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Fraud Detection and Financial Reporting and Audit Delay

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  • Yim, Andrew

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.

Suggested Citation

  • Yim, Andrew, 2010. "Fraud Detection and Financial Reporting and Audit Delay," MPRA Paper 27857, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:27857
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Audit delay; financial reporting lag; extended audit procedures; red flag; fraud detection; SAS 82; SAS 99; business ethics;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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