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JFC
28,3 The scope and limitations of
external audit in detecting frauds
in company’s operations
632 Dragomir Dimitrijevic and Biljana Jovkovic
Department of Economics, Faculty of Economics, University of Kragujevac,
Kragujevac, Serbia, and
Suncica Milutinovic
Faculty of Economics Subotica, University of Novi Sad, Subotica, Serbia

Abstract
Purpose – This study aims to investigate what are the capabilities and limits of external audit in detecting
frauds in companies operating in the territory of the Republics: Serbia, Croatia, Macedonia and Bosnia and
Herzegovina.
Design/methodology/approach – In total, 51 certified auditors from Serbia, Croatia, Macedonia
and Bosnia and Herzegovina were surveyed to analyze what are the most frequent warning signals of
the existence of the frauds auditors encounter during the verification of company’s financial
statements.
Findings – The study indicated that the auditors of the Republic of Serbia more often encountered
groundless overstatement of revenues compared with other countries, while regarding manipulative
representation of inventories, the largest mean value and median are still among the auditors of the Republic
of Serbia.
Practical implications – Based on the research results, it can be concluded that it is necessary to expand
the legal obligation and power of external auditors when, in financial statement auditing, they come to clear
findings that indicate fraud. Expansion of external auditors’ powers would reduce their current limitations
and expand the domain of action.
Originality/value – Limitations in external auditors’ work prevent the processing of frauds. However,
auditors’ analysis of financial statements and pointing to potential irregularities can be a good manner for the
early detection and prevention of frauds in company’s operations.
Keywords Fraud, Financial statements, External audit, Early signals
Paper type Research paper

1. Introduction
Financial statements contain information used by a number of external and internal
stakeholders for making many business decisions. For this reason, financial statements
must be true and objective and need to show the real picture of financial situation and
earning power of a company. However, due to various manipulations in practice, distorting

© Dragomir Dimitrijevic, Biljana Jovkovic and Suncica Milutinovic. Published by Emerald

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Vol. 28 No. 3, 2021
pp. 632-646 both commercial and non-commercial purposes), subject to full attribution to the original publication
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1359-0790
DOI 10.1108/JFC-11-2019-0155 legalcode
of financial statement quality is not rare. Responsibility for the preparation and quality of External audit
financial statements belongs to the company’s managers and persons responsible for the
preparation and presentation of financial statements. To increase customer confidence in the
quality of financial statements, it is necessary that independent, external persons, review
the statements and give an opinion on their quality. This is precisely the role and task of the
external audit. The main objective of financial statement audit is the expression of an
auditor’s opinion on whether the statements are properly prepared in all material respects,
that is to say whether they are true and objective. To express an opinion on the accuracy of
633
financial statements, it is necessary that the auditor is satisfied as to the accuracy of all
balance sheet items in financial statements and in the disclosure of other relevant
information by the management (Jovkovi
c, 2014). As auditors do not check all transactions,
but use sampling methods, they cannot provide absolute assurance that financial
statements are free of material misstatement (Jovkovi
c, 2009). The responsibility of the
auditor for the prevention, detection and reporting of fraud, other illegal acts and errors is
one of the most controversial aspects of auditing (Gay et al., 1997). First responders are the
team that comes into action when a crisis situation is unfolding or is expected to take place.
It may seem strange to consider auditors as first responders. As first responders, auditors
must take the appropriate actions to identify the fraud, stabilize the situation and prevent
continuing resource losses for their client (Smith, 2012).
Manipulations significantly reduce the quality of the information contained in financial
statements; therefore, the subject of the research in the paper is the analysis of most common
types of manipulations in balance sheets and income statements auditors encountered in the
Republics: Serbia, Croatia, Macedonia and Bosnia and Herzegovina during the conduct of
the audit process, as well as the types of tests they found most helpful in detecting
irregularities. Detecting in which balance sheet and income statement items auditors most
often discovered manipulations is an important source of information that can help, not only
to facilitate the detection of manipulation, but also to prevent them in the future. The main
objective of the research is to investigate what are the capabilities and limits of external
audit in detecting manipulations in companies operating in the territory of the Republics:
Serbia, Croatia, Macedonia and Bosnia and Herzegovina, as well as acquiring basic
knowledge about the types and methods of manipulation in financial statements auditors
face in their work.

