Managerial Auditing Journal

Fraud detection, redress and reporting by auditors

Harold Hassink Roger Meuwissen Laury Bollen

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Harold Hassink Roger Meuwissen Laury Bollen, (2010),"Fraud detection, redress and reporting by
auditors", Managerial Auditing Journal, Vol. 25 Iss 9 pp. 861 - 881
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Rocco R. Vanasco, (1998),"Fraud auditing", Managerial Auditing Journal, Vol. 13 Iss 1 pp. 4-71
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Regulation and Compliance, Vol. 10 Iss 3 pp. 266-278
Gerald Vinten, Philmore Alleyne, Michael Howard, (2005),"An exploratory study of auditors responsibility
for fraud detection in Barbados", Managerial Auditing Journal, Vol. 20 Iss 3 pp. 284-303

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Fraud detection, redress and

reporting by auditors

Fraud detection

Harold Hassink, Roger Meuwissen and Laury Bollen

Department of Accounting and Information Management,
School of Business and Economics, Maastricht University, Maastricht,
The Netherlands

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Abstract

861
Received 14 April 2010
Reviewed 25 May 2010
Accepted 21 June 2010

Purpose The primary research question of this study is to what extent auditors comply with
auditing standards once they encounter fraud and whether compliance is associated with particular
fraud characteristics (i.e. material versus immaterial fraud, management versus employee fraud,
statutory versus voluntary audit and external versus internal fraud) as well as with auditor (experience)
and audit firm characteristics (Big Four versus non-Big Four). The study also aims to provide evidence
on the role of auditors in redressing fraud. Redress refers to the auditee taking measures to nullify the
consequences of the fraud, insofar as possible, and to prevent any recurrence of such fraud.
Design/methodology/approach To gather data on the role of auditors in fraud cases, a survey
was conducted among all audit partners of the top 30 Dutch audit firms. In total, 1,218 audit partners
were selected and received a postal questionnaire. In total, 326 questionnaires were returned (27 per cent),
of which 296 (24 per cent) were usable.
Findings The results reveal that auditors fail to comply with some important elements of fraud
standards. There are substantial differences among audit firms regarding compliance with the
relevant auditing standards. Furthermore, auditors appear to encounter corporate fraud only
incidentally. About half of the auditors believe they have a significant impact on redressing fraud.
Research limitations/implications One of the main research findings is that it is difficult for
individual auditors to build up expertise in fraud detection. There appears to be a need for specific
training programs for auditors to help them to detect fraud, emphasizing the need for mandatory
consultation with the technical department of the audit firm once red flags indicating fraud are
found. Indeed, this need for change has been addressed by the Dutch professional accountancy body
NIVRA as a direct result of the findings of this study.
Originality/value This study extends existing research by investigating the compliance of
auditors with fraud standards and it sheds light on the actual redress experiences of auditors. It
focuses on the actions taken by auditors or the lack thereof in situations where auditors encounter
fraud signals. The study indicates that in the absence of good oversight, auditors have mixed
incentives when they are confronted with signals for fraud, resulting in actions that are not always in
line with existing regulatory requirements.
Keywords Auditors, Auditing, Fraud, Professional ethics, Regulation, The Netherlands
Paper type Research paper

Introduction
A study on major European business failures revealed that the role of auditors is most
often questioned and audit firms are most likely to be sued in failures that involve
management or employee fraud (Bollen et al., 2005). A widely used explanation for the
relatively large number of fraud cases in which the role of the auditor has been
questioned is the existence of an audit expectation gap, suggesting that society has
unfulfilled expectations concerning the role of the auditor in fraud cases. The potential
causes of an audit expectation gap have been addressed extensively in existing literature
(for an overview, see Nieschwietz et al., 2000). Studies in the area of fraud have mainly

Managerial Auditing Journal

Vol. 25 No. 9, 2010
pp. 861-881
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686901011080044

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862

focused on the extent to which auditors are able to detect fraud and whether society has
unreasonable expectations in this respect (the reasonableness gap). Less attention has
been paid to the gap between what can reasonably be expected from auditors once they
encounter fraud signals and what they actually achieve. Following Porter (1993), this
part of the expectations gap may be a result of either the deficiency of standards and
regulations with respect to the duties of auditors in fraud situations (the standards gap)
or of the (under)performance of auditors regarding existing duties (the performance
gap). With respect to the standards gap, the general public may have expectations that
are not reflected in existing auditing standards. Comparing expectations with existing
auditing standards could identify opportunities for changing the standards and for
narrowing the standards gap.
Although several studies have indicated that auditing standards and regulatory
changes have not resulted in an increase in the auditors ability to detect fraud
( Jakubowski et al., 2002; Rezaee et al., 2003) it remains unclear to what extent auditing
standards and regulations have impacted the auditors redress and reporting actions in
situations where fraud has been detected. Redress refers to the auditee taking measures
to nullify the consequences of the fraud, insofar as possible, and to prevent any
recurrence of such fraud. Given the existing standards on the role of auditors in fraud
situations, the existence of a performance gap in this context can be due to several
factors, including the lack of knowledge or competence on how to act once corporate
fraud is detected, lack of care in following protocol or the lack of independence of the
external auditor, possibly because of conflicting interests. All of these explanations
touch upon auditors professional ethics[1]. Given the sensitive nature of fraud reporting
and societys expectations of auditors in this respect, compliance with fraud standards is
important to auditors and to society.
The aim of this study is fourfold. The first objective is to present evidence on the
volume and nature of fraud cases detected by auditors. The second objective is to
determine the extent of auditors compliance with auditing standards regarding fraud
redress and fraud reporting. The third objective is to study the impact of various context
variables (i.e. material versus immaterial fraud, management versus employee fraud,
statutory versus voluntary audits and external versus internal fraud) as well as auditor
(experience) and audit firm characteristics (Big Four versus non-Big Four) on the actions
taken by auditors in fraud situations. Finally, this study provides recommendations on
how the performance of auditors regarding the detection of corporate fraud and
compliance with relevant auditing standards can be improved.
The two Dutch professional bodies for auditors, NIVRA and NOvAA, commissioned
the study for which the results are presented in this paper. The focus of this study is on
the period 1995-2002. This is a useful period to study auditors compliance with
regulations because auditing regulations concerning fraud issues remained unchanged
during this period; after 2002, various changes were implemented. In addition, during
this period, there was virtually no oversight of audit firms concerning their actions in
fraud situations; the results of this paper therefore provide a good understanding of the
behaviour and incentives of auditors with respect to fraud situations.
This study is organised in five sections. First, existing studies on fraud detection
and reporting by auditors will be discussed. After that, the auditors responsibility
regarding fraud detection in the Netherlands in the period 1995-2002 will be described.

