Financial statement misrepresentation: the role of internal

and external audit

Abstract

Purpose
This paper focuses on the importance of internal and external audits in reducing
misrepresentation or falsification of financial statements and examines the key
characteristics, reasons, and methods for committing as well as confronting fraud.

Design/methodology/approach
Electronic questionnaires were sent to stock-exchange-listed companies with an
internal audit department. Descriptive statistics, factor analysis, and multiple
regressions show that internal audit contributes significantly to reducing fraud.

Findings
Factor analysis shows a significant internal audit contribution against fraud. Linear
regression highlights the significance of variables concerning the reasons for
falsification, external auditors’ competence, and internal auditors’ and audit
committees’ efficiency.

Research limitations/implications
Business fraud is organised and therefore difficult to detect, disclose, and prevent,
especially when conducted by the board of directors; further, it is more common in
businesses without control mechanisms.

Practical implications

Audit’s role is key in preventing and detecting fraud; it should act as a strong,
internal, independent control function.

Originality/value
Despite the importance of audit, the phenomenon of fraud, there has not been much
empirical research on this issue.

Keywords: financial statement misrepresentation; fraud; internal audit; external

audit; audit committee.

JEL Categories: M42, M48

1
 1. Introduction

Corporate scandals have resulted in huge financial loss for markets, as well as for
investors and employees. The cases of financial fraud that have been revealed have
raised concerns regarding the efficiency of internal audits as well as the reliability
and validity of external audits (Rezaee, 2002).
Users of financial statements make investment decisions based on the
information that has been extracted from companies. Consequently, this information
has to be valid and depict the reality in order for the right decisions to be made.
However, the intensely competitive corporate environment has led to a focus on
presenting a better image rather than improving efficiency (Lundelius, 2011).
Each institution has to take measures in a timely manner to avoid any unpleasant
situations. A powerful system of internal and external audits helps corporations in
completing the difficult task of preventing their employees from committing fraud
(Zager et al., 2016). Consequently, audit plays a major role, acting as a protector of
audit reliability in economic matters and helping to prevent fraud (AICPA, Section
240).
To date, only a few studies have examined the role of auditing in relation to
reducing the falsification of financial statements. The goal of this study is to examine
the factors that affect the falsification level of accounting financial statements. It
focuses on the falsification of financial statements, aiming to examine its
characteristics and the reasons for, and ways of, committing and confronting fraud.
The results show the importance of internal and external audit, as well as of the
audit committee in fighting corporate fraud and ensuring the reliability of financial
statements. Furthermore, the results reveal that some demographic characteristics
play a vital role in how internal and external audits are conducted.
The contributions of this study, on an academic and business level, are based on
a complete framework related to the auditing role being a medium through which to
recognise and confront fraud in financial statements.

2. Literature review and theoretical framework

2
2.1 Ways of committing financial statement fraud

Ghazali et al. (2014) examined the existence of fraud and highlighted the preventive
measures applied in Malaysia. The results showed that the types of fraud most
frequently committed are: the misappropriation of capital; false allegations regarding
working hours or overtime; and the manipulation of accounts. These three types of
fraud refer to the most frequent cases that respondents had witnessed. Theft and
forgery were found to be the least common types of fraud. Finally, it was revealed
that employees are often aware of fraud in their working environment, confirming
that their organisations had been victims of fraud in the past.
Deloitte (2009) found that 38% of fraud is related to exploiting revenues, 12%
to concealing costs, 12% to inappropriate disclosures, and 8% to manipulating
liabilities.
Finally, Zager et al. (2016) found that the most common techniques used for
falsifying financial statements are inappropriate techniques for excessive capital
appreciation and undervalued costs. The most frequent techniques for
undervaluing/overestimating costs include not recording costs and not properly
recognising the expenditure. According to this study, corporations often accelerate
their revenue recognition and record double revenues in order to increase their
financial income by the end of the fiscal year. Concerning the misappropriation of
assets, the respondents asserted that the theft of inventories is more common than the
theft of long-term assets or cash.

2.2 Causes of committing financial statement fraud

Cressey (1950) concluded that the three factors that lead to financial statement
fraud are: motive; opportunity; and rationalisation. Zulkurnai et al. (2006) conducted
a survey concerning the concept of fraud, with the results showing that bad
management techniques are the main reason behind fraud (86%). Financial pressure
was the second most significant factor (57%). Inadequate education, increased
workload, and political interests were also recognised as factors contributing to fraud.
Consequently, the non-existence or inefficiency of internal audit, as well as poor
corporate governance supervision should be monitored and addressed in order to
prevent fraud.

