Error or Fraud? The Effect of Omissions on Management’s Fraud Strategies and Auditors’ Evaluations of Identified Misstatements

Abstract

Using experiments with 58 corporate managers and 215 auditors, we examine whether managers attempt to reduce the perceived intentionality of their fraudulent misstatements by perpetrating fraud via omission, as opposed to a more active form of commission, and how auditors evaluate the resulting misstatements. We find that managers choose to omit a transaction from the financial statements rather than record a transaction inappropriately. They also choose to omit critical information from supporting documents rather than provide misleading information. However, auditors generally believe misstatements involving omission are unintentional. Specifically, we find auditors are less skeptical of an omitted transaction compared to a misrecorded transaction. They are also less skeptical of a misstatement that results from management omitting information from a supporting document compared to misrepresenting information. Overall, our studies identify a method of fraud—omission—that managers are likely to use, but that auditors are unlikely to judge as being intentional.

Keywords: Audit Evidence, Audit Quality, Fraud Detection, Misstatement, Omission Bias, Omission Strategy