Auditing in Firms: Quantitative Project

Introduction

Background

Auditing offers an independent method to assess the effectiveness of a firm’s internal controls. Auditors generally evaluate financial statements and records of a firm and provide their qualified opinions on whether the records and financial information provided by management reflects the true and fair state of affairs of a company and the expectations for users of financial records (Gbadago 53). This implies that auditing helps companies to be trustworthy based on their operation and asset and capital management. Thus, it is imperative to understand why firms require auditors.

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Auditing helps firms to attain some fundamental corporate goals and currently offers one of the most vital aspects of internal control (Chui and Pike 204). It enhances supervision, prevention, and identification of any irregular activities. Further, auditing assesses corporate performance and improves productivity. Auditors have the responsibility of evaluating internal control systems against set standards, proposing areas for improvements, and initiating processes for investigation if irregular transactions have been detected. They evaluate records for misstatement, and companies without auditors cannot detect such anomalies. Auditing offers assurance to users of financial statements, especially to financiers, shareholders, and other stakeholders (Chui and Pike 204). Additionally, it provides credibility to management and corporate governance of a firm.

Other additional roles of auditing have also been noted (Gbadago 54). Auditing is applied to detect and prevent errors and fraud inherent in transactions. Errors and fraud have been responsible for enhanced corporate governance across majorities of firms. Hence, auditing assists organizations to maintain best practices in management.

Problem Statement

Numerous studies and reports have captured instances of fraud in large and small firms, global firms, family firms, and government entities despite standards and work ethics implemented to promote professionalism (Oguda et al. 47; Chong 47-53). Fraud continues to present a significant challenge to businesses as they lose billions of dollars every year. Thus, more robust and effective methods for detecting and averting fraud and other schemes that drain the profits and productivity of entities are required.

Aim

The purpose of this research was to demonstrate the importance of auditing in detecting and preventing fraud in a firm.

Objectives

  • To determine how auditing is important in detecting and preventing fraud in a firm
  • To determine methods of fraud detection and prevention in a firm

Rationale

Auditing creates value to a company by enhancing control and monitoring systems to detect fraud. As previously mentioned, fraud is a common issue across many organizations. This study aims to demonstrate how organizations can apply auditing to detect and deter fraud, thereby providing valuable insights for effective management and internal control measures for their success.

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Auditing is usually a part of the regulations and policies in a country to protect shareholders and other stakeholders of organizations. Thus, the government agencies and policymakers responsible for enforcing corporate governance practices could apply results from this study to revamp or formulate policies and frameworks that promote auditing in fighting corporate fraud. This study would therefore provide an important opportunity for regulators to act on its recommendations to reduce fraud. Additionally, researchers and academics interested in auditing and fraud would find this research useful and understand application in real-life cases. The research is intended to expand previous findings and knowledge on auditing, propose areas for further study, and provide reference materials for similar studies in the same or different contexts.

Literature Review

Accounting has offered a methodical approach concerning financial activities of entities through financial statements to different users. This information, however, requires an independent input of an auditor who expresses an opinion on the contents of financial information and any other underlying issues (Ayorinde and Babajide 150). It is noteworthy that a management executive is in charge of preparing the financial statements of an entity (Ayorinde and Babajide 150). Auditing is initiated to determine if management adheres to provided rules, regulation, norms, and practices. Thus, outcomes should inform stakeholders and shareholders about their business corporate governance practices and management outcomes. Audit sets when business ownership and control are separated. The primary goal of shareholders is focused on value maximization. Conversely, managers who run the business generally concentrate on self-gratification. Hence, the challenge of agency: The agency problem occurs because of the diverse goals of shareholders and managers.

To offer shareholders the required assurance that their investments are well managed and run effectively, robust internal control systems, including auditing, have been implemented to protect assets and other resources and to ensure that a firm attains its business objectives. Shareholders can only learn about such issues from financial reports. Hence, information contained in the financial reports should be trustworthy and free from any forms of material misstatements, misappropriation of resources, and fraud. Internal control systems should help firms to detect and deter such malpractices. In this regard, auditing assists firms to reduce costs related to wastage and theft that usually increase the costs of doing business. Auditing is, therefore, a vital aspect in corporate governance for tackling the agency problem (Othman et al. 59). Auditing aims to protect shareholders’ interests and realign management goals to ensure congruence in an organization. From this observation, stakeholders and shareholders require auditors to qualify information and meet their expectations. Hence, auditors should perform to the expected standards and only provide reliable opinions to users of financial statements.

