Islamic Work Ethics, Good Corporate Governance

Practices and Fraudulent Financial Statements

Reskino1, Intan Salwani Mohamed2*,
Norazida Mohamed2 and Endah Sulistyowati1
1
Universitas Islam Negeri (UIN) Syarif Hidayatullah Jakarta, Indonesia
2
Accounting Research Institute (HICoE), Universiti Teknologi MARA, Shah Alam,
Selangor, Malaysia

ABSTRACT

This study examined the effects of Islamic work ethics (IWE) and good
corporate governance (GCG) on fraudulent financial statements (FFS) in
Islamic financial institutions (IFIs). The study used a questionnaire survey
to examine the relationship between IWE and GCG practises on FFS in IFIs.
The finding revealed that IWE and GCG practices significantly influenced
FFS through fraud prevention. This study gives banking and insurance
professionals a practical grasp of the aspects to consider in the fight against
fraud in financial statements. This is the first study that gives empirical
evidence of the importance of Islamic work ethics in fraud prevention and
its impact on FFS in IFIs in the context of Indonesia, the country with the
highest Muslim population. This study suggests that policymakers and
the financial services authorities should redouble their efforts to prevent
fraudulent financial statements by instituting an effective anti-fraud strategy
and integrating Sharia compliance auditing standards. These findings can
also assist internal auditors around the globe in identifying the indicators
that management may be considering FFS, thereby decreasing the likelihood
of fraud occurring.

Keywords: Islamic works ethics (IWE), good corporate governance (GCG)

practices, fraud prevention, fraudulent financial statements (FFS), and
Islamic financial institutions (IFIs)

ARTICLE INFO
Article History:
Received: 16 April 2022
Accepted: 30 April 2023
Published: 31 August 2023

♣
Corresponding author: Intan Salwani Mohamed. E-mail: intan838@uitm.edu.my
Asia-Pacific Management Accounting Journal, Volume 18 Issue 2

INTRODUCTION

Islamic financial institutions (IFIs) are financial institutions that base their
business operations on the Qur’an, Hadith, and Ijma of the scholars (Dowell-
Jones, 2013; and Maradita, 2014). IFIs collect customer or community
funds and distribute loans to customers or the general public (Kidwell et
al., 2007). Along with the development, numerous IFIs, such as Islamic
banking and insurance, have emerged in the community (Musari, 2016).
IFIs are organisations whose operations abide by and are in accordance with
Shariah law and regulations. IFI’s principles eliminate Islam-prohibited
elements and replace them with Shariah or traditional Islamic contracts
(Mardani, 2017).

The establishment of the IFIs is based on the prohibition of riba (usury)

in financial and non-financial transactions [...God has permitted buying and
selling and forbids riba (QS. Al-Baqarah (2): 275)]. In addition, establishing
IFIs, especially Islamic banks, improves some of the weaknesses in the
conventional system (Arifin, 2009), namely, (1) Interest-based transactions
violate justice or business fairness, which is clearly against the norms of
justice in Islam; (2) The inflexible interest-based transaction system that
causes bankruptcy; and (3) The issue of bank’s commitment to the security
of depositors’ money along with the interest that makes the bank anxious to
return the principal interest (Machmud, 2010). The development of IFIs has
implications for how IFIs can maintain customer trust and loyalty (Aman,
2019). As a result, it is necessary to improve IFIs’ image and reputation in
clients’ eyes (Andaleeb et al., 2016), which is one of the issues confronting
IFIs today (Falikhatun & Assegaf, 2012).

Financial and accounting fraud is a seemingly infinite phenomenon,

including fraud in Islamic financial organisations (Reskino et al., 2021;
Hamidah & Reskino, 2021). The question therefore becomes, have Sharia
principles been applied to IFIs to ensure they are free of fraud? (Aziz et al.,
2019; Fakhfakh et al., 2017; Mujib et al., 2017). Many incidents demonstrate
that IFIs are not immune to fraud, such as the case of PT. Bank Syariah
Mandiri, which provided bogus loans to 197 fictitious customers, resulting
in a Rp102 million loss. In another case, Syariah is still embroiled in a fake
credit case for 548 billion at PT Bank Jawa Barat and Banten (BJB).

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These cases prove there is no guarantee that IFIs, particularly Islamic

banks and insurance companies, are exempt from fraud. Analyses conducted
by various organisations and regulators found that cases in banking and
insurance were caused mainly by ineffective internal factors, such as Islamic
work ethics (IWE) and good corporate governance (GCG) practices. Various
acts of fraud still occur because the management of IFIs has not been able
to guarantee Sharia compliance for every product and service IFIs provided,
so fraud cannot be avoided (Anugrah, 2014).

Has management implemented GCG effectively? Previously, Brief

et al. (1996) lamented the ethical vacuum at the heart of big business
corporations. They asserted that, while most managers know right and wrong
as humans, they do not feel obligated to act on that basis as managers. As
a result, it makes GCG practices questionable. Therefore, the regulator
requires Islamic banking to apply the principles of GCG (Alhammadi et
al., 2020; Jan et al., 2021), which is the embodiment of the responsibility
to improve the performance of IFIs. In addition, Islamic work ethics is a
seldom-discussed topic in a fraudulent financial statement. There is still a
lack of empirically validated findings. Given these gaps, this study examined
the influence of Islamic work ethics and good corporate governance on
fraudulent financial statements.

