Intentional Misstatements Research Articles

Explaining Away Intentional Misstatements: Do Management-Provided Excuses Decrease Auditor Skepticism?

SUMMARY When auditors identify a misstatement, they typically engage in client inquiry to understand the misstatement’s cause (e.g., whether due to error or fraud). If a misstatement was caused intentionally, client management may attempt to reduce auditor skepticism by making their behavior seem unintentional (an excuse) or appropriate (a justification). Using two experiments, we examine the type of explanation managers use to conceal their fraudulent intent and its effectiveness in reducing auditor skepticism. We predict and find managers use excuses (e.g., “I forgot”), rather than justifications, to “explain away” fraud caused by omission/inaction (omitting information from a source document) as opposed to active misrepresentation (providing misleading information). When these same excuses are provided to auditors, we find they have a skepticism-decreasing effect, particularly when used to explain misstatements resulting from omission. Together, our findings suggest managers’ ability to conceal fraud may persist even after the auditors have identified an intentional misstatement.

Fraud Pentagon dan Kecurangan Laporan Keuangan: Potret pada Perusahaan Sektor Kesehatan di Indonesia

Financial statement fraud is an intentional misstatement related to the reporting of company conditions to obscure financial statement users in making decisions. This research was conducted to examine the influence of the five pentagon fraud elements namely pressure, opportunity, rationalization, ability, and arrogance on fraudulent financial statements. This research uses the Beneish M-Score Model to detect potential fraud in financial reports. The data used in this study is secondary data derived from the annual financial reports of health sector companies listed on the Indonesia Stock Exchange during the 2016-2020 period. The sampling method used a purposive sampling method and the total research sample was 13 companies. Hypothesis testing was carried out using logistic regression analysis with SPSS 26.0 software statistical tools. The research results show that pressure has an influence on financial report fraud. Meanwhile, opportunity, rationalization, ability and arrogance have no effect on fraudulent financial reporting.
 Keywords: Fraud Pentagon; fraudulent financial reporting; Logistic Regression

The Role of Board Financial Monitoring Strength and Donor Pressure in Nonprofit Auditors’ Assessment of Changes in Program Expense Allocations

SUMMARY Nonprofits face inherent risks from both donor pressure to increase program spending and a high propensity for reporting errors. Simultaneously, in contrast to for-profit settings, limitations of nonprofit governance can raise auditors’ concerns about a board’s effectiveness as a control mechanism. We experimentally examine how a nonprofit board’s stronger and weaker monitoring strength influences auditors’ assessments of a client’s program expense allocations under conditions of higher and lower donor pressure to increase program spending. Auditors assess management’s expense allocations as more appropriate, and document fewer risk factors, only when board financial monitoring is strong and donor pressure is lower. Further, auditors rely on strong boards to reduce errors, but not intentional misstatements related to management’s allocation of functional expenses. These findings suggest that, in contrast to how auditors use for-profit governance, auditors may question the ability of even strong nonprofit boards to mitigate instances of intentional functional expense allocation misreporting.

Clawback policy enforcement: To disclose or not to disclose

The SEC proposed in 2015 to require the disclosure of incentive compensation recovery efforts by companies' boards of directors. While such disclosure of enforcement can signal the effectiveness of corporate governance as the SEC suggested, firms have argued that the proposed enforcement disclosure may harm executives' reputation regardless of their involvement in misstatement because the clawback includes a no-fault clause. Results of our experimental study suggest that when the board does not disclose its clawback enforcement, investors perceive weak corporate governance, particularly when a restatement results from an intentional misstatement. This, in turn, leads investors to be less willing to invest than when clawback enforcement is disclosed. We also find that investors' perception of management reputation is not negatively affected following the board's clawback enforcement disclosure. Overall, our study provides insights into the potential effect of the SEC's proposal requiring the disclosure of clawback enforcement and addresses concerns raised in comment letters.

The Similarities and Differences between Earnings Management and Fraud

Objective: The main objective of this article is to indicate differences between earnings management and fraud.Research Design & Methods: The research methods applied are based on a critical analysis of the literature on the subject, both in Polish and English, a comparative analysis of legal acts and inductive reasoning.Findings: Earnings management involves intentional and lawful actions undertaken by an entity’s management, aimed at changing the figures it reports, particularly earnings, in order to present the desired picture of the entity’s financial standing and economic position, as well as its achievements in financial statements for the purpose of misleading financial statement users or obtaining benefits guaranteed in managerial contracts. This is achieved by applying accounting judgment and estimates, changing these estimates, choosing specific methods from among the acceptable accounting methods allowed by the applicable accounting regulations, structuring of economic transactions or undertaking actual activities.Implications / Recommendations: Earnings management should not be identified with fraud, as earnings are managed within the framework of legal regulations in the field of accounting and taking account of solutions adopted in the accounting policy of a given entity. However, any abuse in this field, whether it involves departing from or violating the accounting principles or standards, may lead to intentional misstatements in financial statements – that is, fraud in its broad sense.Contribution: Inspiring further development of research on earnings management from the viewpoint of determinants or tools applied.

