The Effects of Accurate Fraud Risk Assessment on Audit Professionals’ Judgments of Auditor Performance in Cases of Undetected Fraud: Evidence of Shifting Standards

Abstract

We provide theory and experimental evidence that, in cases of undetected fraud, professional evaluators (i.e. experienced auditors) do not evaluate auditor performance any more favorably when the auditor more accurately assessed a heightened risk of fraud. This occurs despite professional evaluators indicating both that (1) more accurate fraud risk assessments are higher quality risk assessments, and (2) higher quality risk assessments improve auditor performance. These beliefs do not ultimately increase performance evaluations of auditors who more accurately assess fraud risks because professional evaluators, consistent with theory, react to accurately heightened risk assessments by non-normatively increasing their conceptualization of the standard of care auditors must meet to comply with audit standards. The tendency to hold auditors to higher (lower) standards when they more (less) accurately assess fraud risks yields a judgment pattern that is inconsistent with, and potentially undermines the paramount value accorded to accurate risk assessment by audit practitioners, standards, regulators, and academics.

Keywords: risk assessment, undetected fraud, auditor liability, auditor foresight, black sheep effect

JEL Classification: M42, M41