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3GFFIRS 06/03/2013 17:33:15 Page Using Analytics to Detect Possible Fraud 3GFFIRS 06/03/2013 17:33:15 Page Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their company, from accounting and finance to internal controls and performance management 3GFFIRS 06/03/2013 17:33:15 Page Using Analytics to Detect Possible Fraud Tools and Techniques PAMELA S MANTONE 3GFFIRS 06/03/2013 17:33:16 Page Cover image: Wiley Cover design: # iStockphoto.com/Artur Figurski Copyright # 2013 by John Wiley & Sons, Inc All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 646–8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201) 748–6008, or online at www.wiley com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762–2974, outside the United States at (317) 572–3993 or fax (317) 572–4002 Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Library of Congress Cataloging-in-Publication Data: ISBN 978-1-118–58562-7 (Hardcover); ISBN 978-1-118–71595-6 (ebk) ISBN 978-1-118–71598-7 (ebk) Printed in the United States of America 10 3GFFIRS 06/03/2013 17:33:16 Page To all who cherish the opportunity to continue to learn and excel in whatever they may 3GFFIRS 06/03/2013 17:33:16 Page 3GFTOC 06/03/2013 18:16:56 Page Contents Preface xi Acknowledgments xv Chapter 1: Overview of the Companies The Four Companies Company Company Company Company Summary Chapter 2: The “Norm” and the “Forensic” Preliminary Analytics: Basics Everyone Should Know Liquidity Ratios Working Capital Working Capital Index Working Capital Turnover Current Ratio Case Studies: Liquidity Ratios Profitability Ratios Gross Profit Gross Profit Margin Stock Sales Return on Equity Case Studies: Profitability Ratios Company Horizontal Analysis Company Company Company 2 10 16 19 20 21 21 22 22 22 25 26 26 26 27 27 31 36 36 43 50 vii 3GFTOC 06/03/2013 viii 18:16:56 & Page Contents Company Vertical Analysis Company Company Company Company Summary Chapter 3: The Importance of Cash Flows and Cash Flow Statements Cash Flows and Net Income Company Company Company Company Other Cash Flow Techniques Company Company Company Company Summary 61 66 66 70 73 79 79 83 85 87 89 92 97 100 101 104 107 114 117 Chapter 4: The Beneish M-Score Model 119 Company Company Company Indices of the Primary Government Indices of the Governmental Funds Company Summary Notes 124 133 143 145 151 158 166 170 Chapter 5: The Accruals Dechow–Dichev Accrual Quality The Four Companies: Dechow–Dichev Model Sloan’s Accruals The Four Companies: Sloan’s Model Jones Nondiscretionary Accruals The Four Companies: Jones Model Summary Notes 171 173 175 184 185 191 192 196 198 3GFTOC 06/03/2013 18:16:56 Page Contents Chapter 6: Analysis Techniques Using Historical Financial Statements and Other Company Information The Piotroski F-Score Model Company Company Company Company Lev–Thiagarajan’s 12 Signals Company Company Company Company Summary Notes Chapter 7: Benford's Law, and Yes—Even Statistics Benford’s Law Company Company Company Company Simple Statistics Company Company Company Company Summary Note Company Company Company Company Summary 333 199 200 203 205 207 212 215 220 222 225 230 233 235 237 293 294 302 310 320 326 329 About the Author Index ix 239 243 249 255 267 272 277 281 284 289 290 292 Chapter 8: Grading the Four Companies Bibliography & 331 3GFTOC 06/03/2013 18:16:56 Page 10 ... 06/03/2013 17:33:15 Page Using Analytics to Detect Possible Fraud Tools and Techniques PAMELA S MANTONE 3GFFIRS 06/03/2013 17:33:16 Page Cover image: Wiley Cover design: # iStockphoto.com/Artur Figurski... will need to assess in determining the results of analytical testing of financial information Using Analytics to Detect Possible Fraud: Tools and Techniques, First Edition Pamela S Mantone Ó 2013... in the book to define anyone who wants to understand financial statement changes from year to year, so the tools and techniques are useful not only to practitioners, but also to investors, brokers,