This study also investigated the role of fraud prevention in mediating

the relationship between IWE and fraudulent financial statements. Four
hypotheses were tested to answer four (4) research questions: do IWE
and GCG influence fraudulent financial statements? Do IWE and GCG
influence fraud prevention? Does fraud prevention influence fraudulent
financial statements? This study enriches the previous studies on fraudulent
financial statements concerning the theory, framework, and study sample.
The findings will contribute significantly to internal auditors worldwide in
recognising the signs that can trigger management motivation to engage
in fraudulent financial statements, thereby increasing the likelihood of
preventing fraud.

The current research is critical because GCG practises and IWE are
critical internal factors in IFIs. After all, the weakness of these internal
factors can open the door to fraud. Second, the researcher wanted to know
whether GCG practises and IWE at Indonesian IFIs affect fraud prevention

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and whether fraud prevention can reduce the company’s high level of
fraudulent financial statements.

LITERATURE REVIEW

Fraud is an illegal conduct (Dinapo, 2008) committed to harm others. Fraud

is the intentional theft of assets or rights by individuals or groups in the
financial and non-financial sectors, according to Tunggal (2012). One party
or individual commits fraud to profit, avoid obligations or cause financial
or non-financial losses to others. Kennedy (2018) believes fraudsters do it
for themselves. Fraud is a severe problem in the company (Comer, 2017)
and has become difficult for all stakeholders to eliminate (Olaoye et al.,
2014). Eradicating fraud from its roots (Sari et al., 2020) necessitates not
only considerable work (Prabowo, 2014) but also an intense desire to do
so (Pancasilwati, 2020).

Agency Theory

Jensen and Meckling (1976) defined the Agency Theory as

shareholders as principals and management as agents working together. The
principal hires the agent to perform duties and make decisions on their behalf
(Purdwiastuti & Nofiyanti, 2012). Through information asymmetry, agents
may utilise their information for their profit (self-interest), causing financial
harm to the principal and enterprises in Sharia banking and insurance.

Fraudulent Financial Statements

A company’s financial statement signals to investors that certain

information owned by management will soon be made public. Depending on
the company’s state, investors could be given either good or bad news from
management (Reskino, 2015). However, fraudulent financial statements
have caused widespread alarm among investors and government agencies
like the SEC (Rezaee, 2004). According to the ACFE-created “fraud tree,”
financial statement fraud is a branch of the more common types of fraud,
including corruption, asset misappropriation, and financial statement
manipulation (ACFE, 2016).

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The Association of Certified Fraud Examiners defines financial

statement fraud as the intentional, deliberate misstatement or omission of
material facts or accounting data that, when considering all the information
available, would cause the reader to change or alter his or her judgement or
decision. Several reputable academic journals and textbooks define financial
statement fraud. Academic literature written by academics, professional
literature written by practitioners, and official statements made by reputable
authorities all provide various definitions of financial statement fraud.

Based on the preceding statement, a fraudulent financial statement is

a presentation of financial statements that contain elements of misstatement
in order to deceive users of financial statements for the personal benefit
of the party committing fraud, with a presentation that is not based on
actual financial conditions and thus cannot produce the right decision from
interested stakeholders.

Islamic Work Ethics

Early ethics were based on the Qur’an (Bektovic, 2016; Nugraha,

2018). The Qur’an is the guideline for Muslim life in all aspects (Aldulaimi,
2016; Wakhidah & Erman, 2022). IWE values fairness, hard work, honesty,
commitment, and work dedication. Working to instil IWE can help to keep
someone from committing fraud. If someone has instilled Islamic values in
his work, he/she will not commit fraudulent acts detrimental to the company.

Several previous researchers conducted a literature review and

developed a conceptual framework for Sharia compliance implementation.
Employees must work and behave in an Islamic manner as part of Sharia
compliance (Ayedh et al., 2019; Shamsudheen & Muneeza, 2022). In
testing the conceptual framework of IWE, Kamaluddin and Manan (2010)
concluded that the role of IWE in shaping employee moral hazard is critical.
The current literature supports Kamaluddin and Manan’s (2010) statement,
which shows that studies on IWE (Nasution & Rafiki, 2020; Norziaton et
al., 2020; Salin et al., 2017) have been gaining popularity among researchers
for a long time.

In an Islamic context, IWE is defined by Beekun (1996) as a set of

moral principles that distinguish right from wrong. Yousef (2001) defines

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IWE as hard work, commitment, dedication to work, work creativity,

avoidance of unethical wealth accumulation methods, cooperation, and
competitiveness in the workplace. Furthermore, using IWE will result in
socio-economic transformation by contributing to community welfare (UL
Hassan, 2010). This is because Islam ensures that humans have a sustainable
life in which their needs are constantly met and fulfilled (Salin et al., 2017).

According to Amilin et al. (2018), for good governance to coexist

peacefully with the ideals espoused in the Quran and Hadith, professional
accountants should pay more attention to the importance of Islamic work
ethics in organisational working environments. Because they believe that
rewards will naturally follow when employees perform to their highest
potential, Islamic work ethics emphasise receiving blessings from Allah
rather than just rewards.