2. Literature review
The concept of manipulation was dealt with by many authors. “Manipulation is intentional
misstatement or concealment of material fact” (Carmichael et al., 1996, p. 72). One of the first
to deal with responsibility for manipulation in financial statements was Emile Woolf, citing:
[. . .] the attitude adopted in SAS-140 quite reasonably addresses the responsibility for detecting
manipulation to auditors, if they are material to financial statements and therefore directly impact
the auditor’s report on the truthfulness and fairness of financial statements. It can be argued that
manipulation, if any, significantly impacts account balances – which are certainly important for
true presentation of financial statements as a whole Woolf (1997, pp. 385-386).
Financial statement manipulation (FSF) is costly for investors and can damage the
credibility of the audit profession. To prevent and detect manipulation, it is helpful to know
its causes (Wuerges and Borba, 2014). There are various methods for performing
manipulation in financial statements: manipulation, falsification, concealment and alteration
of accounting records or supporting documents from which financial statements are
prepared, misrepresentation in or intentional omission from the financial statements of
JFC events, transactions or other significant information, misapplication of accounting
28,3 principles and inappropriate classification or disclosure in balance sheet items
(Ljubisavljevi
c, 2013).
An important place in the literature, in the field of audit, refers to the question of who are
the perpetrators of manipulations in accounting. Obtaining the answer to this question is
significant, as efforts toward the prevention and detection of manipulation could be more
634 effective if they were focused on a specific area, i.e. hierarchical position in the company. In
other words, the internal control of financial reporting should be directed particularly
toward the employees who are prone to manipulation. Many manipulations that have been
investigated by the SEC – Securities and Exchange Commission – in the USA were
performed by the top management (Jovkovi
c, 2013). Under the patronage of the COSO – The
Committee of Sponsoring Organizations of the Treadway Commission, a research on
the perpetrators of the manipulation “False Financial Reporting: 1987-1997” and “False
Financial Reporting: 1998-2007” was carried out. According to the first research, managing
directors and chief financial officers (CFOs) were mentioned as perpetrators of accounting
manipulations in 83 per cent of cases considered, and in 89 per cent in the second research.
False financial reporting was directed to improper revenue recognition (in 50 per cent of
cases in the first and 60 per cent in the second research), overstatement of assets and
improper capitalization of expenses. The first research included 294, and the second 347
cases of manipulation under investigation by the SEC (Beasley et al., 2010). The importance
of truthful financial reporting and the absence of manipulation in companies are emphasized
by persons interested in the general state of company’s operations, by current and potential
investors. Their interest in quality financial statements is primary in relation to the other
users of audited financial statements (Gackowski, 2017).
However, when it comes to manipulations, audit is not the main verification activity.
Authors Klikovac and Tušek explored the possibility of a new discipline – forensic audit in
manipulation investigation. They defined forensic audit as:
[. . .] an extensive investigation of accounting and other records conducted by an independent and
qualified persons in order to detect manipulation or remove suspicion of the occurrence of
manipulation, wherein the evidence is collected, usable in the court case and presented to the court
by an examiner if necessary (Tušek and Klikovac, 2013, p. 104).
The quality of financial statements and capabilities of audit to meet the expectations and
requirements of both the profession and users were significantly wavered by numerous
finance scandals that have escalated at the end of the past and at the beginning of this
century. There are many authors who have talked about the major accounting scandals in
the past decade. An auditor’s role and responsibility for the discovery of manipulation in
financial statements, with the adoption of SOX Act of 2000, was aimed at reducing
manipulation in the future (Albrecht et al., 2008). To detect manipulation, a research was
carried out on a sample of 76 Greek companies by calculating more than ten financial
indicators. The results of the work indicated that the analysis of financial indicators,
obtained as a ratio between the items (indebtedness, inventory turnover, net income/
revenue, etc.), can be useful for identifying falsified financial statements and the like
(Spathis et al., 2002).
The initial failure in detecting manipulation, or difficulties in detecting it, is due to not
applying auditor skepticism, stressed Pomeranz. “Detecting manipulation in balance sheet
items requires an optimal level of auditors’ professional scepticism” (Pomeranz, 1995, p. 17).
Managers are responsible for the prevention and detection of manipulation, but can also be
the primary perpetrators of it. The author states that it cannot be expected to provide
absolute assurance that the auditor discovered and identified all material errors. Tort (2008) External audit
In addition, the auditors themselves deviate from the requirements of International
Standards on Auditing 700-701 in their audit reports, from formal and substantive aspects.
The author’s research leads to the conclusion that continuing education and practice
development of auditors are necessary (Šapina and Ibrahimagic, 2011).

