CHAPTER EIGHTEEN

Other Detection Procedures

ANALYSIS UTILIZING MULTIPLE RATIOS

Using single ratios as an indicator of fraud can be valuable. There is some evidence, however, that using a blend of several ratios can be an even more reliable method of detecting fraud than any single ratio alone.

The M-Score

In his 1999 article, “The Detection of Earnings Manipulation,” Messod Beneish describes a blended formula, called the M-Score, that may be useful in detecting financial statement fraud. The formula was based on an evaluation of the financial statements of a sample of companies that had engaged in earnings manipulation. In particular, the financial statements of the first period in which earnings manipulation occurred were compared to the preceding year's financial statements.

The M-Score described by Beneish is a weighted blend of eight different indexes, each measuring the change in a ratio from one year to the next. The eight indexes utilized in the M-Score are as follows:

1. DSRI = Days' Sales in Receivables Index. This is the ratio of the current year's days' sales in receivables to that of the prior year, expressed as the following formula, where CY stands for current year and PY stands for prior year:

2. GMI = Gross Margin Index. This is the ratio of the prior year's gross margin to that of the current year, where an index of less than 1 means that margins have declined. ...

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