According to the above definition, IWE is a set of moral principles that

distinguish between right and wrong, emphasising hard work, commitment,
dedication to work, work creativity, avoidance of unethical wealth
accumulation methods, cooperation, and competitiveness in the workplace,
which leads to social transformation economy through its contribution to
society’s welfare.

Good Corporate Governance Practices

Corporate governance is the framework by which business corporations

are directed and governed. The corporate governance structure lays out the
rights and obligations of the Board of directors, managers, shareholders,
and other stakeholders, as well as the rules and procedures for making
decisions and conducting business. It also offers the structure through which
the company’s objectives are determined and the means of achieving them
and measuring performance (OECD, 2004).

GCG provides a framework for the equitable distribution of rights

and responsibilities among the Board, executives, and other stakeholders
(Firmansyah & Devi, 2017; Sarbah & Xiao, 2015). According to Syakhroza
(2003), GCG practice is a system used to direct and control and supervise
(directing, controlling, and supervising) the management of organisational
resources efficiently, effectively, economically, and productively (E3P)

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following the principles of transparency, accountability, responsibility,

independent, and fairness (TARIF) in order to accomplish organisational
objectives. Rules and decision-making procedures are established to provide
a framework for company objectives and performance monitoring (Priantara,
2017). Moreover, Reskino (2022) states that corporate governance protects
businesses and public sector organisations from fraud.

GCG is a system designed by the regulator that aims to direct the

management of the company professionally based on the TARIF principles
(transparency, accountability, responsibility, independence, and fairness),
which outline the rights and responsibilities of directors, managers,
shareholders, and other stakeholders, as well as the rules and procedures
that must be adhered to when making decisions and conducting business.

Fraud Pentagon Theory

According to Horwath (2011), fraud arises from five factors: pressure,

opportunity, rationalisation, competence, and arrogance. The pressure,
opportunity, and rationalisation factors are the same as the fraud triangle
theory because each person has pressure so that there is an impetus to commit
fraud, someone has the opportunity to commit fraud due to weak supervision,
and someone seeks justification for the fraud. Furthermore, the other two
factors are competence and arrogance. Competence is similar to the ability
or capability described in the fraud diamond theory. Competence is the
ability of employees to ignore internal supervision, develop concealment
strategies, and control social situations for personal gain (Horwath, 2011).
The arrogance factor, namely, the attitude of superiority over the rights
holder and that internal control or company policy does not apply to him.

Based on the description above, it can be concluded that anyone

can commit fraudulent acts, from the top management level to line staff.
Therefore, it must first be understood what factors are behind the occurrence
of fraud to minimise the tendency to commit fraud. Several steps that
can be taken to minimise a person’s tendency to commit fraud are to
improve GCG, raise awareness of anti-fraud, conduct training and improve
employee competence, build good individual morality, provide appropriate
compensation, improve compliance with regulations, and implement GCG
practices.

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Hypothesis Development

Islamic Work Ethics on Fraud Prevention

Beekun (1996) defined ethics as moral principles or guidelines
distinguishing good from bad. Islamic rules outlined in the al-Quran and
hadith are sources of ethics intended to be principles in human actions
to maintain integrity. As a universal religion, Islam is a complete and
comprehensive source of ethics for humans in various aspects of life,
including organisational assets and finances (Chapra, 1979). When
individual morality is in line with Islamic ethics and is practised, it can
prevent or minimise cases of accounting fraud (Dolgoff et al., 2011)

Urumsah et al. (2018) showed that religious traits and attitudes could
prevent someone from committing fraud. However, these conditions cannot
occur consistently. Religious beliefs can change if individuals are under
pressure, thus ignoring their religiosity. In addition, anti-fraud promotion
has not been widely implemented in organisations. Hamdani (2015) also
stated that implementing IWE can reduce a person’s desire to commit
internal fraud, evidenced by the negative influence of implementing IWE
on internal fraud.

According to Salin et al. (2017), substantial consideration should be

given to Islamic-based ethics to stop corporate fraud and malpractice. This is
because Islamic morals are dedicated to and confidence in God (Aldulaimi,
2016). Thus, both societal welfare and well-being can be attained in addition
to the goal of profit maximisation. Islam is also a comprehensive way of
living because it regulates every facet of life, including trade and business.
Islamic ethics ensures the correct operation of the market and the proper
fulfilment of the linked people’s interests. The discussion supports the
premise that IWE affects fraud prevention:

H1a: There is a significant relationship between Islamic work ethics and

fraud prevention.

Good Corporate Governance Practices on Fraud Prevention

Gusnardi’s (2011) research showed that GCG could prevent company
fraud. The results of this study were also supported by (Kwatingtyas, 2017;
Nadia et al. 2018; Soleman, 2013), with the research results that GCG has
a positive effect on fraud prevention.

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The studies conducted by Husna (2013) and Saputra (2017) also

showed that the better the implementation of GCG practices, the level of
fraud will decrease. As indicated by the research results, namely GCG
practices has a significant negative effect on fraud. This study showed
that fraud prevention could be done by eliminating the driving factors for
fraud by applying the GCG practices, namely transparency, accountability,
fairness, integrity, and participation.

In’airat (2015), on the other hand, demonstrated that the existence

and implementation of GCG are insufficient to reduce fraud due to a lack
of understanding and inadequate application of GCG. As a result of the
inconsistency of the findings of the research results, the authors developed
the following research hypothesis:

H1b: There is a significant relationship between good corporate governance

and fraud prevention.