3. Methodology and hypotheses 635

The research was conducted on a sample of 51 respondents from four countries, namely, the
Republics: Serbia, Croatia, Macedonia and Bosnia and Herzegovina. The data were collected
by questionnaires. Survey is sent to certify external auditors employed in registered
auditing agencies, and they were contacted via e-mail. We contacted more than 200 external
audits in the above-mentioned Republics. All respondents are persons who have been
performing auditing activities in different positions for a number of years.
Because of the large amount of data in the paper, statistical program IBM SPSS Statistics
was used. Descriptive analysis was performed using the SPSS, and as for the tests, we
carried out analysis using the Kruskal–Wallis test as a non-parametric test, while one-way
analysis of variance was used as a parametric test. To collect data, survey method was
performed in the paper. The survey contained 16 questions, of which the first two are open-
ended questions, while 13 are closed-ended questions in which we used five-point Likert
scale (from 1 – hardly ever to 5 – very often). In the last question, the respondents were
asked to indicate which of the tests were the most helpful in disclosing irregularities in
financial statements. h 2, which is one of the most frequently used indicators of effect size,
shall be calculated for the obtained statistically significant results. In some cases, especially
when a sample is large, even small differences observed within a group could be statistically
significant. Therefore, by calculating h 2, the actual effect of differences between groups can
be seen. Based on defined goals and subjects of the research in the paper, the following
hypotheses of which the research starts are set:

H1. External audit of company’s financial statements, as an independent form of

examination, does not lead to successful and constant detection and prevention of
manipulations in a company’s operations.
H2. The appropriate use of in-depth tests of transactions is an important method for
detecting irregularities in a company’s financial statements.

4. Research results
The survey is composed of three parts; the first part that examines whether the auditors in
general have encountered some irregularities, and if these irregularities were of material or
fundamental significance. The second part of the survey considers whether auditors in their
work encountered an unreasonable overestimation, underestimation or manipulation of
various balance sheet items (income, expense, assets, liabilities, receivables, cash,
inventories and cash flows). The last question in the survey is about the tests that most often
helped auditors discover irregularities in financial statements. Table I shows the number of
respondents by countries and percentage structure of the total number of surveyed auditors.
Responses to the questions regarding responsibilities of surveyed auditors in a team and
their years of work experience have shown that in all the countries, surveyed auditors are
mostly in managerial positions in a team and that an auditor’s average work experience is
approximately 16 years.
JFC Analyzing the responses to the first question: “How often do you encounter irregularities
28,3 in the process of financial statement auditing?” according to the data obtained, we found
that the largest number of respondents (47.06 per cent) said that they often encountered
certain irregularities in the performance of the audit process. The rest of the respondents
said: occasionally 27.45 per cent, very often 21.57 per cent, while only 3.92 per cent said
rarely and hardly ever, as shown in Table II.
636 The next two questions are to enable the analysis of whether the irregularities, which
surveyed auditors noticed in their work, are of material or fundamental significance.
Omissions or misstatements of items are material (significant) if they could, individually or
together, impact economic decisions that users make on the basis of financial statements
(International Accounting Standard [IAS] 8, 2009). Fundamental errors (after revising IAS 8,
this concept was replaced with “prior period errors”) are omitted or misstated data from an
entity’s financial statements for one or more periods arising from non-use or misuse of
reliable information (International Accounting Standard (IAS) 8, 2009). Most of respondents
said that they occasionally encountered both materially and fundamentally significant
irregularities. In terms of percentage, 52.94 per cent of the respondents gave this response.
There are differences in the responses of other respondents. By calculating the arithmetic
mean, it was concluded that larger number of respondents more often encountered
irregularities that were materially significant, rather than of fundamental significance, as
shown in Table III.
Manipulations can be achieved using many elements of financial statements, but the
practice has shown that the manipulations of revenues and expenses in income statements
are most frequently used in the realization of manipulations in financial statements
(Dimitrijevi
c, 2013).
The next four questions analyzed the situations in which auditors encountered certain
irregularities regarding income statement items, i.e. whether they encountered groundless
overstatement/understatement of revenues item and/or groundless overstatement/
understatement of expenses item. The survey showed that 43.10 per cent of the respondents

