Forensic Service Supply by Audit Firms: Classification, Market, Methods, and Prior Research

27.10.2017 | Darmstadt University of Technology | Reiner Quick | 1 Reiner Quick Department of Accounting and Auditing Darmstadt University of Technology Forensic Service Supply by Audit Firms: Classification, Market, Methods, and Prior Research October 19, 2017 Màlaga 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 2 Agenda New opportunities for audit firms Forensic Services portfolio From auditing to Forensic Services The market for Forensic Services Methods for Forensic Services Forensic Services research Summary 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 3 NEW OPPORTUNITIES FOR AUDIT FIRMS Motivation 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 4 Services offered by audit firms New opportunities for audit firms Non-audit services (NAS) Audit services Other assurance services Other non-audit services −Legal −IT −Valuation −Human ressources −Actuarial −Transaction −Forensic −… Tax advisory 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 5 New opportunities for audit firms 0 100 200 300 400 500 600 700 800 Deloitte EY KPMG PwC Revenue Audit 2015 Revenue Audit 2016 Revenue NAS 2015 Revenue NAS 2016 +7% +7% -8% +2% +41% +43% +12% +12% 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 6 New opportunities for audit firms 2014 EU-regulation adds further challenges Black-list of prohibited NAS −Provision of non-prohibited NAS is more attractive Forensic Services are non-prohibited NAS NAS fee cap −Provision of NAS worth more than 70% of three-year-average audit fees is prohibited Provision of NAS to non-audit clients is essential 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 7 New opportunities for audit firms Article 5.1 EU-regulation: Prohibited NAS Tax services Management services Bookkeeping and preparing financial statements Payroll services Designing and implementing internal control or risk management procedures Valuation services Legal services Internal audit services Financial services Promoting, dealing in, or underwriting shares in the audit entity Human resource services 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 8 New opportunities for audit firms Development of NAS-audit-fee-ratio for major German stock indices from 2009 to 2013 Source: Laudemann et al. (2016) DAX30 MDAX SDAX TecDAX Year Ratio Year Ratio Year Ratio Year Ratio 2009 76.1% 2009 60.5% 2009 70.6% 2009 58.2% 2010 67.8% 2010 54.8% 2010 78.9% 2010 56.7% 2011 70.1% 2011 58.0% 2011 68.1% 2011 52.7% 2012 82.5% 2012 58.2% 2012 59.0% 2012 63.4% 2013 77.3% 2013 53.8% 2013 64.2% 2013 50.6% Average 74.5% Average 57.0% Average 67.8% Average 56.2% 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 9 FORENSIC SERVICES PORTFOLIO Practice I 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 16 Other services include (2/4): Corporate Intelligence Forensic Services portfolio Data Security Data AnalyticsForensic Due Diligence Anti-bribery and corruption services Anti-money laundering services Cyber insurance services Background checks Business partner screenings Executive integrity assessment Compliance checks, e.g. of suppliers 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 17 Other services include (3/4): Forensic Due Diligence Forensic Services portfolio Corporate Intelligence Data Security Data Analytics Anti-bribery and corruption services Anti-money laundering services Cyber insurance services Support of buyers or vendors of a company 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 18 Other services include (4/4): Data Analytics Forensic Services portfolio Corporate Intelligence Data Security Forensic Due Diligence Anti-bribery and corruption services Anti-money laundering services Cyber insurance services Rapidly identifying and extracting information associated with a business risk 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 19 Forensic Services portfolio covered Topics include: 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 20 Forensic Services portfolio covered Topics include: Price gouging 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 21 Forensic Services portfolio covered Topics include: Price gouging 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 22 Forensic Services portfolio