Islamic Work Ethics on Fraudulent financial statements

Maharani (2013) showed that Islamic business ethics significantly
negatively affect accounting fraud in financial reporting; this indicates that
increasing Islamic business ethics will reduce the tendency of accounting
fraud in financial reporting. Conversely, the decline in Islamic business
ethics will increase the tendency of fraudulent accounting in financial
reporting. Based on the discussions, it can be concluded that IWE affects
fraudulent financial statements; the hypothesis formulated in this study
was as follows:

H2a: There is a significant relationship between Islamic work ethics and

fraudulent financial statements.

Good Corporate Governance Practices on Fraudulent

financial statements
A growing number of researchers are discovering that poor GCG
practices, financial statement manipulation, and dissatisfied stakeholders
are the primary contributors to poor performance. Companies and regulators
are now attempting to identify and correct flaws in their reporting systems
(Eferakeya et al., 2016)

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According to a study conducted by Martins and Junior (2020) on

corporate governance and the mitigation of fraudulent financial reporting,
the corporate governance structure impacts the mitigation of FFS,
either directly or indirectly, by reducing the possibility of bankruptcy or
earnings manipulation. Furthermore, their findings show that board-related
governance practises are more effective at predicting bankruptcy, while
audit-related practises are associated with less revenue manipulation.

Rohmatin et al. (2021) previously investigated the relationship

between the causes of fraud, good corporate governance, and fraud. Even
though good corporate governance can reduce the impact of opportunity
and rationalisation on fraud, it also strengthens the competence Impact on
Fraud. Meanwhile, good corporate governance does not mitigate pressure
and arrogance. Based on the research findings, this study developed the
following research hypothesis:

H2b: There is a significant relationship between good corporate governance

practices and fraudulent financial statements.

Fraud Prevention on Fraudulent financial statements

According to Zager et al. (2016), fraudulent activities such as
fraudulent financial reporting and asset misappropriation are significant
issues confronting businesses worldwide. In general, fraud against fraudulent
financial statements is less common than fraud against misappropriated
assets; however, fraud in financial statements causes tremendous loss. In
response to the rising rate of financial statement fraud, the SEC has taken
several steps to strengthen regulations (Rezaee, 2004).

Management and all organisation members carry primary responsibility

for fraud prevention to ensure that financial reports are presented reliably.
As a result, it is critical to develop various internal solid company systems
to prevent fraud. Based on the above description, it is possible to conclude
that fraud prevention affects FFS; thus, the hypothesis formulated in this
study was as follows:

H3: There is a significant relationship between fraud prevention and

fraudulent financial statements.

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The Mediating Effect of Fraud Prevention on the Relationship

between Islamic Work Ethics and Fraudulent Financial
Statements
Islamic business ethics is a way out of a culture of corruption and
unprofessionalism. As a result, it is hoped that implementing Islamic
business ethics will reduce financial reporting fraud. Islamic business
ethics significantly negatively impact financial reporting fraud (Maharani,
2013b). According to Zager et al. (2016), the employee’s code of ethics
influences fraud prevention and reduces financial statement fraud. Based
on the preceding discussion, it is possible to conclude that IWE and fraud
prevention have an impact on fraudulent financial statements; the hypothesis
formulated in this study was as follows:

H4a: Fraud prevention mediates the relationship between Islamic work

ethics and fraudulent financial statements.

The Mediating Effect of Fraud Prevention on the Relationship

between Good Corporate Governance and Fraudulent
Financial Statements
Implementing GCG can help to reduce fraud, particularly one of the
most detrimental to the company, FFS. Prior research by Bhasin (2017),
Eferakeya et al. (2016), and Halbouni et al. (2016) demonstrated that
GCG has a positive effect on fraud prevention. According to Maryana et
al. (2018), applying GCG principles significantly impacts the quality of
financial statements. According to the discussion, using GCG principles in
a corporation can deter fraud and lower the danger of fraudulent financial
statements. As a result, the financial reports are of the highest quality and
dependability. The following hypotheses wasdeveloped in this study:

H4b: Fraud prevention mediates the relationship between good corporate

governance and fraudulent financial statements.

METHODOLOGY

Data Collection

Finance staff with the following qualifications were drawn from the
population as a sample: (1) finance staff working in Sharia banking and

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Sharia insurance in the DKI Jakarta area. (2) Finance staff with at least
one year of experience were considered to have sufficient knowledge of
the company. Questionnaires were distributed to 200 employees in the
DKI Jakarta area who worked as finance staff in Sharia banking and Sharia
insurance. There were 98 questionnaires returned, which were all processed.

Instrumentation, Data Measurement and Analysis Procedure

This study employed the Questionnaire survey as the research

instrument. Previous studies were used to obtain the measurement used
to operationalise the constructs. An ordinal (Likert) scale from 1 to 5 was
used to evaluate each statement. The responses received were given the
following ratings: (1) strongly disagree, (2) disagree, (3) neutral, (4) agree,
and (5) strongly agree. The study’s hypotheses were tested using partial
least square (PLS) -SEM.

