What is Benford's Law and how can it be applied to detect financial statement fraud?

Expert Solution

Benford Law is a mathematical theory which deals with a set of digits. It states that in a data sets, the leading digits i.e. the first digit of the set is distributed in a non uniform way. The probability of having 1 as the leading digit usually has the highest probability, 2 as the leading digit having lesser probability and the probability of having the each successive number as the leading number will be progressively smaller.

The law can be applied to detect a financial statement fraud while audit of the financials. If majority of the financial statement figures have leading digits or the first digit as 9,8 or 7 , it may indicate that the management has deliberately modified figures in the financials.

As per Benford law , all the digits in the series 1-9 must be distributed equally in the data set. However, if there is one digit or there are two digits that are leading in the data set, then it is an indication of a fraud.

ekkarill92 answered 3 months ago

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