Country No. of respondents % of the respondents

Republic of Serbia 32 62.75

Republic of Croatia 13 25.49
Republic of Bosnia and Herzegovina 4 7.84
Table I. Republic of Macedonia 2 3.92
Structure of Total 51 100
respondents by the
country of origin Source: Authors

Table II. No. of respondents (%) Cumulative (%)

Structure of
respondents 1 – very rarely 1 1.96 1.96
according to the 2 – rarely 1 1.96 3.92
3 – sometimes 14 27.45 31.37
frequency of 4 – often 24 47.06 78.43
irregularities 5 – very often 11 21.57 100
encountered in the
auditing process Source: Authors
stated that they occasionally encountered groundless overstatement of revenues, and 33.30 External audit
per cent said rarely. On the other hand, 35.30 per cent of the respondents said they rarely or
occasionally came upon understatement of revenues. By comparing the responses, it can be
seen that majority of respondents stated they often encountered manipulative presentation
of revenues, i.e. their overstatement. By manipulating expenses, the company’s management
wants to show the best possible image of company’s operations, in other words, to reduce or
to cover expenses so that the company would seem more profitable and more liquid 637
(Dimitrijevi
c, 2012). As for the expenses, the respondents more often encountered situations
in which there were understatements of expenses. About 41.2 per cent of the respondents
said they rarely came upon overstatement of expenses, but 45.10 per cent of the respondents
responded that they sometimes or often came across overstatement of expenses. Regarding
understatement of expenses, 33 per cent occasionally encountered manipulation of expenses,
and when we add the answers of the respondents who often encountered understatement of
expenses to this percentage, it amounts to 56.5 per cent of respondents. It must be noted that
the respondents more often encountered groundless misrepresentation of expenses item
rather than revenue item in the performance of the audit process, which can be seen in
obtained arithmetic means. Table IV shows the obtained results for manipulative
representation of revenues and expenses.
After analyzing income statement items, there are also questions concerning balance
sheet items, specifically whether the auditors during the audit of financial statements

Table III.
Fundamentally significant Structure of
Materially significant irregularities irregularities respondents
No. of respondents (%) No. of respondents (%) according to the
evaluation of
1 – very rarely 1 1.96 5 9.80
2 – rarely 4 7.84 10 19.61 whether the
3 – sometimes 27 52.94 27 52.94 irregularities they
4 – often 14 27.45 5 9.80 encountered in the
5 – very often 5 9.80 4 7.84 auditing process are
Arithmetic mean 3.35 2.86 materially or
fundamentally
Source: Authors significant

Manipulative representation of revenue Manipulative representation of expense

Overstatement Understatements Overstatement Understatements
No. of No. of No. of No. of
respondents (%) respondents (%) respondents (%) respondents (%)
Table IV.
1 – very rarely 4 7.80 8 15.00 6 11.80 4 7.80 Structure of
2 – rarely 17 33.30 18 35.30 21 41.20 15 29.40 respondents
3 – sometimes 22 43.10 18 35.30 16 31.40 17 33.00 according to the
4 – often 6 11.80 6 11.80 17 13.70 12 23.50 evaluation of
5 – very often 2 3.90 1 2.00 1 2.00 3 5.90
Arithmetic 2.71 2.49 2.53 2.90
manipulative
mean representation of
revenue and expense
Source: Authors items
JFC encountered misrepresentation (manipulative representation) of assets, liabilities and
28,3 accounts receivable items. Manipulations in balance sheets are directly or indirectly
associated with the manipulations of revenues and expenses in income statements and cash
flows in cash flow statements. In other words, it is impossible to manipulate individual
elements of balance sheet without affecting expenses and revenues (Dimitrijevi
c, 2015). Of
the total respondents, 39.22 per cent occasionally encountered manipulative representation
638 of assets and accounts receivable items, and 47.10 per cent of liabilities. Susceptibility to
manipulations related to liabilities is even greater if manipulationulent operations can be
transferred to balance sheets and income statements. Different liabilities offer different
options for manipulating (Milojevi
c, 2010). Despite this, of the three items, the respondents
found least irregularities in the liabilities item, and most in accounts receivable item, as
indicated by the obtained arithmetic mean. The reason why most irregularities are found in
the accounts receivable item could be associated with manipulative overstatement of
revenues. In terms of audit, from the aspect of evidence, entries in accounts receivable item
are created on the basis of internally created documents (sales invoices) created by a
company – audit client. The documents are kept in the company; therefore, the easiness of
performing manipulation seems logical as opposed to the entries in the liabilities item
created on the basis of externally created documents (purchase invoices). Practice has shown
that fictitious revenues are one of the most common forms of manipulationulent financial
reporting, which are usually achieved by entering non-existent revenues, entering sales to
non-existent customers or entering false sales to existing customers (Jones, 2011). The
obtained results for the three balance sheet items are presented in Table V.
Assets, liabilities and accounts receivable are the most common categories of balance
sheets that are the subject of manipulations. On the other hand, the other balance sheet items
could also be the subject of manipulations; therefore, the following questions served to
analyze the possibilities of misrepresentation (manipulative representation) of cash and
inventories, as well as cash flows represented in a separate statement. Numerous cases of
manipulation in companies all around the world have indicated that cash, as the most liquid
form of company’s assets, was the subject of frequent misappropriation. Manipulations with
cash imply taking cash from the employer, and according to the statistics of the Association
of Certified Manipulation Examiners – ACFE, manipulations with cash prevail in the
category of appropriation of funds (Singleton et al., 2006). However, this manipulation is
difficult to detect when considering a company’s financial statements. For these reasons,
even 52.94 per cent of the respondents responded that they hardly ever encountered
manipulative representation of these balance sheet items, and 43.14 per cent of respondents
said rarely. The audit of inventories is the most complex part of the audit process, especially

