Fraud detection researchers have devoted much effort to searching for information signals (often called “red flags”) that signal the presence of fraud (Albrecht and Romney 1986). This research was motivated by the desire to improve auditors' accuracy in detecting fraud, particularly financial statement fraud. Despite the intuitive appeal of the red flag approach, studies have shown that this search for signals has not been entirely successful. Red flags have often proven ineffective, sometimes even hindering an auditor's ability to detect fraud (e.g., Pinkus 1989; Johnson, Jamal, and Berryman 1989). Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get an Original Essay With striking similarity, psychology researchers have looked for “Pinocchio signals,” which are signals or patterns of signals that are reliably present when one lies or otherwise attempts to deceive another. Not only have these signals proven elusive to discover, but studies have also shown that relying on such signals can be detrimental to accurate detection, as judges of deception often pay attention to signals that are unrelated to actual deception (DePaulo, Lindsay & Malone 2003). To overcome this impasse, researchers in both psychology and auditing have proposed shifting the focus of their research away from the search for warning signs (Pinocchio signals), and towards a deeper understanding of the cognitive processes through which individuals identify , interpret and evaluate information. this may be indicative of misrepresentation (e.g., O'Sullivan 2003). We believe this research strategy is powerful and fruitful. For over a decade we have studied in great detail the problem-solving behavior of external auditors who are and have not been successful in detecting financial reporting fraud (e.g., Johnson et al. 1989;11992; 1993; 2001). This paper reviews our approach to understanding an auditor's cognitive processes, describes the theory we have developed to explain what auditors do, and examines key findings from our experiments. Our studies show that detecting fraud based on an analytical examination of a company's financial statements is difficult, but not impossible. On the one hand, even Big 4 audit partners often fail to detect fraud using standard analytical procedures (recorded accuracy in controlled laboratory environments is 50-75% - Johnson et al. 1992; 2001). On the other hand, these same studies also demonstrate the possibility of success: approximately 10% of auditors are able to consistently detect fraud in cases submitted to them for review.