Moderating “Cry Wolf” Events with Excess MAD in Benford's Law Research and Practice

2016 ◽  
Vol 1 (1) ◽  
pp. A66-A90 ◽  
Author(s):  
Bradley J. Barney ◽  
Kurt S. Schulzke
Keyword(s):  
False Positives ◽  
Financial Statement ◽  
Benford’S Law ◽  
Type I ◽  
Absolute Deviation ◽  
Sarbanes Oxley ◽  
Mathematical Correlation ◽  
Public Company ◽  
Benford's Law ◽  
Additive Modeling

ABSTRACT False positives or “Type I errors,” wherein test results indicate fraud where none actually exists, have been described as a costly “cry wolf problem” in auditing practice. Benford's Law, which is used as one tool among many in screening for financial statement manipulation, is especially prone to false positives when applied to small and moderately sized datasets. Relying in part on Monte Carlo simulations, we describe with greater precision than extant literature the mathematical correlation between N and Mean Absolute Deviation (MAD), a statistic increasingly used for assessing deviation from Benford's Law. We recommend replacing MAD with an alternative, Excess MAD, which explicitly adjusts for N in estimating deviation from Benford's Law. Applying nonparametric, generalized additive modeling to public company financial statement numbers, we demonstrate the differing outcomes expected from Excess MAD and MAD and produce evidence suggesting that, despite Sarbanes-Oxley and Dodd-Frank legislation, Benford's Law conformity of public company financial statement numbers remained relatively stable across four decades beginning in 1970.

scholarly journals Benford’s Law and Fraud Detection: Facts and Legends

2010 ◽  
Vol 11 (3) ◽  
pp. 397-401 ◽  
Author(s):  
Andreas Diekmann ◽  
Ben Jann
Keyword(s):  
Fraud Detection ◽  
Scientific Data ◽  
False Positives ◽  
Benford’S Law ◽  
Test Results ◽  
False Negatives ◽  
Benford's Law ◽  
Valid Test

Abstract Is Benford’s law a good instrument to detect fraud in reports of statistical and scientific data? For a valid test, the probability of ‘false positives’ and ‘false negatives’ has to be low. However, it is very doubtful whether the Benford distribution is an appropriate tool to discriminate between manipulated and non-manipulated estimates. Further research should focus more on the validity of the test and test results should be interpreted more carefully.

scholarly journals THE APPLICATION OF BENFORD'S LAW IN PSYCHOLOGICAL PRICING DETECTION

2018 ◽  
pp. 37-57
Keyword(s):  
Uniform Distribution ◽  
Benford’S Law ◽  
Mean Absolute Deviation ◽  
Chi Square ◽  
Absolute Deviation ◽  
Discrete Uniform Distribution ◽  
Benford's Law ◽  
Kolmogorov Smirnov ◽  
Discrete Uniform ◽  
Chi Square Tests

This paper presents the application of Benford's law in psychological pricing detection. Benford's law is naturally occurring law which states that digits have predictable frequencies of appearance with digit one having the highest frequency. Psychological pricing is one of the marketing pricing strategies directed on price setting which have the psychological impact on certain consumers. In order to investigate the application of Benford's law in psychological pricing detection, Benford's law is observed in the case of first and last digits. In order to inspect if the first and last digits of the observed prices are distributed according to the Benford’s law distribution or discrete uniform distribution respectively, mean absolute deviation measure, chi-square tests and Kolmogorov-Smirnov Z tests are used. Results of the analysis conducted on three price datasets have shown that the most dominating first digits are 1 and 2. On the other side, the most dominating last digits are 0, 5 and 9 respectively. The chi-square tests and Kolmogorov-Smirnov Z tests have showed that, at significance level of 5%, none of the three observed price datasets does have first digit distribution that fits to the Benford’s law distribution. Likewise, mean absolute deviation values have shown that there are large differences between the last digit distributions and the discrete uniform distribution implying psychological pricing in all price datasets.

scholarly journals APLIKASI HUKUM BENFORD DALAM MENGANALISA KASUS GARUDA INDONESIA

2020 ◽  
Vol 13 (2) ◽  
Author(s):  
Theresia Hesti Bwarleling
Keyword(s):  
Distribution Pattern ◽  
Financial Statements ◽  
Benford’S Law ◽  
Average Absolute Deviation ◽  
Absolute Deviation ◽  
Audit Planning ◽  
Benford's Law ◽  
Benford Law