Manipulative representation Manipulative representation Manipulative representation of

Table V. of assets of liabilities accounts receivable
Structure of No. of respondents (%) No. of respondents (%) No. of respondents (%)
respondents
according to the 1 – very rarely 8 15.69 6 11.76 2 3.92
evaluation of 2 – rarely 8 15.69 13 25.49 10 19.61
manipulative 3 – sometimes 20 39.22 24 47.10 20 39.22
4 – often 13 25.49 7 13.72 14 27.45
representation of 5 – very often 2 3.92 1 1.96 5 9.80
assets, liabilities and Arithmetic mean 2.86 2.69 3.20
accounts receivable
items Source: Authors
due to the occurrence of obsolete inventory. It is necessary to determine whether all External audit
inventories are registered and whether all registered inventories actually exist, which is
often not possible. It should be noted that, according to the legislation and the International
Auditing Standards, auditors are required to observe the inventory count. However,
although they are required, the auditors are often not in the company at the time of
inventory count, which creates great opportunities for manipulations. The research results
indicate that even 47.10 per cent of the respondents occasionally encountered manipulative
representation in inventories item. Therefore, although cash is more suitable asset for 639
appropriation, in practice, the inventories item is more often manipulated.
Manipulations performed in cash flow statements are related to the manipulations of
operating activities. In the opinion of certain scholars, there are four main methods of cash
flow manipulations in companies, such as: transferring an inflow from financial activities to
an inflow from operating activities, transferring outflows from operating activities to
outflows from investing activities, inflating cash flows from operating activities using
acquisitions or selling a part of or the whole company and increasing cash flows from
operating activities using additional “auxiliary” activities (Schilit and Perler, 2010). Cash
flow manipulations are very rare in practice. This fact may be the result of either being
difficult to hide these manipulations or being difficult to detect them in the investigation and
control of financial statements. This is exactly what the research results indicated, as even
54.90 per cent of the respondents said that they rarely encountered misrepresentation of
cash flow item, and 17.65 per cent of respondents said hardly ever and occasionally. All of
the above data on the manipulations with the items of cash, inventories and cash flows are
represented in Table VI.
Summarized results for all of the aforementioned questions are given in Figure 1. The
results show that respondents most often encountered irregularities regarding accounts
receivable and inventories, and least often regarding cash. If we consider the items by
statements, it is evident that balance sheet items were more manipulated. However, we
should not forget that it is impossible to manipulate a certain item in income statement
without directly or indirectly affecting the items in other financial statements.
The last question in the survey is about the tests that most often helped auditors discover
irregularities in financial statements. They were offered to circle the following answers:
sampling tests, in-depth tests of transactions, the tests of weaknesses in internal control/
selected sample and the tests of auditor’s belief confirmation. After analyzing and
processing the responses respondents gave to the last question in the survey, it was
concluded that the most effective test for detecting irregularities in financial statements is