DETECTION OF FRAUDULENT FINANCIAL STATEMENTS USING THE BENEISH RATIO INDEX FOR MANUFACTURING COMPANIES LISTED ON THE INDONESIAN STOCK EXCHANGE IN 2016 AND 2017 PERIOD

Fraud is an action taken intentionally and it is done for personal or other people's purposes, where the action has caused harm to certain parties or certain institutions. Misstatements contained in fraudulent financial statements are intentional misstatements to deceive users of financial statements. The source of this misstatement includes manipulation or falsification of accounting records, intentional misstatements or omissions from financial statements, and / or incorrect application of accounting principles. In Indonesia, accounting fraud also occurs at the company level, both private and government companies. On December 6, 2012, the announcement of Indonesia's score in the Corruption Perception Index (CPI) was 32 and ranked 118th out of 176 countries which measured the level of corruption (Transparency International, 2012). In 2001, a fraud scandal occurred by PT Kimia Farma Tbk. PT Kimia Farma is a state-owned company whose shares have been traded on the exchange to become public company. Based on indications by the Ministry of BUMN and Bapepam's examination, it was found that there were misstatements in the financial statements which resulted in overstatement of net income for the year ended 31 December 2001 of Rp. 32.7 billion, which represented 2.3% of sales and 24.7% from net income. The author's purpose of this study is to discuss about detecting fraud in financial statements by using 5 (five) of the 8 (eight) Beneish ratio indices, because Beneish's research states that the Days Sales in Receivables Index (DSRI) ratio index, the Gross Margin Index ( GMI), Asset Quality Index (AQI), Sales Growth Index (SGI), and Total Accrual to Total Asst Index (TATA) have significant results to detect financial report manipulation.

Classifying Restatements: An Application of Machine Learning and Textual Analytics

Restatements of audited financial statements are used for evaluating reporting quality, audit quality and for other evaluative purposes. Prior research shows that restatements that correct unintentional errors have different implications for statement preparers, users, auditors and regulators than restatements that correct intentional misstatements. However, manually classifying restatements into these categories can be tedious, time-consuming and inconsistently performed. Therefore, we constructed a Naive Bayes machine learning algorithm to classify restatements by management intent based on the language in restatement announcements. Empirical tests of the algorithmically classified restatements show that this classification is an effective, efficient alternative to manual classification and more reliable than other commonly used automated methods such as classifying based on restatement direction or magnitude. Our method does not require a dictionary of words associated with management intent, is easily replicated and scalable and may be used to classify restatements disclosed at the same time as financial results.

The Association between Changes in Accounting Estimates and Accounting Restatements

This paper investigates the relationship between changes in accounting estimates and subsequent restatements. Theory suggests that depending on the underlying reason for an estimate change, this relationship can be either negative (for changes in estimates made in response to new developments or management having obtaining new information) or positive (for changes in accounting estimates made with an objective of managing earnings or changes that are not reliably estimated and are poorly audited). We hypothesize and find a positive relationship between changes in estimates and restatements. There is also support for the prediction that the presence of a change in accounting estimate(s) is associated with an increased likelihood of subsequent restatement to correct intentional misstatement. The findings of the study are of interest to accounting academics, regulators, and audit practitioners.

Using Evidential Reasoning Technology to Enhance the Audit Quality Assurance Inspection Process

ABSTRACTThis paper considers the use of an emerging technology based on formal evidential reasoning to help audit quality assurers conduct higher-quality inspections of audit engagements. Although the ideas should be relevant to the inspection process in general, we focus on PCAOB stated objectives and procedures and, as an illustration, the inspection of Satyam Computer Services Limited. To enhance audit quality assurance (AQA), we propose and illustrate a portion of a prototype technology that uses formal evidential reasoning to help assess audit quality. The use of a formal evidential reasoning model and a structured process should provide better documented and more precise, consistent, and rigorous AQA assessments of risk, of the sufficiency and competency of audit evidence collected, and of various auditor judgments. The potential of this technology is illustrated by evaluating the Public Company Accounting Oversight Board's (PCAOB) inspection of Satyam Computer Services Limited, in particular the assessment of the risk of financial statement misstatement due to either unintentional or intentional misstatements. The illustration suggests that the proposed technology is likely to facilitate an enhanced inspection of audit quality. By implication, we assert that use of such technology will result in other enhancements to AQA.