3
 A decade later, Reynolds (2018) examined the most frequent reasons for
committing fraud, as well as proposing ways to prevent fraud. Furthermore, 86% of
employees were aware of the corporations’ inadequacy in conducting proper audits,
thus severely limiting their ability to recognise fraud. Finally, 39% of the respondents
agreed that were treated unjustly and underestimated in their work environment.

2.3 Auditor’s competence

Krambia (2002) researched the auditor’s competence in relation to highlighting

irregularities. It is understood that the auditor has to know the cause of the fraud in
order to track down any irregularities, by drawing information from other sectors.
Consequently, the auditor must have knowledge of other fields, such as psychology
and sociology. Finally, corporations that are more likely to present irregularities are
characterised by the lack, both of an efficient internal audit system and a code of
conduct.
Subsequently, Hammersley (2011) described the factors affecting fraud. The
results showed that the competence of the auditors in evaluating efficiently the fraud
risks is affected by their experience and could be improved through further discussion
within the audit team. Moreover, significant factors in the detection of fraud include
the auditors’ knowledge, their ability to solve problems, and academic background.
Knowledge is obtained through experience and education. Some studies, examined
the effect of auditors’ education on their ability to detect fraud. Those auditors who
had participated in additional educational courses or obtained more knowledge
concerning fraud, and financial statements would recognise more efficiently cases of
fraud (Bierstaker et al., 2012; Ocak and Kurt, 2019).
The Financial Reporting Council (FRC) (2014) focused on the legislation and
rules that auditors have to follow in order to confront efficiently the risks of fraud. In
this context, auditors have to collect adequate evidence concerning legislative
compliance in order to carry out audit procedures. Relevant laws and regulations have
to be defined in the corporate environment and transmitted to employees, while
auditors examine a firm’s compliance to the letter of the law. Consequently,
corporations have to provide adequate information, guidance, and training to their
audit teams regarding relevant laws and regulations. According to the study of
Othmana et al. (2015), which focused on the training and education of government

4
officials in order to prevent cases of fraud, 47% of the respondents agreed that they
were frequently trained in this regard. However, it is worth noting that 53% of
respondents had not attended adequate educational courses in order to detect and
prevent cases of fraud.

2.4 Ways of detecting fraud

Ziegenfuss (1996) examined cases of fraud at the state- and local-government level in
the US. The most common methods of fraud detection include investigation by the
authorities, internal audits, and accidental discovery. Chtourou et al. (2004) later
examined how much the expertise, independence, and activities of the audit
committee affect the quality of the published financial data of a corporation.
Subsequently, Ghazali et al. (2014) investigated the actions undertaken in
several corporations following a fraud scandal. Most cases of fraud were revealed
through the procedures of internal audits, which highlight the significance of internal
audits. The results also showed that fraud is often detected after reports made by
employees (71%). Other mechanisms for detecting fraud are accidental discovery,
external audit, anonymous reports, and special audit due to corporate governance.
Coram et al. (2008) estimated how likely organisations with internal audits are
to detect fraud in comparison with organisations without such audits. Thusly,
organisations with internal audits are more likely to recognise cases of fraud than
those without any such audits. Consequently, internal audit plays a vital role in fraud
recognition using the tools at its disposal, namely the improvement of the audit
environment and the monitoring of fraud risks.
Later, Zager et al. (2016) examined the roles and the responsibilities of relevant
institutions in preventing and detecting fraud. The respondents were external auditors
and the study focused on evaluating the frequency with which cases of fraud occur.
The respondents agreed that the existence of internal audits significantly affects the
prevention of disclosing fraudulent financial information. The following measures are
proposed in order to reduce fraud cases: job rotation; training managers and
employees concerning fraud; an anonymous system for reporting fraud cases;
external audits to check financial statements; an independent audit committee; and a
code of conduct.

5
 Kassem and Higson (2016) aimed to examine the responsibility of external
auditors in the context of corporate corruption and to underline the consequences of
seeking external auditors’ advice. The results showed that external auditors are
responsible for estimating fraud risks, but that their role has not yet been clearly
defined by the external audit authorities. Othmana et al. (2015) examined ways to
detect and prevent fraud in the public sector in Malaysia. The results showed that the
most efficient procedures for detecting and preventing cases of fraud are the
following: strong audit committees; internal audit; job rotation; and a hotline for
reporting fraud. The study revealed that fraud cases are mainly detected through audit
procedures led by internal auditors.
More recently, due to the difficulty of detecting fraud in financial statements,
companies and researchers focus their studies into machine learning techniques (El-
Bannany et al., 2021) and prediction models (Erdogan and Erdogan, 2020). However
small and developing countries do not seem to follow this trend and act randomly
without strategy towards knowledge and technological support (Mustapha and Lai,
2017; Lois et al., 2019).

