complex tasks, and
auditors have had difficulty implementing previous fraud standards
(Nieschwietz et al., 2000). Recent evidence suggests that auditors also have
had difficulty implementing SAS No. 99 (PCAOB, 2007).
Recent research has examined the effect different brainstorming policies
have on auditorsfraud planning judgments (Carpenter, 2007; Hoffman and
Zimbelman, 2009; Lynch et al., 2009; Hunton and Gold, 2010). However,
these studies do not examine evidence evaluation, even though many
alleged audit failures involve failures in evidence evaluation (Erickson et al.,
2000; Turner, 2000). The PCAOB has expressed concerns about the
mechanical implementation of the standard, and PCAOB inspection teams
have observed instances of auditors providing insufficient documentation of
identified fraud risks and failing to respond appropriately when audit
evidence warrants further fraud risk consideration (PCAOB, 2007). More
generally, PCAOB inspectors report that audit deficiencies are caused, at
least in part, by auditors insufficient skepticism when evaluating audit
results (PCAOB, 2008). In response, the PCAOB calls for more documentation
of the results of performing fraud-related audit procedures, beyond checking
off items on checklists and standard audit procedures. (Hammersley, Bamber
& Carpenter, 2010)
SAS No. 99 requires the identification of specific fraud risks in addition
to an overall fraud risk assessment at the planning stage. Documentation of

these fraud risks provides a decision aid that facilitates subsequent retrieval
of the results from the brainstorming session
(Nelson, 2009).
Carpenter (2007) and Hoffman and Zimbelman (2009) experimentally study the influence
of brainstorming sessions on the link between fraud risk and fraud risk assessment and the link
between risk assessment and the nature of the audit procedures selected, respectively. Carpenter
(2007) examines hierarchical teams that brainstorm and concludes that teams generate lists with
more quality fraud risks than do individual auditors. Further, these teams provide more effective
fraud risk assessments i.e., higher when fraud was present than when it was not than auditors
working alone. Hoffman and Zimbelman (2009) investigate the role that brainstorming plays
with regard to audit managers planned audit procedures. They document that brainstorming
versus no brainstorming leads to more effective modification of standard audit procedures in a
specific high fraud risk case. While both of these studies provide important insights, neither
captures the collective fraud process i.e., the relations among fraud risk factors, risk assessments,
and responses, nor do they examine actual audit teams where partners judgments are likely very
important. (Brazel, Carpenter & Jenkins, 2010)
Prior psychology research suggests that the effectiveness of judgments and decisions
likely depends on the quality of a teams interaction. (Stasser, 1977) Prior experimental research
has typically found that when fraud risk factors are present, fraud risk assessments tend to be
higher (Nieschwietz et al., 2000). Further, prior experimental research has documented that
auditors have difficulty responding to fraud risk assessments by altering the nature of their
testing (Zimbelman,1997; Glover et al., 2003). Actual audit engagements are rich in context and
the fraud risk assessment is typically determined after engagement team deliberation. Such an
environment is difficult to create in an experimental setting. Specifically, when audit teams
engage in higher quality brainstorming sessions, fraud risk assessments are more positively