Next, the research method of the study will be presented. Subsequently, the empirical
results of the study will be presented and finally, conclusions will be drawn.

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Auditors and fraud

During the past couple of decades, a fairly large body of research on auditors
experiences with fraud has emerged. In their overview study, Nieschwietz et al. (2000)
distinguish three branches of empirical research in the field of fraud detection:
(1) research investigating the environmental conditions related to auditors
detection of fraud;
(2) research on auditors assessment of the risk of fraud; and
(3) research on auditing plans related to detecting fraud.
In the first type of fraud-related auditing research, the existence of an expectation gap
is used to explain the level of lawsuits against auditors in fraud cases (Palmrose, 1991;
Bollen et al., 2005). Such lawsuits have introduced the effect of litigation risk into
auditors fraud detection, as a result of which auditors may adjust their audit planning
to understate firm performance (Baron et al., 2001). The second type of studies deals
with predictors of fraud and auditors use of fraud cues to assess fraud risk, with or
without the help of decision aids. The studies on the predictors of fraud have
provided empirical evidence on the validity of fraud cues by having partners identify
and evaluate fraud cases to determine fraud cues or so-called red flags (Albrecht and
Romney, 1986; Loebbecke et al., 1989). The studies on the use of fraud cues are
predominantly based on behavioural decision theory and focus on how auditors assess
fraud risk (Hackenbrack, 1992; Zimbelman, 1997; Knapp and Knapp, 2000). These
studies have found many factors that affect the ability of auditors to detect fraud
(e.g. experience and ethical reasoning), and that auditors generally have difficulty in
assessing fraud risk. Furthermore, research in this area has shown that the use of tools
and decision aids improves fraud detection, although auditors typically are very
reluctant to use such aids (Eining et al., 1997). The third type of research concerns
auditing plans and procedures and the way they relate to the detection of fraud. Studies
in this area have shown that as a result of changes in auditing standards, auditors may
become more responsive to fraud risk (Glover et al., 2003; Mock and Turner, 2005),
while others found no association between fraud risk assessment and the planning of
more effective fraud procedures, thus questioning the effectiveness of standard
auditing tools in a fraud setting (Asare and Wright, 2004).
Actions taken by auditors once fraud is detected
All three research areas mentioned focus on the ability of auditors to detect fraud, but
ignore the actions taken by auditors once fraud has been detected, and also ignore the
role of professional ethics in (refraining from) taking such actions. A study on personal
values was conducted by Gowthorpe et al. (2002), looking for the predominant ethical
orientation among auditors in New Zealand, and by Arnold et al. (2005) who looked at
the dynamics of auditor decision making in a situation where a clean audit opinion is
not possible. Although these studies do provide insights on professional ethics in the
context of auditing, they provide little evidence on the ethical aspects of the behaviour
of auditors once fraud is suspected or detected. There are a number of (case) studies

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864

that provide anecdotal evidence on the response of the auditor once fraud is suspected
or detected; these studies focus on accounting scandals and the auditors role therein
(Moriceau, 2004; Melis, 2005). These studies indicate that in some instances auditors
were aware of fraud schemes but were unwilling to address the issue in order not to
harm the relationship with the client. Inherent in the nature of these studies, the
evidence provided on the behaviour of auditors once fraud is suspected or detected is
nevertheless focused specifically on unique fraud cases and consequently may not be
applicable in a broader empirical setting. Overall, the scarce literature on auditors
reactions to fraud situations may suggest that auditors encounter fraud cases very
infrequently, and that consequently there is no common framework on how to react in
such situations. This issue has increased in importance now that both the auditing
profession and various regulatory bodies have raised the level of standards which
must be adhered to in the context of fraud.
Limitations of prior studies
Probably, the foremost limitation for studies in all areas of fraud-related auditing
research, is the restricted access to data on the actual experiences of external auditors
with fraud detection. Given the sensitive nature of fraud situations and because of the
rather low frequency of detected fraud cases, most empirical studies in this area use
experimental settings or surveys focusing on auditor perceptions, rather than actual
fraud cases as a source of data. The only exceptions are a few empirical studies from the
1980s in the USA, in which audit partners are surveyed on actual fraud cases
(Romney et al., 1980[2]; Loebbecke et al., 1989[3]). The participants in Romney et al. (1980)
were 27 audit partners who detected fraud in a recent audit as well as 36 audit partners
who did not encounter fraud. By having these partners evaluate their engagement,
evidence was collected on red flags indicating frauds. One-third of the 87 red flags
indicated were found to be significant predictors of fraud. These generally pertain to
personal characteristics of management. Loebbecke et al. (1989) surveyed 277 US KPMG
audit partners who detected an average of 3.1 fraud cases in their auditing career. Cases
of material fraud appear to be rather rare[4]. Management fraud was detected more often
than employee fraud (56 versus 44 per cent), and fraud incidence differed across client
industries. In addition, material fraud was detected more frequently than immaterial
fraud (60 versus 40 per cent). Further conclusions are that a weak control environment,
decisions dominated by only a few employees and significant difficult-to-audit
transactions are conditions that increase the likelihood of fraud.
The current study expands the Loebbecke et al. (1989) research by not only
investigating the detection of fraud but also by looking at the follow-up of auditors, to
better understand their redress effectiveness and their resignation behaviour. The study
also addresses the effect of further characteristics on auditors actions (i.e. material
versus immaterial fraud, management versus employee fraud, statutory versus
voluntary audit and external versus internal fraud) as well as auditor (experience)
and audit firm characteristics (Big Four versus non-Big Four). The Big Four/non-Big
Four dichotomy is relevant in this context given the argument that larger audit firms
have fewer incentives to behave opportunistically to ensure retention of clients and
thus they may provide higher quality audits in comparison with smaller audit firms
(DeAngelo, 1981). Overall, consistent evidence is provided that larger audit firms
provide higher quality audits (Palmrose, 1988; Deis and Giroux, 1992; Krishnan, 2003).