covered Topics include: Price gouging Money laundering and financing of terrorism 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 23 Forensic Services portfolio covered Topics include: Price gouging ML and FOT 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 24 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 25 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 32 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 33 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 34 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime Industrial espionage 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 35 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime Ind. espionage 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 36 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime Ind. espionage Fraud and asset misappropriation 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 37 Forensic Services portfolio covered Topics include: Price gouging ML and FOT Tax Fraud San. and Em. Vio. of CCOC Corruption Cybercrime Ind. espionage Fraud and asset misappropriation 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 38 FROM AUDITING TO FORENSIC SERVICES Theory I 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 39 From auditing to Forensic Services Historically, detection of fraud core task of statutory auditor „The detection of fraud is a most important portion of the Auditor‘s duties“ -L. R. Dicksee: „Auditing: a practical manual for auditors, 4th ed., London: Gee & Co., 1900, p. 8. Today: Detection of material misstatement (error or fraud) 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 40 From auditing to Forensic Services The auditor’s responsibilities relating to fraud in an audit of financial statements (ISA 240): Primary responsibility for prevention and detection of fraud those charged with governance and management Auditor is responsible to obtain a reasonable assurance that financial statements are free from material misstatements (error and fraud) −Professional skepticism −Discussion among the audit team −Risk assessment procedures −Identification and assessment of the risks of material misstatement due to fraud −Responses to these risks −Evaluation of audit evidence 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 41 From auditing to Forensic Services Irregularities No influence on financial statements Error Fraud Non-compliance with laws and regulations (on purpose or not) Fraudulent financial reporting Asset misappropriation and non-compliance with laws and regulations To be disclosed in the report to those charged with governance Material misstatements of the financial statements To be disclosed in auditor’s report AUDIT FORENSIC Figure following local auditing standard IDW PS 210 Forensic Services go beyond auditing: 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 48 The market for Forensic Services Comparing Forensic Services of the German Big 4 Educational background: −Business/Economics −Computer Sciences −Legal Studies (lawyers) and Law Enforcement (e.g. public prosecutors, tax investigators) −Crimonology (e.g. police, military, intelligence services) −Other (e.g. architecture, natural sciences, psychology, politology, sociology) Average yearly growth of employee number since 2010: 10.8% Criterion Deloitte EY KPMG PwC No. of offices 6 8 5 2 No. of employees 120 200 80 90 Employee ratio 1.96% 2.12% 0.78% 0.87% 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 49 METHODS FOR FORENSIC SERVICES Theory II 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 50 Methods for Forensic Services Manifold, multidisciplinary methods, from audit, criminology, statistics, etc. Comprehensive overview not feasible Proposed classification: data collection data analysis preventive measures Data collection (examples) Technical recovery of deleted, destroyed or encrypted data Under consideration of privacy regulations Data recovery Collecting important unstructured data by interviewing involved parties Interviews 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 51 Methods for Forensic Services Quantitative data analysis (examples) Using large data-sets to classify / predict characteristics, e.g. using logistic regressions Classification methods Comparing data / characteristics to