Manipulative
Manipulative Manipulative representation representation of
representation of cash of inventories cash flow
No. of respondents (%) No. of respondents (%) No. of respondents (%) Table VI.
Structure of
1 – very rarely 27 52.94 2 3.92 9 17.65 respondents
2 – rarely 22 43.14 13 25.49 28 54.90 according to the
3 – sometimes 2 3.92 24 47.10 9 17.65 evaluation of
4 – often – – 7 13.72 3 5.88
5 – very often – – 5 9.80 2 3.92
manipulative
Arithmetic mean 1.51 3.00 2.24 representation of
cash, inventories and
Source: Authors cash flow items
JFC
28,3

640

Figure 1.
Percentage share of
irregularities by all
financial statement
items

the in-depth test of transactions with 44.44 per cent. The tests of transactions deal with the
processing of certain transactions in the accounting system, entries or documentation are
tested, i.e. whether the transactions are appropriately encompassed, and they are usually
conducted before the end of the year, prior to account balance testing (Jovkovi
c, 2011). These
tests show whether the data is reliable and whether it is necessary to increase or decrease
the checks to obtain enough evidence to substantiate auditor’s opinion. Sampling tests with
23.61 per cent are the second tests that help detect irregularities in financial statements.
Without sampling, auditors would have to check all transactions in the company. Sampling
enables the auditor’s belief to be founded on sufficient and reliable evidence, which could not
be found easy and cost-effective without the selected samples (Jovkovi
c, 2010). Figure 2
shows the obtained results for all four tests.
Kruskal–Wallis test was conducted in the research, as a nonparametric test, to examine
whether there are differences between different types of manipulations in financial
statements that auditors most often encountered when performing the audit process,
grouped by countries. This test is used for comparing the results of a continuous variable for
three or more groups (Pallant, 2011). As a categorically independent variable, we used a

Figure 2.
Frequency of certain
tests in detecting
irregularities
country, from which we obtained answers, with its four categories: the Republic of Serbia, External audit
the Republic of Croatia, the Republic of Bosnia and Herzegovina and the Republic of
Macedonia. As a dependent variable, various types of manipulations were used. Based on
these results, the only statistically significant differences are between the types of
manipulations between the countries regarding groundless overstatement of revenues and
misrepresentation of inventories item. For a statistically significant difference to exist, it is
necessary that the significance level is less than or equal to 0.05. The significance level of
groundless overstatement of revenues is 0.008, and of misrepresentation of inventories 0.03.
641
This suggests that there are statistically significant differences between countries as
concerns these two groups of manipulations. To determine the country in which these kinds
of manipulations were carried out most often, it is necessary to compare their mean values of
responses ranking and median. The values are presented in Table VII.
Based on the data in Table VII, it can be seen that the highest mean value of ranking, as
well as median, is in relation to groundless overstatement of revenues in the Republic of
Serbia. This suggests that auditors in the Republic of Serbia often encounter groundless
overstatement of revenues compared with other countries. As concerns manipulative
representation of inventories item, although there is no large difference between the
Republic of Serbia and the Republic of Bosnia and Herzegovina, still, the highest mean and
median are among the auditors in the Republic of Serbia.
The same kind of test was repeated, but this time, we used years of experience in
auditing as the categories of independent variables. Subsequently, the responses were
grouped into three categories. The first group included responses from auditors who have
less than ten years’ experience in auditing, the second group includes auditors with
experience between 10 and 19 years, while the third group consists of auditors with more
than 20 years’ experience. In this test, the only statistically significant difference was in the
responses given by auditors to the question regarding irregularities in inventories item.
Concerning misrepresentation of inventories item, the significance level is 0.01. Additional
tests were conducted to determine which group of respondents most often encountered
irregularities in inventories item, as in the previous case. The test results are shown in
Table VIII.
The data in Table VIII suggest that the group of auditors with experience in auditing of
less than ten years most often responded that they encountered misrepresentation of
inventories item, in contrast to the auditors of 20 or more years’ experience in auditing.
There is a possibility that young auditors, with less work experience than other members of
the audit team, are mainly responsible for the audit of inventories.
One-way analysis of variance of different groups (ANOVA) was used as a parametric
alternative to Kruskal–Wallis test. The aim is to show whether there are differences between
Table VII.
Mean values of
ranking, average
Overstatement of revenues Misrepresentation of inventories values, and median
Country Mean values of ranking Median Mean values of ranking Median by different countries
regarding responses
Republic of Bosnia and Herzegovina 18.75 2.00 28.25 3.00 on groundless
Republic of Macedonia 7.75 1.50 5.25 1.50 overstatement of
Republic of Croatia 19.00 2.00 20.15 3.00 revenues and
Republic of Serbia 30.89 3.00 29.39 3.00
misrepresentation of
Source: Authors inventories item
JFC mean values regarding irregularities in financial statements between countries and to
28,3 calculate the size of the effect, if there are any statistically significant deviations. This test,
as well as the previous one, showed that there are statistically significant deviations of the
mean values (at the level of probability p < 0.05) between countries regarding questions on
irregularities concerning the overstatement of revenues and inventories, but also showed
that there are deviations concerning groundless overstatement of expenses.
642 This test showed that the largest deviations of the mean values regarding groundless
overstatement of revenues are between responses given by auditors of the Republic of
Serbia and the Republic of Macedonia. As for the misrepresentation of inventories item,
there is also a statistically significant difference, and the responses of auditors of the
Republic of Macedonia have the largest deviations of mean values in relation to other
countries. With a significance level of 0.03, there are also statistically significant differences
between countries based on the mean values of auditor’s responses to the question of
groundless overstatement of expenses. Statistically significant differences regarding
groundless overstatement of expenses can also be found between the responses of the
auditors from the Republic of Croatia on the one side, and the Republic of Macedonia and
Bosnia and Herzegovina on the other. The obtained mean values for all the four countries
can be found in Table IX.
To investigate the effect of deviations, it is necessary to calculate h 2, which is obtained
by dividing the sum of the squares of different groups’ deviations by the total sum of
squares. According to the value of obtained h 2, the effect size of deviation is determined.
Table X contains data on obtained h 2 for groundless overstatement of revenues, expenses
and manipulative representation of inventories item.
By implementing ANOVA of different groups, it was found that there were significant
statistical differences within the above-mentioned groups of independent variables. Only
after calculating h 2 can it be seen that the real effect of differences between the mean values