RESULTS AND DISCUSSION

Two hundred survey forms were distributed to targeted respondents as of

March 2019. The data collection took about two months, and researchers
were able to retrieve 98 survey forms. As a result, the response rate was
84.48%.

Test Results of Research Instruments

The outer model was examined in this study, utilising convergent

validity, discriminant validity, and reliability. IWE, GCG practises,
fraud prevention, and fraudulent financial statements were all assessed
descriptively. Findings revealed that most respondents “agree” with the
factors IWE, GCG, fraud prevention, and fraudulent financial statements.

Outer Model or Measurement Model Test Results

The correlation between the item score or component score estimated
by the SmartPLS software was used to assess the convergent validity of the
indicator reflective measurement model. The individual reflective measure
is high if the correlation with the measured construct is 0.70. A loading
factor limit of 0.50 was used in this study.

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Discriminant validity is used to ensure that each latent variable concept

is distinct from the concepts of other variables. The model has excellent
discriminant validity if each loading value is the greatest compared to
other loading values for other latent variables. Each indicator of each latent
variable examined in this study already had an enormous loading factor value
compared to the loading factor value of other latent variables. Therefore,
it was concluded that all latent variables had good discriminant validity.

The reliability criterion can be seen in each construct’s composite

reliability and Cronbach alpha values. A construct is highly reliable if its
composite reliability value is greater than 0.70 and its Cronbach alpha value
is greater than 0.60.

Table 1: Composite Reliability and Cronbach Alpha

Composite Reliability Cronbach Alpha
IWE 0.890 0.864
Good Corporate Governance Practice 0.901 0.880
Fraud Prevention 0.895 0.869
FFS 0.875 0.839
Source: Primary data that is processed

As shown in Table 1, the variable IWE was 0.890, the GCG practises
variable was 0.901, the fraud prevention variable was 0.895, and the FFS
variable was 0.875. The results of the composite reliability above showed
that all variables had a composite reliability value above 0.70, and it was
concluded that all constructs met the reliability criteria.

The Cronbach alpha variable for IWE was 0.864, the fraud prevention
variable was 0.869, and the FFS variable was 0.839. The results of the
Cronbach alpha above indicated that all variables already had a Cronbach
alpha value above 0.60, thus indicating that the level of consistency of
respondents’ answers in each construct had good reliability.

Inner Model or Structural Model Test Results

The inner or structural models must be tested to see the relationship
between significant value constructions and R-Square. Therefore, the
R-Square for the dependent construct, the t-test, and the significance of
the structural path parameter coefficients were all used to evaluate the
structural model.
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Figure 1: Structural Model of Bootstrapping Results

Source: Primary data that is processed

Based on the picture above, it can be explained that model assessment

with SmartPLS begins by looking at the R-Square for each latent dependent
variable. The goodness fit model test is the result of estimating the R-Square
using SmartPLS.

Table 2: R-Square Value

R-Square
Fraud Prevention 0.696
FFS 0.653
Source: Primary data that is processed

As shown in Table 2 above, the R-Square value for the fraud prevention
variable was 0.696, and the FFS variable was 0.653. These results indicated
that the variables IWE and GCG practices can simultaneously explain the
fraud prevention variable by 69.6%. The remaining 30.4% was explained
by other variables not hypothesised in the model.

The subsequent results for the variables IWE and GCG practices
can explain the FFS variable by 65.3%; the remaining 34.7% is explained
by other variables not hypothesised in the model. According to (Baron &
Kenny, 2013), this R-Square value is moderate to high.
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The result of the calculation of Q-Square in this study was 0.704,

which meant that 70.43% of the independent and intervening variables were
feasible in explaining the dependent variable, namely the FFS.

The final model evaluation was by looking at the GoF of the model.
Evaluation of the goodness of fit model is carried out to purify and refine
the validity or reliability test of the (Purwohedi & Imam Ghozali 2015)
construct (2015). The GoF validates the inner and outer models’ combined
performance. GoF values ranged from 1 to 0 with interpreted values of 0.1
(small GoF), 0.26 (moderate GoF), and 0.36 (large GoF) (Wetzels et al.,
2009) in (Yamin et al, 2011). The results of the GoF calculation in this
study showed a value of 0.5489. This GoF value was greater than 0.36.
Therefore, it can be said that this research model had a high ability to
explain the empirical data.

Hypothesis Test Results

The basis for testing the hypothesis is the value of the output path
coefficient for testing the structural model. The t-statistic value compared
with the t-table specified in this study is 1.9850, where it is known that
the df value is 96 (the number of samples is reduced by two: 98 – 2) and
α is 0.05 (two-tailed). The limit for accepting and rejecting the proposed
hypothesis is + 1.9850, where if the t-statistic value is in the range of -1.9850
and 1.9850, then the hypothesis will be rejected or, in other words, accept
the null hypothesis (H0).

