Using Nonfinancial Measures to Assess Fraud Risk

TLDR

Auditors can use nonfinancial measures that correlate with financial metrics, and discrepancies between them may signal firms at high fraud risk. This study investigates whether auditors can effectively employ nonfinancial measures to evaluate the reasonableness of financial performance and thereby detect financial statement fraud. The study finds that the gap between financial and nonfinancial performance is larger for fraudsters, serves as a significant fraud indicator in multivariate models, and overall demonstrates that nonfinancial measures can effectively assess fraud risk.

Abstract

ABSTRACT This study examines whether auditors can effectively use nonfinancial measures (NFMs) to assess the reasonableness of financial performance and, thereby, help detect financial statement fraud (hereafter, fraud). If auditors or other interested parties (e.g., directors, lenders, investors, or regulators) can identify NFMs (e.g., facilities growth) that are correlated with financial measures (e.g., revenue growth), inconsistent patterns between the NFMs and financial measures can be used to detect firms with high fraud risk. We find that the difference between financial and nonfinancial performance is significantly greater for firms that committed fraud than for their nonfraud competitors. We also find that this difference is a significant fraud indicator when included in a model containing variables that have previously been linked to the likelihood of fraud. Overall, our results provide empirical evidence suggesting that NFMs can be effectively used to assess fraud risk.