Fraudlent Financial Reporting and CFlow

8/12/2019 Fraudlent Financial Reporting and CFlow

1/7

Fraudulent

ABSTRACT

Financial statement fraud(Association of Certified Fraudthat correlations between (a) cascontinuing operations were diffeto firms without detected financiauditors, security analysts, inves

information. The study includeda fraud sample of firms with detsample of firms without detected

For the control group theincome from continuing operatio.45 for the fraud group. The diffequality of the correlations was r

Recent historic relationsfrom continuing operations maysubstantive changes in the relatifrom continuing operations may

Keywords: Fraud, financial repo

Journal of Finance

Fraudulent

financial reporting and cash flow

Henry Elrodniversity of the Incarnate Word

Megan Jacqueline Gorhumniversity of the Incarnate Word

in the United States may average $100 billionxaminers, 2008). This study was to determine t

flows from operating activities and (b) earninrent for firms with detected financial reportingal reporting fraud. This information may be imors, regulators, and other users of financial stat

analysis of the correlations between the dependcted fraudulent financial reporting, compared tfraudulent financial reporting.correlation between cash flow from operating ans was positive and strong, at .96, and positiverence in the r values was significant and the hyejected (z = 25.05, a = .05, p (2-tailed test) 0.0).

ips between cash flows from operating activitybe examined, taking note of unexplained changnship between cash flows from operating activibe taken as warranting further examination and

rting, cash flows, accounting.

nd Accountancy

financial, Page 1

er yearhe extent, if any,s fromraud comparedortant toment

nt variables fora control group

ctivities andbut moderate atothesis of

and incomes. Unexplainedties and earningsinvestigation


2/7

INTRODUCTION

Auditors, accountants, instatements free of material misstStandards Board, 1978), and the

Financial statement fraud in the(Association of Certified Fraudexamine the extent to which analactivities and (b) earnings fromfraud.

Financial statement fraud& Albrecht, 2006; Sessions, 199committed by WorldCom, Enrothe response of the United StatesCompany Accounting Reform alosses in the United States may b

reporting fraud may average asExaminers, 2008).The central premise of t

relationship between (a) cash flooperations may be used to detectfrom operating activities and earthe research because of the simptool for stakeholder users of finaprinciples of double entry bookktwo elements, and acknowledge,receivable, financial statement rerelationship of cash flows and earecorded as credit sales, the receibetween cash flows from operatidisrupted.

Two research questionsrelationship between cash flowsoperations:

Q1: To what extent, if aoperating activities and (b) earni

Q2: To what extent, if anactivities and (b) earnings fromreporting fraud compared to fir

Previous research (Elrodtests, did not show significant diearnings from continuing operaticompared to a control group witwas intended to build on the worElrod, to determine whether casoperations were indeed statistica

Journal of Finance

Fraudulent

vestors, financial analysts, regulators, and otheratement, whether caused by error or fraud (Finaefore are interested in identifying fraudulent fi

nited States is estimated to average $100 billixaminers, 2008). The research reported in thisysis of the relationship between (a) cash flowsontinuing operations might be used to detect fi

has become a problem in the United States (Al; Wells, 1997). The recent media attention of t

, and others, have brought the issue into publicCongress enactment of the Sarbanes-Oxley A

d Investor Protection Act," 2002). The Occupae as much as $994 billion per year, and financi

uch as $100 billion per year (Association of C

e research was to examine the extent to whichws from operating activities and (b) earnings frfinancial reporting fraud. These dependent vari

ings from continuing operations, were chosenicity if the idea: a simple measure may becomencial statements. By intuition based on understaeping, financial statement users grasp the relatat least for fraud involving revenue recognitionporting fraud is an independent variable that shrnings. In its simplest form, for instance, if fictivables will not convert into cash receipts, and tng activities and earnings from continuing oper

ere developed to guide the focus of the statisticfrom operating activities and earnings from con

y, was there a correlation between (a) cash flogs from continuing operations?

y, were the correlations between (a) cash flowsontinuing operations different for firms with des without detected financial reporting fraud?, 2010) using quasi-experimental static pre andferences in the ratios cash flows from operatinons, for samples firms engaged in fraudulent fiout identified financial reporting fraud. The cu

k of Beneish (1999), Lee et al. (1999), Dechowflows from operating activities and earnings fr

lly related, and whether that relationship was di

nd Accountancy

financial, Page 2

need financialncial Accountingancial reporting.

