THE APPLICATION OF BENFORD’S LAW IN DETECTING ACCOUNTING FRAUD IN THE FINANCIAL SECTOR

PROJECT INFORMATION

Format: Ms Word /  Chapters: 1-5 /  Pages: 70 /  Attributes: Data Analysis

CHAPTER ONE

  1. INTRODUCTION

1.1 BACKGROUND OF STUDY

The financial sector is one of the fast growing sectors with over 50% contribution to the economic growth and development in Nigeria; but the level of accounting fraud has limited the full potentials of the financial sectors in Nigeria. Accounting fraud has increased overtime in Nigeria especially in the financial sector. Several methods have been implemented to reduce or completely eradicate fraud in the financial sector of Nigeria; the audit role in detecting financial fraud has done a lot lately although not significantly effective. The research on financial fraud has captured the attention of researchers and economist globally. Some great countries of the world have had these issues recently; countries Italy, France, Portugal and the world power USA. Take the Lehman brothers of USA for instance; the issue of accounting fraud has plagued them for some time now. The same goes to parlmalat of Italy, Vivendi of France and BPN of Portugal. As the level of accounting fraud continue to increase in the financial sector, the role of auditors becomes ineffective; in the search for the best way to completely eradicate and determine accounting fraud comes the introduction of Benford’s law as a tool for fraud detection and prevention in the accounting sector.

Benford‘s Law is widely regarded as a powerful tool for auditors. The Benford’s law view data from a different perspective from the eyes of a normal auditor.

Instead of looking for the largest amounts or a sufficient amount of coverage like the normal auditor, Benford‘s Law allows the auditor to evaluate the digits that make up the numbers themselves. Benford‘s Law is of great importance to the financial sector; it is not used to detect defective deliveries, contract rigging or off-book transactions, bribes, kickbacks, or asset thefts but it is used to find payroll, expense, sales, accounts receivable, fixed asset, and journal entry anomalies as well as industry-specific account anomalies.

Benford‘s Law is based on the fact that many numbers normally used in business (and elsewhere) are not random, but rather follow some ordered progression. For example, a chart showing wealth will show that it is not uniformly distributed; a few people have much wealth and many people have less wealth. Sales, inventory, and disbursements are also not uniformly distributed. Benford‘s Law uses this fact to help point to fraud, inefficiencies, and other forms of data manipulationBack in the 1800s an astronomer, Simon Newcomb, noticed that the earlier pages in books of logarithm tables were more worn than the later pages. Logarithm books were used to multiply (and divide) large numbers. Newcomb posited that numbers beginning with lower digits were used more often than numbers beginning with higher digits. He published Note on the Frequency of Use of the Different Digits in Natural Numbers in 1881. He offered his observation but gave neither a use nor a proof. The article was promptly forgotten. In the years following the Great Depression, without apparent knowledge of Newcomb or his article, FrankBenford noticed the same thing. He was working for General Electric and had a lot of time on his hands. He decided to test his hypothesis. Benford analyzed 20 lists of large data sets (total of 20,229 data points) and 10 lists of smaller data sets (total of 2,968 data points). These lists came from random sources, such as the numbers in an issue of a magazine and death rates, as well as from sources that were not random populations, horsepower lost, and molecular weight, and so on. Benford published his observation and proof as The Law of Anomalous Numbers in 1938. Though he did not identify any uses, Benford‘s article had a better reception than Newcomb‘s and we now have Benford‘s Law. A few more things had to be established before Benford‘s Law could be of any use to those on the finance side of things. In 1961 Roger Pinkham proved that Benford‘s Law held true no matter what the unit of measurement. That means that it does not matter whether you measure items in yen, dollars, feet, miles, or meters. In 1972, Hal Varian found that you could use it to detect fraud in socioeconomic data. In the 1980s it was used to detect the reasonableness of round numbers and it was also found that invented numbers do not conform. Carslaw, in 1988, found that companies in New Zealand were not completely honest in their annual financial reports. (In the succeeding years, this finding was verified by others and for other countries). Ted Hill, also in 1988, found that people cannot create numbers and still conform to Benford‘s Law. The real breakthrough for auditors came in 1994 when Mark Nigrini, a South African chartered accountant, codified a practical use. His 1992 thesis showed that accounting data conforms to Benford‘s Law. In 1994 he assisted tax agencies find suspect returns. From there, he worked with companies tofind fraud and continued his research to expand the applications of Benford‘s Law.