Therefore, Big Four auditors are expected to show a higher level of willingness to
redress and report fraud cases.

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Legal context
This section describes the legal context with respect to the role of auditors in fraud
cases in the Netherlands at the time of this study (1995-2002). In this period, Dutch
auditors were required by their professional bodies, NIVRA and NOvAA, to comply
with two fraud standards:
(1) the Dutch Auditing Standard 240 fraud and error (further referred to as DAS
240); and
(2) the by-law on reporting on fraud (further BLF)[5].
DAS 240 was based on the international standard ISA 240 and held the client primarily
responsible for preventing and detecting fraud. The auditor was not held responsible
for fraud prevention. DAS 240 specified several issues auditors had to take into
consideration before and while performing the audit; see also Figure 1 and the Appendix.
The BLF extended the scope of ISA 240, by additionally requiring the auditor to inform
management in writing if he suspected fraud. If it concerned material or management
fraud, he had also to notify the supervisory body in writing. If, after further investigation,
fraud was indeed detected, the auditor had to inform management again and redress had
to be demanded. The supervisory body was contacted again if management failed to take
reasonable steps to redress the fraud. If the supervisory body failed to take appropriate
action, the auditor had to resign from his engagement. If the engagement concerned
a statutory audit, the auditor had to notify a dedicated governmental agency. Hence, in
the window 1995-2002, Dutch auditors had to take the following steps in case fraud
signals appeared while an audit was being performed:
(1) Inform management in writing when fraud is suspected[6].
(2) Inform the supervisory body in writing:
.
in case of management fraud;
.
in case of material fraud with regard to the financial statements; and
.
in case the management fails to take reasonable action[7].
(3) Request redress from management when fraud is detected[8].
(4) Resign from his engagement when insufficient steps have been taken to redress
material fraud[9].
(5) Notify the relevant governmental agency of the lack of redress in case of a
statutory audit[10].
Research method and sample construction
To gather information on the role of auditors in fraud cases, a survey was conducted
among all audit partners of the top 30 Dutch audit firms. The professional bodies
NIVRA (2000) and NOvAA provided a database containing the names and addresses of
all audit partners of the top 30 audit firms in The Netherlands. A written questionnaire
was used, which had been tested and adjusted in a pilot study[11]. The questionnaire
contained three types of questions:

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Start

Inquiries of management and

governance (ST)

Planning discussions with

audit team (ST)

Risk assessment and

planning of audit (ST)

Before the audit

During the audit

866

Finish audit as
planned/issue
opinion (GL)

Document risk
factors (ST)

No

Obtain written statement of

management/governance (ST)

Yes
No

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Inform
management (BL)

Finish audit as
planned/issue
opinion (ST)

Yes
No

Yes

Inform management about misstatements and sources. Management might have to adjust
accounting procedures. Finish
audit as planned. (ST)

Adjust audit plan and

risk assessment if
necessary (ST)
Redress

YES

Figure 1.
Outline of audit procedure
according to Dutch
Auditing Standard 240
and by-law

Notes: Parts to be found in DAS 240 are tagged with (ST); parts coming from the by-law with (BL)

(1) Questions relating to the features of the fraud cases auditors had experienced in
the period 1995-2002.
(2) Questions on the reporting and redress of these fraud cases.
(3) Questions on the perceived role of the auditor in the redress process.

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To improve the response rate and to limit response bias due to the sensitive nature
of the subject of the questionnaire, a procedure was designed that fully guaranteed
the anonymity of the individual respondents as well as their audit firms. The
envelopes, containing a cover letter, the questionnaire and a self-addressed envelope,
were mailed by a notary in civil law. The questionnaires were marked with a unique
number per audit firm (five categories: four Big Four audit firms and one category
non-Big Four audit firms) that was known only to the notary. Approximately, three
weeks after mailing the questionnaires, a reminder was sent to every selected auditor
(including those auditors who had already responded)[12]. In total, 1,218 partners of the
top 30 Dutch audit firms as measured by revenues were selected. Table I shows
that eventually 326 questionnaires were returned (27 per cent), of which 296 (24 per cent)
turned out to be usable[13]. Of the respondents, 49 per cent were partners at a Big
Four audit firm, while 43 per cent were partners at a non-Big Four audit firm.
The miscellaneous category consists of partners who were affiliated with both a
Big Four and non-Big Four audit firm in the window of the study. About 10 per cent of
the respondents were affiliated with Audit firm A, 8 per cent with Audit firm B, 14 per
cent with Audit firm C, 20 per cent with Audit firm D and 48 per cent with non-Big
Four audit firms. On average, the respondents had 9.9 years of experience as an audit
partner. Exactly, half of the respondents had limited experience as an audit partner
(0-10 years). Average (11-20 years) and extensive (20 years) experiences were
exhibited by 38 and 12 per cent of the sample, respectively.
Three remarks can be made concerning the quality of the collected data. First, the
overall response rate is satisfactory, especially considering the sensitive nature of the
topic. Second, although it cannot be guaranteed that the sample is representative for
the population as a whole, there are no indications of the existence of a non-response
bias. This has been examined by comparing a number of characteristics of the later
respondents with the characteristics of the early respondents. The rationale here is
that later respondents exhibit some similarities to the non-responding group. t-tests do
not indicate significant differences. Third, an inherent risk of a questionnaire is that the
respondents give socially desirable answers. This risk has been mitigated as much
Number of questionnaires sent
Number of questionnaires returned
Before reminder
After reminder
Total
Number of questionnaires usable for research
Big Four audit firm
Non-Big Four audit firm
Miscellaneous
Audit firm A
Audit firm B
Audit firm C
Audit firm D
Low partner experience (0-10 years)
Medium partner experience (11-20 years)
High partner experience (20 years)
Note: Values within the parenthesis denote percentage

Fraud detection

867

1,218
216 (18)
110 (9)
326 (27)
296 (24)
144 (49)
127 (43)
25 (8)
29 (10)
23 (8)
41 (14)
60 (20)
148 (50)
113 (38)
35 (12)

Table I.
Response to
questionnaires

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as possible by making use of the services of a notary in civil law for the mailing
procedure, thereby guaranteeing the anonymity of respondents and audit firms. Also,
many questions referred to facts instead of judgments, which increased the probability
of receiving reliable answers.