2.5 Results of internal audits

Initially, Chun (1997) focused on the functions of internal audits. Internal

audit has to be an independent procedure in the corporate environment based on
controlling and monitoring the internal audit system and providing it with useful
information to enable it to efficiently and properly carry out its duty.
Razali and Arshad (2014) examined the relationship between corporate
governance structures and the possibility of falsifying financial statements. Thusly,
the function of internal audits is one of the most powerful supervision mechanisms
within the framework of an efficient corporate governance system in an organisation.
To achieve efficiency in an internal audit, direct communication with the audit
committee is required. Moreover, the organisation should establish clear
interaction/communication between the procedures of internal audits and audit
committees. In this context, the importance of internal audits being independent is
evident. In the same year, Kamau et al. (2014) analysed, using a questionnaire, the
activities of internal auditors in Kenya. Internal auditors need the necessary

6
knowledge, skills, and other qualifications to accomplish their task. Finally, internal
audit activity should be free from interventions during its procedures.
Rudhani et al. (2017) analysed the factors that increase internal audit efficiency
in the public sector in relation to preventing the abuse of resources. The results
showed that efficiency is positively related to internal audit quality, the responsibility
of the internal audit team, independence, and support of the internal audit through
corporate governance. Moreover, the results showed that corporate governance is
extremely well informed about the needs of an audit but that it provides more support
for personal audit. The results confirmed that several factors (internal audit quality,
the responsibility of the internal audit team, independence, and support of the internal
audit through corporate governance) have a positive impact on the efficiency of
internal audits. Thus, an audit is efficient if its quality is adequate and if the audit
team has the competence, independence, and support to handle the task.
It should be mentioned that culture or geographical factors could also affect the
significance of the internal auditor in the detection of fraud. A study on banking
companies listed in the Indonesia stock exchange, argues that external auditors play a
small part in the detection of fraud in financial statements (Syahria, 2019). In
developing countries, factors reducing levels of fraud include loss of occupation, drop
in business sector capitalization, and criminal indictment, due to a country’s high rate
of unemployment (Shree B., 2020). In another example, Uwuigbe et al. (2019), when
investigating corporate governance and financial statement fraud among listed firms
in Nigeria suggest less emphasis on audit committee independence, board
composition and independent non-executive directors’ effectiveness.

2.6 Efficiency of audit committees

Agrawal and Chadha (2005) empirically examined whether specific corporate

governance mechanisms are related to the possibility of a corporation committing
fraud. Analysing a sample of corporations in the US, the results showed that many
main characteristics of corporate governance (such as independence of councils/audit
committees and services provided by external auditors) are not related to the
possibility a corporation falsifying financial information.
A decade later, Razali and Arshad (2014) examined the relationship between
corporate governance and the possibility of deliberate financial misinformation.

