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Fraud Detection and Financial Reporting and Audit Delay

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  • Yim, Andrew

Abstract

I formulate a model to emphasize the fraud detection role of auditors in the financial market, providing a theoretical framework to examine the likelihood of and market reaction to a financial reporting and audit delay. The model has an auditor considering whether to perform extended audit procedures after observing a red flag generated from regular audit procedures. An audit delay is represented by the event of extending audit procedures and manifested as a financial reporting delay observed by the market. I find that the equilibrium likelihood of a delay decreases when the reliability of regular and extended audit procedures improves and/or when the ex ante probability of fraud reduces. My result on the market reaction to a delay suggests that while a negative average reaction is intuitive and has been documented, the reaction can be positive for an individual firm. I derive a closed-form condition indicating when a positive reaction is possible. Specifically, a delay can be good news to the market when the ex ante probability of fraud, the imprecision of a red flag, and the effectiveness of extended audit procedures for detecting fraud are all high. The result is new in the literature. I also discuss the model's empirical implications with suggestions for regression equation specifications.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 27857.

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Date of creation: 20 Sep 2010
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Handle: RePEc:pra:mprapa:27857

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Related research

Keywords: Audit delay; financial reporting lag; extended audit procedures; red flag; fraud detection; SAS 82; SAS 99; business ethics;

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  1. Wilcox, Nathaniel, 2007. "Stochastically more risk averse: A contextual theory of stochastic discrete choice under risk," MPRA Paper 11851, University Library of Munich, Germany.
  2. Shleifer, Andrei & Wolfenzon, Daniel, 2002. "Investor protection and equity markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 66(1), pages 3-27, October.
  3. Navin Kartik, 2008. "Strategic Communication with Lying Costs," 2008 Meeting Papers 350, Society for Economic Dynamics.
  4. McLelland, Andrew J. & Giroux, Gary, 2000. "An empirical analysis of auditor report timing by large municipalities," Journal of Accounting and Public Policy, Elsevier, Elsevier, vol. 19(3), pages 263-281.
  5. Sengupta, Partha, 2004. "Disclosure timing: Determinants of quarterly earnings release dates," Journal of Accounting and Public Policy, Elsevier, Elsevier, vol. 23(6), pages 457-482.
  6. Johnson, Laurence E. & Davies, Stephen P. & Freeman, Robert J., 2002. "The effect of seasonal variations in auditor workload on local government audit fees and audit delay," Journal of Accounting and Public Policy, Elsevier, Elsevier, vol. 21(4-5), pages 395-422.
  7. Graham Loomes, 2005. "Modelling the Stochastic Component of Behaviour in Experiments: Some Issues for the Interpretation of Data," Experimental Economics, Springer, vol. 8(4), pages 301-323, December.
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