Table 3: Path Coefficients (Mean, STDEV, T-Value)

Original Sample Standard
T-Statistic
Sample Mean Deviation P-Value
(IO/stdev)
(O) (M) (STDEV)
IWE FP 0.551 0.561 0.080 6.873 0.000
GCG FP 0.208 0.202 0.086 2.423 0.016
IWE FFS 0.480 0.493 0.099 4.835 0.000
GCG FFS -0.017 -0.011 0.095 0.173 0.863
FP FFS 0.245 0.221 0.113 2.172 0.030
IWE  FP  FFS 0.211 0.209 0.055 3.802 0.000
GCG  FP  FFS 0.905 0.905 0.079 11.506 0.000
Source: Primary data that is processed

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As shown in Table 3, the effect of IWE on fraud prevention was

0.551 and significant at 0.5 (6.873> 1.9850). The effect of GCG on fraud
prevention was 0.208 and significant at 0.5 (2.423> 1.9850). The effect of
IWE on fraudulent financial statements was 0.480 and significant at 0.5
(4.835> 1.9850). The effect of GCG on fraudulent financial statements
was -0.017 and not significant at 0.5 (0.173 <1.9850). The effect of fraud
prevention on fraudulent financial statements was 0.245 and significant at
0.5 (2.172> 1.9850).

Intervening Effect Test Results

The table above (Table 3) shows the test results through the intervening
test, namely 3.802 <1.985 for the IWE variable, so it may be concluded
that the intervening variable influenced fraud prevention on the indirect
relationship between IWE variables and fraudulent financial statements.
Furthermore, GCG had obtained t-count results significant of 0.05, namely
11.506 <1.9850. So, it was concluded that the intervening variable influenced
fraud prevention on the indirect relationship between GCG variables and
fraudulent financial statements.

RESULTS AND DISCUSSION

The Effect of Islamic Work Ethics on Fraud Prevention

Hypothesis 1 tested the effect of Islamic work ethics (IWE) on

fraud prevention. Table 3 shows that the IWE path coefficient on fraud
prevention was positive with a t-statistic value (0.551) smaller than 1.96
and a probability value> 0.05. Thus, it can be concluded that IWE had a
significant effect on the fraud prevention. This study proved that IFIs in
Indonesia had implemented religious values to prevent someone from
committing fraud. If someone works based on Islamic values, they will
consider committing fraud because Allah will see it even if people do not
know it. In this context, Islamic ethics can offer a good solution, especially
for Indonesia, where most citizens are Muslims, and Islam has been declared
the national religion in the constitution.

This finding is consistent with prior research examining the

influence of IWE on fraud prevention, such as in Urumsah et al. (2018)

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and Hamdani (2015), who both state that IWE affects fraud prevention.
Following the variables tested, namely banking and Sharia insurance, IWE
had the greatest statistical t value in this study compared to other variables.
However, Hamdani (2016) findings show that Sharia-compliant banking
has not eliminated fraud within the organisation. Internal fraud arises as a
result of pressure, opportunity, rationalisation, a lack of internal control,
and the implementation of ethical values. According to Mulia et al. (2017),
a person’s morale impacts whether or not they will commit fraud.

The Effect of Good Corporate Governance on Fraud

Prevention

Table 3 displays the statistical findings of the association between

good corporate governance (GCG) and fraud prevention. The GCG had a
path coefficient value of 0.208 and a t-statistic value of 2.423. This value
exceeds the t-table value of 1.9850. According to the third hypothesis, the
findings showed that GCG practises significantly affected fraud prevention.

This study justifies the theory that companies can prevent fraud by
decreasing the potential for fraud by applying the principles of GCG. The
principles of GCG align with the analysed fraud prevention indicators.
The principle of transparency and accountability can be seen yearly in
that Islamic banking and insurance companies publish financial reports
useful for users of financial statements, both internal and external parties.
The principle of accountability can prevent someone from committing
fraud because procedures and policies are carried out simultaneously by
all organisational members. The principle of independence can be carried
out by each employee working by their respective roles and duties to make
decisions objectively on their duties. The principle of fairness is carried out
by providing fair services to all organisational members.

According to Anugrah (2014), fraud prevention can be minimised by

minimising the causes that drive fraud; one is through adopting the GCG
principles of transparency, accountability, responsibility, independence, and
fairness. This study is consistent with empirical investigations on GCG in
fraud prevention by Enofe et al. (2016), Gusnardi (2011), and In’airat (2015),
all of which show that GCG affects positive fraud prevention. Eferakeya et
al. (2016) state that effective corporate governance procedures prevent fraud.

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Good governance procedures include an effective internal audit function,

audit committee, external auditor, and Board of directors. This governance
mechanism is beneficial and must be reinforced to avoid fraud.

This result is not in line with In’airat (2015), which states that the
existence and application of GCG are not enough to reduce fraud. This is
due to a lack of understanding. In addition, the implementation of GCG
has not been maximised, so continuous improvement is needed under the
principles of GCG.

The Effect of Islamic Work Ethics on the Fraudulent financial

statements

Hypothesis 3 tested the effect of Islamic Work Ethics (IWE) on

fraudulent financial statements (FFS). In Table 3, it can be seen that IWE
on FFS showed a path coefficient value of 0.480 with a t-statistic value of
4.835. This value was greater than the t-table 1.9850. This means that IWE
had a significant influence at 0.05 on fraudulent financial statements.

The findings, as shown in Table 3, are consistent with those reported

by Maharani (2013b), Mayhew and Murphy (2009), and Rahma and
Yulianti (2018), which state that IWE affects the tendency of accounting
fraud. This result indicated that Islamic banking and insurance companies
in Indonesia had implemented IWE, evident by the financial staff who have
understood and implemented IWE. If employees, especially financial staff,
have implemented IWE well, they will present financial reports reliably and
under actual conditions. Thus, FFS can be minimised because the main task
of the financial staff is to make the company’s financial statements.

