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Volume 2: No. 1, January–June, 2010

JFIA

Volume 2: No. 1, January–June, 2010

Table of Contents:


Does Familiarity with an Interviewee's White Lying Make It Easier to Detect the Interviewee's Deception? | Full Article (PDF)
Chih-Chen Lee
Robert B. Welker
 
Abstract: This experimental study assesses whether familiarity with an interviewee’s communicative style improves an interviewers’ ability to detect deception. In the experimental treatment, interviewers observed interviewees as they told truths and white lies over the course of ten weeks. During this period, the accuracy of detecting white lies increased from sixty-one percent to eighty-one percent, suggesting the acquisition of familiarity. After the experimental treatment, the interviewer and interviewee participated in an interview to assess a company’s hiring practices. The interviewee answered interview questions, either truthfully or falsely, about an employee’s job qualifications. Interviewers made a decision as to whether the interviewee had responded truthfully in the interview. Familiarity with the interviewee’s communicative style had an insignificant effect on deception-detection accuracy in the interview. White-lie detection skills may not pertain to deception-detection in interviews perhaps because interviewees behave differently in interviews than in non-interview communicative situations.
 
Keywords: Deception detection; deception-detection ability; familiarity; inquiry; interview. 
Data Availability: Confidentiality agreements with participants, written with the assistance of the host university’s human subjects committee, prevent the sharing of data with others.

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Audit Inquiries and Deception Detection: Standards, Research, and Guidance | Full Article (PDF)
Donald L. Ariail
J.P. Blair
L. Murphy Smith
 
Abstract: During each phase of an audit, members of the engagement team ask numerous questions of personnel of the organization being audited, the answers to which may affect both the course and outcome of the audit. An understanding of the psychology of lying/deception can assist auditors in evaluating verbal responses to audit inquiries and thereby lessen detection risk. A large body of literature suggests that people are only about 4% better than chance at identifying deception. This paper provides a review of audit inquiry standards and past research on deception detection. Further, this paper specifically addresses the importance of veracity judgments in four key areas of the audit: audit planning, fraud risk consideration, the understanding of internal controls and its effectiveness, and the collection of audit evidence. In addition, this paper provides guidelines that can assist auditors in making more accurate judgments of truth or deception. 
 
Keywords: Audit inquiries, deception detection, detection risk, audit red flags, veracity, lying. 

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Corporate Governance Ratings and Financial Restatements: Pre and Post Sarbanes-Oxley Act | Full Article (PDF)
Mohammad J. Abdolmohammadi
William J. Read
 
Abstract: Using ratings of corporate governance developed by RiskMetrics Group (RMG), formerly Institutional Shareholder Services, we investigate whether relatively poor governance is associated with financial restatement, and whether restatement results in improved governance. We identify 150 firms that restated their 2003 financial statements to correct material error, and we use Compustat to generate a control sample matched on the basis of Global Industry Classification Standard (GICS), auditor type, year, and size. Compared to control firms, we find that restatement firms have significantly lower governance ratings in the restated year suggesting that poor governance results in financial impropriety. We also find that restatement firms improve their governance ratings in the year following the restated year, primarily by strengthening board independence, to the extent that significant differences with the control firms no longer exist. To test for the robustness of the results and provide insight into the likely direction of causation, we (1) match our test sample with other firms that did not restate in 2003, but had the same RMG corporate governance ratings (for evidence on post-SOX 2002), and (2) expand the examination period to pre-SOX (2002) and identify new test and control samples. The alternative empirical designs and related analyses support the finding that financial restatement results in board changes, which in turn improve governance ratings and reduction in chances of subsequent restatement.
 
Keywords: Financial restatements, corporate governance.
 
Data Availability: Performance and financial data are available from Compustat. Restatement and select audit committee and executive compensation data are from public sources identified in the manuscript. Corporate governance ratings were obtained from Institutional Shareholder Services.

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The Forensic Audit: An Example from the Public Sector | Full Article (PDF)
Ronald J. Huefner
 
Abstract: This paper provides an in-depth illustration of the conduct of a forensic audit for a major fraud case in a local government setting. Extensive detail on techniques employed in a forensic audit is typically not publicly available. Further, fraud cases outside the corporate arena have not been well represented in the literature.
 
The paper describes the forensic audit carried out by state auditors in the case of a major fraud in a local school district. Two lengthy public reports by the State Comptroller’s Office provide richness of detail for this illustration. 
 
Even in the face of missing documents and records and manipulation of the accounting system, auditors were able to reach a good understanding of what had transpired, how it had been accomplished, how much loss the school district had incurred, and who was responsible. The thoroughness of the audit led to the subsequent conviction of most of the perpetrators.
 
Keywords: Governmental forensic audit; public sector; school district audit; credit cards; fraud.

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Enron’s Banks Escape Liability: Reconsidering the Accounting Profession’s Opposition to Private Party Litigation to Prevent Third-Parties from Assisting in Fraud | Full Article (PDF)
Thomas C. Pearson
 
Abstract: Discussion is needed about the appropriateness of having several of Enron’s investment banks escape liability after participating in fraudulent schemes with Enron. This article takes issue with the appropriateness of the AICPA’s legal position in Stoneridge Investment Partners v. Scientific America, which the Supreme Court decided in 2008 in a 5-3 decision. The AICPA’s concern was about liability for third parties related to services other than the annual audit. The author presents the legal background on securities law on fraud by third parties and provides analysis. The author believes the AICPA’s position opposing private party lawsuits against third party fraudsters was a strategic mistake for a service profession which relies on integrity and attempts to ensure reliable financial reporting. Refocusing the accounting profession on investor interests requires supporting reasonable legal accountability for any third parties engaged in financial fraud.
 
