Chapter 17

The Detection of Financial Statement Fraud

This chapter reviews the use of forensic analytics to detect financial statement fraud. The general belief is that analytic and analysis methods alone cannot detect fraudulent financial reporting. With this in mind, this chapter offers some methods and insights into the detection of some highly specific financial-reporting irregularities.

The first section of this chapter reviews the detection of financial statement fraud based on an analysis of the digit and number patterns of the reported numbers. The second section reviews the use of Benford's Law and other techniques to detect biases across many financial statements. Biases are a gravitation to some section or sections of the real number line, possibly for some psychological advantage. For example, retail store prices are biased toward being slightly below whole dollar amounts while gasoline prices in the United States are biased toward having an ending digit 9. The third section reviews the published financial statements of Enron, Inc. and the review shows that several suspect patterns were evident from those numbers. The final section reviews an application of the risk-scoring method to detect controller fraud at operating divisions. The risk-scoring method follows the same format and logic as is shown in the previous two chapters.

The Digits of Financial Statement Numbers

Fraudulent financial reporting is the intentional misstatement of, or an omission from, the financial ...

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