<p><strong>ABSTRACT</strong>: Benford's Law is a simple and effective tool in finding fraud for an auditor. The purpose of this study was to determine whether Benford's Law can be used effectively in analyzing the indication of ambiguity in the financial statements of PT. Garuda Indonesia (Persero) Tbk. 2018. To answer this question, this research uses all accounts in the company's financial statements from 2018 and 2017. In assessing whether these accounts have differences in distribution with Benford's Law, this study uses the average absolute deviation. Then the predicted absolute deviation results are tested by referring to the exposure of Garuda's incidental publications (July, 2019). The results of this study indicate that the value of the financial statements of PT. Garuda Indonesia (Persero) Tbk. in the year 2018 fulfills the Benford Law distribution pattern. Meanwhile, in 2017 there were several deviant account values which were then asked to be restated in the 2018 reporting. Benford's law has once again proven to be used as an effective tool in audit planning.</p><p><strong>Keywords:</strong> Benford Law, Garuda Indonesia Financial Statements, Average Absolute Deviation</p><p align="center"><strong> </strong></p><p><strong>ABSTRAK:</strong> Hukum Benford merupakan alat bantu yang sederhana dan efektif dalam menemukan kecurangan bagi seorang auditor. Tujuan dari penelitian ini adalah untuk mengetahui apakah Hukum Benford dapat digunakan secara efektif dalam menganalisa adanya indikasi kerancuan Laporan Keuangan PT. <a href="https://www.cnnindonesia.com/tag/garuda-indonesia">Garuda Indonesia</a> (Persero) Tbk. Tahun 2018. Untuk menjawab pertanyaan tersebut, riset ini menggunakan seluruh akun dalam laporan keuangan perusahaan tahun 2018 dan 2017. Dalam menilai apakah akun-akun tersebut memiliki perbedaan distribusi dengan Hukum Benford, penelitian ini menggunakan rata-rata deviasi absolut. Kemudian hasil rata-rata deviasi absolut diuji prediksinya dengan merujuk pada paparan publikasi insidentil Garuda (Juli, 2019). Hasil dari penelitian ini menunjukkan bahwa nilai akun Laporan Keuangan PT. <a href="https://www.cnnindonesia.com/tag/garuda-indonesia">Garuda Indonesia</a> (Persero) Tbk. Tahun 2018 memenuhi pola distribusi Hukum Benford. Sedangkan pada tahun 2017 terdapat beberapa nilai akun yang menyimpang dan kemudian diminta untuk disajikan ulang di pelaporan tahun 2018. Hukum Benford sekali lagi terbukti dapat digunakan sebagai alat bantu yang efektif dalam perencanaan audit.</p><p><strong>Kata Kunci: </strong>Hukum Benford, Laporan Keuangan <a href="https://www.cnnindonesia.com/tag/garuda-indonesia">Garuda Indonesia</a>, Rata-rata Deviasi Absolut</p>

Audit Quality Inputs and Financial Statement Conformity to Benford’s Law

2020 ◽  
pp. 0148558X2093046
Author(s):  
Thien Le ◽  
Gerald J. Lobo
Keyword(s):  
Cash Flow ◽  
Audit Quality ◽  
Financial Statements ◽  
Audit Fees ◽  
Financial Statement ◽  
Benford’S Law ◽  
Audit Report ◽  
Audit Firm ◽  
Income Statement ◽  
Benford's Law

We examine whether audit quality inputs are related to the conformity of financial statements to Benford’s law. We find that overall financial statement conformity increases with audit fees, nonaudit fees, and audit report lag, and decreases with audit firm tenure. We also find that these audit quality inputs are more strongly associated with income statement conformity than with cash flow statement conformity. Our findings document the role that auditing plays in enhancing the conformity of financial statements to Benford’s law.

scholarly journals Benford’s Law in Forensic Analysis of Income Statements of Economic Entities in Bosnia and Herzegovina

2021 ◽  
Vol 23 (1) ◽  
pp. 31-61
Author(s):  
Ševala Isaković-Kaplan ◽  
◽  
Lejla Demirović ◽  
Mahir Proho ◽  
◽  
...  
Keyword(s):  
Bosnia And Herzegovina ◽  
Financial Statements ◽  
Forensic Analysis ◽  
Financial Statement ◽  
Benford’S Law ◽  
Business Decisions ◽  
Full Disclosure ◽  
Wide Range ◽  
Benford's Law ◽  
And Performance