Table VIII.
Mean values of
ranking and median Misrepresentation of inventories
by different groups Years of experience in auditing Mean values of ranking Median
of experience in
auditing for <10 33.07 3.00
responses regarding 10-19 26.35 3.00
20þ 18.94 2.00
misrepresentation of
inventories item Source: Authors

Mean values of Mean values of Mean values of

overstatement overstatement misrepresentation
Country of revenues of expenses of inventories

Republic of Bosnia and Herzegovina 2.25 2.00 3.25

Republic of Macedonia 1.50 2.00 1.50
Republic of Croatia 2.31 3.15 2.62
Table IX. Republic of Serbia 3.00 2.38 3.22
Data on mean values
by different countries Source: Authors
of the groups is large. Effect sizes of 0.01, 0.06 and 0.14 are termed as small, medium and External audit
large, respectively. This confirms that in addition to statistically significant differences,
there is also a real large difference between the mean values of the responses of auditors
from different countries regarding these three questions.
Practice has shown that the perpetrators of manipulation cannot achieve
manipulation unless they manipulate, directly or indirectly, almost all financial
statement elements. The easiest to detect are the irregularities concerning revenues and
expenses as income statement elements, but practice has shown that all manipulations
643
impact the balance sheet and its elements (assets, liabilities, accounts receivable and
capital). All these irregularities do not necessarily mean that a manipulation has been
executed, but require further, more detailed control by the competent authority.
Therefore, the external audit cannot independently detect manipulations, but can only
point to the existence of doubt on manipulation execution. In this way, H1 “External
audit of company’s financial statements, as an independent form of examination, does
not lead to successful and constant detection and prevention of manipulations in
company’s operations” is confirmed.
One of the biggest limitations of external audit in the process of detecting
manipulations is not being able to thoroughly examine the entire company’s operations
but doing it on a sample basis. In this way, the external audit cannot give an opinion
that will with absolute certainty confirm or deny the existence of manipulation. The
research has shown that of the most commonly used tests by auditors in their work
(sampling tests, in-depth tests of transactions, the tests of weaknesses in internal
control/selected sample, the tests of auditor’s belief confirmation) the in-depth test of
transactions proved to be the best in detecting irregularities in company’s financial
statements in all the four countries. In this way, H2 “The appropriate use of in-depth
tests of transactions is an important method for detecting irregularities in company’s
financial statements” is confirmed. As the survey indicated that auditors in all the four
countries faced numerous irregularities in company’s financial statements, and that the
number of detected and processed manipulations has not decreased for years in all
these countries, but in some countries has also increased, it can be concluded that these
irregularities, revealed by external audit, are attempted manipulations. For this reason,
it is important for the external audit to cooperate very closely with the competent
authorities to point out in time to the irregularities that need to be investigated further,
which external audit cannot do because of its limitations.

