Liming Guan

Can financial ratios detect fraudulent financial reporting

Fraudulent financial reporting is a matter of grave social and economic concern. The Treadway Commission recommended that the Auditing Standards Board require the use of analytical procedures to improve the detection of fraudulent financial reporting. This is an exploratory study to determine if financial ratios of fraudulent companies differ from those of nonfraudulent companies. Fraudulent firms were identified by examining the SECs Accounting and Auditing Enforcement Releases issued between 1982 and 1999. The fraudulent firms (n=79) were then matched with nonfraudulent firms on the basis of firm size, time period, and industry. Using this matched‐pairs design, ratio analysis for a seven‐year period (i.e. the fraud year −/+ 3 years) was conducted on 21 ratios. Overall, 16 ratios were found to be significant. Of these, only three ratios were significant for three time periods. Of the 16 statistically significant ratios, only five were significant during the period prior to the fraud year. Using discriminant analysis, misclassifications for fraud firms ranged from 58 percent to 98 percent. These results provide empirical evidence of the limited ability of financial ratios to detect and/or predict fraudulent financial reporting.

Auditing, integral approach to quarterly reporting, and cosmetic earnings management

Purpose – This study examines the effect of auditing and the integral approach to interim reporting on cosmetic earnings management, referred by Kinnunen and Koskela as earnings manipulative behavior to report earnings numbers to achieve key cognitive reference points represented by N×10k.Design/methodology/approach – Using Benfords Law, the analysis employs 182,278 positive quarterly earnings observations and 103,470 negative quarterly observations for all publicly listed US companies from 1993 to 2003.Findings – The empirical results show that firms tended to engage in cosmetic earnings management in each of the four fiscal quarters. More importantly, it was found that the degree of cosmetic earnings management is significantly less severe in the fourth fiscal quarter, which is the only quarter audited, than any of the previous quarters. This result suggests that the auditor plays an important role in reducing the cosmetic earnings manipulative behavior.Originality/value – The findings of the study add...

The evolution of IT auditing and internal control standards in financial statement audits

The rapid escalation of technology and the use of computers in business practice result in more information technology (IT) auditing and internal control standards and guidelines to assist auditors in their roles and responsibilities. Several organizations, such as the American Institute of Certified Public Accountants (AICPA), the International Federation of Accountants and the Information Systems Audit and Control Association (ISACA), have issued standards in this area to be observed by their members in performing an IT audit. This paper traces the evolution of US IT auditing and internal control standards in financial statement audits and discusses their significance for the auditing profession. We primarily focus on the discussion of the IT audit standards issued by the AICPA and ISACA. As the use of computers in business data processing gets more widespread and the integration of IT in business processes gets more intricate, we expect to see more pronouncements of IT audit standards in the future. Auditors should well understand these pronouncements, standards and guidelines when performing an IT audit.

Earnings Management and Forced CEO Dismissal

Abstract This study examines the discretionary accounting choices made by CEOs facing forced dismissal. The results support the notion that CEOs who are faced with termination engage in income-increasing earnings management in the year prior to termination. We also examine Murphy and Zimmermans (1993) argument that poor firm performance may have led to both the CEO turnover and the discretion over accounting choices. The results indicate that firm performance and other company-specific confounding factors cannot explain away the discretionary accruals observed in firms prior to forced CEO dismissals. We also find evidence suggesting that the incoming CEOs deliberately depress earnings, i.e. taking a “big bath,” in the transition year.

Can Investors Detect Fraud Using Financial Statements: An Exploratory Study

This study explores the question of whether investors can successfully detect management fraud using a firms financial statements. Using financial ratios obtained from fraudulent companies’ financial statements, we examine the effectiveness of both logit and discriminant analyses in predicting the likelihood of fraud. Sixty-eight fraudulent companies used in the study are identified from the SECs Accounting and Auditing Enforcement Releases. Our research design has addressed certain weaknesses present in prior fraud-detection studies. The empirical results suggest that ratio analysis is grossly ineffective in detecting financial statement fraud. We also discuss the implications of our findings on future research.

Further evidence on shareholder wealth effects of announcements for newly created CIO positions

Chatterjee, Richardson and Zmud (2001) provided evidence of abnormal stock returns associated with the announcements of new CIO positions, indicating a positive reaction in the stock market to the announcements. However, an examination of the behavior of analysts who follow the firms used in the Chatterjee et al. sample finds that just over 50% of the firms actually had analysts regularly following them; and the vast majority either reflected no changes in earnings forecasts or experienced a downward adjustment. A systematic reexamination of the results reveals the following: (1) firms not tracked by analysts demonstrate positive abnormal returns at the event date; (2) Chatterjee et al.s findings of positive abnormal returns from new CIO position announcements appear to be driven by the sub-sample of firms not tracked by analysts; (3) analyst tracked firms generally do not yield abnormal returns at the event date but they do exhibit abnormal returns in the days before the announcement indicating analysts may be using leaked information from management; and (4) despite apparently disclosing private information from management to their clients, analysts do not disclose this information through revisions of earnings forecasts. Overall, our results significantly strengthen the understanding of the phenomenon while further supporting Chatterjee et al.s conclusion that new CIO position announcements are important to the capital markets.

Corporate control and earnings management: evidence from MBOs

Using a matching approach and multivariate logit analysis we determine that management of firms involved in MBOs more frequently chose income increasing accounting policies than did a matched sample of non‐MBO firms. The results provide support for the managerial economic incentives hypothesis as a motivation for accounting policy choices. The results of the study are consistent with a number of earlier studies such as Groff and Wright (1989), Hagerman and Zmijewski (1979) and Zmijewski and Hagerman (1981) that also find support for the managerial economic incentives hypothesis for accounting choices. DeAngelo (1986), Perry and Williams (1994) and Wu (1997) find evidence supporting the hypothesis that, in order to reduce the cost of acquiring shares from current stockholders, managers seeking to take firms private make income decreasing discretionary accruals in the period immediately prior to the MBO. In testing this theory DeAngelo (1986), Perry and Williams (1994) and Wu (1997) focus on the overall eff...