Surreal illustration of a financial statement with mismatched puzzle pieces, symbolizing inconsistencies being closely examined by an auditor.

Are Your Auditors and Audit Committees Really Catching Red Flags? What You Need to Know

Lena Voss in Business & Economy June 2025 • 4 min read.

"New research reveals surprising insights into how auditors and audit committees can—and sometimes don't—effectively lower fraud risk. Learn what to look for to ensure financial oversight is truly protecting your business."

In today's complex business environment, fraud remains a significant threat. Companies can lose millions, and reputations can be tarnished overnight. While internal controls and ethical practices are crucial, the role of external auditors and audit committees is equally vital. Are these gatekeepers truly effective at detecting and preventing financial deception? A recent study sheds light on this critical question, revealing some surprising insights.

The study, titled "Do Auditors and Audit Committees Lower Fraud Risk by Constraining Inconsistencies between Financial and Nonfinancial Measures?" by Brazel and Schmidt (2018), digs deep into how well auditors and audit committees identify those inconsistencies that often signal fraudulent activity. It's not just about the numbers adding up; it's about whether the story the numbers tell aligns with the real-world activities of the business.

This article breaks down the core findings of this research, exploring the methods used and highlighting the key implications for businesses seeking to bolster their fraud defenses. We’ll uncover what makes some auditors and audit committees more effective than others, and where common assumptions might fall short.

The Red Flag: When Numbers and Reality Don't Match

Surreal illustration of a financial statement with mismatched puzzle pieces, symbolizing inconsistencies being closely examined by an auditor.

One of the key takeaways from the study is the importance of aligning financial and nonfinancial measures. Think of it this way: revenue growth should be supported by corresponding growth in areas like the number of stores, employees, or patents. When these measures diverge significantly, it raises a red flag. Researchers have found that companies committing fraud often exhibit large inconsistencies between reported revenue growth and growth in these revenue-related nonfinancial measures (NFMs).

Imagine a company reporting a 25% increase in revenue, but the number of employees has remained stagnant, or even decreased. This discrepancy warrants a closer look. While not all inconsistencies indicate fraud, they serve as a warning sign that something might be amiss. These "difficult to manipulate" NFMs provide a crucial, independent benchmark for assessing the validity of financial statements.

So, what kind of nonfinancial measures should you be paying attention to?

Number of Stores/Facilities: Are new locations opening to justify revenue increases?
Employee Headcount: Is the workforce growing in line with sales?
Patents and Trademarks: Is innovation driving revenue, as reflected in intellectual property filings?
Production Capacity: Can the company physically produce the increased sales volume?

The study emphasizes that auditors and audit committees should be actively looking for these discrepancies. However, it also acknowledges that auditors aren't always adept at identifying and addressing these differences. This is where the research gets interesting, exploring which factors make auditors and audit committees more likely to catch these red flags.

Turning Insights into Action: Protecting Your Business

The Brazel and Schmidt (2018) study provides valuable insights for businesses looking to strengthen their fraud defenses. By understanding the importance of aligning financial and nonfinancial measures, and by carefully evaluating the expertise and approach of their auditors and audit committees, companies can take proactive steps to mitigate fraud risk and safeguard their financial integrity. Ultimately, a vigilant and informed approach to financial oversight is the best way to protect your organization from the potentially devastating consequences of fraud.

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This article is based on research published under:

DOI-LINK: 10.2308/ciia-52258, Alternate LINK

Title: Do Auditors And Audit Committees Lower Fraud Risk By Constraining Inconsistencies Between Financial And Nonfinancial Measures?

Subject: Accounting

Journal: Current Issues in Auditing

Publisher: American Accounting Association

Authors: Joseph F. Brazel

Published: 2018-09-01

Everything You Need To Know

Why is it important for companies to focus on the alignment between financial and nonfinancial measures (NFMs)?

Focusing on the alignment between financial measures, like revenue, and nonfinancial measures (NFMs) is crucial because inconsistencies can signal potential fraudulent activity. Companies committing fraud often exhibit discrepancies between reported financial growth and related NFMs, such as employee headcount, number of stores, or production capacity. These NFMs provide an independent benchmark for assessing the validity of financial statements, and significant divergences should raise red flags for auditors and audit committees.

What are some examples of nonfinancial measures (NFMs) that should be monitored in relation to revenue growth?

Several nonfinancial measures (NFMs) should be monitored in relation to revenue growth to detect potential inconsistencies. Examples include the number of stores or facilities (to justify revenue increases), employee headcount (to ensure the workforce is growing in line with sales), patents and trademarks (to confirm innovation is driving revenue), and production capacity (to verify the company can physically produce the increased sales volume). Significant discrepancies between revenue growth and these NFMs warrant closer scrutiny by auditors and audit committees.

According to the Brazel and Schmidt (2018) study, what role do auditors and audit committees play in detecting financial fraud, and what makes them more effective?

The Brazel and Schmidt (2018) study emphasizes that auditors and audit committees play a vital role in detecting financial fraud by identifying inconsistencies between financial and nonfinancial measures (NFMs). However, the study acknowledges that auditors aren't always effective at spotting these discrepancies. Factors that make them more effective include actively looking for divergences, possessing expertise in relevant industries, and having a skeptical mindset. When auditors and audit committees understand the importance of aligning financial and nonfinancial data, and are diligent in their approach, they enhance a company's fraud defenses. The study suggests deeper investigation and understanding of business activities are required.

What are the potential consequences for companies that fail to effectively monitor and address inconsistencies between financial and nonfinancial measures?

Companies that fail to effectively monitor and address inconsistencies between financial and nonfinancial measures (NFMs) face potentially devastating consequences. These consequences include significant financial losses due to undetected fraud, a tarnished reputation leading to loss of investor confidence and customer trust, and potential legal and regulatory penalties. Furthermore, failure to address these inconsistencies can undermine the effectiveness of internal controls and ethical practices, creating an environment where fraud can thrive. Proactive monitoring and addressing of inconsistencies are crucial for safeguarding financial integrity and protecting the bottom line. Missing these may involve restatements of financial results.

How can businesses use the insights from the Brazel and Schmidt (2018) study to improve their fraud defenses?

Businesses can use the insights from the Brazel and Schmidt (2018) study by emphasizing the importance of aligning financial and nonfinancial measures (NFMs) within their organization. They should ensure that auditors and audit committees actively look for discrepancies between financial results and related NFMs, such as employee headcount, store counts, and production capacity. Companies should also carefully evaluate the expertise and approach of their auditors and audit committees to ensure they are equipped to identify and address these red flags. By taking a vigilant and informed approach to financial oversight, businesses can mitigate fraud risk and safeguard their financial integrity. This can also include improving internal training or hiring more specialized auditors.