Aggressive Accounting and Corporate Frauds in Malaysia

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RESEARCH METHODOLOGY IN ACCOUNTING

RAC700

Aggressive Accounting and Corporate Frauds:

Investigation on Malaysian Listed Companies 2007-2013

ABSTRACT

This study examines the relationship between financial reporting behaviors of the firm’s and the involvement of the firm’s in corporate frauds. The investigation period only covered from years 2007 to 2013 and the analysis will cover five years prior to the occurrence of fraud. It’s an empirically examine whether firms practice aggressive financial reporting is most slightly involved with corporate fraud. Firm’s practices aggressive financial reporting determines by 1) Financial ratio for five years prior to the frauds year 2) using Beniesh models. The result from this study expected to shows whether there are significant relationship between firm that practices aggressive accounting and corporate frauds. Thus, this study contributes to the literature on the impact of financial reporting behavior and Corporate Frauds.

Keywords: Aggressive accounting, Corporate Frauds, and Financial ratio

Contents

ABSTRACT

1.0INTRODUCTION

1.1Overview

1.1.1Financial Statement

1.1.2Corporate frauds.

1.2 Problem Statement

1.3 Research Objectives

2.0 LITERATURE REVIEW

2.1 Aggressive Accounting

2.2 Corporate frauds

3.0 RESEARCH METHODOLOGY

3.1 Research Framework

3.2 Hypothesis Development

3.3 Selection of Sample

3.4 Data Collection Method

3.5 Independent Variable, Dependent Variable and Control variable

References

1.0 INTRODUCTION

1.1 Overview

1.1.1 Financial Statement

Financial Statement can be defining as a record or summary of the financial transaction activities for business, person or entity. Financial Statement should be presented in a structured and understandable. Basically, financial statement can be use by internal and external. For internal user, financial statement information is for management discussion before makes any decisions. Financial statements include the income statement, balance sheet, statement of cash flow.

1.1.2 Corporate frauds.

Financial statement frauds can be defined as deliberate misstatement or misrepresentation or omission of financial statement data purposely to mislead the reader and giving false impression on organization's financial strength. Association of Certified Fraud Examiners (ACFE) defines fraud as "dishonesty or misrepresentation by entity or individual who knew that the falsification may result in some unlawful benefit to the another party”. “Falsify financial reporting primarily consists of manipulate essentials by overstate assets, Revenue and profit, or understate liabilities, operating expense, or losses” (Spathis, 2002).

Chartered Institute of Management Accounting (CIMA) report in Topic Gateway Series no 7 stated that there a few type under corporate frauds which is misuse of account, procurement frauds, financial statement frauds etc. However for this study we only focus on financial Statement frauds. We will discuss the reason in problem statement part.

There a few motives why business commit fraud. First, to secure investors interest, Obtain borrowing/financial with the banks, Increase bonuses or salaries or they are trying to meet analysis or expectation of analysis forecast. Usually, there are close relationship between upper management and corporate fraud due to financial statement prepared at management level. Base on triangle theory develop Dr Donald Cressey explain on 3 element or factor why fraudster commit frauds. Firstly, there are appearances of pressure. Secondly, there perceived opportunity to conceal the dishonest act or illegal activities. Lastly, there are some way fraudsters to rationalize the act as justifiable.

1.2 Problem Statement

Recently, corporate frauds cases brought attention among business player; this could affect business performances in many ways. Survey conducted by ACFE 2014 reveal that the victims incurred financial median losses in year 2010-2014 under financial statement frauds in between of US$1,000,000 to US$4,100,000. In Malaysia environment, survey conducted by PricewaterhouseCoopers (PWC) reported that by 58% in year 2014 in the frequency and the financial impact on economic crime. Moreover, the survey also reveal that almost 10% Malaysian organization experiences losses more than US$1 Million from the year 2013-2014. Although, Bursa Saham Malaysia and Securities Commission (SC) of Malaysia gave and taking seriously on quality of financial reporting and continuously practices Financial Restatement. Due to act, the firms had given a significant impact on financial loss indirectly impact to reputation on accounting practice. Corporate fraud causes companies to lose prospective investors and Shareholder confidence (Kamarudin, 2012).Therefore, our aim of this study is to examine firm’s financial reporting behavior and involvement to corporate frauds

1.3 Research Objectives

The objective of this study is to examine firm’s financial reporting behavior and involvement to corporate frauds than those that do not from evidence from Malaysian listed companies for the years from 2007 to 2013. Thus, the specific objectives of this study to examine firms who are practices aggressive financial reporting are most slightly involved with Corporate Frauds.