868

Empirical results
The detection of fraud
In the 296 usable questionnaires, a total of 317 detected fraud cases were mentioned,
suggesting that on average audit partners of the top 30 audit firms in the Netherlands
detected 1.07 fraud cases in the period 1995-2002. The low number is consistent with
previous research, although it is still smaller than the number given by Loebbecke et al.
(1989), who reported an average of 3.1 cases. However, the time frame investigated in
the current study (eight years) is narrower than the one in Loebbecke et al. (1989).
Furthermore, Loebbecke et al. excluded partners who had not encountered fraud
(40 per cent of their sample). Translating the findings of Loebbecke et al. to the
parameters of the current study suggests that the respondents in the Loebbecke et al.
study would have encountered on average 0.76 fraud cases in the eight-year period, which
is more comparable to the empirical findings of 1.07 fraud cases in the current study[14].
In the remainder of this section, the characteristics of fraud cases mentioned by the
respondents will be analyzed in more depth. The analyses will focus on four elements:
(1) material versus immaterial fraud;
(2) management versus employee fraud;
(3) fraud detected during a statutory audit versus voluntary audit; and
(4) external versus internal fraud.
Table II summarizes the results.
1. Material versus immaterial fraud. Fraud is considered material if it could
influence the decisions of users of financial statements. The first two columns of
Table II indicate that there are fewer cases of material fraud among the 317 cases
detected than there are cases of immaterial fraud (37 versus 63 per cent). Material fraud
was found more often by respondents of non-Big Four audit firms than by those of Big
Four audit firms (46 versus 35 per cent). However, this difference is not statistically
significant. There were no significant differences between individual audit firms in the
amount of detected material fraud. Respondents indicate that material fraud occurs
more often in the services and trade industries than in the manufacturing and
non-profit industries, but again these differences are not statistically significant.
Materiality of detected fraud and level of partner experience do not seem to be related.
2. Management versus employee fraud. Management fraud is committed by members
of top management, while employee fraud is committed by other employees. Table II
reveals that there were more cases of employee fraud than of management fraud
(59 versus 41 per cent) among the 317 fraud cases detected. Big Four audit firms
discovered relatively fewer cases of management fraud than did non-Big Four audit
firms (37 versus 49 per cent). There is some evidence of a relationship between the type of
audit firm (A-E) and the proportion of detected management versus employee fraud. This
relationship is significant at the 10 per cent level. There turned out to be no significant
relationship between partner experience and detected management and employee fraud.

65
54
68
75
70
61
59
64
60
78
62
59
66

35
46
32
25
30
39
41
36
40
22
38
41
34

38
42
40

n.a.
n.a.
n.a.
n.a.

30
46
30
42

37
49

129
41
0.44

63
0.67

199 * * *

118
37
0.4

Management
fraud

Immaterial
fraud

74
100
93
89

70 *
54
70
58

62
58
60

n.a.
n.a.
n.a.
n.a.
79
82
81

n.a.
n.a.
n.a.
n.a.

88
66

63 *
51

59
0.64

258
81
0.87

Statutory
audit

188 * * *

Employee
fraud

Notes: Statistical significance at: *10, * *5 and * * *1 per cent levels (two-tailed test); n.a. not available

Number of cases
Percentage
Number of cases per partner
Big Four vs non-Big Four
Big Four audit firm (%)
Non-Big Four audit firm (%)
Big Four auditing firm
A (%)
B (%)
C (%)
D (%)
Client industries
Trade (%)
Production (%)
Services (%)
Non-profit (%)
Partner experience
High (20 years) (%)
Medium (10-20 years) (%)
Low (0-10 years) (%)

Material
fraud

21
18
19

n.a.
n.a.
n.a.
n.a.

26 * * *
0
7
11

12 * * *
34

19
0.20

59 * * *

Voluntary
audit

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42
29
25

n.a.
n.a.
n.a.
n.a.

32
8
26
21

24
47

93
29
0.31

External
fraud

100
100
100
100
100
100
100
100
100
100
100
100
100

76 * * *
53
68 * * *
92
74
79
n.a.
n.a.
n.a.
n.a.
58 *
71
75

71
0.76

317
100
1.07

Total

224 * * *

Internal
fraud

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Table II.
Detection of fraud

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870

3. Statutory versus voluntary audit. Most of the 317 fraud cases were detected during
statutory audits rather than during voluntary audits (81 versus 19 per cent). Non-Big
Four audit firms discovered fraud more often during voluntary audits in comparison
with Big Four audit firms (34 versus 12 per cent). Furthermore, differences were found
among audit firms with respect to the proportion of fraud cases detected during
statutory or voluntary audits. For instance, audit partners in audit firm B detected all
fraud cases during statutory audits, while in audit firm E only two-thirds of the fraud
cases were detected during statutory audits. These differences are significant at the
1 per cent level. Finally, partner experience was not related to the detection of fraud
during statutory versus voluntary audits.
4. External versus internal fraud. In the survey, external fraud was defined as fraud
that predominantly harms external parties, such as the government or customers. In
contrast, internal fraud was described as fraud that primarily harms the company of
the person who commits fraud. Examples of internal fraud include theft of assets and
incorrect claiming of expenses. Table II shows that a large proportion of the 317 cases
reported referred to internal fraud rather than external fraud (71 versus 29 per cent).
Also, the proportion of detected external versus internal fraud differed between Big
Four and non-Big Four audit firms. Big Four audit firms detected external fraud less
frequently than did non-Big Four audit firms (24 vs 47 per cent) which is significant at
the 1 per cent level. Table II indicates significant differences at the 1 per cent level
among audit firms in discovering external or internal fraud. In audit firm E, for
example, 43 per cent of all cases of detected fraud concerned external fraud, while in
audit firm B this is only 8 per cent. Finally, more experienced audit partners detected
external fraud more often than did less experienced partners (42 versus 29 and
25 per cent at the 10 per cent significance level).
Auditor redress and reporting of fraud
This section focuses on the actions Dutch auditors are required to take once fraud is
detected, according to the auditing standards and regulation as defined above.
1. Reporting to management. As soon as the auditor detects fraud or receives
signals that could be interpreted as such, the auditor needs to report this to
management in writing. The data indicate that the fraud was reported verbally more
often than in writing (77 versus 48 per cent, see Table III). These per centages add up to
more than 100 per cent, because some fraud cases were reported both verbally and in
writing. As far as reporting verbally to management is concerned, differences among
types of fraud, audit firms or levels of audit partner experience were not significant.
Still, the results indicate that verbal reports to management were more common for Big
Four audit firms (79 versus 72 per cent) and for more experienced partners (87 per cent
for extensive experience, 77 and 74 per cent for average and limited experience,
respectively). Reporting in writing to management occurred significantly more often in
cases of material fraud (59 versus 41 per cent for immaterial fraud) and significantly
more often in cases of management fraud (57 versus 41 per cent for employee fraud).
Both differences are significant at the 1 per cent level. In cases of statutory audits and
in cases of external fraud, respondents indicated that they reported to management in
writing slightly more often, though these differences are not significant. Furthermore,
Big Four audit partners reported to management in writing more often than did
non-Big Four audit partners (53 versus 41 per cent). Finally, more experienced audit