7
Analysing 227 listed companies in Malaysia for the year 2010–2011, the results
showed that the corporate governance structure reduces the possibility of fraudulent
financial misinformation. More specifically, the results demonstrated the significantly
negative relationship between the efficiency of the audit committee (and of internal
audit) and the independent non-executive bodies in relation to the possibility of
falsifying financial statements.
In the same year, Chukwunedu et al. (2014) studied the factors affecting the
quality of the audit committee. Based on responses from 52 accountants in Nigeria,
the results showed that the most significant factors affecting the quality of audit
committees are education and the number of members on an audit committee. More
specifically, the members of the audit committee should have three years of
experience in a similar position and participate in regular educational courses to
improve the quality of financial information. Moreover, the audit committee has to be
composed of at least three members, while the majority should be independent and
non-executive members. The least important factors in relation to preventing the
falsification of financial statements were the audit committee meetings with external
and internal auditors, as well as the frequency of audit committee meetings.
A year later, Persons (2015) developed a study to examine the importance of the
audit committee in relation to the possibility of a company committing fraud by
falsifying financial statements. Using a sample of 222 companies, 111 of which had
been victims of fraud, the results showed that the likelihood of fraud is lower in two
cases: when the audit committee is exclusively composed of independent members;
and when these members have fewer managerial responsibilities. The article also
concluded that the possibility of committing fraud is lower when the audit committee
has been in service for a long period of time and the CEO is not the chair of the board
of directors.
Subsequently, Inaam and Khamoussi (2016) examined the role of audit
committee efficiency and audit quality in providing correct financial information.
Using regression models for Tunisian corporations, the results showed that the
independence, size, and meeting frequency of the audit committee are significant
characteristics that improve its efficiency and quality. Consequently, these
characteristics have a negative relationship with the falsification of financial
statements. More specifically, the number of audit committee meetings is positively
related to better audit quality. In this way, employees are less able to perpetrate fraud.
8
Moreover, auditors with a long service record affect the independence of audit
committees, as the audit committee, which has a long-term relationship with the
external auditors, creates a trust bond with the auditor.
Shortly afterwards, Nuhul et al. (2017) examined the effect of audit committee
quality (members of the audit committee, audit committee meeting control, fiscal
expertise of the audit committee) regarding the financial performance of companies
listed on the Nigerian Stock Exchange (NSE). The results revealed a significantly
positive effect between audit committee meetings, financial expertise, and financial
performance. The audit committee would be more efficient, and the financial
performance of companies would be improved, if the majority of the audit committee
was characterised by financial expertise. They also concluded that the audit
committee meetings have a significantly positive effect on the financial performance
of corporations.
Finally, in a more recent study, Gebral et al. (2018) examined the impact that
the audit committee and the internal audit have on the quality of a corporation’s
financial information. Based on a sample of 71 non-financial corporations, findings
showed that the frequency of audit committee meetings and internal audits positively
affect the quality of financial information in a corporation. Further, an audit
committee that has more frequent meetings provides more efficient supervision of
financial information. Similarly, internal audit is considered a significant mechanism
in corporate governance for protecting the quality of financial information through
the monitoring of risks, the evaluation of the internal audit, and the detection of
potential errors.
In an everyday business routine, true independence between the audit committee
and financial management is difficult to achieve or maintained. For example the
mentoring and training responsibilities of an audit committee chairperson towards
newly appointed financial officer posses as a familiarity threat (Grange et al., 2021).

2.7 Theoretical framework

The term “fraud” refers to the intentional falsification of corporate financial

statements in order to create a false image in these statements (ACFΗ, 2017;
Harrison, 2015). Fraud is also defined as an act that is intentionally committed and
misleads through false financial statements, aiming to gain an unlawful advantage

9
over one or more individuals (ISA 240). Furthermore, the ACFE defines fraud as the
manipulation of information used in a widely published financial statement.
In all the above-mentioned definitions, the word “intentional” is used, as the
falsification of financial statements can occur in two cases: fraud; or error. While
fraud is intentional, error is unintentional. This distinction is, however, sometimes
hard to make, as the audit is not designed to define the intention. The auditor focuses
on the act that causes the falsification of financial statements, and not on its intention
(unintended or intended). However, the internal auditor has to take into consideration
the distinction between fraud and error while carrying out the procedures of the audit.
In this way, the auditor can define whether it is a fraud or an error. Recognising this
distinction relies on the auditor’s experience and knowledge.
The internal audit is a set of procedures that corporate governance applies in
order to protect its assets from waste, inefficiency, and fraud (Harrison, 2015).
Additionally, the ΙΙΑ defines internal audit as an independent and objective activity.
This activity is of a stabilising and advisory nature, being designed to add value and
to improve the function of an organisation. The internal audit can also assist the
organisation in achieving its goals by adopting a systematic and professional
approach for the evaluation and improvement of the risk management procedures as
well as of the system regarding internal audit and corporate governance.
The objective of the external audit is to express to what extent the data in the
financial statements are compliant with the authorities’ requirements and rules
regarding accounting standards.
The audit committee is considered a necessity in big corporations, since its
function, in accordance with the institutionalised principles and regulations, is to
defend shareholders’ interests (Okaro and Okafor, 2010). According to the IIA
(2013), the audit committee is responsible for supervising both the procedures of the
internal audit and the implementation of the internal audit systems.
The primary responsibility of the audit committee is to supervise the integrity of
financial statements, the efficiency of internal audits, and the monitoring of internal
and external audits (Mohammad, 2015). The committee has to cooperate with the
internal audit team in order to configure and implement the audit plan by mitigating
the risks that threaten the smooth operation of the organisation. A second task of the
committee is to ensure the independence of the internal audit unit in the context of
efficient corporate governance. Furthermore, the committee has to supervise the
10
external auditors and ensure that they maintain their independence and coordinate
internal and external audit in order to avoid any overlapping of tasks. The
responsibility of the committee is to inform the board of directors about all issues,
including the potential conflicts that may emerge between members of the board and
corporate interests. It is necessary that the internal and external auditors submit
proposals or recommendations to the corporate governance concerning areas of high
risk and confront any functional weaknesses that may have been detected.