associated with changes to the nature, staffing, timing, and extent of fraud-related audit
procedures.
An alternative view of brainstorming is presented by Kerr and Tinsdale (2004), who
question the effectiveness of brainstorming groups. They suggest that Osborn and most
members of brainstorming group (Paulus et al., 1993) believe that such groups routinely
outperform equal sized sets of non-interacting individuals (627). However, numerous studies
have criticized group brainstorming because they find nominal groups to be superior to
interacting groups in terms of the quantity and quality of ideas generated (Hill, 1982; Diehl &
Stroebe, 1987; Lamm & Trommsdorff, 1973; Mullen, Johnson and Salas, 1991; Dennis &
Valacich, 1993). On the basis of these studies, it has been concluded that the usual melee of
group discussion tends to interfere with our ability to get a productive train of thought started, or
can effectively derail an ongoing train of thought (Kerr & Tindale, 2004).
Early research by Taylor, Berry, and Block, 1958 indicated that individuals brainstorming
on their own generated more ideas than those brainstorming in groups. Their study randomly
assigned groups who worked together to generate ideas with randomly assigned collection of
individuals whose results were pooled after working alone on the task (nominal groups). The
effects of the actual guidelines for brainstorming were not tested because both experimental
conditions had the same brainstorming guidelines. Subsequent studies investigating group versus
individual differences with brainstorming have also found nominal groups to be superior to real
groups in terms of the quantity of ideas generated, which seems to be inconsistent with Osborns
claims (Hill, 1982; Diehl & Strieve, 1987; Lamm and Trommsdorff, 1973; Mullen et al, 1991;
Dennis & Valacich, 1993). Isaken (1998) provides a critical review of over 50 studies conducted
since Osborn (1957) and notes that most of the studies focused on individual versus group
brainstorming guidelines. The few studies that have tested the brainstorming guidelines have

found support for them (Isaksen, 1998), including an increased productivity for brainstorming in
terms of quantity of ideas generated (Parnes & Meadoe, 1959; Price, 1985). Also, significantly
more good-quality ideas were produced under brainstorming guidelines, with a positive
correlation between quality and quantity of ideas (Parnes & Meadows, 1959). However, it is
noted that the few studies that have examined brainstorming have restricted the quantity of ideas
generated by the nonbrainstorming groups by instructing participants to list all good items and
not to put forth any idea they felt was not good. More recent studies have explored the reasons
for failure of brainstorming groups and have been concerned with productivity losses in
brainstorming groups.
The review paper by (Isaksen, 1998), is extremely critical of the brainstorming research
conducted. He conclude that most studies used untrained students working in artificial groups
on relatively meaningless tasks with little or no concern for measuring anything but sheer
quality (21). In particular, he was critical of the tasks used, concluding that it would appease
that most of the empirical literature falls short when considering the reality of the tasks used to
study the brainstorming (17). Most of the studies used tasks such as having subjects test the
benefits over drawbacks of having an extra thumb or generate unusual uses for a coat hanger or
broom. Isaksen (1998, 17) suggests that the above tasks do not meet the criteria for a real
problem solving task, which would require that, prior to generating ideas, some energy should
be invested in preparing and understanding the problem. Isaksen also notes that brainstorming
was designed to used by adults working on real challenges within organizations(18), but the
studies used in brainstorming literature have used undergraduate college students.
Carpenter (2007) also notes that most brainstorming studies in the psychology literature
have been performed with ad hoc groups and hypothetical problems, whereas SAS No. 99
requires the brainstorming to be conducted by auditors with the relevant training and experience.

Carpenter (2007) finds that group brainstorming sessions result in a loss of ideas generated by
individual auditors prior to the brainstorming, and group brainstorming generated additional
quality ideas. That is, the brainstorming audit teams eliminated some non-quality fraud ideas and
generated new quality fraud ideas during the brainstorming sessions.
The above differences suggest that there are factors that my impact the effectiveness of
brainstorming in an audit environment. In fact, previous studies have shown the importance of
task differences on the performance of interacting groups (Trotman, 1985) and the importance of
recognizing the relative expertise of group members in the interacting group (Libby et al., 1987).
(Trotman, Simnett & Khalifa, 2009)
The study examines the decision quality and fraud likelihood rating used while
brainstorming in the fraud risk assessment by groups and individuals with and without decision
aid materials. It is anticipated that the individuals will rely on the decision aid material more than
the brainstorming groups. The brainstorming groups are expected to identify more quality fraud
ideas without the use of the decision aid material. The participants will include 30 auditors who
have at least three years of audit experience. The tasks will be completed individually and as a
group with and without decision aid material. Similar to Pincus (1989), individual participants
were asked to take the role of company external auditors during the planning stage. Individual
participants were instructed to read a case and identify any fraud or suspicion of fraud and
identify the likelihood that fraud may occur. Fifteen were given the case with the decision aid
material and fifteen were given the case without the decision aid material. A different case was
given for the group assignment. DeSanctis and Gallupe (1987, p. 590) defined a decision-making
group as two or more people who are jointly responsible for detecting a problem, elaborating on
the nature of the problem, generating possible solutions, evaluating potential solutions or
formulating strategies for implementing solutions. Later they were placed into ten groups of