The findings are supported by research conducted by Mayhew and

Murphy (2009), who found that ethics education should be taught at
a young age to prevent someone from committing fraud. The findings
revealed that when participants were anonymous, the misreporting rate was
nearly the same regardless of ethics programme participation. On the other
hand, participants who completed the ethics programme misreported at a
considerably lower incidence than those who did not receive it when their
reporting conduct was made public to the cohort. The findings indicated
that while ethical education does not always result in internalised ethical
beliefs, it can impact ethical behaviour.
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The Effect of Good Corporate Governance Practice on the

Fraudulent financial statements

Hypothesis 4 tested the effect of good corporate governance (GCG)

on fraudulent financial statements (FFS). Table 3 shows that GCG on FFS
showed a path coefficient value of -0.017 with a t-statistic value of 0.173.
This value was smaller than the t-table 1.9850. This means that GCG
practices do not have a significant effect of 0.05 on FFS, which follows
the eighth hypothesis.

Employees lack to understand the corporate governance guidelines,

which regulate in detail the rights and obligations of workers, so these
regulations are not implemented properly. This will result in when the
employee is under pressure, they are vulnerable to fraud. In addition,
employees at work do not adhere to the precautionary principle and have
not complied with the laws and regulations, articles of association, and
company regulations, so this triggers fraud. Widodo and Syafruddin (2017)
examined the disclosure of corporate governance structure on fraudulent
financial statements. They found that board members with international
experience, audit committee effectiveness, internal audit effectiveness,
and the existence of Big-4 audit firms have a significant positive effect
in reducing the likelihood of fraudulent financial reporting. However, the
number of Board of Commissioners members has no significant effect on
the likelihood of fraudulent financial reporting.

Maryana et al. (2018) believed effective company governance affects

financial report quality. Good financial reports avoid misstatements and
accurately portray the company’s finances. Martins and Junior (2020)
suggest corporate governance practises can prevent fraudulent financial
reporting, bankruptcy, and earnings manipulation. Board of directors’
practises mitigating bankruptcy better than other corporate governance
practises.

This study contradicts Razali and Arshad (2014) but agrees with
Citra (2013) that the GCG mechanism, as measured by transparency,
accountability, responsibility, independence, and fairness, does not
significantly affect financial statement integrity. Poor financial statements
might contain fraud. Thus, financial statements must be accurate.

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The Effect of Fraud Prevention on Fraudulent Financial

Statements

Fraud prevention with a positive path coefficient of 0.245 had a

t-count of 2.172>t-table of 1.98, then H5 was accepted, which means
fraud prevention had a significant positive effect on fraudulent financial
statements. This is in line with Zager et al. (2016), which stated that fraud
prevention can reduce fraudulent financial statements.

According to the Association of Certified Fraud Examiners (ACFE)

findings in 2018, a fraudulent financial statement is one of the frauds that
does not often occur but causes the most significant losses. The most
commonly used technique is presenting excessive assets to look like the
company is healthy. Fraud prevention is very effective if it starts from within
the company because internal parties have an essential role. Therefore,
the company must build a sound internal control system to prevent fraud.
Management is primarily responsible for preventing fraud but must also be
assisted by all organisational members to ensure that financial statements
are presented reliably and are free of misstatements.

The findings of this study suggest that efforts to reduce fraud in

financial statements are significantly impacted by fraud prevention. These
findings are in line with research by (Paranoan et al., 2022) and (Schuchter
& Levi, 2016), which finds that preventive measures have an enormous
impact on attempts to reduce fraud and that they also have a significant
beneficial impact on efforts to reduce fraud in financial statements. This is
because people know that committing fraud can result in punishments, such
as dismissal, which will serve as a deterrent. Good corporate governance
(GCG), deployment of a sound internal control system, and adequate
supervision within the organisation or institution are all necessary for
fraud prevention to impact efforts to reduce fraudulent financial statements.
Mohamed (2013) offers anti-fraud programs, particularly concerning the
prevention, detection, and response strategies, as part of a company’s efforts
to mitigate financial statement fraud.

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The Effect of Islamic Work Ethics on Fraudulent financial

statements through Fraud Prevention

The sixth hypothesis examined is the influence of Islamic work

ethics on fraudulent financial statements through fraud prevention. The
outcome revealed a significant t-value of 0.05, meaning 3.802>1.9850.
This hypothesis demonstrated that fraud prevention could be employed
as an intervening variable in the indirect influence of IWE on fraudulent
financial statements. Kuncoro and Wibowo (2019), and Hamdani (2015)
generally agree that IWE has affected fraud prevention.

Employees can accomplish their responsibilities by working tirelessly

to conduct tests on documents and information obtained to reduce financial
statement fraud through implementing anti-fraud control programmes based
on company values. Furthermore, employees can work to the best of their
abilities to predict types of fraud in order to reduce fraudulent financial
statements by raising awareness of fraud in the organisation. Likewise,
employees believe that the agency’s employee relationships should be
given special attention since they attempt not to take fictitious payments to
reduce fraudulent financial statements by being honest, open, and helpful
to one another.