1.2 STATEMENT OF PROBLEM

The ongoing issue in the financial sector of Nigeria and the rest of the world has had its root running deep in the financial sector. The major problem is the inability to completely eradicate the accounting fraud in the financial sector. The level of accounting fraud has a negative effect on the economy and the performance of most financial sectors and institutions in Nigeria. The root cause of accounting fraud in the financial sector is greed. It can also be the desire to limit the financial profit of the stakeholders in the financial sector of Nigeria. The positional differences in office can also influence accounting fraud in the financial sector

1.3 AIMS AND OBJECTIVES OF STUDY

The aim of the study is examine the effect of Benford’s law on financial fraud in the financial sector. The specific aims of the research work are:

I.  To examine the role of Benford’s law in the control and detection of accounting fraud in the financial sector.

II. To examine the effect of accounting fraud on the Nigeria economy

III. To examine the relationship between Benford’s law and the level of accounting fraud in the financial sector

IV. To examine the factors affecting accounting fraud in the financial sector.

V.  To give recommendation to aid decision making and further research on accounting fraud in financial sector.

1.4 RESEARCH QUESTION

In order to ascertain the following aims and objectives the study came up with the following research questions; some of the questions are stated below as follows:

I. What are the roles of Benford’s law in the control and detection of accounting fraud in the financial sector?

II. What is the effect of accounting fraud on the Nigeria economy?

III. What is the relationship between Benford’s law and the level of accounting fraud in the financial sector?

IV. What are the factors affecting accounting fraud in the financial sector?

V. In what ways can accounting fraud be reduced in the financial sector?

1.5 SCOPE OF THE STUDY

The study the application of Benford’s law in detecting accounting fraud in the financial sector covers the financial crises in Nigeria and the world from the 2003 to the year 2012.

1.6 SIGNIFICANCE OF STUDY

The study the application of Benford’s law in detecting accounting fraud in the financial sector will be of immense benefit to the financial sector of Nigeria and the world in decision making. The study will also help the students and other research in other research that are related to accounting fraud in the financial sector of Nigeria.

1.7 DEFINITION OF TERMS

ACCOUNTING FRAUD:Accounting fraud is intentional manipulation of financial statements to create a facade of a company's financial health. It involves an employee, account or the organization itself and is misleading to investors and shareholders

BENFORD’S LAW:Benford's law, also called the first-digit law, is an observation about the frequency distribution of leading digits in many real-life sets of numerical data. The law states that in many naturally occurring collections of numbers, the leading significant digit is likely to be small

DETECTION:Detection is the act of noticing or discovering something

REFERENCES

A Meta Learning framework for detection financial fraud, Abbasi, A., Albrech, C., Vance, A. & Hansen, J., 2012. Metafraud

Current Trends in Fraud and its detection, Albrecht, W., Albrecht, C. & Albrecht, C. C., 2008.

Comparing Financial Systems, M. press, ed. Cambridge, USA: s.n., p. 520

Informational Security Journal :A Global Perpective, pp. 2-12. Allen, F. & Douglas

Earnings Management among the Firms During the pre-sec Era: Benford's Law Analiysis, Arcahambault, J. J. & Arcahambault, M. E., 2011

Association of Certified Fraud Examiners, 2012

The Law of anomalous numbers. Proceedings of the American philosophical Society, 78, pp. 551-572.

Onde-dimensional dynamical systems and Benford’s Law, Berger, A., Bunimovich, L. & Hill, T., 2005