Author(s) :

Minny Narang.

Volume/Issue :

Abstract :

The purpose of this paper is to identify the likely manipulations in the financial statements of companies listed in India. It aims to examine the statistical differences among the manipulator and non-manipulator companies along with determining the ratios that may be significant predictors of financial statement fraud. The sample for the study comprises top 200 companies listed on BSE for the period 2018-2022. M-Scores of the companies were calculated using the Beneish model and ratio analysis with twenty ratios was conducted. Logistic Regression was carried out to find out the significant predictors of possible manipulations in the financial statement. The findings reflect that manipulations exist in the financial statements of companies. Some of the profitability, liquidity, leverage, and efficiency ratios are found to statistically differ between two sets of companies. Profitability ratio acts as a likely predictor of fraud in financial statements. The paper is one of the few studies carried out in the Indian context to predict fraudulent financial reporting by non-financial companies using the Beneish model and Ratio analysis. The paper offers relevant insights to the stakeholders for carefully analyzing specific ratios in the financial statements for detecting possible manipulations. The knowledge drawn from this academic research may help auditors, regulators and policy makers to put rigorous processes in place for early identification of fraud.

No. of Downloads :

21

KEYWORDS:

Beneish M-Score, Ratio Analysis, Financial Statement Fraud, Earnings Manipulation.

INTRODUCTION & OBJECTIVES:

Financial statement fraud is one of the rapidly growing financial frauds in the corporate world. Even after two decades of Enron scam in US and consequent regulatory measures such as enactment of Sarbanes-Oxley Act and establishment of Public Companies Accounting Oversight Board (PCAOB), financial statement misreporting and manipulations are rampant. India witnessed a similar incident in the Satyam scandal in 2007. A recent survey of over 35 countries (including India) claims that the financial statement fraud market was valued at USD 20.8 billion in 2021. Further, it is anticipated that this figure may touch USD 82.53 billion by 2029, with a CAGR of 18.80% during the period 2022-2029 (Data Bridge Market Research, 2022)[7]. Financial statement fraud is a white-collar crime by management to misrepresent an enterprise's financial position by exaggeration, concealment, understatement, omission, or commission in financial accounts to present a positive outlook for the companies. The underlying objectives include profit linked compensation, performance pressure, personal growth, fighting competition etc. The Fraud Triangle Theory, propounded by Donald R. Cressey, specifies the existence of three factors for fraud perpetration- opportunity, incentive, and rationalization. Opportunity means circumstances enabling fraud such as absence of or weak internal control system, insufficient auditing procedures, poor tone at the top, weak accounting policies etc. Incentives or Pressures include profit linked compensation, need to consistently perform better than the peers, personal financial exigencies, meeting investors’ expectations, among others. Rationalization is the justification provided by a fraudster for committing fraud. Since the amount involved in financial statement frauds is generally huge, it is imperative to prevent and detect its likelihood as early as possible. The Association of Certified Fraud Examiners (ACFE) defines financial statement fraud as “the deliberate misrepresentation of the financial condition of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users'' (ACFE 2018)[2]. The Association has further predicted an increase in financial statement fraud is anticipated in the post COVID-19 pandemic period. Beneish (1999)[3] defines earnings manipulation as the deliberate violation of accounting rules by management through the adoption of illegal and fraudulent schemes to present positive financial performance of the company. It is generally achieved through an overstatement of assets, a documented increase in sales, or an upward change in profits figures. Another way includes understatement of liabilities, expenses, or losses (Spathis, 2002)[23]. For a corporate fraud to thrive, management’s malafide intentions coupled with a weak regulatory system and non-existent fraud reporting guidelines are prerequisites. An ineffective board that lacks oversight in auditing and accounting practices of the companies can give further push to the rise of such frauds (Gupta and Gupta, 2015)[8]. In their study on bank frauds in India, Bhasin (2015)[4] emphasized that a low level of compliance, weak internal control system, inaccurate employment procedures, less training programme and excessive work pressure are some significant factors responsible for fraud. Further, upholding the fraud triangle theory Huang et al. (2017)[10] claimed that financial statement frauds are driven by severe corporate pressures and a desire for incentives. Inadequate business performance, need for external financing, inefficient board, financial anguish and competition provoke fraud. However, such fraudulent financial reports adversely affect the market sentiments and lead to incorrect decision making by the investors and others users of such statements (Kizil and Kasbasi, 2018)[14]. India has seen a series of accounting frauds in the recent past with Satyam, Reebok, Kingfisher Airlines, PNB scams to name a few. Occupational fraud is the most serious concern for auditors and is believed to be spreading rapidly across all industries and sectors. (Fraud Examination in India, n.d.)[6]. In its latest report, Hindenburg Research specializing in forensic financial research, has made serious fraud allegations against one of the largest conglomerates in India. However, there are only a few studies in India that focus on financial statement fraud identification in the corporate sector. This paper seeks to fill the gap and attempts to contribute towards the predictors of financial reporting fraud for early detection to mitigate economic losses to the investors and other stakeholders. It is sought to be done by applying the fraud triangle theory as explained above. The pressure aspect of the fraud triangle is generally exhibited by revenues & income inflation and an understatement of liabilities (quantified by profitability, leverage and efficiency ratios in the paper). The second element of the fraud triangle i.e. the opportunity exists when the internal controls are weak, supervisions are inadequate and thus providing sufficient scope for adopting alternate policies in order to influence figures in accounts (captured by ratios on liquidity, efficiency and measurement of assets). The final angle rationalization is the justification and reasoning given by the management for committing fraud. Since it relates to the personality and attitude of a person (Skousen et.al., 2009)[24], its measurement is outside the scope of this paper. By testing the fraud triangle theory for Indian companies, the paper has significant insights to offer to the investors, policy makers and corporates. The succeeding parts of the paper discuss the research methodology adopted, results obtained, and conclusions drawn followed by the limitations of study.

DOI:

10.58426/cgi.v5.i1.2023.70-81