n per yearpaper was torom operatingancial reporting

brecht, Albrecht,e fraudview, as seen byt. ("Publicional fraudl statement

rtified Fraud

nalysis of them continuingables, cash flowsor the focus ofa more practicalnding of theonship of theseand accounts

ould affect theious sales aree relationshiptions will be

al analysis of theinuing

s from

from operatingtected financial

post treatmentactivities andancial reportingrent researchet al. (1995) andm continuingferent for firms


3/7

with financial statement reportinreporting fraud. This informatiodetecting fraudulent financial sta

STUDY

The primary independentoperating activities and (b) earnireporting, particularly involvingvariables were cash flow from osets were drawn, including the cfrom continuing operation, totalpoints such as company name, titwo primary data sets: (a) a contNew York Stock Exchange, exclinvestment trusts, and the like, (

fraud, as noted in the press and ifraud group was further classifiethe fraud group after discovery a

There is anecdotal evidethe size of a firm, measured eithrelative strength (weakness) of ficontributor to financial statemenFraud Examiners, 2008). Additifraud, the most common accountfactor in fraud prediction models(Beneish, 1999). Accordingly, invariable.

The null hypotheses for tdifferences in the correlations becontinuing operations (i.e., the c(b) there were no statistically sigof the cash ratios when the datarepresented in each group.

Additionally, the null hy(a) revenue and assets, (b) revenincome from continuing operatioand income from continuing opewas tested for the fraud sample,

RESULTS

The rvalues for each of tevaluate the significance of the dfollowing the method recommenconfirmed by the statistic u to ev

Journal of Finance

Fraudulent

g fraud compared to a control group without finmay be useful to auditors, regulators, investors

tement reporting.

variable driving the correlation between (a) casgs from continuing operations was fraudulent

revenue recognition and accounts receivable. Terating activities and earnings from continuingmponents of the cash flows from operating acti

assets, total revenues, and other descriptive andker symbol, industrial classification number, eol group drawn at random from a the securitiesuding mutual funds, exchange traded funds, rea) a group of companies that had engaged in fin

Securities and Exchange Commission Litigatiinto data before restatement of their financialnd restatement of their financial statements.ce in the accounting and fraud detection literatr in assets or revenues, may be a component corms internal accounting control systems, and creporting fraud (Albrecht, et al., 2006; Associ

nally, Albrecht, et al. note that in financial stats manipulated are accounts receivable and revehas been partially confirmed in the academic lithis research size was deemed a secondary ind

he research were: (a) there were no statisticallytween cash from operating activities and earninmponents of the cash ratio) among the three da

nificant differences in the correlations betweenroups are subdivided according to the relative

othesis of no statistical difference in the correle and cash flows from operating activities, (c)ns, (d) assets and cash flows from operating act

rations, and (f) cash flows to income from contior firms above and below the mean assets in th

he data groupings are set out in Table 1. The stifference in two independent correlations,z, waded by Fisher (Aczel & Sounderpandian, 2006).aluate the difference between two correlations,

nd Accountancy

financial, Page 3

ancial statement, and others in

h flows frominanciale dependentoperations. Datavities, incomeidentifyingc. There werelisted on thel estatencial reporting

n reports. Thetatements, and

re to indicatentributing to theteris paribus, ation of Certifiedment reportingues. Size as a

teraturependent

significants from

ta groups, andthe componentsizes of the firms

tions betweenevenue andivities, (e) assetsnuing operations

sample.

tistic used tos calculatedResults were

as computed by


4/7

the correlation comparison comperlangen.de/cgi-bin/usignificanc

The analysis confirmed sbetween the income from continvalues, presented in Table 3, co

revenue and cash flows from opoperations, (d) assets and cash flcontinuing operations, and (f) caabove the diagonal represent resreporting, before restatement, withe diagonal represent results ofbefore restatement, with assets btesting the significance of the di

The results of the researcthe cash from operating activityratio, for both the control group

between cash flow from operatinand strong, at .96, and positive bvalues was significant and the ha = .05, p (2-tailed test) 0.0). Forrevenue and cash flows from opcontinuing operations, were posisample, correlations between revand income from continuing opecash flow statistic, and positiveoperations correlation. As the dastatistically different from thosevalues were rejected (metrics in

