Auditors’ Reactions to Inconsistencies between Financial and Nonfinancial Measures: The Interactive Effects of Fraud Risk Assessment and a Decision Prompt

Posted: 1 Oct 2013 Last revised: 19 Apr 2014

See all articles by Joseph F. Brazel

Joseph F. Brazel

North Carolina State University - Poole College of Management - Department of Accounting

Keith L. Jones

University of Kansas

Douglas F. Prawitt

Brigham Young University

Date Written: April 18, 2014

Abstract

Nonfinancial measures (NFMs), such as employee headcount and production space, are operational measures that are not included on the face of the financial statements but are often disclosed elsewhere in the annual report or 10-K (e.g., in Management’s Discussion and Analysis). Professional standards, auditing texts, and prior research suggest that external auditors can use NFMs to verify their clients’ reported financial information and, in turn, improve audit quality. In an initial experiment where auditors develop an expectation for a client’s sales balance, they generally fail to identify a seeded inconsistency between the client’s sales and related NFMs. In our second experiment, where we introduce an NFM prompt and manipulate fraud risk as high and low, auditors are more likely to react to the inconsistency (i.e., rely more on inconsistent NFMs/develop expectations that reflect the client’s current year decline in NFMs) when they are specifically prompted to consider the implications of NFMs and fraud risk is high (vs. low). Our results suggest the following: (1) a minority of auditors use NFMs as an information source for testing and do not increase their reliance on NFMs when the NFMs point to a fraud red flag; (2) the presence of high fraud risk alone is insufficient to increase auditor consideration of inconsistent NFMs; (3) auditors are able to react appropriately to an inconsistency if they are effectively prompted; and (4) the influence of a prompt on auditor reliance on NFMs and account balance expectations is stronger when fraud risk is assessed as high.

Keywords: analytical procedures, audit, fraud, nonfinancial measures

JEL Classification: M40, M41

Suggested Citation

Brazel, Joseph F. and Jones, Keith Lamar and Prawitt, Douglas F., Auditors’ Reactions to Inconsistencies between Financial and Nonfinancial Measures: The Interactive Effects of Fraud Risk Assessment and a Decision Prompt (April 18, 2014). Behavioral Research in Accounting, Volume 26, Issue 1, pp. 131-156., Available at SSRN: https://ssrn.com/abstract=2333956

Joseph F. Brazel (Contact Author)

North Carolina State University - Poole College of Management - Department of Accounting ( email )

Campus Box 8113
Nelson Hall
Raleigh, NC 27695
United States
919-513-1772 (Phone)

Keith Lamar Jones

University of Kansas ( email )

1654 Naismith Drive
MS 5F4
Lawrence, KS 66045
United States
785-864-6997 (Phone)
785-864-5328 (Fax)

Douglas F. Prawitt

Brigham Young University ( email )

Provo, UT 84602
United States
801-422-2351 (Phone)

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