similar cases / firms, e.g. for valuation purposes Cross-sectional analyses Structured search for unexpected data patterns, e.g. using Benford’s Law Pattern-based analyses Qualitative data analysis (example) e.g. keyword search and review of e-mails Examination of (digital) documents 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 52 Methods for Forensic Services Excursion: Benford’s Law 0% 5% 10% 15% 20% 25% 30% 35% 123456789 Probability First digit of number 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 53 Methods for Forensic Services Preventive measures Training material and processes to improve employee compliance behavior Fraud trainings To make sure that one employee’s work gets monitored regularly Mandatory vacations To avoid that one person alone can perpetrate fraud Segregation of duties Evaluate employees behavior, e.g. by reviewing criminal records Background checks 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 54 FORENSIC SERVICES RESEARCH Research 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 55 Forensic Services research Forensic Accounting journals: •Journal of Forensic Accounting (2000-2008) •Journal of Forensic and Investigative Accounting (since 2009) •Journal of Forensic Studies in Accounting and Business (since 2009) •Journal of Forensic Accounting Research (since 2016) AAA journals from 2000 to 2011 2.5% of the titles include “fraud” 0.4% include “forensic” Stone and Miller 2012 Top 30 accounting journals (combined German, British ranking) 1990 to 2016 Abstract of 372 (1.65%) papers contains “fraud”, 14 (0.06%) contain “forensic” Forensic Accounting journals 2000 to 2014 45.1% of the papers deal with fraud 25.7% with forensic accounting (litigation support) DiGabriele and Huber 2015 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 56 Forensic Services research 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% Top 30 Accounting journals 1990-2016 AAA-journals 2000-2011 Forensic-Journals Fraction of papers Scope "forensic" papers "fraud" papers 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 57 Forensic Services research High quality forensic services research is missing Some fraud topics are researched somewhat extensively, e.g. Quantitative “red flags research” Primarily archival research with logistic regression analyses Based on different databases on restatements or fraud, above all on SEC’s AAERs Research approach Beasley (1996) Summers/Sweeney (1998) Lee et al. (1999) Farber (2005) Erickson et al. (2006) Yijiang/Chen (2008) Brazel et al. (2009) Lennox et al. (2013) Kohlbeck/Mayhew (2017) Notable Publications Fraud rises with, e.g., insider trading, weaker corporate governance, less tax aggressiveness, related party transactions Non-financial information can serve as an indicator for fraud Key Results 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 64 Bibliography (2/7) Davis, J., and H. Pesch. 2012. Fraud dynamics and controls in organizations. Accounting, Organizations and Society 38 (6–7): 469–83. Dechow, P. M., W. Ge, C. R. Larson, and R. G. Sloan. 2011. Predicting Material Accounting Misstatements. Contemporary Accounting Research 28 (1):17–82. DiGabriele, J. A., and W. D. Huber. 2015. Topics and methods in forensic accounting research. Accounting Research Journal 28 (1):98-114. Erickson, M., M. Hanlon, and E. L. Maydew. 2006. Is There a Link between Executive Equity Incentives and Accounting Fraud? Journal of Accounting Research 44 (1):113-143. Farber, D. B. 2005. Restoring Trust after Fraud: Does Corporate Governance Matter? Accounting Review 80 (2):539-561. Free, C. and P. R. Murphy. 2015. The Ties that Bind: The Decision to Co-Offend in Fraud. Contemporary Accounting Research 32 (1):18–54. 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 65 Bibliography (3/7) Hammersley, J. S., E. M. Bamber, and T. D. Carpenter. 2010. The Influence of Documentation Specificity and Priming on Auditors' Fraud Risk Assessments and Evidence Evaluation Decisions. Accounting Review 85 (2):547-571. Hoffman, V. B., and M. F. Zimbelman. 2009. Do Strategic Reasoning and Brainstorming Help Auditors Change Their Standard Audit Procedures in Response to Fraud Risk? Accounting Review 84 (3):811-837. Jones, K. L., G. V. Krishnan, and K. D. Melendrez. 