Integration of Fraud Risk in the Risk of Material Misstatement and the Effect on Auditors’ Planning Decisions

This paper responds to recent questions posed by PCAOB regarding how to more effectively utilize fraud risk assessments in the audit process. It examines the effects of explicitly integrating fraud risk assessments into auditors' judgments of the risk of material misstatement (RMM). Specifically, I test the impact on auditors' risk assessments and planning judgments. Participants make risk assessments and audit planning judgments using either the traditional source-based view of RMM (i.e., based on inherent and control risk) or a new type-based view of RMM (i.e., based on error and fraud risk). The results indicate that auditors in the type-based group assess higher RMM and consequently, expand their audit plans relative to auditors in the source-based group. Further investigation of procedures chosen for varying levels of fraud risk shows that auditors in the type-based group address higher fraud risk with greater use of procedures that are new to the audit program as compared to auditors in the source-based group. In addition, the type-based group assigns more experienced staff levels to address high fraud risk than the source-based group does