Friday, July 13, 2012

Benford Law to Detect Irregularities

Another useful tool that can be used to detect financial irregularities is the Benford Law technique.  Essentially,  Benford's Law provides a data analysis method that can help alert forensic accountants to possible errors, potential fraud, manipulative biases, costly processing inefficiencies or other irregularities. Premised on its statistical-based principle of number frequency, it has been suggested that the law could be used to detect possible fraud in lists of socio-economic data.  Based on the plausible assumption that people who make up figures tend to distribute their digits fairly uniformly, a simple comparison of first-digit frequency distribution from the data with the expected distribution according to Benford's law ought to show up any anomalous results.  Following this idea, Benford's law could be used in forensic accounting investigation and auditing as an indicator of accounting and expenses fraud. In practice, applications of Benford's law for fraud detection routinely use more than the first digit.  The Law posits that the use of the number "1" as a first digit is about 30%; number "2" about 16%; number "3" about 12%... and number "9" about 5%.  Any abnormality constitutes possible financial shenenigans