1.4 Scope of the Study

This study examined companies where involved in corporate frauds and does firm practices aggressive accounting can slight to corporate frauds?. The investigation period only cover from years 2007 to 2013 and the analysis will cover the five years proceeding to the incident of frauds occur. The data were collected from annual reported of the each company which will be downloaded from the Bursa Malaysia website.

2.0 LITERATURE REVIEW

2.1 Aggressive Accounting

Aggressive accounting can be define as modification or manipulated financial figures from actual to desire figures with intent to taking advantage of the existing rule or regulation. In general, aggressive accounting is trying to report company’s revenues with higher then the truly amount for representing attractive figures to current and prospective investors. However, not all aggressive accounting practices constitute frauds (Badawi, May 2008). “In practice, financial deception mainly consists of falsify financial statements which include manipulate elements which is overstate assets, revenue and profit, or understate liabilities, operating expense, or losses.” (Dalnial, Kamaluddin, Mohd Sanusi, & Khairuddin, March 2014).

2.2 Corporate frauds

Although we are already discus on definition of Fraud, again CIMA define corporate frauds as deception to make/taking advantage for oneself with dishonestly and create loss to another. Does it is general explanation to explain meaning of “Frauds”. Base on CIMA report there are a few frauds can consider under Corporate Frauds. Which is, Bribery and Corruption, Suspense accounting frauds, financial Statement frauds and etc. For this study, we only focus on financial statement frauds.

3.0 RESEARCH METHODOLOGY

3.1 Research Framework

3.2 Hypothesis Development

The objective is to examine firms that practice aggressive financial reporting is more likely to be involved in Corporate Frauds. Thus, the following hypotheses have been developed and stated in alternative forms as follows:

Hypothesis: Firms that practice aggressive reporting are most slightly to engaged with Corporate Frauds.

3.3 Selection of Sample

The examination of aggressive accounting and corporate frauds are based on companies listed on Bursa Malaysia from the years 2007 to 2013. The companies are from various sectors. There 2 basic selections for dependent variables which are:

  1. Selection of financial reporting frauds firms:

The selection of the firm involving financial reporting frauds is obtained from the Bursa Malaysia. Basically, all firm will be summarizes according to the offences against listing of requirement by Bursa Malaysia Securities Berhad, were most of the firm reporting material misstatement in their financial report. The data obtained for five years prior to fraud year. First, Fraud years is identifying. The fraud year is the years were the companies commit/detect frauds. Secondly, four preceding years will be obtained. For example, if the frauds year happen in year 2013, then, four year preceding years which is 2012,2011,2010 and 2009. Therefore, the result of selection will be in five years data. Frauds year data will be abstracted from the original data before any adjustment was made. Firms from insurances and financial sector will be excluded due to insufficient data where the firms are not dealing with inventory and account receivables

  1. Selection of non financial reporting frauds Companies:

The selection of the firm is using matched system. Whereby, each fraud firms will be matched with non frauds firm on the basis of the time period, Industry and size. This 3 control variable is key point as firm with same industry and size will as similar nature or business environment. The data from the financial statement of non fraud firm were obtained the same year of the fraud year of fraud firm. In order to get sufficient data, all non fraud firms also required to have completed financial data during matching process. Both firm are matched with regards to: (i) Firm size, (ii) Industry, and (iii) Time period.

3.4 Data Collection Method

This study will fully utilizes the secondary data (Published Audited Financial Report as main source of information) obtained Bursa Malaysia Berhad Media Centre. Annual reports are regarded as the main form of communication with shareholders as well as the public and they are widely distributed and are the most commonly produced documents.

3.5 Independent Variable, Dependent Variable and Control variable

The data collection involves an examination of fraud firms’ and non-fraud firms’ data from companies’ financial statements available in its annual report. The list of the data is reported in Table 1 and Table 2:

Table 1: Measurement Independent Variables Extracted from Financial Statements for financial ratio

NO

Independent variable

Measurement

ABBREVIATIONS

1

Financial Leverage

Total Debt/Total Equity

TD/TE

2

Total Debt/Total Asset

TD/TA

3

Profitability

Net Profit/Revenue

NP/REV

4

Asset Composition

Current Assets/ Total Assets

CA/TA

5

Receivables/Revenue

REC/REV

6

Inventory / Total Assets

INV/TA

7

Liquidity

Working Capital to Total Assets

WC/TA

8

Capital Turnover

Revenue to Total Assets

REV/TA

Table 2: Measurement Independent Variables Extracted from Financial Statements for Beneish Model.

