Modelling the Impact of Earnings Management on the Probability of Financial Statements Fraud

Abstract

In the last decades, numerous financial scandals were reported, many related to earnings manipulation and fraud financial reporting. Analytical models were designed and estimation techniques were improved. However, current design of those models suffers from some limitations. The objective of our study is to bring improvements to the analytical models of detection of potential fraudulent financial reporting practices. Therefore, we separately evaluate the impact of real activities earnings management and innate accruals component on the probability of potential fraudulent financial reporting. The empirical analysis is made on a sample of firms with headquarters in G7 countries and the research methodology consists of time series analysis. The results show that, on a long term, the F score is negatively affected by real earnings management activities. Instead, the innate component of accruals seems to reverse over time, having no significant impact in the long run on the probability of fraudulent financial reporting.