3. Methodology

In the survey used in the current study, only listed corporations were selected, which
are obliged to have a department for internal audit. The questions used were derived
from the theoretical background, and the responses were gathered using a Likert-type
scale. The questionnaire investigated whether there had been a falsification of
financial statements in the corporation in which the respondents were working, and
how this falsification had been committed. Subsequently, the respondents were asked
to respond to a set of questions regarding the reasons for the falsification of financial
statements in a corporation. The next section in the questionnaire referred to the
education and training of external auditors regarding financial fraud. Finally, the
efficiency of internal audits and the factors that affect the efficiency of an audit
committee were examined.

4. Results

4.1 Descriptive statistics

The survey sample comprised 62 individuals, of which 48 (77.4%) were male and
only 14 (22.6%) were female. The majority of the sample (51.6%) had more than 15
years of experience, and most possess a bachelor or master’s degree.
There was a statistically significant difference of opinion between respondents
with a doctoral degree and those with a bachelor or master’s degree (p=0.044), well
as graduates from institutes of vocational training (p=0.021). Individuals with a
doctoral degree had a more positive attitude towards internal and external audits. It
can be concluded that the positive attitude towards internal and external audits
increased respectively with the educational background and age.

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Table 1 Descriptive statistics

Very
None mild Mild Moderate Excessive
Reasons for falsification
Pressure in the corporate environment 8.1% 29.0% 29.0% 22.6% 11.3%
Unrealistic goals 24.2% 25.8% 35.5% 12.9% 1.6%
Many responsibilities and obligations 11.3% 21.0% 37.1% 17.7% 12.9%
compared to income
Inadequate audit system 37.7% 36.1% 21.3% 4.9% 0%
No extraordinary audits 19.4% 46.8% 19.4% 6.5% 8.1%
Deficiency in 29.0% 29.0% 24.2% 9.7% 8.1%
describing/distinguishing tasks
Financial/family difficulties 26.7% 18.3% 30.0% 21.7% 3.3%
External auditor’s competence
Experienced audit staff 1.6% 4.8% 32.3% 45.2% 16.1%
Auditors are trained regarding topics 1.6% 12.9% 33.9% 41.9% 9.7%
of fraud detection
Auditors are informed about the new 0% 8.1% 21.0% 45.2% 25.8%
provisions and laws
Auditors participate in vocational 6.5% 11.3% 32.3% 30.6% 19.4%
seminars
Auditors also have knowledge of 23.0% 14.8% 31.1% 31.1% 0%
psychology and statistics
Ways of detecting fraud
Internal audit 0.0% 3.3% 18.0% 54.1% 24.6%
External audit 0.0% 3.2% 17.7% 59.7% 19.4%
Employees’ suspicions 6.5% 21.0% 45.2% 16.1% 11.3%
Audit committee 0.0% 4.8% 46.8% 41.9% 6.5%
Other way 32.4% 27.0% 29.7% 0.0% 10.8%
Efficiency of internal audit
The internal auditor acts 1.6% 11.3% 29.0% 32.3% 25.8%
independently and impartially
The relations between auditors and 12.9% 22.6% 32.3% 27.4% 4.8%
employees are not friendly
The internal auditor has access to all 0% 4.8% 14.5% 37.1% 43.5%
data
If you notice something, you will 3.2% 6.5% 21.0% 48.4% 21.0%
inform the manager responsible for
internal audits
There is excellent cooperation 1.6% 1,6% 18.0% 59.0% 19.7%
between internal and external auditors
Efficiency of the audit committee
The meeting frequency of the 0% 6.5% 29.0% 46.8% 17.7%
members of the audit committee
The number of years served in audit 0% 14.5% 25.8% 45.2% 14.5%
committees
Communication between the board of 0% 0% 14.5% 53.2% 32.3%
directors/internal and
auditors/external auditors
The independence of the corporate 0% 3.2% 14.5% 30.6% 51.6%
governance members
The number of members in the audit 8.1% 14,5% 38.7% 27.4% 11.3%
committee