three. Five of the groups were given decision aid material and the other five were not given
decision aid material. As a group, they had to list any risk that they observed with the case and
whether there was any suspected fraud or likelihood of fraud.
The study jointly investigated the brainstorming requirement of SAS No. 99 and the use
of decision aid material in helping in fraud risk assessment. The results show that brainstorming
and decision aid material are very beneficial when determining fraud risk assessment. Groups
with and without the decision aid material performed much higher than those individuals with
and without decision aid material. (See Table 1) According to Butler (1985), decision aids
redirect auditors attention to broad classes of problems and, as such, the findings demonstrate
the benefits associated with SAS No. 99 brainstorming requirement and also indicate that
providing groups of auditors with a decision aid can help the group to stay focused and
incorporate important areas into the risk assessment. The results also show that individuals relied
a greater deal on the decision aid material than the groups but the group came up with more
quality fraud ideas. The group fraud rating was high with and without the decision material. This
shows that the group shared a lot of information.
There are limitations that should be considered dealing with the results of this
investigation. The study was done on a very small sample size. Future research should examine
larger, multi-layered groups. Future research can also build on the findings individuals are more
like to rely on decision material more than groups.

References
Alon, A. & Dwyer, P. (2010). The impact of groups and decision aid reliance on fraud risk
assessment. Management Research Review, 33(3), 240-256.
Arnold, V., Sutton, S., Hayne, C., & Smith, C. (2000). Group decision making: the impact
of opportunity-cost time pressure and group support systems. Behavioral Research
in Accounting, 12, 69-96.
Bamber, E.M., Watson, R.T., & Hill, M.C. (1996). The effects of group support system
technology on audit group decision making. Auditing, 15(1), 122-124.
Beasley, M.S., & Jenkins, J.G. (2003). A primer for brainstorming fraud risks. Journal of
Accountancy, 196(6), 32-38.
Brazel, J., Carpenter, T., Jenkins, J. (2010). Auditors use of brainstorming in the consideration
of fraud: reports from the field. The Accounting Review, 85(4), 273-1301.
Hammersley, J.S., Bamber, E.M., & Carpenter, T. (2010). The influence of documentation
specificity and priming on auditors fraud risk assessments and evidence evaluation
decisions. The Accounting Review, 85(2), 547-571.
Hampton, C. (2005). Determinants of reliance: an empirical test of the theory of technology
dominance. International Journal of Accounting Information Systems, 6, 325-44.
Pincus, K.V. (1989). The efficacy of red flags questionnaire for assessing the possibility of
fraud. Accounting, Organizations and Society, 14(1)(2), 153-163.
Trotman, K.T., Simnett, R., & Khalifa, A. (2009). Impact of the type of audit team discussions
on auditors generation of material frauds. Contemporary Accounting Research, 26(4),
1115-1142.
Table I. Results Summary

Hypothesis 1

Hypothesis 2
Hypothesis 3
Hypothesis 4

Predictions

Results

Brainstorming groups will generate more

quality fraud ideas than individuals with a
decision aid
Brainstorming groups will generate more
quality ideas without a decision aid
The fraud risk assessment will be higher for a
brainstorming team than for an individual.
The fraud risk assessment will be more
effective for a brainstorming team than for an
individual.

Individuals-5
Groups-15
Individual-3
Groups-9
Individual-25%
Groups-75%
According to hypothesis 3, the percentages
Are greater for groups than individuals so this
would make the teams more effective

Individual and group numbers were determined by the number of ideas generated
from the case with and without decision aid material.
Percentages were based upon total ideas provided by each divided by the total
number of ideas.