The Model of Fraud Detection in Financial Statements by Means of Financial Ratios

Rasa Kanapickiene

Abstract


Purpose. Financial statements are drawn to present fair information about the financial position, operating performance and cash flows of the company. The reason for that is that the owners of companies, investors, creditors, governmental institutions make decisions regarding the development of the company on the basis of the information provided in financial statements.

However, according to the international standards on auditing, management is in a unique position to perpetrate fraud because of management’s ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls that otherwise appear to be operating effectively Therefore, it is essential to analyse the different methods of fraud detection in financial statements.

This notwithstanding, issues of fraud detection in the financial statements are usually analysed in the context of the audit. It is worth mentioning that models designed for the external users of financial statements are analysed in scientific papers insufficiently. Analysis of financial ratios is one of those simple methods to identify frauds. This relevant issue is dealt by foreign scientists (Spath et al., 2002; Wells, 2001, 2007; Lenard, Alam, 2009; Crumbley et al., 2009; Ravisankar et al., 2011; Pustylnick, 2012), but such studies are insufficient in Lithuania. The aim of the research is to develop the model of fraud detection in financial statements by means of financial ratios.

Methodology. The theoretical research investigates frauds in financial statements and possibilities to detect frauds by means of financial ratios.

The analytical study deals with fraudulent and nonfraudulent financial statements of surveyed companies. During the study 1) financial ratios exhibiting information about fraud in the financial statements were selected by applying statistical methods; 2) possibility to use the bankruptcy prediction models when identifying fraud in the financial statements was assessed; 3) models of linear discriminant analysis and logistic regression were investigated with regard to possibility of their use for fraud detection; 4) the most appropriate model for fraud detection was selected.

Results. The model of fraud detection in financial statements has been developed.

The theoretical contribution. The theoretical study has revealed that financial ratios in the scientific papers are analysed in order to assess which statement ratios are the most sensitive to the motives of fraud exercising by company managers and employees.

Practical implications. The designed model can be used by external users of financial statement information when making decisions for investment and company evaluation.

Keywords: fraud detection, financial statements, financial ratios.

Paper type: Research paper.

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