Regarding the falsification level of financial statements, 41.9% of the sample

stated that there has been no falsification of financial data in their corporate

12
environment, 58.1% stated that there had been very mild or mild falsifications in their
corporate environment, while none of the individuals thought that there had been an
excessive level of falsification. Concerning the means of committing financial
statement fraud, the most frequent ways highlighted were: improper valuations
(29%); virtual revenues (12.9%); and timing differences (11.3%). The independent
variables of the survey are presented in Table 1.
Concerning the reasons for which an individual may falsify financial statements,
39.9% highlighted pressure in the corporate environment. Furthermore, 37.7%
responded that the corporation in which they work does not provide adequate audit
systems, while 46.8% responded that there are no extraordinary audits. Finally, 60%
of the respondents answered that there are no deficiencies in describing tasks (on
either the “very mild” or “none” scale).
Regarding the efficiency of external audits, 61.3% thought that the corporation
in which they work employs an experienced audit staff. A total of 51.6% stated that
the auditors are moderately trained regarding topics of fraud detection. A high rate of
71% stated that auditors are moderately informed regarding the new provisions and
laws. A total of 50% stated that external auditors participate in vocational seminars.
Finally, 31.1% stated that external auditors have moderate knowledge of more fields,
such as statistics and psychology.
Regarding the ways of detecting fraud, 88.7% thought that internal audits can
help in detecting fraud. Similarly, 79.1% stated that external audits assist in fraud
detection. Only 48.4% thought that fraud can be detected by the audit committee,
while 45.2% stated that employees’ suspicions are “mildly” helpful in this regard.
Regarding the efficiency of internal audits, 58.1% of the sample stated that
internal auditors act independently and impartially. In addition, 35.5% stated that
there are no friendly relations between auditors and employees. A significant
proportion (80.6%) stated that the internal auditor has moderate access to all the data
required. Moreover, 69.4% stated that the information level of those responsible for
internal audits plays a moderate role in cases where an employee notices and
highlights possible transgression, errors or parts of the process that require immediate
improvement. Finally, 78.7% “moderately” supported that the cooperation between
internal and external auditor is excellent.
Finally, regarding the efficiency of the audit committee, 64.5% thought that the
meeting frequency of the members of the audit committee affects efficiency.
13
Moreover, 85.8% stated that communication between the board of directors, internal
auditors, and external auditors “moderately” affects the efficiency of the audit
committee. Finally, the independence of the audit committee in relation to corporate
governance and the number of members were considered significant factors for the
efficiency of the audit committee.

4.2 Factor analysis

In order to check reliability, Cronbach’s alpha was used. Table 2 shows that the
factors ranged from 0.7 to over 0.8, thus demonstrating reliability. Subsequently,
factor analysis was performed (see Table 3).
The factors extracted can be categorised as “Reasons for falsification”,
“External auditor’s competence”, and “Ways of detecting fraud”.
Subsequently, two factors were revealed highlighted regarding fraud detection.
Regarding the efficiency of the internal audit, two factors were also revealed: the
“information level of the internal auditor” (documents, cooperation, informal
information) and the “level of friendship between auditors and employees”. The
analysis also underlined the importance of the factor “efficiency of the audit
committee”. Finally, the significance of internal audit in detecting fraud is underlined
based on the responses to this questionnaire.

Table 2 Cronbach’s alpha values for the questionnaire

Questionnaire section Cronbach’s alpha

Reasons for falsification 0.821
External auditor’s competence 0.885
Way to detect fraud 0.693
Efficiency of internal auditor 0.697
Efficiency of audit committee 0.648

Table 3 Factor analysis

Factor Factor loading

Reasons for falsification

Pressure in corporate environment 0.802

Inadequate audit system 0.802

Financial/family difficulties 0.785

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Deficiency in describing/distinguishing tasks 0.769

Unrealistic goals in corporation 0.681

Many responsibilities and obligations compared to income 0.612

No extraordinary audits 0.415

Auditor’s competence
Auditor’s educational courses regarding fraud detection 0.813

Participation in vocational seminars 0.891

Auditor should be aware of new provisions/laws 0.813

Experienced audit staff 0.720

Ways of detecting fraud A

Employee’s suspicion 0.859

External audit 0.836

Another way 0.655

Audit committee 0.515

Ways of detecting fraud B

Internal audit 0.797

Efficiency of internal audit

Access of the internal auditor to all the data 0.892

Cooperation between internal and external auditors 0.829

Informing the manager responsible for internal audit in case of 0.758

realising something
Efficiency of internal audit A
Friendship between auditors and employees 0.996

