Deception Detection in Auditing and Auditors’ Assessment of Risk of Material Misstatement Due to Fraud

The investing public has long looked to the independent financial-statement auditor to help prevent and detect instances of material financial-statement fraud. Yet, it has only been in recent decades that audit standards recognize explicitly that auditors are responsible for providing high assurance that the financial statements are not materially misstated due to fraud. Although once generally believed to be an exceedingly rare event, recent research suggests base rates of financial statement fraud may be as high or higher than ten percent of public companies. Cases of fraud that go undetected for years exacts a substantial toll on the confidence of the investing public in capital markets. At the same time, actually providing high assurance that a set of financial statements are not materially misstated due to fraud is difficult for individual auditors due to a combination of questionable economic incentives for individual audit teams to detect fraud as well as psychological preference to avoid believing that one’s own client – a socially close affiliate – has been engaging in deception of the investing public as well as the auditors themselves.