See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/271294108

Financial Statement Fraud: A Case Examination Using Beneish Model and

Ratio Analysis

Article  in  International Journal of Trade Economics and Finance · January 2014

DOI: 10.7763/IJTEF.2014.V5.367

CITATIONS READS

62 5,965

4 authors:

Normah Binti Omar Ridzuan Kunji Koya

Universiti Teknologi MARA University of Bath
207 PUBLICATIONS   1,656 CITATIONS    1 PUBLICATION   62 CITATIONS   

SEE PROFILE SEE PROFILE

Zuraidah Mohd-Sanusi Nur Aima Shafie

Universiti Teknologi MARA Universiti Teknologi MARA
155 PUBLICATIONS   1,303 CITATIONS    7 PUBLICATIONS   152 CITATIONS   

SEE PROFILE SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Financial Statement Fraud View project

Conference View project

All content following this page was uploaded by Normah Binti Omar on 21 June 2015.

The user has requested enhancement of the downloaded file.

 International Journal of Trade, Economics and Finance, Vol. 5, No. 2, April 2014

Financial Statement Fraud: A Case Examination Using

Beneish Model and Ratio Analysis
Normah Omar, Ridzuan Kunji Koya, Zuraidah Mohd Sanusi, and Nur Aima Shafie


Abstract—Fraud is a major concern for organizations II. CASE STUDY–MEGAN MEDIA HOLDINGS BERHAD
world-wide. Governments and regulators are now focusing on (MMHB)
management’s responsibility for effective fraud management
programs. It is not a matter whether your organization is large A. Company’s Background
or small or what country or industry your organization is in, as The company which is to be abbreviated as MMHB was
long as humans are involved in organizations, the risk of fraud established in early 1994. The principal activities of the
is real. This paper discusses a local case and our analyses are
basically subjected to how the fraud was committed and the
company started from producing plastic injection
detection techniques involved. Beneish Model and Ratios components to a range of electronics and automotive parts.
Analysis were selected as detection tools in reference to this Recognizing the future prospects of the data storage media
case. Being the best tools chosen for this case, those techniques industry in 1996, MMHB ventured into the manufacturing of
will benefit the auditors and other professionals. They can learn 3.5" multi-function disk (MFD) and videotapes through its
these simple, yet effective methods of financial statement fraud subsidiary company MTSB. In the 1999, MTSB expanded
detection. Legal implications and its uses will also be discussed
in this paper.
into the manufacturing of compact disc-recordable (CD-R)
and digital versatile disc-recordable (DVD-R). It became the
Index Terms—Fraud management, detection techniques, first Malaysian company to receive pioneer status from the
beneish model, legal implications. Ministry of International Trade and Industries for
manufacturing magnetic and optical data storage products.
On August 8, 2000, MMHB was listed onto the Second
I. INTRODUCTION Board of the Kuala Lumpur Stock Exchange. MMHB's entire
According to a study conducted by the Association of share capital transferred from the Second Board to Main
Certified Fraud Examiners (ACFE), fraudulent financial Board of the Exchange under the "Industrial Products" sector