75
24
242
76
15
6
227
94
196
86
31
14

17
5
4
27

Redress
Redress not requested
%
Redress requested
%

Not redressed
%
Redressed
%

Redressed without pressure

%
Redressed after pressure
%

Resignation
Resigned because of fraud
%
Resigned because of lack
of redress (%)

13
11
3
43

65
78
18
22

7
8
83
92

4*
2
1
13

131**
91
13
9

8
5
144
95

47
24
152
76

59
30
52**
26

153
77
82 *
41

63

11

16
12
4
36

73
75
24
25

11
10
97
90

21
16
108
84

56
43
53
41

98
76
74
57

41

1*
1
0
0

123*
95
7
5

4**
3
130
97

54**
29
134
71

49*
26
46*
24

147
78
78*
41

59

14

12
5
n.a.
n.a.

161
88
23
13

14
7
184
93

56
22
198
77

98
38
93
36

202
78
129
50

81

5
8
n.a.
n.a.

31
86
5
14

0
0
36
100

19***
32
36
61

7*
12
6*
10

43
73
23
39

19

10
11
3
38

48
79
13
21

8
12
61
88

24
26
69
74

30
32
28
30

73
78
51
55

29

7**
3
1
14

148***
89
18
11

7***
4
166
96

51
23
173
77

75
33
71
32

172
77
101
45

71

13
6
3
43

132
89
17
11

7
4
149
96

47
23
156
77

87
43
81
40

160
79
107
53

64

4
5
1
17

40
80
10
20

6
11
50
89

23
29
56
71

6*
8
7*
9

57
72
32***
41

25

4
8
1
20

30
97
1
3

5
14
31
86

14
28
36
72

20
40
18
36

40
80
28
56

16

2
8
1
100

16
94
1
6

1
6
17
94

6
25
18
75

17
71
10
42

21
88
14
58

3
6
0
n.a.

46
92
4
8

0
0
50
100

4
7
50
93

233
43
24
44

42
78
28
52

17

4
4
1
100

51
80
13
20

1
2
64
98

27
29
65
71

6
39
37
40

69
75
45
49

29

104
74
56*
40

2
30
34***
24

35
25
105
75
5
5
100
95
81
81
19
19

8
6
n.a.
n.a.

96
77
60
48

24
34
46
37

28
22
97
78
6
6
91
94
83
91
8
9

6
5
n.a.
n.a.

45
87
36
69

214
40
19
37

32
89
4
11

3
6
n.a.
n.a.

4
10
36
90

12
23
40
77

44

39

16

Notes: Statistical significance at: *1, **5 and ***10 per cent levels (two-tailed test); athe data on redress are based on a subset of 309 cases out of the 317
cases; n.a. data are not available

15
7

46
39
47
40

105
33
99
31

External notification
No. of not redressed
No. of should have been
reported in the sample
No. of actually reported in
the total population

92
78
70
59

245
77
152
48

28
24
90
76

37

100

%
Reported to
management
Reported verbally
%
Reported in writing
%
Reported to
supervisory board
Reported verbally
%
Reported in writing
%

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partners reported in writing more often than did less experienced partners (69, 48 and
40 per cent for extensive, average and limited experience, respectively). No significant
relationships were found between the frequency of written fraud reports to
management and the five categories of audit firms (A-E).
2. Reporting to the supervisory board. At the time the study was performed, auditing
standards explicitly required certain types of fraud to be reported in writing to the
supervisory board: cases of management fraud, cases of material fraud and cases
where management refuses to redress the fraud. Table III indicates that in 41 per cent
of the cases of management fraud and in 40 per cent of the cases of material fraud the
auditor actually reported to the supervisory board in writing. Reporting verbally to the
supervisory board tended to take place more often in cases of material fraud (39 versus
30 per cent for immaterial fraud), in cases of management fraud (43 versus 26 per cent
for employee fraud) and in cases of fraud detected during a statutory audit (38 versus
12 per cent for voluntary audits). The first difference is not statistically significant;
the other two are significant at the 1 per cent level. Verbal reporting to the supervisory
board was not significantly related to the external/internal dimension. Big Four
auditors reported verbally to the supervisory board more frequently than did non-Big
Four auditors (43 versus 8 per cent significant at the 1 per cent level). Different
audit firms reported verbally to the supervisory board with significantly different
frequencies: audit firm B reported verbally most often (71 per cent) while audit firm
E did so least often (9 per cent). The data indicate that verbal reporting to the
supervisory board is not significantly related to the amount of audit partner experience,
although more experience seems to be consistent with more frequent reporting. When it
comes to reporting to the supervisory board in writing, material fraud, management
fraud and fraud encountered during a statutory audit were reported more often than
other types of fraud. Reporting to the supervisory board in writing appears to be
unrelated to the external/internal dimension. Big Four audit partners reported more
often to the supervisory board in writing than did non-Big Four auditors (40 versus
9 per cent). Again, differences among the different audit firms were significant at the
1 per cent level: audit firm C reported in writing most often (44 per cent) and audit firm E
did so least often (10 per cent). Auditors with high or medium experience issued more
written reports to the supervisory board than did audit partners with low experience
(37, 37 and 24 per cent, respectively, significant at the 10 per cent level).
3. The redress process. When the auditor has detected fraud and management has
not yet taken appropriate steps to redress the effects of the fraud, the auditor is required
to demand that the fraud be redressed, i.e. the consequences of the fraud have to be
rectified as far as possible and recurrence needs to be prevented. In cases where
management has already taken appropriate action, the auditor does not demand
redress but verifies that the actions taken are satisfactory. At the time of the survey,
auditing standards required the auditor to demand redress of material fraud. If redress
was not accomplished, the auditor was required to withdraw from the engagement and,
when the engagement concerned a statutory audit, report this fact to a central
governmental agency[15]. The results show that in 76 per cent of the fraud cases, the
auditor demanded the entity to redress the fraud. It is possible that in the remaining
24 per cent of the cases the audit client had already taken sufficient measures to redress
the fraud on their own initiative; therefore, in those cases there was no need for the
auditor to demand redress. Table III indicates that redress was requested more often

