IDENTIFICATION OF

FALSIFIED FINANCIAL
STATEMENTS
U TA D I S – A n e m p i r i c a l a n a l y s i s

Authors:-
Kirti Tripathi
Senior Consultant, Deloitte

Dr. M Venkateshwarlu
Professor of Finance, NITIE,
INDIA
 AGENDA

1. Introduction

2. Literature Review

3. Methodology Description

4. Result Analysis & Conclusion

5. Future Scope & Way forward

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 INTRODUCTION

Despite various checks by regulatory authorities, financial frauds have become

quite common in this digital world. Current Study focuses on identifying and
testing statistical models which can help in fraud detection.

The Institute of Internal Auditors’ International Professional Practices

Framework (IPPF) defines fraud as: “… any illegal act characterized by deceit,
concealment, or violation of trust. Frauds are perpetrated by parties and
organizations to obtain money, property, or services; to avoid payment or loss
of services; or to secure personal or business advantage.”

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LITERATURE REVIEW: CASE STUDY OF FRAUDULENT CORPORATES
• Worldcom: Two accounting tactics: accrual releases & capitalization of line costs;
Inflated pretax income
• Satyam: Inflated (non-existent) cash and bank balances, understated liability and
an over stated debtors position.
• China Metal recycling: Company’s CAGR and EBTIDA was high but its capital
expenditures, employee count and inventory turnover rates remained lowest
• Lantian Stock: Serious solvency issue, inflated cash flows, sales and profit,
Academic researcher did ratio analysis to detect discrepancy

Frauds can be classified as transactional fraud ( malpractices or illicit

use of funds) and financial fraud (manipulations of Financial
statements)

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LITERATURE REVIEW - GLOBAL PRACTICES
• Based on techniques listed above and few more statistical analysis
Companies like SAP, FICO, ACL, CRISIL which are prominently used by
CITI bank, RBS, Hong Leong Bank, Garanti bank and more.
• Details of Popular Modules
• FICO® Application Fraud Manager
• FICO® Identity Resolution Engine (IRE)
• SAP Fraud Management Powered by SAP HANA
• Early Warning System: Brecon by CRISIL
• ACL P- Card fraud detection
• Artificial and Probabilistic Neural Network, data mining, Decision
tree Logit and discriminant analysis is the basis for above modules

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LITERATURE REVIEW - FRAUD IDENTIFICATION TECHNIQUES
Financial fraud Transactional fraud
Ratio analysis Benford’s law
Beneish Model Artificial Neural Network
Discriminant analysis Discriminant Analysis
Logit Analysis Logit Analysis
Multi-group Hierarchical Support Vector Machines
Discrimination
Today’s Focus Utilities Additive Discriminantes Nearest Neighbor
Time Series Analysis
Probabilistic Neural Network
Outliers detection

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 LITERATURE REVIEW – UTADIS
• Frequent changes in accounting methods, shifting of periods where
expenses or revenues were recognized and fiddling with cost estimates are
key manipulations observed in Falsified Financial Statements (Worthy, 1984)
• As fraud revolves around over and under statement of financial parameters,
it is important to understand their trends across industries and relationships
with actual growth/success of any comapny.
• Evaluated various Multi-criteria decision making techniques and finalized
Analytical Hierarchical Process for assigning weights to the criteria
• A training sample (100+ companies) is used to create the model and built
the cut off and can be validated with different data sets (companies and
time period)
• The Model is to run under various scenario’s and different training sets
including suspicious cases for improving accuracy

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FINANCIAL PARAMETERS SELECTION AS KEY CRITERIA
• Ratios are selected based on experience & studies done on fraud companies, total
of ten variables (nine financial ratios and the size-related TA] used in model are:
• Debt to Equity
• Sales/Total Asset
• Net Profit/Sales
• Receivables/Sales
• Net Profit/Total Assets
• Working Capital/Total Assets
• Gross Profit/Total Assets
• Inventories/Sales
• Total debt/Total assets
• Log TA
• Correlation Analysis and t-tests were carried to rule out overlap in information
• Log TA is size related variable and was excluded as sample data set was of
comparable size

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THE MODEL: UTILITIES ADDITIVES DISCRIMINATES
• Developed by Zopounidis and Doumpos in 2002; published in
European Accounting Review.
• Based on
𝑚
Additive Utility Function
𝑈 = ෍ 𝑝𝑗 𝑢𝑗 𝑔𝑗 ∈ [0,1]
𝑗=1
Where, pj : weight of criterion, gj : Criterion
uj(gj): marginal utility function
• Provides a mechanism for decomposing the aggregate result (global
utility) in terms of individual assessment to the criterion level.
• Ten ratios identified from seventeen (selected based on historical
trends) after Correlation and factor analysis.
• Criterion were normalized to make value of utility function more
logical & comparable

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 UTADIS - RESULTS
Suspicious Non-suspicious
With Suspicious Cases Total
Companies companies
UTADIS Fraud 10 13 23
UTADIS Non fraud 7 47 54
Total 18 60 77
Accuracy 55.5% 78.3%
Without Suspicious Suspicious Non-suspicious
Total
cases Companies companies
UTADIS Fraud 5 9 14
Top Scorer UTADIS Non fraud 3 40 43
Bottom Scorer Total 8 49 57
Accuracy 62.5% 81.6%

Cut- off : 0.35<score<-0.35

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 FUTURE SCOPE

❑ Select samples industry wise and build a cut off score

❑ LP model formulation for minimizing type I & II errors

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 CONCLUSION
• Fraudulent behaviour is not permanent in any company. More than
mathematical (financial) it is the behavioural aspect of management.
• Criterions are never used in isolation. It is disparity between them
which is the trigger for identification.
• For false positive cases in UTADIS method, there can be three
possibilities:
• That company’s behavior is outlier (actual type 1 error)
• Company is on verge of distress, hence may do manipulations further
• It has started showing fraudulent behavior(at moderate stage) but not known
yet
• For false negative cases in UTADIS model
• That company did not have manipulated behaviour in that period.
• The business nature is outlier in the group.

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THANK YOU

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 REFRENCES
1) Kaplan, Robert S., and David Kiron. "Accounting Fraud at WorldCom." Harvard Business School Case 104-071, April 2004. (Revised September 2007.)
2) Bhasin, M. L. (2013). Corporate accounting fraud: A case study of Satyam Computers Limited.
3) Datar M. Srikant, Raina Anjali and Arora Namrata. "Tech Mahindra and the Acquisition of Satyam Computers(A)." Harvard Business School Case 114-049, Jan 2014.
(Revised May 2014.)
4) Amy Lau, Jun Han, Katrina Tai (2014). China Metal Recycling Holdings Limited: Scrap King Gets Scrapped, University of Hong Kong, 2014.
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 THANK YOU
S U BT I T L E G O E S H E R E