statements accounts for approximately 10% of incidents with effect Tuesday, December 3, 2002. MMHB aggressive
concerning white collar crime. Asset misappropriation and market strategy has resulted in thecompany achieving a
corruption attend to occur at much greater frequency, yet the prominent footing as the largest manufacturer of CD-R and
financial impact of these latter crimes is much less severe. DVD-R in the country.
ACFE defines fraud as “the deliberately misrepresentation of
B. Case Background
financial condition of an enterprise, by intentionally
misstating or omitting amounts disclosures in the financial Mr KH, the former Financial Controller of the company,
statements so as to deceive their users”. Fraud’s effect on an has abetted MMHB who had with intent to deceive, furnished
organization’s bottom line is just the tip of the iceberg. false statements to Bursa Malaysia. The false statements were
Without a proactive approach to combating fraud, the ability in relation to MMHB’s revenue figures in its Financial
to gain and to maintain customer loyalty is almost Statements for the year ended 30 April 2006 and Quarterly
non-existent [1]. Additionally, organizations are said to lose Reports on Consolidated Results for the Financial Period
an average of six percent of their annual revenue to fraud and ended 31 July 2006, 31 October 2006 and 31 January 2007
abuse committed by internal employees. A proactive respectively. At the material time, Mr KH was the personal
approach to fraud identification is the only way to address assistant to the Executive Chairman of MMHB. The
and to lessen the effect of fraud on organizations today. Executive Chairman, Mr MA was also charged under the
Sophisticated techniques and methods are utilized to build a same section as Mr KH, for furnishing false information on
financial profile of a suspected fraudster [2]. the revenue figure for MMHB’s third quarter 2007 financial
figure.
C. How Fraud Was Committed
MMHB’s woes surfaced in early May when its two
Manuscript received October 14, 2013; revised December 15, 2013. This subsidiaries – MTSB and Singapore-based MPL – defaulted
work was supported in part by the Fundamental Research Grant Scheme,
Malaysian Ministry of Education and Research Management Institute, on a RM47 million payment to bondholders. A preliminary
Universiti Teknologi MARA. report on MTSB by a group of private forensic accountants of
N. Omar and Z. Mohd Sanusi are with the Accounting Research Institute, FH Company revealed that "substantial irregularities" and
Universiti Teknologi MARA, 40450 Shah Alam, Selangor, Malaysia
(e-mail: normah645@salam.uitm.edu.my,
that the company's financial position had been “materially
zuraidahms@salam.uitm.edu.my). misstated”. The findings showed that MTSB’s suspect
R. Kunji Koya was with the Universiti Teknologi MARA (e-mail: transactions included a RM211mil deposit paid for 13
normah645@ salam.uitm.edu.my). production lines that could be fictitious, in addition to the
N. A. Shafie is with the Faculty of Accountancy, University Teknologi
MARA, 40450, Shah Alam, Malaysia (e-mail: ishaiman87@gmail.com). fictitious trading that resulted in receivables totaling

