Forensic Analytics, 2nd Edition

CHAPTER 15Detecting Financial Statement Fraud

THIS CHAPTER REVIEWS THE use of forensic analytics to detect irregularities in financial statements, also known as financial statement misconduct. In line with the previous chapters, the methods described offer some insights into the detection of some specific financial reporting irregularities. In this chapter we will initially look at these irregularities from the standpoint of an outsider looking in, and then move over to looking for irregularities as an insider with access to the details underlying the numbers.

The chapter starts with an overview of financial statement fraud and offers some generalities related to an analysis of the reported numbers. The next section reviews the use of Benford's Law and other analytic techniques to detect biases in financial statement numbers. Biases are a gravitation to some numbers and tie in to our discussions of thresholds in Chapter 5. The chapter then reviews the financial statements of Enron, HealthSouth, and WorldCom to gain some insights into financial statement fraud and the detection thereof. This is followed by a review of the use of abnormal accruals and the Beneish M-Score to detect earnings management (the euphemism for financial statement fraud used in the academic literature). The final section reviews an application of the risk-scoring method to detect financial statement fraud at the operational level.

AN OVERVIEW OF FINANCIAL STATEMENT FRAUD

Fraudulent financial statements ...