Detecting earnings manipulation and fraudulent financial reporting in Slovakia

Abstract

Research background: Misleading financial reporting has a negative impact on all stakeholders since financial records are the primary source of information on financial stability, economic activity, and financial health of any company. The handling of them is primarily the responsibility of managers or owners and reasons for doing so may differ. Their common denominator is the artificial creation of information asymmetry to get different types of benefits. It is, therefore, logical that the issue of detecting opportunistic earnings management comes to the fore.
 Purpose of the article: The purpose of the study is to create a discriminant model of the detection of earnings manipulators in the conditions of the Slovak economy. 
 Methods: We used the discriminant analysis to create a model to identify fraudulent companies, based on the real data on companies that were convicted from misleading financial reporting in connection with tax fraud in the years 2009–2018. The model is inspired by the Beneish model, which is one of the most applied fraud detection methods at all.
 Findings & Value added: In order to achieve more accurate detection results, we extended the original model by taking into account the values of indicators from three consecutive years, i.e. by taking into account the development of the potential tendency of companies to be involved in opportunistic earnings management. Our model correctly identified 86.4% of fraudulent companies and overall reaches 84.1% classification ability. Both models were applied on empirical data on 1,900 Slovak companies from the years 2016–2018, while their overlap was 32.7% for fraudulent companies and 38.4% for non-fraud companies. This is a very useful result, as the application of both models rein-forces the results obtained and the identical classification of the company into fraudulent indicates that the manipulation of earnings occurs with a high probability.

Detecting the manipulation of earnings in the company: triangulation of methods

“…For the detection of earnings management, we used triangulation of methods: one of the most frequently used model in this area, Beneish model [21], the model for Slovak companies − [9], which was created under the inspiration of the Beneish model and finally, the model of the company's propensity score of manipulation − [22]. In all three of these methods, we use a set of variables, following Beneish's original approach.…”

“…The authors state that corruption has a very strong effect on earnings management and that controlling the level of corruption in their countries can discourage managers of the companies from earnings management. Several studies dealing with the issue of earnings management and its detection have also been published by authors from Slovakia, such as [1][2][3][4][7][8][9][16][17][18][19][20].…”

“…The main idea of this study is that the application of three different methods will strengthen the obtained results and if these methods agree in the result, it is more likely that this phenomenon really occurs in the company. With this article, we also try to fill the scientific gap, which is still in this area of research in the Slovak Republic, where only a few first studies on this issue are published and the model for Slovak companies was created in the study [9]. The aim of this paper is to extend this study to the knowledge of other suitable methods that can be applied for the detection of earnings management in the Slovak environment.…”

Motives and techniques of earnings management used in a global environment

“…[5] Misleading financial reporting harms all stakeholders since financial records are the primary source of information on financial stability, economic activity, and financial health of any company. [6] Different motives lead managers to use different techniques, which is a global business environment [7] that can be classified according to two types of earnings management. There is real earnings management which represents the activity where managers try to influence reported earnings through actions that substantially change the underlying cash flows thereby influencing reported earnings and accrual-based earnings management which operates within the accounting norms choices that try to obscure the true performance of companies.…”

Creative accounting in a global business environment

“…The correctness of financial statements is important in every company existing in a global business environment. The main essence of financial statements is a true and fair view of accounting [1] because accounting information is an essential source of information about the company, which in the global business environment is used by other internal as well as external entities. [2] Based on the above, it is clear that each of the interest groups expects different values and results to achieve their expected goals.…”