DOI: 10.7763/IJTEF.2014.V5.367 184

 International Journal of Trade, Economics and Finance, Vol. 5, No. 2, April 2014

RM334.3mil. It also revealed that MTSB’s assets could that the derived variables can be used for the M-Score
potentially fall short by RM456mil. It was also discovered calculation using the given formula. Table II illustrates:
that the payments to all trading creditors were actually made Derived variables:
to other parties in an attempt to channel cash out of MTSB. Total M-Score: 0.863
MMHB reported an unaudited loss of RM1.3 billion for its
TABLE II: DERIVED VARIABLES
fiscal year ended April 2007 from a profit of RM60 million
DSRI 1.140
the year before. MMHB's total equity stands in deficit to the
tune of nearly RM797 million and its net liability per share is GMI 0.946
nearly RM4 compared to a net tangible asset per share of AQI 0.750
RM2.31 in FY 2006. SGI 1.144
DEPI 0.906
SGAI 0.165
III. ANALYSIS Total Accruals/TA -0.016

A. Beneish Model LVGI 0.668

Created by Professor MessodBeneish, the M-Score is a
mathematical model that uses eight financial ratios to identify Based on the formula from the mathematical model, the
whether a company has manipulated its earnings [3].The study managed to clarify that the M-Score for MMHB is
variables are constructed from the company's financial larger than -2.22, thus gave an indication of MMHB had
statements and create a score to describe the degree to which manipulated its earnings. Ratio analysis will be further
the earnings have been manipulated.In many ways it is continued as another tool in detection of fraud, particularly
similar to the Altman Z-Score, but it is focused on involving earnings management to substantiate and to
detecting earnings manipulationrather than bankruptcy. strengthen our investigation that MMHB had committed the
There are eight variables taken into account for developing same.
the M-Score, as listed below:
 DSRI - Days' sales in receivable index
B. Ratio Analysis
 GMI - Gross margin index The ratio analysis is used to observe 4 main areas of the
 AQI - Asset quality index financial indicators, namely Profitability, Operating
 SGI - Sales growth index Efficiency, Liquidity & Coverage and Fundingstructure.
 DEPI - Depreciation index The result has been concluded in the Financial Factor table as
 SGAI - Sales and general and administrative expenses stated in Table III below:
index
TABLE III: FINANCIAL FACTORS
 LVGI - Leverage index
Indicators 2005 2006 2007
 TATA - Total accruals to total assets
Profit before Interest and 10.75% 12.64%
M-Score that based on the 8 variables as above, calculated Tax ("PBIT") Margin (%) (1040.87%)
by using the formula of: Return on Capital 9.19% 9.85% (928.70%)
Employed, (ROCE) (%)
M = -4.84 + ( DSRI + GMI + AQI + SGI + DEPI + SGAI +TATA+ LVGI ) Days Trade Debtors (as 106.18 123.15 25.94
days turnover)
Days Inventory (as cost of 16.95 17.98 33.86
By using this approach, total M-Score calculated with the sales)
figure of bigger than-2.22suggests that the company had Current Ratio (times) 0.84 1.12 0.13
Quick Ratio (times) 0.76 1.05 0.07
manipulated their earnings. According to the ratio calculated Short Term Cash 0.08 0.10 0.01
from MMHB’s financial statement, the input variables are Adequacy (times)
stated in Table I below. Interest Coverage (times) 3.34 2.87 (24.12)
Gearing (times) 1.55 1.87 (1.16)
TABLE I: INPUT VARIABLES
Input Variables 2006 2005
PBIT has significantly increased compared to the years
Net Sales 1,034,797 904,696
mainly due to significant increase on the revenue for the year
CGS 885,525 781,284
and this scenario might be caused by the economic downturn
Net Receivables 81,760 62,705
in 2007 and the impact of restated for the financial report
Current Assets (CA) 671534 370,991
(Profitability). The impact from low sales has also turns
PPE (Net) 660,983 712,071
ROCE into negative level and it might shows that the
Depreciation 121,465 116,492 company did not fully utilize its capital. Days Trade Debtors
Total Assets 1,389,094 1,145,265 has increased, same goes to Days Inventory (Operating
SGA Expense 100,334 530,031 efficiency). It might show a tight cash flow for this company
Net Income (before Xitems) 86,792 68,634
and the current asset might not be insufficient to cover the
obligation or debt. This situation was showed by the Quick
CFO (Cash flow from operations) 109,063 129,729 Ratio and Short Term Cash Adequacy (Liquidity). The lower
Current Liabilities 330,236 443,275 Interest Coverage ratio, the more the company is burdened by
Long-term Debt 597,153 701,990 debt expenses. Hence the scenario looks worse as showed in
the table above.The Gearing ratio has significantly decreased
Following the input variables, indices are calculated so and it might show that the company was holding a large