The findings demonstrated that fraud prevention can be used as an

intervening variable in the indirect effect of IWE on fraudulent financial
statements. Rahma and Yulianti (2018) and Maharani (2013a) stated that
IWE affects FFS. Hamdani (2015), Kuncoro and Wibowo (2019), and
Urumsah et al. (2016) all agree that IWE has an impact on fraud prevention.

Based on the findings from this study, IWE can prevent someone from
committing fraud at work, reducing numerous frauds such as fraudulent
financial statements, corruption, and asset misuse. Because the number of
Islamic financial institutions in Indonesia is identical to Islamic law, it is
critical for management and all members of the organisation to maintain
Sharia institutions’ good name so that acts of fraud do not taint them.

Several previous research investigated how IWE directly influenced

fraudulent financial statements without accounting for the indirect
relationship (Intervening) between IWE and fraudulent financial statements.

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As a result, this research contributes to the body of knowledge by

investigating the indirect relationship between IWE and fraudulent financial
statements, with fraud prevention as a mediator.

Effect of Good Corporate Governance Practice on Fraudulent

financial statements through Fraud Prevention

Hypothesis testing using the single test method showed a significant

t-value at 0.05, 11.506 <1.9850. This hypothesis proved that fraud prevention
could be used as an intervening variable in the indirect effect of GCG on
fraudulent financial statements.

The results indicated that the practice of GCG directly affects

fraudulent financial statements. With the addition of the intervening variable,
namely fraud prevention, the research results can mediate the relationship
between GCG practices and fraudulent financial statements. This results
did not support the research conducted by Rohmatin et al., (2021).

Financial statements need to be presented accurately and on time

to users of financial statements. The aim is to convey an overview of the
actual condition of the company. What is the position of assets, liabilities,
and equity in a period? Before issuing financial statements, the company
will test the documents and information obtained to minimise fraudulent
financial statements.

Based on respondents’ answers, the company had provided complete

information to users of financial statements. Submitting this complete
information can reduce the misuse of company assets because the company is
a law enforcer who can build a culture of honesty and openness. In addition,
employees must work according to standard operating procedures (SOPs)
and applicable regulations so that with SOPs, companies can examine
documents and information obtained to minimise financial statement fraud.
Specific components that apply to bank operational procedures at all levels
of the organisation are governed by good corporate governance. For the
vision and goals of an organisational unit to be achieved collaboratively,
superior corporate governance based on five GCG principles can be applied,
namely Transparency, Accountability, Responsibility, Independence, and
Fairness (TARIF).

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Acceptance of Hypothesis 7 is consistent with the Agency Theory,

which holds management accountable to stakeholders to meet their
expectations, one of which is the application of good corporate governance,
which generates profits that can reduce fraud and lead to maximum profit
gain. The implementation of effective GCG can reduce the opportunities
for fraud to occur. This ensures that good corporate governance reduces the
chances of anyone committing fraud.

Many previous studies tested GCG directly affecting fraudulent

financial statements without considering the indirect relationship
(Intervening) between GCG and fraudulent financial statements. So, this
study contributes to the literature by examining the indirect relationship
(intervening) of GCG and fraudulent financial statements with fraud
prevention as a mediator.

FUTURE RESEARCH

Future research could be extended to a mixed-methods approach. Integrating

quantitative and qualitative methods can provide further insight into issues
related to fraudulent financial statements. As the field of study is less
explored, especially concerning IWE and fraud, a qualitative approach
can gather information directly from IFI practitioners. The mixed-methods
approach is predicted to be a worthy effort to strengthen the research design,
resulting in more valid and reliable findings. Future research should also
explore how the whistleblowing system and internal control factors moderate
the relationship between GCG practices and fraudulent financial statements.
Furthermore, a study on testing religiosity as a moderator variable that
strengthens the relationship between IWE and fraud prevention should be
explored. This is based on the premise that religiosity will strengthen the
relationship between IWE and fraud prevention.

CONCLUSION

This study contributes significantly to the early detection of organisational

financial statement fraud. This research, which is based on the Al-Quran
and Hadith, also adds to the development of knowledge on how to work in

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an Islamic manner. It fills the gap in the literature by applying Islamic work
ethics to the preparation of reliable financial statements. Work values derived
from the Al-Qur’an and Hadith can be used as a guide when preparing
financial reports and are supported by GCG principles such as transparency,
accountability, responsibility, independence, and fairness (TARIF), which
must be implemented appropriately to prevent financial reporting fraud.

This study adds to the body of knowledge on fraud prevention

and fraudulent financial statements from the perspective of the Fraud
Pentagon Theory, specifically in Islamic financial institutions. This
research also emphasises the importance of fraud prevention in mitigating
fraudulent financial statements and moderating the relationship between
Islamic work ethics, good corporate governance, and fraudulent financial
statements. In addition, it demonstrates that fraudulent financial statements
can be combated by applying Islamic work ethics founded on the Qur’an
and Sunnah. Employees understand their primary responsibility is not to
humans (stakeholders) but God. They will refrain from committing fraud
out of dread of sinning when they realise Allah will observe their actions.

ACKNOWLEDGEMENT

We would like to thank the Accounting Research Institute (ARI),

Universiti Teknologi MARA, Malaysia and Ministry of Higher Education
Malaysia, for the research fund 600-RMC/ARI 5/3(010/2023).

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