Keywords: Third party liability; fraud; private party litigation; Enron’s banks; financial fraud.

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Alternative Earnings Measures, Key Performance Indicators and Firm Value in the IT Professional Services Sector | Full Article (PDF)
Lisa Bryant
Steven L. Henning
Wayne H. Shaw
 
Abstract: This study examines the value-relevance of alternative earnings measures in the presence of non-financial measures for firms in the IT Professional Services industry. We begin our analysis by examining the value-relevance of GAAP earnings, S&P core operating earnings, and firm-specific pro forma earnings. During a period of market expansion, we find that pro forma earnings are more highly associated with stock price than either GAAP or S&P earnings. However, in a period of market contraction, we find that GAAP and S&P earnings are more highly correlated than pro forma earnings. We next examine the incremental relevance of industry specific non-financial measures. We find that the information contained in pro forma earnings is supplanted by non-financial measures. Lastly, we find that the information eliminated from GAAP-based earnings to arrive at pro forma earnings is value relevant throughout the period examined even after including non-financial information. 
 
Keywords: GAAP based earnings; proforma earnings; alternative earnings measures; IT Professional Services sector; performance indicators.

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The Effects of Decreased User Confidence on Perceived Internal Audit Fraud Protection | Full Article (PDF)
Kevin L. James
Scott J. Seipel
 
Abstract: This study uses data on user perceptions before and after Enron and other high profile frauds to explore how perceptions of the internal audit function were affected and to consider what, if any, response is appropriate. While internal auditors shared little blame for recent frauds, our results show a clear drop in user perceptions of the internal audit function irrespective of the structure of the function. This generalized effect likely stems from a general drop in confidence in the accounting profession.
 
Results also indicate that internal audit departments that report to senior management are perceived as less likely to prevent financial statement fraud than outsourced internal audit functions, even when the function is outsourced to the financial statement auditor. This finding implies that the SEC should consider more closely whether to regulate the relationship between the audit committee and the internal auditor. The internal audit profession may also take voluntary actions to enhance corporate governance and public perceptions. 
 
Keywords: Internal audit; outsourcing; financial statement fraud; user confidence.
 
Data Availability:  Please contact the first author for data availability.

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Opportunities for Fraud and Embezzlement in Religious Organizations: An Exploratory Study | Full Article (PDF)
Melvin Ventura
Shirley J. Daniel
 
Abstract: This research develops a rationale for why religious organizations are particularly vulnerable to financial fraud and embezzlement. The rationale is then validated through an exploratory survey of Christian Churches in California and Hawaii. Data from 41 church members and 32 pastors from churches were analyzed to examine the relationship between trust and the oversight of financial management and segregation of duties affecting the opportunity for fraud. The results provide a framework for future empirical research that would test the unique roles of trust and opportunity in the financial management practices of churches and the incidence of fraud and embezzlement.
 
Keywords: Fraud, non-profit organizations, trust, embezzlement.

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A Forensic Audit of Staffing and Census in a Long-Term Care Facility | Full Article (PDF)
Bruce R. Neumann
Maggie Crowdes
David Neumann
 
Abstract: We conducted a forensic audit of staffing and census data in a 60-bed nursing home to identify errors in daily staffing ratios and to evaluate evidence in a Federal false claims fraud case alleging that insufficient staffing had been provided. These claims were based largely on daily staffing ratios shown on the Management Staffing Report (MSR), which was an informal management reporting tool. The MSR was not linked to audited payroll records and it was not reconciled with the facility’s accounting records.
 
Our audit focus was on daily nursing hours paid (worked) and daily census data. We reconciled and corrected the original daily staffing data and census data based on our audit results. We reconstructed payroll and census records for four years (1997-2000). Payroll records were the best available source data that could be used to validate nurse staffing hours. 
 
When we conducted our audit, the facility’s electronic payroll records had been lost or corrupted. The only available payroll records were ‘hard-copy’ records from the patient units and from the outside vendor that had been computing the bi-weekly payroll. In order to reconstruct the direct nursing hours, we began with daily time sheets for all nursing staff and reconciled them to biweekly reports from the external payroll service. We relied on the external payroll records for both hourly and salaried nursing staff. To validate the daily patient census, we relied on internal daily patient logs and other source documents. Finally, we used the reconstructed data to compute the ratio of nursing hours per patient day (PPD) and compared those results to those PPD ratios shown on the MSR.
 
We identified significant reporting errors in both staffing and census data as originally reflected on the MSR. No other prior research has examined census and staffing reporting errors at this level of detail. The ‘denominator effect’ of census errors has not been previously reported.
 
We found a 9% average staffing understatement and annual understatements of 4-21% in nursing hours per patient day (PPD). The ‘denominator effects’ of census errors were skewed and not randomly distributed. The highly variable and predominantly one-sided staffing and census adjustments were unexpected and somewhat counter-intuitive. We summarize the evidentiary nature of our staffing and census audit adjustments in several data tables. Improving the accuracy of staffing hours and census will improve analysis and public policy in long-term care. Fraud auditors in any health care setting must be concerned about the reliability of nurse staffing ratios and the PPD ratios. Care must be exercised to validate the accuracy and usability of this prominent staffing ratio.
 
Keywords: Long-term care, nursing homes, nursing hours PPD, hours per resident day (HPRD), census reporting errors, nurse staffing reporting errors, and forensic audit.