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in case of management fraud (84 versus 71 per cent for employee fraud), and fraud
discovered during a statutory audit (77 versus 61 per cent for voluntary audit).
Furthermore, demands for redress were significantly related to the audit firm: audit
firm C requested redress in 93 per cent of the cases, while audit firm D did so only
71 per cent of the time. Demands for redress were not related to the remaining
characteristics of fraud or to any other auditor characteristic.
Of the fraud cases in which redress was requested, redress was accomplished,
eventually, in 94 per cent of the cases. Redress more often took place in cases of employee
fraud in comparison with management fraud (97 versus 90 per cent) and more often
in cases of internal fraud than in cases of external fraud (96 versus 88 per cent).
Redress effectiveness was not significantly related to fraud materiality and to the
statutory-voluntary audit dimension. Respondents of Big Four audit firms tended
to achieve a higher redress effectiveness than those of non-Big Four audit firms
(96 versus 89 per cent), though this difference is not statistically significant. A significant
relationship did exist between redress effectiveness and audit firm: audit firm C
managed to achieve redress in all requested cases, while audit firm A achieved redress
least often (86 per cent). Redress effectiveness tended to decline with auditor experience,
but this relationship was not significant.
Furthermore, the auditor can achieve redress with or without putting pressure on
the auditee. Table III reveals that the auditor needed to use pressure more frequently in
the cases involving material fraud (22 versus 9 per cent), management fraud (25 versus
5 per cent) and external fraud (21 versus 11 per cent). Also, partners of audit firms D
and E needed to use pressure significantly more often than did partners of other audit
firms. Whether fraud was detected during a statutory or voluntary audit, by a Big Four
or non-Big Four audit partner or by an experienced or less experienced partner did not
seem to affect the need for pressure to achieve redress.
4. Auditor resignation. The auditing standards at the time of the study allowed the
auditor to resign from the assignment in case of fraud, but required the auditor to
resign if a case of material fraud was not redressed[16]. Results indicated that in
17 (5 per cent) of the 317 fraud cases the audit partner resigned. This occurred more
often in cases of external, management and material fraud than in other fraud cases.
Respondents indicated that in three out of these 17 resignations, resignation resulted
from the fact that redress had not taken place although the fraud was material.
The data in Table III, however, suggest that there were actually seven cases of material
fraud that were not redressed by management, and therefore, should have led to the
auditors resignation. Consequently, in four cases of non-redressed material fraud, the
auditor did not resign despite an obligation to do so.
5. External reporting of fraud. Finally, auditing standards state that when material
fraud discovered during a statutory audit has not been redressed by the audit client
within a reasonable time frame, the auditor is not only required to resign from the
engagement, but also to notify the dedicated governmental agency. The 296 respondents
in this study identified seven material fraud cases for the period 1995-2002 that had not
been redressed, all of which were discovered in the course of a statutory audit. This
means that in this sample seven cases should have been reported to the central reporting
agency. Given the fact that the initial sample of the top 30 audit firms covers the vast
majority of the population of Dutch auditors who perform statutory audits, the response
rate of 24 per cent (which is almost a quarter of the audit partners of the top 30 audit

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firms) results in an expected number of about 28 cases (7 4) for the entire population,
which should have been reported to the government agency[17]. In reality, the agency
was notified only twice in the period 1995-2002, indicating that external reporting of
fraud is less frequent than might be expected from the results of this study.
Perceptions of the role of the auditor in the redress process
A final issue concerns the audit partners perceptions of their role in the redress
process. For this analysis, auditors who had not actually detected fraud were
eliminated from the sample (Table IV)[18]. Most auditors who do have experience
with fraud detection perceived their role in the redress process to be significant
(56 per cent). Results also show that perceptions of the role of the auditor in the redress
process differed between Big Four and non-Big Four auditors; Big Four auditors
perceive their role in the redress process to be limited more often than do non-Big
Four auditors (33 versus 17 per cent). In addition, non-Big Four auditors did not have
an opinion on their role in redressing fraud more often than did Big Four auditors
(24 versus 13 per cent). The influences of the different audit firms and years of audit
partner experience on auditor role perceptions proved not to be significant.
Conclusions
In this study, evidence has been presented on the volume and nature of fraud cases
detected by audit partners and the extent of these partners compliance with auditing
standards regarding redress of fraud and reporting fraud to a governmental agency.
Also, the study provides evidence on the experiences of auditors requesting redress
once they have encountered cases of corporate fraud.
The first conclusion to be drawn from this study is that fraud detection by auditors is a
relatively rare event; this result is consistent with previous research by Loebbecke et al.
(1989). On average, the audit partners in the sample detected 1.07 fraud cases in an
eight-year window. Furthermore, non-Big Four auditors seemed to detect the more
serious fraud cases (i.e. management fraud with an external scope) more often than did
Big Four auditors. These results indicate that most auditors have insufficient opportunity
to build expertise in the area of fraud detection, reporting and redress of detected fraud.