Efficiency of audit committee B

Level of independence from corporate governance 0.861

Level of communication between board of directors, internal 0.638

auditors, and external auditors

Number of the members in the audit committee 0.560

Number of years served in the audit committee 0.487

4.3 Correlation analysis

Initially, the study measures how an external auditor’s competence influences the
degree of falsification found in the financial statements. The results revealed that the
falsification level of financial statements has a statistically significantly negative
correlation, which can be characterised as mild, with the experience of audit staff
(rho=–0.410, p=0.001<0.05) and the level of participation in educational courses
(rho=–0.399, p=0.001<0.05). There is also a negative correlation, which can be

15
characterised as moderate, with the level of vocational training of auditors in relation
to detecting fraud (rho=–0.530, p=0.000<0.05). A negative but very mild correlation
was also revealed between the knowledge level of auditors regarding knowledge on
psychology (on psychological factors utilized in frauds) and statistics as control aids
(rho=–0.410, p=0.001<0.05).
Subsequently, the way in which the efficiency of internal auditor affects the
falsification level of financial statements was examined. The results showed that the
falsification level of financial statements has a significantly negative correlation,
which can be characterised as mild, with the independence level of the internal
auditor (rho=–0.470, p=0.000<0.05). There is also a negative correlation with the
friendship level between auditors and employees (rho=–0.012, p=0.012<0.05), while
a negative and strong correlation was found between the information level of those
responsible for the internal audit (in this case, an employee suspecting irregularities
or transgressions) (rho=–0.508, p=0.000<0.05) and the level of cooperation between
internal and external auditors (rho=–0.657, p=0.000<0.05).
Finally, no statistically significant correlation was found between the efficiency
of the audit committee and the falsification level of financial statements.

4.4 Regression analysis

Linear regression analysis revealed significant results for the variables concerning the
reasons for falsification, the competence of external auditors, and the efficiency of
internal auditors and of audit committees.
Initially, a linear model was created, with the final model including the
following variables: pressure in the corporate environment; unrealistic corporate
goals; competence of external auditors (new continuous variable); efficiency of
internal auditors (new continuous variable); and efficiency of audit committees (new
continuous variable). The results of the fourth and final model are presented in Table
4.
The final model demonstrates that 95.8% of the sample is statistically
significant (F=126,532, p=0.000<0.05) and includes three variables: pressure in the
corporate environment; degree of achieving corporate goals; and competence of
external auditors. These three variables have a statistically significant impact on the
model’s precision.

16
Table 4 Fourth model

Unstandardised Standardised
coefficients coefficients

Std.
Model B Error Beta t Sig.
Pressure in corporate environment ,268 ,066 ,478 4.056 ,000

The goals of the corporation are unrealistic ,189 ,076 ,277 2.488 ,016

External auditor’s competence ,228 ,099 ,489 2.314 ,024

5. Discussion

According to the research results, 41.9% of the sample stated that there had been no
instances of falsifying financial statements in their corporate environment, while
58.1% stated that the corporation had committed falsification on a very mild/mild
scale, primarily through two means: improper valuations; and virtual revenues. These
results are in accordance with the results of previous studies conducted by Zagera et
al. (2016) and Deloitte (2009). However, the results contradict those of Ghazali et al.
(2014) and Ziegenfuss (1996). In these cases, the most frequent ways of falsifying
financial statements were the misappropriation of capital and false allegations. The
findings of the present research reinforce the importance of audits. However,
incidences of improper valuations require not only strengthening the audit system and
the controls used but also utilising modern technology for reducing incidences of
mismanagement. This option should be enforced in cases where public authorities are
aiming to achieve and maintain the level of sophistication required. This in turn
implies the provision of training for public servants and their respective state
agencies.
Concerning the reasons behind misrepresentation, the pressure in a corporate
environment with low income is more significant in comparison to pressure in a
corporate environment with high income (33.9% vs 30.6%). The inadequate audit
system is also another minor cause. In previous studies, the main reasons were found
to be bad management techniques, together with financial pressure (Zulkurnai et al.,
2006), improper audits, and the auditors feeling unjustly treated or underestimated in