2008. Do Models of Discretionary Accruals Detect Actual Cases of Fraudulent and Restated Earnings? An Empirical Analysis. Contemporary Accounting Research 25 (2):499–531. Kohlbeck, M. and B. W. Mayhew. 2017. Are Related Party Transactions Red Flags? Contemporary Accounting Research (2):900–928. Larcker, D., and A. Zakolyukina. 2012. Detecting deceptive discussions in conference calls. Journal of Accounting Research 50 (2): 495–540. 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 66 Bibliography (4/7) Laudemann, H., R. Quick, F. Schmidt, and B. Warming-Rasmussen. 2016. Die zeitliche Entwicklung von Abschlussprüferhonoraren in Deutschland - Eine empirische Untersuchung der Jahre 2009 bis 2013. Die Unternehmung 70 (2): pp. 153-186. Laux, V., and P. C. Stocken. 2012. Managerial reporting, overoptimism, and litigation risk. Journal of Accounting and Economics 53 (3):577-591. Lee, T. A., R. W. Ingram, and T. P. Howard. The Difference between Earnings and Operating Cash Flow as an Indicator of Financial Reporting Fraud. 1999. Contemporary Accounting Research 16 (4):749-786. Lennox, C., P. Lisowsky, and J. Pittman. 2013. Tax Aggressiveness and Accounting Fraud. Journal of Accounting Research 51 (4):739-778. Lynch, A. L., U. S. Murthy, and T. J. Engle. 2009. Fraud Brainstorming Using ComputerMediated Communication: The Effects of Brainstorming Technique and Facilitation. Accounting Review 84 (4):1209-1232. 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 67 Bibliography (5/7) Matsumura, E. M., and R. R. Tucker. 1992. Fraud Detection: A Theoretical Foundation. Accounting Review 67 (4):753-782. Morales, J., Y. Gendron, and H. Guénin-Paracini. 2014. The construction of the risky individual and vigilant organization: A genealogy of the fraud triangle. Accounting, Organizations and Society 39:170–194. Morton, S. 1993. Strategic Auditing for Fraud. Accounting Review 68 (4):825-839. Murphy, P. R. 2012. Attitude, Machiavellianism and the rationalization of misreporting. Accounting, Organizations and Society 37 (4):242–259. Newman, D. P., E. Patterson, and R. Smith. 2001. The Influence of Potentially Fraudulent Reports on Audit Risk Assessment and Planning. Accounting Review 76 (1):59-80. Patterson, E. R., and J. R. Smith. 2007. The Effects of Sarbanes-Oxley on Auditing and Internal Control Strength. Accounting Review 82 (2):427-455. Price, R. III., N. Sharp, and D. Wood. 2011. Detecting and predicting accounting irregularities: A comparison of commercial and academic risk measures. Accounting Horizons 25 (4):755–80. 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 68 Bibliography (6/7) Purda, L. and D. Skillicorn. 2015. Accounting Variables, Deception, and a Bag of Words: Assessing the Tools of Fraud Detection. Contemporary Accounting Research 32 (3):1193–1223. Smith, J. R., S. L. Tiras, and S. S. Vichitlekarn. 2000. The Interaction between Internal Control Assessment and Substantive Testing in Audits for Fraud. Contemporary Accounting Research 17 (2):327–356. Stone, D. N., and T. C. Miller. 2012. The State Of, and Prospects For, Forensic and Fraud Research that Matters. Journal of Forensic & Investigative Accounting 4 (2):35-76. Summers, S. L., and J. T. Sweeney. 1998. Fraudulently Misstated Financial Statements and Insider Trading: An Empirical Analysis. Accounting Review 73 (1):131. Trompeter, G. M., T. D. Carpenter, N. Desao, K. L. Jones, and R. A. Riley, Jr. 2013. A Synthesis of Fraud-Related Research. Auditing: A Journal of Practice & Theory 32 (Supplement 1):287–321. 27.10.2017 | Darmstadt University of Technology | Reiner Quick | 69 Bibliography (7/7) Watters, M., K. M. Casey, J. Humphrey, and G. Linn. 2007. CPA Firms Offering of Forensic Services Surprisingly Consistent Over Time: Are CPA's Missing out on a Forensic Accounting Gold Rush? Academy of Accounting and Financial Studies Journal 11 (2):89-95. Xiaoling Chen, C., K. T. Trotman, and F. Zhou. 2015. Nominal versus Interacting Electronic Fraud Brainstorming in Hierarchical Audit Teams. Accounting Review 90 (1):175-198. Yijiang, Z., and K. H. Chen. 2008. Staggered Boards and Earnings Management. Accounting Review 83 (5):1347-1381. Zwernemann, J. 2015. Forensic Services - Eine Analyse im Kontext zur Jahrsabschlussprüfung, Fakultät für Wirtschaftswissenschaft, Otto-von-GuerickeUniversität Magdeburg, Wiesbaden.