Signaling fraud by using analytical procedures

One way to combat management fraud involves a multitiered effort that brings together the talents and resources of internal auditors, controllers, and external auditors. Two approaches are employed in assessing the effectiveness of analytical procedures (AP) as a tool in signaling errors and irregularities in financial statements: 1. review and analysis of actual audit working papers and court cases, and 2. experiments that review and analyze the results of simulated analytical procedures using simulated or actual data. APs can be used at 3 stages of the audit: planning, fieldwork, and final review stages. Two fundamental problems must be resolved when using APs: 1. deriving the expectation, and 2. specifying the decision rule for the investigation decision. The combination of a statistical decision rule and a sophisticated estimation model will result in a powerful analytical auditing tool. Quantitative APs alone will not detect fraud - they simply signal the likelihood of a problem.