For the fraud sample, bifbetween cash flows from operatipositive and moderate (r = .48 awere not statistically different (aand 4 for the other tests and met

CONCLUSION

This study confirmed thefinancial statements may expectactivities and income from conticash flows from operating activimoderate for firms with known freceivable. The differences betwmoderate correlations in the frauuseful to auditors, regulators, inrecent historic relationships betcontinuing operations may be ex

Journal of Finance

Fraudulent

utation software available at http://peaks.infor.cgi, following the procedures outlined therein

ize measured by total assets as a factor in the co ing operations and cash flows from operating a

pare the relationships between (a) revenue and

rating activities, (c) revenue and income from cows from operating activities, (e) assets and incsh flows to income from continuing operations.lts of calculations for firms engaged in fraudul

th assets above the mean assets for the group. Talculations for firms engaged in fraudulent finlow the mean assets for the group. Table 4 sho

ference in the rs from Table 3, for the hypotheh were that there was a predicted statistical corrnd earnings from continuing operations compond the fraud sample. For the control group the

g activities and income from continuing operatit moderate at .45 for the fraud sample. The difpothesis of equality of the correlations was rejethe control group, as predicted, the correlationsrating activity, and between revenue and incomtive and strong at r = .96 and .98, respectively.enue and cash flow for operating activity, and brations were positive and moderate, at r = .66 fond weak at r = .17 for the revenue to income fra in Table 2 show, the correlations for the contfor the fraud group, and the hypotheses of equal

able 2.)rcated above and below mean total assets, the

ng activities and income from continuing operaove the mean and .38 below the mean), and the= .928, p (2-tailed test) .3212) from one anothe

ics.

intuitive notion that, for firms without known fa strong positive correlation between cash flowuing operations. These results showed the corr

ies and income from continuing operations wer raudulent financial reporting involving sales or

en the strong correlations for the control groupgroup were statistically significant. This infor

estors and other users of financial statements.een cash flows from operating activity and incamined, taking note of changes in that relations

nd Accountancy

financial, Page 4

atik.uni-(Maier, 2009).rrelationsctivities. The rassets, (b)

ontinuingme fromThe figuresnt financial

he figures belowncial reporting,

ws the results foris r1= r2.lation between

nents of the cashorrelation

ons was positiveerence in the rcted (z = 25.05,between

e fromor the fraudetween revenuer the revenue tom continuingol group wereity of the r

orrelationsions werese correlationsr. See Tables 3

aud, users offrom operatinglations betweenpositive and

accountsand the

mation should beor a given firm,me fromip not explained


5/7

or explainable by reference to chor circumstances such as substanchanges in the relationship betwcontinuing operations may be ta

FURTHER STUDY

The magnitudes of the chactivities and earnings from contsuch changes may be subjects foof studies of this kind, as well as(1999), and others are confoundfraud is present are tainted, by thdefinition, including attempts bygroup data, intended to be free frthe general population, must hav

data from either group, fraud saphenomena may also warrant fur

REFERENCES

Aczel, A., & Sounderpandian, J.Hill Irwin.

Albrecht, W. S., Albrecht, C. C.,OH: Thomson South-We

Association of Certified Fraud Eand abuse.Austin, TX:

Beneish, M. (1999). The detecti24-36. Retrieved from Pr

Dechow, P. M., Sloan, R. G., &Accounting Review, 70, 1

Elrod, H. (2010).Examination oPhilosophy Dissertation,

Financial Accounting Standards1. Norwalk, CT: Financi

Lee, T. A., Ingram, R. W., & Hooperating cash flow as anAccounting Research, 16doi:ProQuest document I

Maier, A. (2009). Speech of ChilIngenieur Dissertation, Ufrom http://peaks.inform

Public Company Accounting Re30, 2002).

Sessions, W. (1990). The FBI'sRetrieved from Business

Journal of Finance

Fraudulent

anges in company policy such as terms of saletial change in product mix, etc. Such unexplainen cash flows from operating activities and earen as warranting further examination and inves

anges in the relationship between cash flows frinuing operations, in the presence of fraud, andr further study. Additional areas for further studthe previous work by Dechow (1995), Benish (d in two ways. First, data from firms where fineir fraudulent natures. Such data contain fraudumanagement to mask their fraudulent activitiesom fraudulent financial reporting, but being repe some fraudulent content, as yet undiscovered.

ple or control group, may not behave has expe ther study.