Petraşcu and Tieanu (492) point out that the concept of fraud has multiple meanings. These definitions capture terms and phrases, such as irregularities and illegal actions; failure to communicate information by violating a given obligation; embezzlement; and any action or unintentional omission regarding using or presenting of false, incorrect, or incomplete declarations and documentation. Additionally, fraud is also defined in relation to attempts to obtain a certain gain or cause a certain loss or even to expose others to risk in a dishonest manner; a false testimony; conflict of interest; illegal gratuity; and a theft that implies the distortion, suppression, or falsification of a financial situation (Petraşcu and Tieanu 492-493). In the accounting profession, fraud reflects an intended act that leads to a material misstatement in financial statements, which are the subject of an audit (Oguda et al. 49). A material misstatement is reflected through asset misappropriation and fraudulent financial transactions. When management misappropriates company assets, it steals from the company and consequently materiality misstates in the financial statements. Thus, the above-mentioned terms, which fall under different categories, such as theft, corruption, violation of trust, and concealment of material facts, reflect instances of fraud in organizations. In this sense, fraud should not be narrowly defined in order to ensure that all possible meanings are reflected. The motive to commit a fraud, rationalization, and opportunity are major factors that are common in any instances of fraud. Absent or weak internal control measures may enable fraud to thrive in a firm.

Organizational structures, cultures, people, work ethics, and authority that help to accomplish goals generally influence internal control measures. While checks and balances are already established to guide practices in organizations, accountability may not meet expectations of various stakeholders. Internal controls account for control environments; risk assessment and management; control activities; information and communication; and monitoring and assurance.

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Empirical evidence shows how fraud has permeated both public and private entities (Oguda et al. 47 – 57; Othman et al. 59 – 67). Most governments are known for wanton corruption. On the one hand, corporate scandals, such as Enron, Adelphia, WorldCom, and Tyco, are examples of the adverse consequences of fraud. According to Oguda et al. (47-57), past studies have shown inconsistent results on the relationship between internal controls and the possibilities of fraud. Nevertheless, effective internal control measures have been found to curtail fraud and instances of sanctions because of fraudulent reporting. Othman et al. (60) cited a KPMG Malaysia survey that showed that employees in non-management positions were responsible for the highest number of fraud (50%). Compared to a previous study (2012), the rate of fraud had increased by 16% in the Malaysian public sector. Customers , service providers, and suppliers were all responsible for fraud in the public sector. Most cases of fraud were related to theft during payments and theft of physical assets. Additionally, individuals were involved in theft of cash, cash receipts, false invoice, and inventories. These fraudulent practices were seen as bad for organizations and society. Notably, sufficient motive, incentive, and rationalization often led culprits of fraud to seek for opportunities that were available within the internal control measures to commit fraud.

Conceptual Framework

The conceptual framework of this study is based on aspects of auditing and control measures as well as fraud detection and prevention in organizations. Proactive auditing, for instance, is an aspect of internal control measures that was applied to understand fraud detection and prevention.

Methodology

This study applied a quantitative method to assess the importance of auditing to a firm.

Sample

A randomly selected sample was comprised of 15 respondents who were selected from various companies in public and private sectors. Study participants were mainly organizational internal auditors and accountants.

Measures

A structured survey questionnaire was distributed to assess demographic characteristics of respondents, fraud awareness, and fraud detection and deterrence approaches.

Variables

The independent variable was fraud audit, while the dependent variable was fraud awareness and detection in organizations.

Data Analysis

Both descriptive and inferential statistics were used to perform data analysis. Descriptive statistics helped to describe, summarize, and present data in a meaningful way. Conversely, inferential statistics assisted in the generalization of the findings to the population of study from where samples were obtained. It was also used to show the relationship between fraud auditing and fraud awareness, detection, and deterrence in organizations. A multiple regression analysis was used in inferential statistics to determine the correlation between variables. SPSS was used to analyze the collected data.