Budgets and other lies: Evidence of bias in financial planning

Budgets are considered by many to be a necessary evil. Within organizations, budgets are used to allocate financial resources to individuals who are charged with managing funds. This allows them to accomplish corporate goals and objectives. When reviewing the differences between actual and planned spending for a number of cost centers evidenced in data covering a 4-year period, it was noted that favorable variances exceeded unfavorable ones more than 50% of the time, although probability suggests that favorable and unfavorable results are equally likely to occur. As budgets are only best guesses about the future, these results indicate that planned spending was intended to manage uncertainty. In other words, the budgets were intentionally misstated—that is, they were lies. This Executive Digest explores ways of uncovering these lies. The consequences of intentional misstatement of planned spending are serious. In such cases, financial resources are not only misallocated, but also allocated in a suboptimal way. This means that future borrowing costs may increase, important projects could be delayed, and necessary operating expenditures are not made.

Imperfect Accounting and Reporting Bias

ABSTRACTErrors and bias are both inherent features of accounting. In theory, while errors discourage bias by lowering the value relevance of accounting, they can also facilitate bias by providing camouflage. Consistent with theory, we find a hump‐shaped relation between a firm's propensity to engage in intentional misstatement and the prevalence of unintentional misstatements in the firm's industry for the whole economy and a majority of the industries. The result is robust to using firms’ number of items in financial statements and exposure to complex accounting rules as alternative proxies for errors and to using the restatement amount in net income to quantify the magnitude of bias and errors. To directly test for the two effects of errors, we show that when errors are more prevalent, the market reacts less to firms’ earnings surprises and bias is more difficult to detect. Our results highlight the imperfectness of accounting, advance understanding of firms’ reporting incentives, and shed light on accounting standard setting.

What Drives the Consequences of Intentional Misstatements? Evidence from Rating Analysts’ Reactions

AbstractThis paper aims to identify the mechanisms through which intentional misstatements adversely affect firms by analyzing rating analysts’ reaction to misstatements. In order to identify the mechanisms through which the misstatement affects firms’ credit ratings, we analyze the content of rating reports. Rating analysts are concerned about seven different mechanisms. They are most concerned about misstatement‐related violations of debt covenants that increase a firm's liquidity risk. We find that, subsequent to an intentional misstatement becoming publicly known, credit ratings of misreporting firms are adversely affected for up to seven years. The adverse impact of an intentional misstatement on a firm's credit rating is most pronounced in cases in which rating analysts mention concerns about misstatement‐related violations of covenants. Our results suggest that these covenant violations are the most severe mechanism through which misstatements adversely affect firms’ creditworthiness.

Perceived Accounting Quality and the Information Content of Prior Insider Trades

We examine how shocks to perceived accounting quality lead to market prices that reflect an increased weighting on prior disclosures of insider trading. Using a sample of firms where industry peers have restated financial information, we find that the short-term market reaction to announcements of restatements by industry peers is significantly more negative for companies with recent insider net selling than for companies with recent insider net buying. We also find that recent insider trading signals are more informative to investors in situations characterized by greater information asymmetry prior to a peer restatement and when the peer restatement is an intentional misstatement. Our findings suggest that insider selling disclosures are an important source of information when perceived accounting quality is low and that a significant portion of the intra-industry information transfers arising from peer restatements is due to a reweighting of other information.

Evaluating the Intentionality of Identified Misstatements: How Perspective Can Help Auditors in Distinguishing Errors from Fraud

SUMMARYAlthough auditors are responsible for detecting misstatements arising from either error or fraud, the auditing standards require very different audit responses when a misstatement is believed to be the result of an intentional act (AS No. 14, PCAOB 2010a). Specifically, if auditors suspect intentional misstatement, then they should perform additional audit procedures, reassess overall fraud risk and the integrity of management, and communicate potential concerns to the audit committee. Thus, if auditors fail to recognize and respond to information indicating a misstatement was caused intentionally, then audit quality may be impaired. The objective of this study is to investigate whether auditors who consider the perspective of the manager responsible for a misstatement's occurrence are more sensitive to circumstances indicating the misstatement was intentional. Using an experiment with audit managers and senior managers, I find that auditors who consider the client manager's perspective assess the misstatement as significantly more likely to be intentional when circumstances surrounding it indicate high, as opposed to low, fraud risk. In contrast, auditors who do not consider the client manager's perspective do not assess intentionality any differently, regardless of the level of fraud risk.