(2006). Complete business statistics(6th ed.).

& Albrecht, C. O. (2006). Fraud examination(stern.xaminers. (2008).Report to the nation on occussociation of Certified Fraud Examiners.n of earnings manipulation. Financial AnalystsoQuest Multiple databases. doi:ProQuest Doc Iweeney, A. P. (1995). Detecting earnings man

93-225.Earnings and Cash Flows as Indicators of Fra

Northcentral University, Prescott Valley, AZ.Board. (1978). Statement of Financial Accountil Accounting Standards Board.ward, T. P. (1999). The difference between earindicator of financial reporting fraud. Contemp

, 749-786. Retrieved from Business Source ElitD 53448465dren with C left Lip and Palate: Automatic Ass

niversitat Erlangen-Nurnberg, Erlangen, Germatik.uni-erlangen.de/maier.pdf.orm and Investor Protection Act, 15 U.S.C. 7

ar on bank fraud: Facts and figures. Challenge,Source Elite database.

nd Accountancy

financial, Page 5

r credit policy,d substantiveings from

tigation.

m operatingthe direction ofy along the lines1999), Lee, et al.ncial reportinglent elements by. Second, controlresentative ofAccordingly,

ted. These two

oston: McGraw-

2nd ed.). Mason,

ational fraud

Journal, 55(5),45575116

gement. The

ud.Doctor of

ng Concepts No.

ings andorary

database.

ssment Doktor- ny. Retrieved

201 (2002 July

33(4), 57-59.


6/7

Wells, J. T. (1997). Occupationa

APPENDIX

Table 1

rvalues for correlations among t

1 Revenue2 Assets3 Cash flow, operations4 Income continuing operatiMSD

Note: Control group is above thediagonal; n= 594. Means

Table 2

zvalues for significance of diffe

Revenue v. assetsRevenue v. cash flows from oRevenue v. income from cont.Assets v. cash flows from oper

Assets v. income from cont. oCash flows v. income from co

Note: n for fraud sample = 594;

Table 3

rvalues for correlations among t

1 Revenue2 Assets

3 Cash flow, operations4 Income continuing operatiMSD

Journal of Finance

Fraudulent

l fraud and abuse.Austin, TX: Obsidian Publis

he variables as a function of fraud.1 2 3 4

- .77 .96 .98.69 - .81 .80.66 .68 - .97

ons. .17 .28 .45 -4.19 11.82 0.56 -0.0512.80 61.33 4.77 3.31

diagonal; n= 420. Fraud group before restateand standard deviations in millions.

ences in rs from fraud & control samples (TaR

Fraudsample

Controlsample

z

(=.05)

p

.69 .77 2.69erations .66 .96 18.03operations .17 .98 33.40ations .68 .81 4.66

erations .28 .80 12.68t. operations .45 .97 25.05

for control group = 420.

he variables in the fraud sample, as a function o1 2 3 4

- .61 .67 .25.63 - .65 .33

.50 .33 - .48ons. .26 .25 .38 -1.09 .97 .049 .0053.15 1.91 .191 .275

nd Accountancy

financial, Page 6

hing Company.

M SD

28.95 254.4186.83 334.324.88 35.972.33 18.35

ent is below the

le 1) for r1= r2.

(2-tail)


7/7

Note: Fraud group before restateFraud group before restatMeans and standard devi

Table 4

zvalues for significance of diffe

Revenue v. assetsRevenue v. cash flows from oRevenue v. income from cont.Assets v. cash flows from operAssets v. income from cont. oCash flows v. income from co

Note: n for above the mean = 67

Journal of Finance

Fraudulent

ment, above mean total assets is above the diagement, below mean total assets, is below the ditions in millions.

ences in rs from fraud sample (Table 3) for r1r, fraud sample

Belowmean

Abovemean

z

(=.05)

p

.61 .63 2.45erations .67 .50 1.97operations .25 .26 .081ations .65 .33 3.27erations .33 .25 .660t. operations .48 .38 .928

n for below the mean =5 27; both from the fra

nd Accountancy

financial, Page 7

nal; n= 67.gonal; n= 527.

= r2.

(2-tail)

.4929 Reject

.4759 Reject

.0319 Accept

.4994 Reject

.2454 Accept

.3212 Accept

d sample.

Documents

Fraudlent Financial Reporting and CFlow