Table IV.
Perceptions of the role of
the auditor in the redress
process

Total
Big Four vs non-Big Four
Big Four audit firm
Non-Big Four audit firm
Big Four audit firm
A
B
C
D
Experience as a partner
High
Medium
Low

No/limited role

Significant role

No opinion

41 (29)

79 (56)

21 (15)

28 (33)
7 (17)

47 (55)
24 (59)

11 (13)
10 (24)

3
4
11
14

14
8
9
19

(16)
(31)
(52)
(35)

5 (24)
19 (32)
17 (28)

Note: The values within the parentheses denote percentage

(74)
(62)
(43)
(48)

14 (67)
33 (56)
32 (52)

2
1
1
7

(11)
(8)
(5)
(18)

2 (10)
7 (12)
12 (20)

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The overall conclusion with respect to the redress process is that Dutch auditors do not
comply with certain key elements of the standards. The compulsory written report to
management was issued in only 48 per cent of the cases. Also, the written report to the
supervisory board was issued in just 41 per cent of all management fraud cases and in
40 per cent of all instances of material fraud. This is more than just a documentation
error. If fraud is not reported in writing, the fraud case may not be included in the audit
file and in case of a file review, the auditor will not be held responsible if his response
was inadequate.
Also, data show that the reporting rules were followed more strictly by Big Four
auditors and in cases of material and management fraud. In addition, redress
effectiveness (i.e. whether redress is actually achieved) was lower in cases of
management and external fraud, and pressure was needed in the more serious cases of
material, management and external fraud. This indicates that management was less
likely to redress a serious instance of fraud than it was to redress a less serious case.
When considering the requirement for an auditor to resign when material fraud is not
redressed, it turns out that auditors resigned in three out of seven cases. External
reporting to a governmental agency took place even less often. In the window of this
study, the governmental agency was actually notified with regard to two fraud
cases[19]. These empirical findings cannot be compared to previous work since this
concerns a unique feature of the Dutch framework that has not been investigated
previously.
The results of the current study are generally in line with those reported by
Loebbecke et al. (1989). As explained above, both studies concluded that auditors rarely
encounter fraud. There are, however, some differences between the current results and
those reported by Loebbecke et al. (1989). In the present study, a much smaller
proportion of the total number of fraud cases could be classified as management or
material fraud (41 and 37 per cent, respectively) than was the case in Loebbecke et al.
(56 and 60 per cent). There are several explanations for these differences. First, the
population under investigation differed between the studies. Loebbecke et al. focused
on the USA, while the focus of the current study was on the Netherlands. Institutional
and cultural differences may have an impact on the types of fraud committed and on
the willingness of respondents to provide honest answers. Second, the sample of the
current study included partners of the top 30 Dutch audit firms, while Loebbecke et al.
focused on a single audit firm. This study provided indications that auditor
experiences with fraud detection do differ across audit firms, thereby providing an
explanation for the observed differences between the two studies. Third, the window
differed between the studies. Loebbecke et al. focused on the period prior to 1990, while
the current study investigated the window 1995-2002. Fourth, the difference in the
classifications of fraud cases as either management or employee fraud may be due to
inconsistent interpretations among respondents.
Given the sensitive nature of reporting fraud and societys expectations of auditors in
this respect, compliance with audit standards on fraud detection and reporting is a key
issue in auditors professional ethics. Most existing studies in this area have focused on
the question of the extent to which auditors are able to detect fraud, implicitly focusing
on the fact that society may have unrealistic expectations in this matter. However, the
evidence provided in this study suggests that in cases where the auditor has detected
fraud, relevant procedures and regulations are not fully complied with.

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There may be several causes for the finding of non-compliance in the current study.
Possibly, auditors may decide not to comply with the standards because they face
conflicts of interest, or because they are careless or for efficiency reasons, or it might be
they are not fully aware of what the standards require. With regard to this latter
possibility, respondents claimed that they hardly ever detect fraud, and therefore, did
not build up experience with responding to actual fraud cases in line with auditing
standards. This increases the probability that they fail to do so when fraud occurs.
Compare this situation to that of airline pilots. The likelihood that an average airline
pilot will be confronted with a near crash in his career is extremely low. Since they
should nevertheless know how to deal with such situations, aviation authorities require
airline pilots to be trained in the procedures for handling near crash situations in flight
simulators. Auditors, however, often do not train for similar rare events and as a
consequence they do not build up expertise in finding and dealing with corporate
fraud. Existing studies have indicated that changes in auditing standards and
regulatory changes have not resulted in an increase in auditors ability to detect fraud
or in an improvement of audit effectiveness in discovering fraud (Jakubowski et al.,
2002; Rezaee et al., 2003). Our results suggest that a lack of knowledge among auditors
about the details of such standards and regulations may have further limited their
effect on auditors demands for redress and on their reporting actions in fraud cases. In
addition to increasing educational efforts, this finding may also lead to the conclusion
that in cases of fraud, the audit team should be expanded to ensure the availability of
specific expertise that may be available at the technical department of the audit firm.
However, as mentioned, auditors may also decide not to comply with the standards
because they face conflicts of interest, or because they are careless or for efficiency
reasons, in addition to the lack of knowledge or specific training with regard to
detecting and responding to fraud.
As a direct result of the outcomes presented here, the Dutch professional body
NIVRA took several steps. First, all Dutch auditors have been obliged to take a special
course on fraud standards, to make sure that they are well aware of the latest
standards regarding corporate fraud. In addition, existing fraud regulations have been
amplified with respect to the consultation of experts, to encourage the engagement
team to use the expertise of specialists to address potential fraud situations.
Furthermore, regulations concerning the reporting of fraud have been strengthened.
Previously, the auditor was required to report fraud cases to the supervisory body only
in cases of management or material fraud, but under the new standards all cases of
fraud must be reported. Furthermore, under the new standards, the auditor should
consider resigning from the engagement not only in material cases but also in all cases
where management fails to take reasonable steps to redress fraud. These changes
should limit the number of situations in which auditors are exempted from taking
actions as laid down in standards relating to fraud situations, making what can be
expected from the auditor in fraud-related situations more transparent for auditors as
well as for the general public.
As with all other studies on the occurrence of fraud, this research suffers from an
inherent limitation. The sensitive nature of the subject and the tendency of audit
partners to protect themselves and their firms may lead to socially desirable answers.
There may also be a non-response bias. These risks were mitigated as far as possible
by using a notary in civil law as an intermediary in the data-collection process