17
their work environment (Reynolds, 2018). This new perspective demonstrates the
possible evolution in an auditor’s line of work. However, knowledge management
and emotional corporate maturity are needed to help in the application of audit
techniques in a more proactive and efficient way in order to avoid burnout and
psychological stress among employees and management.
Moreover, internal and external audits play a vital role in detecting fraud (78.7%
and 79.1%, respectively). According to these results, internal audit is an important
way of detecting fraud. Thus, the preservation of the internal audit procedures within
the organisational framework is a highly efficient option, in combination with the
external audit or other control mechanisms for fraud detection. These results are in
accordance with those of Ghazali et al. (2014) and Coram et al. (2008). Furthermore,
it was observed that the educational background of an individual has a positive
impact on her/his belief concerning internal and external audits as ways of detecting
fraud. This was expected since, in socioeconomic terms, more corporations and their
employees are in touch with world markets and aware of their regulations.
In this research, the efficiency of an external audit was found to depend mainly
on the awareness of new provisions and laws, educational background, and several
years’ experience. Concerning the efficiency of internal audit, it seems that this
depends on cooperation between internal and external auditors, as well as on the
availability of corporate data and information. This result contradicts that of Rudhani
et al (2017), who concluded that good communication between internal and external
auditors of little significance. On the other hand, Kamau et al. (2014) concluded that
the most important factor is the independence of the internal audit. These results
could differ depending on geographical factors and should be further investigated.
However, is indisputable that internal and external auditors must work cooperatively
in order to ensure the disclosure and accuracy of information.
Finally, it was revealed that the most significant factors affecting the efficiency
of the audit committee are communication between the board of directors and internal
and external auditors, as well as appropriate levels of independence for members of
the audit committee from the corporate governance structure. These results are in line
with those of Persons (2015) and Inaam and Khamoussi (2016), while they contradict
those of Chukwunedu et al. (2014), who found that the efficiency of the audit
committee is mainly affected by educational background, service, and number of
members, and not by audit committee meetings with external and internal auditors.
18
 However, an interesting finding from Bitter et al., (2021) demonstrates that
communication also includes statements of accounting and non-accounting experts
and in particular the written statements in financial statement disclosures. The
research was based on the lack of rational basis standard directly incorporated into
accounting or auditing literature. The authors argue the significance of accounting
guidance updates towards sample language incorporated into audit standards. This
would protect the auditors, their client, but also enhance the quality of the audit and
the information provided to users of financial statements and registration statements.
On the other hand, debates regarding the importance of meetings and
cooperation have been a controversial issue; the communication of information is
vital on a variety of corporate levels. Balancing information, managerial goals, and
working conditions is an issue of critical importance, considering the changes in
technology and the availability of information. Furthermore, following worldwide
incidents affecting welfare and health issues, it is understandable that corporations
have had to change their immediate goals, as well as the procedures for achieving
these goals. Although audit and finance (from their respective perspectives) allow
corporations to disclose their financial position, the external environment of a
corporation can change, leading to unpredictability by traditional management
standards. Therefore, it is possible that further investigation is needed, especially
regarding the utilisation of risk management and the latter’s possible interaction with
auditing.

6. Conclusion

Evidently, the training and experience of auditors are key in reducing the incidence of
financial statements falsifications and the detection of attempted fraud. On the other
hand, although mild, the relationship among work environment factors and their
effect on the auditors’ quality of work is important. However, the mild negative
correlation between falsification and an internal auditor’s independence highlights an
important issue that should be investigated further. Cases of intercompany
relationships affecting and audit’s efficiency are expected. However, regarding the
audit committee, few results of significance could be found regarding auditors’
difficulty of performing freely. The three most significant variables affecting

19
falsification and the audit’s efficiency were found to be: pressure from the corporate
environment; unrealistic corporate goals; and external auditors’ competence.

7. Future research

The factors revealed in this research raise some interesting questions regarding
management and the goals it sets. Further investigation is required on the effect that
the pressure imposed on auditors has on the quality and efficiency of audits, as well
as financial statement misrepresentation. The origin of these factors could open up
new research affecting broader concepts than managerial decisions.

8. Research limitations

Although highly trained and experienced respondents expressed their point of view,
the results demonstrate moderation in their answers. It is possible that further
investigations using human resources as a basis for a future approach may prove to be
informative regarding intercompany relationships and management and audit
efficiency.

9. Research implications (academic and market-oriented)

This research has highlighted an aspect of audit that has not been sufficiently
investigated. The association of auditors with management and colleagues, as well as
the possibly unrealistic goals that auditors are expected to achieve, can create a
system with seemingly overlapping areas. Dealing with the human factor in business
is a sensitive issue, especially given the constant evolution of technology and the risk
of cyber-attacks. The preparedness of a company is based on the ability and ethics of
all its employees, regardless of position. This research opens up topics for further
discussion in the field of applied ethics and optimal cooperation.

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