Statistical detection of fraud in the reporting of Croatian public companies

Abstract

siniša slijepčević, branimir blašković: statistical detection of fraud in the reporting of croatian public companies financial theory and practice 38 (1) 81-96 (2014) introductionThe usage of statistical methods in the analysis and detection of fraud in financial reporting is becoming widespread and necessary. Perhaps the simplest and best known, but still effective test is based on Benford's law. Newcomb (1881) and later Benford (1938) noted that in a sufficiently large collection of numerical data expressed in a decimal form, the distribution of occurrences of first digits is not uniform (we explain Benford's distribution in more detail in section 2). Many authors, including Carslaw (1988), Guan et al. (2006), Kinnunen and Koskela (2003), Nigrini (2005), Niskanen and Keloharju (2000), Skousen et al. (2004), Thomas (1989) and Van Caneghem (2002, 2004 investigated the applicability of this fact in accounting and auditing, and specifically in the detection of "cosmetic earning management". It has been shown that the distribution of first digits in financial reports normally complies with Benford's law. If, however, there have been a-posteriori "cosmetic interventions", then for both statistical and psychological reasons, the distribution of first digits changes. As a result, the likelihood of "cosmetic earning management" can be statistically verified, and at least theoretically, the reliability of a specific financial report can be quantified.

Reliability of Financial Information from the Perspective of Benford’s Law

“…The use of Benford’s Law has proved effective in many fields: insurance [ 6 ], databases [ 7 , 8 ]), economics [ 9 , 10 ], education [ 11 ], election [ 12 ], public administration [ 13 ], real-estate [ 14 ], religion [ 15 ], statistical studies [ 16 , 17 ]. In the field of finance and accounting, Benford’s Law has been applied in audits to establish specific procedures [ 18 ] and to identify potential frauds at the company level [ 19 , 20 , 21 , 22 , 23 ], as well as to combat tax evasion by identification of companies that resort to manipulating the tax base, in order to be included in a lower tax ceiling [ 24 ].…”

Using the Benford’s Law as a First Step to Assess the Quality of the Cancer Registry Data

“…The statistic may vary between 0 (no differences) to 1 (maximum difference) ( 12 ). Z statistic: the average of the Z values for each comparison between the nine observed and theoretical digits distributions ( 5 ): where i = 1, …, 9 is a fixed digit, b i is the frequency expected by Benford, and e i is the observed frequency for each digit i. The cut-off value for statistical significance, with alpha = 0.05 and one side tail, is 1.64.…”

“…Not all the numbers abide by the Benford’s law, but for those which do, violations raise concerns. For example, in accounting and auditing, also at a Governmental level, the Benford’s law has been widely used to detect possible frauds ( 3 – 5 ).…”

A Benford Analysis of National Collegiate Athletic Association Division I Finance Data

“…The use of statistical tests to detect irregularities in financial data has become more widespread. Among the simplest yet most effective test is based on Benford's Law of First Digits (Slijepčević & Blašković, 2014). Benford's Law (sometimes called Newcomb-Benford's Law) was first discussed by mathematician Simon Newcomb in his 1881 article in the American Journal of Mathematics (Newcomb, 1881).…”