Beneish model was developed byMessod D. Beneish. This model also known’s M-Score where its mathematical model that using eight financial ratios to identify does Company has manipulated their earning. Those variables are constructing from the company's financial reporting and it created a score to explain the extent to which the earnings have been manipulated. This M-score most slightly similar to Altman Z-Score, However, Altman Z-score only focus on bankruptcy and M-score looking from different angle which is earnings management (Omar, April 2014).

Item

Factor

Name

Formula

Basis

1

DSRI

Days’ Sales in Receivables Index

Receivables / Total Sales

Present year / Previous year

2

GMI

Gross Margin Index

Gross Profit / Total Sales

Previous year / Present year

3

AQI

Asset Quality Index

(Non-Current Assets – PP&E) / Total Assets

Present year / Previous year

4

SGI

Sales Growth Index

Total Sales

Present year / Previous year

5

DEPI

Depreciation Index

Depreciation / (Depreciation + Net PP&E)

Previous year / Present year

6

SGAI

SG&A Expense Index

SG&A / Revenues

Present year / Previous year

7

TATA

Total Accruals to Total Assets

(Working Capital – Cash) – Depreciation

Present year / Previous year

8

LVGI

Leverage Index

Total Debt / Total Assets

Present year / Previous year

3.5 Empirical Models and Variable Definitions

This study used which is measured as follows:

Frauds model is stated as follows:

FFR = bo + b1(SIZE) + b2(TD/TE) + b3(TD/TA) + b4(NP/REV)+ b5(CA/TA) + b6(REC/REV) + b7(INV/TA) + b8(WC/TA) + b9(REV/TA)+ e

Next, to measure the company financial manipulation as per below using Beneish model (M-Score):

M-Score = -4.84 + 0.92*DSRI + 0.528*GMI + 0.404*AQI + 0.892*SGI + 0.115*DEPI – 0.172*SGAI + 4.679*TATA – 0.327*LVGI

References

Accountant, C. I. (May 2009). Corporate fraud - Topic Gateway Series No. 57. CIMA Publisher.

Badawi, I. M. (May 2008). Motives And Consequences Of Fraudulent Financial Reporting. the 17th Annual Convention of the Global Awareness Society International. San Francisco.

Dalnial, H., Kamaluddin, A., Mohd Sanusi, Z., & Khairuddin, K. S. (March 2014). Detecting Fraudulent Financial Reporting through Financial Statement Analysis. Journal of Advanced Management Science Vol. 2, No. 1,.

Elmabrok Mohammed, ,. A., & Ng, K.-S. (July 2012). Using Altman's Model and Current Ratio to Assess the Financial Status of Companies Quoted In the Malaysian Stock Exchange. International Journal of Scientific and Research Publications,, Volume 2, Issue 7,.

Eragbhe, E., & Omoye, A. S. (2014). Accounting Ratios and False Financial Statements Detection: Evidence from Nigerian Quoted Companies. International Journal of Business and Social Science, Vol. 5, No. 7(1).

Kamarudin, K. A. (2012). Aggressive financial reporting and corporate fraud. Procedia - Social and Behavioral Sciences, 638 – 643.

Nelson, S. P. (2012). Post fraud: An empirical study of firms in Malaysia. International Journal of Management and Business Studies, Vol. 2 (3), pp. 059- 065.

Omar, N. (April 2014). Financial Statement Fraud: A Case Examination Using Beneish Model and Ratio Analysis. International Journal of Trade, Economics and Finance.

Persons, D. O. (n.d.). Using Financial Statement Data to Identify Factors Associated with Fraudulent Financial Reporting. Journal of Applied Busines Research, Vol. 11, No 3.

PricesWaterhousecoopers. (2014). What you don't can hurt you.

Schick, B. M. (2003). Are auditors sensitive enough to fraud? Managerial Auditing Journal, 18/6/7, pp. 591-598.

Smith, G. S. (2012). Can an auditor ever be a first responder to financial frauds? Journal of Financial Crime, Vol. 19 No. 3, pp. 291-304.

Spathis, C. T. (2002). Detecting false financial statements using published data: some evidence from Greece. Managerial Auditing Journal, 179-191.

Tugas, F. C. (November 2012). A Comparative Analysis of the Financial Ratios of Listed Firms Belonging to the Education Subsector in the Philippines for the Years 2009-2011. International Journal of Business and Social Science, Vol. 3 No. 21;.

Warshavsky, m. (2012, october/november). forensics/fraud - earnings Quality and the Beneish Model. Analysing Earnings Quality as forensic financial tools, pp. 16-20.

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