Demographic Profile

Table 1 shows the demographic characteristics of the respondents. Out of all participants, 10 were male (66.7%) and 5 were women (33.3%). With regard to age, the highest average age was above 40 years (46.7%) followed by 31-40 years (40%). Most of the respondents had a master’s degree qualification (46.7%) followed by a bachelor’s degree qualification (26.7%).

Table 1

Gender, age, and academic qualification of participants
Frequency Percent Valid Percent Cumulative Percent
Valid Male 10 66.7 66.7 66.7
Female 5 33.3 33.3 100.0
Total 15 100.0 100.0
Age
Valid
< 30 years 2 13.3 13.3 13.3
31-40 years 6 40.0 40.0 53.3
> 40 years 7 46.7 46.7 100.0
Total 15 100.0 100.0
Academic
Valid
Diploma 2 13.3 13.3 13.3
Bachelor’s Degree 4 26.7 26.7 40.0
Master’s Degree 7 46.7 46.7 86.7
Professional training 2 13.3 13.3 100.0
Total 15 100.0 100.0

Source: Author

To evaluate employee awareness on fraud, internal auditors and accountants were asked about awareness of fraud in their organizations, pressure to engage in fraud, and auditing used to detect and deter fraud. Fraud was present in organizations (20%), employees faced pressure to engage in fraud (26.7%), and auditing was an important internal control measure in fighting fraud (53.7%) (see table 2).

The mean score for methods used to detect and deter fraud was 1.73 (see table 4), which shows an agreement that internal control measures, including auditing, were important in fighting fraud in organizations. Fraud auditing (53.7%) was noted as the most important tool relative to fraud training and ethics (20%) and fraud reporting (26.7%) (see table 3).

Table 2

Employees awareness of fraud
Frequency Percent Valid Percent Cumulative Percent
Valid fraud taking place 3 20.0 20.0 20.0
Pressure to commit fraud 4 26.7 26.7 46.7
Auditing used to detect fraud 8 53.3 53.3 100.0
Total 15 100.0 100.0

Source: Author

Table 3

Methods used to detect and deter fraud
Frequency Percent Valid Percent Cumulative Percent
Valid fraud auditing 8 53.3 53.3 53.3
Training on fraud, ethics 3 20.0 20.0 73.3
Fraud reporting 4 26.7 26.7 100.0
Total 15 100.0 100.0

Source: Author

Table 4

Descriptive statistics
Employees awareness of fraud Methods used to detect and deter fraud
N Valid 15 15
Missing 0 0
Mean 2.33 1.73
Median 3.00 1.00
Mode 3 1
Std. Deviation .816 .884
Minimum 1 1
Maximum 3 3
Sum 35 26

Source: Author

In table 5, after regression analysis, it was observed that methods used to detect and deter fraud (Beta value.497) were the major contributor to employee awareness of fraud. When the correlations part of.491 was squared, it gave a value of.241, which is 24%. Hence, methods used to detect and deter fraud uniquely explained fraud awareness by 24%, and the score would drop by the same percentage if not included in the analysis.

Table 5

Coefficientsa
Model Unstandardized Coefficients Standardized Coefficients t Sig. 95.0% Confidence Interval for B Correlations Collinearity Statistics
B Std. Error Beta Lower Bound Upper Bound Zero-order Partial Part Tolerance VIF
1 (Constant) 2.510 .743 3.378 .005 .891 4.129
Methods used to detect and deter fraud -.459 .231 -.497 -1.989 .070 -.962 .044 -.462 -.498 -.491 .978 1.023
a. Dependent Variable: Employees’ awareness of fraud

Source: Author

Findings and Discussion

The results of this study showed that auditing plays a critical role in detecting and deterring fraud. These findings confirm earlier studies that showed how relevant auditing as an internal control measure is useful in detecting and preventing fraud (Petraşcu and Tieanu 489 – 497; Chui and Pike 204-233; Golden et al. e122). While fraud responsibilities may be spread across various departments or units, such as the executive team, internal auditors, and the audit committee, the internal audit is positioned to detect and deter fraud because of its role monitoring risks and fraud.

The internal audit evaluates all internal control measures implemented to detect and deter fraud (Petraşcu and Tieanu 492). Hence, internal auditors are required to have sufficient knowledge and experience to determine potential signs of fraud. Latest practices, for instance, employ data mining techniques to detect fraud (Joudaki et al. 165-172). Auditing should also be a regular procedure in an organization. It is generally observed that once an audit process has exposed an anomaly, the affected department, organization, or country tends to “clean up” by removing the auditor or individual responsible or simply covering up losses to protect the reputation of a department, a firm, or a country (Deleanu e0169632).

