Thelastdecade,especiallyaftertheburstoftheinternetbubble,hasproducedanew

trendofaccountingscandals.Amajorpartofthelatestaccountingscandalshavetaken
place in large public companies. One of the most infamous examples is the fiasco
surrounding the Enron Corp. The worlds leading energy company, had to file
bankruptcyin2001asaresultofaanaccountingfraudinvolvingtheuseofspecial
purposeentitiestoconcealthelossesitsuffered.Thesucceedingcrashofthestockhada
devastatingeffectasthousandsofEnronemployeesandinvestorslosttheirsavingsand
pensions.Astheconsequencesofsuchheftyfraudsisfeltthroughoutsocietyatlarge,the
uncertainty towards accountancy and audited financial reports increases with each
scandal.Thecallforaneffectivemethodtoidentifyearningsmanipulationhasincreased
with each exposed accounting scandal. The Beneish model discriminates between
manipulatorsandnonmanipulators.Themodelbelongstothemostcitedandusedtools
todeterminethelikelihoodofearningsmanagement.Beneish(1997)whoconstructeda
moreholisticmodelthatincludedratiosbasedonincentivesforearningsmanipulation
and ratios that have a positive relationship with earnings manipulation. The model
specifically calculates a percentage, which is a proxy for the chance of earnings
manipulation.Itisuniqueinthisrespectandallegedlyoutperformsconventionalaccrual
models.
TheBeneishmodelisbasedonvariableswhicheithertendtocapturethelikelihoodof
thedetectionofdistortedfinancialdata,ortheincentivesandabilitiesofmanagersto
violateGAAP.Thesetofvariablesassessingthelikelihoodofdetectionispresented
below:
1. DaysSalesinReceivablesIndex(DSRI)Itisdefinedastheratioofdaysin
receivablesintheyearthatthemanipulationisdiscovered(yeart)tothesame
measureintheyeart1.
2. GrossMarginIndex(GMI)Itisdefinedasaratiooftotalsalesminusthecostof
goodssolddividedbysalesinyeart1tothecorrespondingmeasurementinthe
yeart.
3. AssetQualityIndex(AQI)Itisdefinedastheratioofthenoncurrentassets
(otherthanpropertyplantandequipment)totheTotalAssets.
4. DepreciationIndex(DEPI)Itisdefinedastherateofdepreciationintheyeart1
dividedbythedepreciationrateinyeart
5. SalesGeneralandAdministrationIndex(SGAI:ItisdefinedasaratioofSG&A
tosalesinyeartrelativetothecorrespondingmeasureintheyeart1
6. TotalAccrualstoTotalAssets(TATA)Aratiocommonlyusedtogaugethe
degreetowhichearningsarecashbased
Thefollowingvariablesareusedasproxiesfortheabilityandincentivestoviolate
GAAP:
1.CapitalStructure(CS)Higherleverageisanexplicitincentiveformanagerstoviolate
GAAP
2.PriorMarketPerformance(PMP)Decliningstockpricescreateincentivestoinflate
earnings
3.TimeListed(TL)Youngerfirmsaremorelikelytoexperiencefinancialdistress

4.SalesGrowthIndex(SGI)Itishypothesisedthathighgrowthfirmsinherentlyface
moreinducementsforearningsmanipulation
5.PositiveAccrualDummy(PAD)Adummyvariabledenotingwhetherornotaccruals
werepositiveinthecurrentandprioryear.Firmsdisplayingpositiveaccrualsyearafter
yearcouldinflateearningsandattempttoavoidaccrualreversals.
6.DecliningCashSalesDummy(DCSD)Adummyvariabledenotingwhetherornot
salesinthecurrentyeararelowerthaninthepreviousyear.
Manipulation index = -2.224 + 0.221(DSRI) + 0.102(GMI) +
0.07(AQI) + 0.062(DEPI) +0.198(SGAI) - 0.415(TATA) +
0.040(SGI) - 0.684(PMP) - 0.001(TL)+ 0.587(CS) + 0.421(PAD)
0.413(DCSD)
Asimplifiedversionofthemodel
Manipulationindex=4.840+0.920(DSRI)+0.528(GMI)+0.404(AQI)+
0.892(SGI)
0.115(DEPI)0.172(SGAI)+4.679(TATA)0.327(LVGI)
Auditors,regulatorsandinvestorsareabletocalculatetheMscoreeasilyusingpublicly
availableinformation.Thatthehigherthescorethehighertheprobabilityofmanipulative
behaviour.