The objective of preparing and presenting financial statements is to provide information about the financial position and performance of an entity, which is useful to a wide range of users of financial statements for business decisions. If information presented in the financial statements is not full disclosure and/or is incorrect, the presented image of the business entity will be wrong, as well as business decisions made on the basis of such financial statements. Unfortunately, many entities knowingly manipulate revenues and expenses to manage earnings in a way that suits the entity management. Detecting frauds in financial statements is the primary task of forensic accountants. This paper analyzes the possibilities of applying Benford’s law in the forensic analysis of income statements of economic entities in Bosnia and Herzegovina, to detect possible earnings manipulation. The results of the research confirm that the positions of revenues and expenses in the income statements of economic entities in Bosnia and Herzegovina generally follow Benford’s law, but also stress the need to increase attention and conduct additional forensic investigations for certain items as indicators of financial statement manipulation.

scholarly journals Is conditional conservatism a source of deviations of financial statements from Benford's Law?

2022 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Tri Tri Nguyen ◽  
Chau Minh Duong ◽  
Nguyet Thi Minh Nguyen
Keyword(s):  
Financial Distress ◽  
Stock Exchange ◽  
Listed Companies ◽  
Financial Statement ◽  
Benford’S Law ◽  
Assessment Procedure ◽  
Specific Level ◽  
Content Type ◽  
Conditional Conservatism ◽  
Benford's Law

PurposeIn this paper, the authors examine the association between conditional conservatism and deviations of the first digits of financial statement items from what are expected by Benford's Law.Design/methodology/approachThis research uses data of companies listed on the London Stock Exchange. The authors measure deviations of first digits from Benford's Law following Amiram et al. (2015) and firm-year conditional conservatism following previous studies (Basu, 1997; Khan and Watts, 2009; García Lara et al., 2016). The authors use multiple regressions to provide evidence for their hypothesis.FindingsThe results show that conditional conservatism is positively associated with deviations from Benford's Law. The findings are robust across different measures of deviations and conditional conservatism. Also, the authors find that the relationship between deviations from Benford's Law and conditional conservatism is more pronounced for firms with debt issuance, and for leveraged firms facing financial distress. Next, the authors’ analyses confirm previous evidence by showing that the first digits of financial statement items of UK listed companies conform to Benford's Law at the firm-specific level and the market level, and deviations of income statements are larger than those of balance sheets and cash flow statements.Research limitations/implicationsThe research makes significant contributions to the literature. First, this is the first study that provides empirical evidence suggesting that conditional conservatism may be a source of deviations from Benford’s Law. Second, the authors provide evidence confirming previous US findings (e.g. Amiram et al., 2015) showing that the distributions of first digits of financial statement items of UK listed companies also conform to Benford's Law.Practical implicationsThe authors’ findings have implications for auditors. Auditors should be aware of “false positive” for material misstatements when using Benford's Law as a risk assessment procedure. While both conditional conservatism and earnings management are related to deviations from Benford's Law, conservatism-related biases could indicate less audit risks.Originality/valueThe authors provide new and original evidence suggesting that conditional conservatism is related to deviations from Benford's Law.

EARNINGS MANAGEMENT AMONG FIRMS DURING THE PRE-SEC ERA: A BENFORD'S LAW ANALYSIS

2011 ◽  
Vol 38 (2) ◽  
pp. 145-170 ◽  
Author(s):  
Jeffrey J. Archambault ◽  
Marie E. Archambault
Keyword(s):  
Financial Statement ◽  
Benford’S Law ◽  
Operating Environment ◽  
Industrial Firms ◽  
Financial Reports ◽  
Rate Regulation ◽  
Time Period ◽  
Benford's Law ◽  
Utility Companies ◽  
Net Assets

ABSTRACT This paper examines the existence of financial statement manipulation in the U.S. during a time period when many of the current motivations did not exist. The study looks for types of manipulations that would be motivated by the pre-SEC operating environment. To examine this issue, a sample of U.S. firms from the 1915 Moody's Analyses of Investments is divided into industrial firms, railroads, and utilities. The railroad and utility companies faced rate regulation during this time period, providing incentives to manipulate the financial reports so as to maximize the rate received. Industrial firms were not regulated. These companies wanted to attract investors, motivating manipulations to increase income and net assets. To determine if manipulations are occurring, a Benford's Law analysis is used. This analysis examines the frequency of numbers in certain positions within an amount to determine if the distribution of the numbers is similar to the pattern documented by Benford's Law. Some manipulations consistent with expectations are found.

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