Auditing is now becoming more specialized as new tools are introduced to detect fraud (Joudaki et al. 165-172). Roles, responsibilities, specialty, and training are some factors that differentiate fraud professionals from internal auditors. This implies that the role of internal auditors is not absolute in controlling fraud. Instead, internal auditors can improve their skills, procedures, and work techniques to detect and accurately determine potential indicators of fraud.

While training and work ethics are important in fighting fraud, it is imperative to recognize that most organizations have policies and programs to promote training and ethics, but they still suffer fraud (Chong 47-53). Hence, the role of auditing in fraud prevention cannot be underestimated. This role requires auditors to understand possible fraud schemes and specific weaknesses in policies and procedures that perpetrators exploit. Organizations need to train their auditors and invest in tools that make auditing effective. Additionally, external auditing may be necessary to identify other audit queries that internal auditors may not necessary identify.

Conclusion and Recommendations

Based on the findings of this research, it is concluded that auditing plays a critical role in detecting and preventing fraud in organizations. Thus, all organizations require auditors to ensure business efficiency for better management, reducing the cost of doing business, maximizing returns, and helping organizations to attain their short-term and long-term goals. Organizations currently have standards and work ethics to prevent fraud, but they merely capture aspects of professionalism. Hence, auditing brings in due care and diligence in all procedures.

While policies are in place as implemented by managers, it is recommended that auditors should evaluate the reliability of internal control measures to find weaknesses and fight fraud. Such approaches would create robust internal control measures that ensure the public about the quality of financial reports. It is also recommended that auditors should review their skills and resources and adopt new tools and practices to fight fraud. Future studies should explore how technologies could be applied to improve auditing.

Works Cited

Ayorinde, Babatolu and Oyewo Babajide. “Audit Tenure, Rotation and Accounting Conservatism: Empirical Evidences from Nigeria.” Journal of Business & Financial Affairs, vol. 4, 2015, p. 150. Web.

Chong, Gin. “Detecting Fraud: What Are Auditors’ Responsibilities?” Journal of Corporate Accounting & Finance, vol. 24, no. 2, 2013, pp. 47-53. Web.

Chui, Lawrence and Byron Pike. “Auditors’ Responsibility for Fraud Detection: New Wine in Old Bottles?” Journal of Forensic & Investigative Accounting, vol. 5, no. 1, 2013, pp. 204-233.

Deleanu, Ioana Sorina. “Do Countries Consistently Engage in Misinforming the International Community about Their Efforts to Combat Money Laundering? Evidence Using Benford’s Law.” PLoS ONE, vol. 12, no. 1, 2017, p. e0169632. Web.

Gbadago, Frank Yao. “Audit Expectation Gap and MBA Accounting Students’ Knowledge on Auditor(s)’ Responsibilities: Evidence From a Public University in Kumasi Ashanti Region of Ghana.” Journal of Accounting and Taxation, vol. 7, no. 4, 2015, pp. 53-61.

Golden, Linda L, et al. “Detecting Fraud in Accounting and Marketing.” Journal of Accounting & Marketing, vol. 2, 2013, no. e122. Web.

Joudaki, Hossein, et al. “Improving Fraud and Abuse Detection in General Physician Claims: A Data Mining Study.” International Journal of Helath Policy and Management, vol. 5, no. 3, 2016, pp. 165-172. Web.

Oguda, Ndege Joseph, et al. “Effect of Internal Control on Fraud Detection and Prevention in District Treasuries of Kakamega County.” International Journal of Business and Management Invention, vol. 4, no. 1, 2015, pp. 47-57.

Othman, Rohana, et al. “Fraud Detection and Prevention Methods in the Malaysian Public Sector: Accountants’ and Internal Auditors’ Perceptions.” Procedia Economics and Finance, vol. 28, 2015, pp. 59 – 67. Web.

Petraşcu, Daniela and Alexandra Tieanu. “The Role of Internal Audit in Fraud Prevention and Detection.” Procedia Economics and Finance, vol. 16, 2014, pp. 489 – 497.

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