5. Conclusion
Perpetrators of manipulations are capable of numerous methods of manipulations for the
achievement of their personal goals. They are always finding new ways to circumvent

Manipulative Table X.
Overstatement Overstatement representation of Eta squared for
of revenues of expenses inventories groundless
overstatement of
(I) Sum of the squares deviations 8.560 7.511 8.204
(II) Total sum of squares 42.588 44.706 48.000
revenues, expenses
(I)/(II) = h 2 0.20 1.16 0.17 and manipulative
representation of
Source: Authors inventories item
JFC regulations and various control systems. External auditors are only a part of the total
28,3 quality control system of financial reporting in addition to internal audit, government bodies
and other forms of control (forensic accounting, forensic auditing and manipulation
investigators). The biggest problem of the external audit is the scope of their power in work.
Although the detection of manipulation is not their priority when analyzing company’s
operations, upon noticing some irregularities, the auditors do not have legal power to further
644 investigate whether there is a manipulation or it is all a result of unintentional error.
However, even pointing out the possibility of certain irregularities to the competent
authorities (tax, judicial) is a major responsibility for external auditors in the process of
detecting and preventing manipulations in company’s operations.
The research revealed that in all four countries, external auditors very often encountered
various irregularities when analyzing financial statements, prepared by companies. Analyses
indicated that the auditors of the Republic of Serbia more often encountered groundless
overstatement of revenues compared with other countries, while regarding manipulative
representation of inventories, although there is no significant difference between the Republic
of Serbia and the Republic of Bosnia and Herzegovina, the largest mean value and median are
still among the auditors of the Republic of Serbia. On the other hand, concerning groundless
overstatement of revenues, the largest deviations exist between the mean values of the
responses of the auditors of the Republic of Serbia and the Republic of Macedonia. Statistically
significant differences regarding groundless overstatement of expenses exist between the
responses of the auditors of the Republic of Croatia on the one hand, and the auditors of the
Republic of Macedonia and Bosnia and Herzegovina on the other. Also, the analysis indicated
that the group of auditors with less than ten years’ experience in auditing mostly responded
that they encountered misrepresentation of inventories item, unlike the auditors who have 20 or
more years’ experience in auditing.
Based on the research results, it can be concluded that, in the future, it is necessary to
expand the legal obligation and power of external auditors when, in financial statement
auditing, they come to clear findings that indicate manipulation. Expansion of external
auditors’ powers would reduce their current limitations and expand the domain of action.
The authors’ future research would be directed toward comparative analysis of the effects of
changes made after extending the domain of external audit. The contribution of this paper is
to show that all of these countries have similar problems in this area, that in the work of
external audit there are similar situations that require better legal solutions, with which the
external audit and other forms of control will have more authority in detecting
manipulations in the company’s business.

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646 About the authors

Dragomir Dimitrijevic, PhD, is an Assistant Professor at the Faculty of Economics, University of
Kragujevac, where he received his PhD in the narrow scientific field of Accounting, Auditing and
Business Finance. He teaches the undergraduate and master studies of the faculty, the subjects of
financial accounting and forensic accounting. Areas of his scientific interest are financial reporting,
frauds in business and forensic accounting. Dragomir Dimitrijevic is the corresponding author and
can be contacted at: [email protected]
Biljana Jovkovic, PhD, is Associate Professor of Accounting, Auditing and Business Finance
department at the Faculty of Economics, University in Kragujevac, Serbia. He teaches the
undergraduate and master studies of the faculty, the subjects of accounting in financial institutions,
auditing of financial statements, internal control and internal auditing and forensic accounting.
Fields of her interest are internal control, internal audit, external audit and audit of financial
statement of financial organizations.
Suncica Milutinovi
c, PhD, is employed as an Assistant Professor at the University of Novi Sad –
The Faculty of Economics in Subotica on majors: financial reporting and international accounting
legislation, financial accounting, special financial statements. She is also engaged as an exam
invigilator at the Ryerson University.

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