Fraud Detection and Financial Reporting and Audit Delay

Andrew Yim

MPRA Paper from University Library of Munich, Germany

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.

Keywords: Audit delay; financial reporting lag; extended audit procedures; red flag; fraud detection; SAS 82; SAS 99; business ethics (search for similar items in EconPapers)
JEL-codes: G32 K42 M21 M42 (search for similar items in EconPapers)
Date: 2010-09-20
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https://mpra.ub.uni-muenchen.de/33297/2/MPRA_paper_33297.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:27857

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