185
 International Journal of Trade, Economics and Finance, Vol. 5, No. 2, April 2014

amount of debts that might not be able to be settled on time. It analysis for three consecutive years (year end 2005, 2006 and
might also shows that the company had used external fund in 2007). The operating efficiency ratio analysis show that the
running the business (Coverage and Funding). company recorded fictitious revenue amounting to RM
198,727. Therefore, these tools used in our investigation
confirm that the company involve in manipulating their
IV. DISCUSSIONS financial statements.
The offence made by MMHB was charged under section
122B (a)(bb) of the Securities Industry Act 1983 which ACKNOWLEDGMENT
carries a maximum RM3 million fine or 10 years jail, or both, We would like to thank Accounting Research Institute
on conviction. Mr KK pleaded guilty to one of four charges (ARI), Universiti Teknologi MARA, and Fundamental
he was facing and was fined RM350,000 in default of a year’s Research Grant Scheme in collaboration with the Ministry of
imprisonment. MMHB could not sort out its financial woes, Higher Education Malaysia (MOHE) in providing the
which were not surprising considering that a large chunk of financial support for this research project. We are indeed very
its past revenues had been falsified. It failed to submit its grateful for the grant, without which we would not be able to
regularisation plan to the authorities according to the PN17 carry out the research.
timeframe and was delisted in April 2008. The call for an
effective method to identifying earnings manipulation has REFERENCES
increased with each exposed accounting scandal. In our [1] C. A. Conan. (2002). Fraud and forensic accounting in a digital
investigation, the limitation of the tools used (Beneish model environment. White paper for the Institute for fraud prevention.
[Online]. Available:
and financial ratio) is that the limited information provided in http://www.theifp.org/research-grants/IFP-Whitepaper-4.pdf
the financial statements and the footnotes to the accounts. [2] L. Gao and R. P. Srivastava, “The anatomy of management fraud
However, the Bursa Malaysia and Securities Commission schemes: Analysis and implication,” Indian Accounting Review, vol.
announcements and newspaper reports had provided 15, no. 1, June, 2011.
[3] M. D. Beneish, “Detecting GAAP Violation: Implications for
additional information that implicates MMHB involvement Assessing Earnings Management Among Firms with Extreme
in financial fraud. The material misstatement in their Financial Performance,” Journal of Accounting and Public Policy, vol.
financial reporting had brought to the collapse of MMHB [4, 16, no. 3, pp. 271-309, 1997.
[4] Securities Commission. [Online]. Available: www.sc.com.my
5, 6]. The Beneish model and financial ratio can be used as a [5] Bursa Malaysia. [Online]. Available:www.bursamalaysia.com
tool for detecting financial fraud. These tools had result in [6] The Star. (2007). Megan Media defaults on RM894m bank facilities.
significant differences and proved that the company commits [Online]. Available:
an earnings manipulation. http://biz.thestar.com.my/news/story.asp?file=/2007/6/14/business/18
024994&sec=business
A. Uses and Implications [7] M. D. Beneish, “Incentives and penalties related to earnings
overstatements that violate GAAP forthcoming,” The Accounting
Financial statement fraud causes the biggest losses. In the Review, vol. 74, no. 4, October 1999.
US for example, the improved control environment under
Sarbanes-Oxley will certainly affect the numbers going
forward. But financial fraud will likely always rank number Normah Omar started her academic career as a
lecturer at the Faculty of Accountancy, UiTM since
one in losses. Both auditors and investigators can use January 1983. She was first posted at the UiTM
findings by Professor Messod Daniel Beneish. Auditors can Dungun Campus for one semester before being
use Bonefish’s ratios to help carry out the AIS 240 transferred to UiTM Sarawak, where she served for
another four years. In 1987, she was transferred back
requirements to perform audits to be reasonably assured that to UiTM Shah Alam. In, 1989, she secured a
financial statements are free from material misstatement. In scholarship to pursue her PhD program in
the other hand, investigators brought in to investigate a management accounting at the Manchester
Metropolitan University, United Kingdom.She completed her doctoral
suspected fraud can use this tool to help focus the degree in 1993. As an academician, Dr Normah has held many
investigation [7]. Numbers from different reporting period of administrative positions such as program leader, program coordinator,
the income statement and the balance sheet produce results research coordinator, coordinator of Quality Initiatives and deputy
dean. Effective January 2006, Prof. Dr .Normah Omar has been appointed as
that red flag the problem. The Beneish’s ratio measures sales the director of Accounting Research Institute. Currently she is a member of
growth, the quality of assets and gross margins, the the university senate and a project manager to the vice chancellor special
progression of receivables versus sales and the ratio of project (VCSP) entitled "Strategic Alliances with Top Notch Research
Centres & Top Notch Researchers".
general and administrative expenses. The probability of
earnings management goes higher with unusual increases in
receivables, deteriorating gross margin, decreasing assets Zuraidah Mohd Sanusi is currently the deputy
quality, sales growth and increasing accruals. At the end, the director of the Accounting Research Institute (ARI)
ratio results point to whether there is likely a problem. (Postgraduate & Innovation), Universiti Teknologi
MARA and lecturer of Faculty of Accountancy. Her
In the MMHB’s case study, at first, our investigation used current research interest is in the area of forensic
the Beneish model to identify if there is any potential fraud in accounting, financial criminology, auditing and
their financial statement. The M-score is higher than-2.22 corporate governance.
confirm that Megan Media had manipulated their earnings.
We then further our investigation by using the financial ratio

186

View publication stats