The impact of audit penalty distributions on the detection and frequency of fraudulent reporting

F. Greg Burton, T. Jeffrey Wilks, Mark F. Zimbelman

Review of Accounting Studies · 2011 · Volume 16 · Issue 4

Abstract

We investigate how the distribution of the penalties incurred by auditors for failing to detect fraud influences their effort to detect fraud and auditees’ commission of fraud. We compare a probabilistic, skewed audit penalty to a penalty that automatically imposes the expected penalty of the probabilistic distribution (hereafter, a deterministic penalty). Our experiments show that a deterministic penalty with the same expected value of a probabilistic, skewed penalty increases audit effort to detect fraud and decreases fraudulent reporting by auditees and that these benefits hold in a game involving both auditee and auditor players.

Keywords

Audit penalty, Fraud, Legal regime, Prospect theory

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