Allocating audit resources to detect fraud

This paper addresses how to allocate audit resources across different auditable units when misstatements may occur in any or all of the units. We consider two benchmark scenarios. In the first, the extent of overstatement affects only the cost of detection, but not the effectiveness of audit inputs in determining the likelihood of detection. In the second, overstatement directly affects the likelihood of detection but not audit cost. In a two location setting, if overstatement affects only audit effectiveness, the realized value at one location has no impact on the reported value at the other. In addition, the auditor allocates an identical amount of audit resources to each location. In contrast, if overstatement affects only audit cost, the agent’s reporting strategy reflects interdependencies between both realized values and audit costs across locations.