The distinction between aggressive accounting and financial reporting fraud: Perceptions of auditors

Abstract

The ability to distinguish between aggressive earnings management (aggressive accounting) and financial reporting fraud (fraud) is an essential characteristic for auditors in fulfilling their responsibilities. Yet little is known of how auditors make this distinction in practice. Perhaps due to the ambiguity in defining where aggressive accounting ends and fraud begins, few studies have attempted to investigate the distinction between the two types of financial manipulation. This current research provides evidence as to how auditors distinguish between aggressive accounting and fraud in practice. Specifically, this study examines which factors auditors invoke in determining whether an identified financial manipulation constitutes aggressive accounting or fraudulent accounting. Findings from interviews with senior auditors suggest these factors include managerial intent, compliance with Generally Accepted Accounting Principles, materiality level, and measurement subjectivity. Research findings have the potential to alleviate some of the ambiguity associated with distinguishing between aggressive and fraudulent accounting. As such, this study contributes to the earnings management, financial reporting fraud, and audit judgement research literatures