Investment Opportunity and Risk of Fraud in Private Placement Offers: A Case of Middle Eastern Investors Investing Outside the Middle East

This study raises the question about the level of misstatement risk and fraud associated with the Private Placement Memorandum. The reason for raising this question is that Private Placement Memorandum is circulated among potential investors without any regulatory approval to ensure the content. Individuals have tremendous wealth and liquidity in the Middle East region, particularly the six countries of the Gulf Cooperation Council; Hence, investment opportunities through Private Placement Offers are numerous for the investors in the region., The associated risk of fraud or misstatement, therefore, is equally high with Private Placement Memorandum due to lack of any regulatory bodies that control and monitor Private Placement Memorandum in the Middle East. A qualitative study approach was used with a questionnaire circulated among a selected population to secure direct feedback based on participants’ experience. The results of the survey conclude the need for direct regulatory control on the Private Placement Memorandum with the goal to give better protection to investors in the region. The data collected suggests that the Private Placement Memorandum is not transparent mainly due to there being no direct monitoring of the content of Private Placement Memorandum from regulatory authorities in the region. Hence, the study achieved the objective of highlighting the need for statutory bodies to regulate and protect investors’ interests in the region. This study could help authorities understand factors to be considered, while allowing private placement with best possible disclosure in Private Placement Memorandum, with legal and criminal consequences in case of intentional misstatement, misleading information, or lack of sufficient disclosures.

The effects of tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments

AbstractPrior research suggests that internal auditors’ judgements are subject to management influence resulting in compromised risk assessments. This study investigates the effects of the tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments. Results of an experiment involving 64 internal auditors indicate that when the tone at the top is poor, rather than favouring management, internal auditors report a higher risk of intentional misstatements and that coordination with external auditors can further reduce expectations of the incidence of intentional misstatements.

Fear as a Motivation to Commit Management Fraud: A Conceptual Paper Regarding Ethics and Executive Accounting

Motivators for financial statement fraud are different than for traditional fraud that involved theft, management fraud and misappropriation of assets, respectively. Traditional theft of assets involves some element of greed and financial pressure is probably the most likely motivator for these frauds. Management fraud, the intentional misstatement of financial results in reports filed with regulatory agencies and made known to the public through various media, however is quite different in what is being attempted. Although there can be gain to the company, the fraud itself is not gaining financial position for management as much as it is preventing the loss of financial position. This is motivation for executives that revolve around potential damages to their ego when their failed vision for the company is known. This loss or reputation and status for the company executive creates a primary motivator that is the fear of failure. The executive also can entertain persistent, possibly delusional rationalizations for the hope for success in turning the situation around. This conceptual paper explores models for applying this idea to current fraud theory. It also posits that proper risk management evaluation can assist in reducing the incidence of management fraud not just by reducing the likelihood of losses occurring that can act as a catalyst for management fraud but by providing plans for addressing potential negative downturns when they occur that mitigates the strength of this fear.

Do Accounting Errors Breed Fraud?

Errors and bias are both inherent features of accounting. In theory, while errors discourage bias by lowering the value relevance of accounting, they can also facilitate bias by providing camouflage. Consistent with theory, we find a hump-shaped relation between a firm’s propensity to engage in intentional misstatement and the prevalence of unintentional misstatements in the firm’s industry for the whole economy and a majority of the industries. The result is robust to using firms’ number of items in financial statements and exposure to complex accounting rules as alternative proxies for errors and to using the restatement amount in net income to quantify the magnitude of bias and errors. To directly test for the two effects of errors, we show that, when errors are more prevalent, the market reacts less to firms’ earnings surprises and bias is more difficult to detect. Our results highlight the imperfectness of accounting, advance understanding of firms’ reporting incentives, and shed light on accounting standard setting.

A classroom example of the deleterious effects of auditor predictability

Abstract If an auditor employs the same testing strategy (e.g., type of evidence, sample size, scope, selection method) year after year, or otherwise inadvertently discloses information about the audit plan, the auditee can predict auditor behavior on the current audit. The instructional exercise described in this note illustrates the deleterious effects on audit effectiveness of this predictability. Numerical examples and student decisions are used to show that the probability that the auditor will detect intentional misstatements (fraud) may be reduced dramatically if the auditor does not recognize the strategic aspects of auditing.

Jobs, Environmental Controversies, Health, and Activism in the News

Abstract Social movements and collective action have often been studied using newspapers for data. Concerns with newspaper data include selection bias, where a subset of accounts, events, or statements are reported, and description bias, which refers to the veracity of accounts and statements. Bias can be created by intentional or accidental misstatements of events and processes, by type of event selected by journalists, and by characteristics of the reporting entity. In this article, bias and scholarly strategies to address bias are discussed in the context of two West Virginian environmental conflicts; one focuses on mountaintop removal mining and one involves the production of the insecticide methyl isocyanate (MIC). Newspaper data is used to explore what activists say motivates their activism toward corporations causing environmental hazards.