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to guarantee anonymity of the respondent. Also, specific non-response tests were

performed. Nevertheless, further research on the role of auditors in fraud cases remains
crucial. In future research, it would be interesting to distinguish the power of such
factors as:
.
auditors lack of knowledge or competence on how to act once corporate fraud is
detected;
.
lack of care for following protocol; and
.
the external auditors lack of independence.
Moreover, it would be interesting to investigate in more detail the characteristics of
those cases of detected fraud where existing standards were not complied with. More
detailed analyses of real-life fraud cases can offer unique opportunities for improving
current fraud standards.
Notes
1. Professional ethics concerns the moral issues (e.g. fraud reporting) that arise because of the
specialist knowledge that professionals attain, and how the use of this knowledge should be
governed when providing a service to the public (Chadwick, 1998).
2. In a later study, Albrecht and Romney (1986) used the same dataset to extend this research.
3. The dataset used in Loebbecke et al. (1989) consisted only of fraud cases. Several later
studies have used the same dataset, expanding it with a set of non-fraud cases (Bell et al.,
1991; Hansen et al., 1996; Bell and Carcello, 2000).
4. Loebbecke et al. (1989) distinguished between management fraud and defalcations, privately
held or publicly held companies, fraud materiality, client industries, deceptive actions, levels
of client personnel involved, audit areas, auditing procedures first indicating the fraud and
number of prior audits of the client.
5. Currently, the responsibilities of auditors in the Netherlands with regard to corporate fraud
are set in the Audit Firms Supervision Act (2006), the Decree on the Supervision of Audit
Firms (2006) and Audit Standard COS 240 The auditors responsibility to consider fraud in
an audit of financial statements. This is a slightly different situation compared to the
moment the survey in this study was conducted. The current requirements are essentially
the same as the requirements in the situation before 2006 except for the fact that some
responsibilities are now set in a national act instead of in professional standards.
6. See DAS 240 and BLF, now: COS 240.93a.
7. See DAS 240 and BLF, now: COS 240.95b.
8. See DAS 240 and BLF, now: BTA 37.1.
9. See BLF Art. 3, now: COS 240.103. Note that COS 240.130 requires the auditor to consider
resigning whereas BLF Section 2 requires the auditor to resign.
10. See BTA, COS 240.102a.
11. The questionnaire is available from the auditors upon request.
12. Every received self-addressed envelope was opened by the notary in civil law in the absence
of the researchers; the date was put on the questionnaire and the questionnaire was marked
by the notary with a new code per auditing firm. This procedure made it possible for the
researchers to compare fraud experiences among auditing firms while still guaranteeing the

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anonymity of the respondents and of the auditing firm involved. After recoding the
self-addressed envelopes, the notary destroyed the coding table.
13. With respect to non-response bias, a number of characteristics of early versus late
respondents have been tested. The corresponding t-tests have not indicated any significant
differences between both groups.
14. To compare the findings, the average number of fraud cases reported by Loebbecke et al.
was multiplied by 0.6, resulting in an average of 1.86 fraud cases per audit partner. To adjust
for the larger time frame of Loebbecke et al., we divided this number by the average auditing
experience of 19.5 years of the partners sampled in this research and then multiplied this
number by eight years, which is the window of the current study. After these adjustments,
the number of fraud encounters per audit partner in the Loebbecke et al. study is about 0.76,
which is more in line with the findings of the present study (1.07 fraud cases).
15. Note that in the current auditing standards in this situation the auditor only has to consider
withdrawing from the engagement but nevertheless he must report to a central
governmental agency.
16. See also BLF.
17. Of the total population of top 30 audit partners in The Netherlands, about a quarter
participated in this study. Of approximately 130,000 audits in The Netherlands in the period
1995-2002, about 1,250 instances of fraud would have been detected. In 1,000 of these cases
redress would have been requested by the auditor, of which 940 cases would have been
redressed eventually. Therefore, in 60 cases, no redress would have taken place, of which
28 cases would have been material fraud detected during a statutory audit. In 16 of these
instances, the auditor would have resigned, and 28 cases would have been reported to the
external reporting agency.
18. The reason for this removal was that only 15 per cent of this group had an opinion on the
auditors role in fraud redress; eight partners considered their role to be small, and
15 partners considered their role to be significant. The remaining 132 auditors who had no
experience with fraud detection did not have an opinion on the auditor role in the redress
process.
19. Under the old requirements, it was mandatory for auditors to report the fraud to the
governmental central reporting agency (BLF, Section 3) while under the current legislation
this is mandatory according to the Audit Firms Supervision Act, Article 26.

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Appendix
DAS 240
The main points were as follows. Before starting the audit as such, auditors are required to carry
out a pre-assessment, evaluating and documenting the likelihood of financial misstatements and
the presence of risk factors indicating an increased potential for fraud, and making inquiries to
better understand the company, its procedures and its management. Based on this
pre-assessment, the audit procedure should take into account the estimated level of inherent
and control risk, and may have to be adjusted or expanded if circumstances are encountered that
may indicate material misstatement. While conducting the audit, a written representation from
management should be requested including a statement that management feels obliged to detect
and deter the occurrence of fraud, and that the auditor has been informed about all relevant fraud
cases. If material errors are detected, the auditor should report this to management and may,
again, have to revise the audit procedures based on the new information. At the same time, the
integrity of management should be reconsidered, especially if there are indications of
management fraud. If there is fraud or an indication of fraud and the auditor believes that it is
therefore not possible to continue the audit, he should consider reporting to the entity (or, in some
cases, to regulatory authorities) or withdrawing from the engagement. The auditor needs to
terminate his appointment if the audit is impeded by any restrictions or limitations imposed by
the client, and should inform the appropriate level of management and the supervisory body
about his reasons for doing so.
BLF
The main points were as follows. The BLF came into force in 1994 and remained unchanged
throughout the period under study (1995-2002). Both the AS 240 and the Supervision of Auditors
Act (Wet toezicht accountantsorganisaties or WTA) were modified after this study was
completed. These regulations now contain the main points of the BLF, which then ceased to exist
as a separate auditing standard. However, there is one exception to the BLF, and that concerns
the provision that auditors must notify the supervisory body if management refuses to
redress the detected fraud. This step is not covered, either by the WTA or the accompanying
Decree on the Supervision of Auditors (Besluit toezicht accountantsorganisaties, or BTA).
The BTA requires that the competent government authority be notified when the audit client
fails to redress the fraud (whether this concerns management or the supervisory body), thus
omitting the intermediate step of informing the supervisory board.
Abbreviations:
BLF Dutch by-law on reporting on fraud.
BTA Dutch decree on the supervision of audit firms, 2006.
COS Dutch audit and other standards (as of 2007).
DAS Dutch Auditing Standards (until 2007).
ISA

International standard on auditing.

Corresponding author
Harold Hassink can be contacted at: h.hassink@maastrichtuniversity.nl

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