Benford’s Law and the Decreasing Reliability of Accounting Data

Unsurprising but interesting results from a Benford’s time-series analysis of U.S. public company financial accounting data. Things are, in short, getting worse.

So according to Benford’s law, accounting statements are getting less and less representative of whats really going on inside of companies.  The major reform that was passed after Enron and other major accounting standards barely made a dent.

Next, I looked at Benfords law for three industries: finance, information technology, and manufacturing.  The finance industry showed a huge surge in the deviation from Benfords from 1981-82, coincident with two major deregulatory acts that sparked the beginnings of that other big mortgage debacle, the Savings and Loan Crisis.  The deviation from Benfords in the finance industry reached a peak in 1988 and then decreased starting in 1993 at the tail end of the S&L fraud wave, not matching its 1988 level until … 2008.

The time series for information technology is similarly tied to that industrys big debacle, the dotcom bubble.  Neither manufacturing nor IT showed the huge increase and decline of the deviation from Benfords that finance experienced in the 1980s and early 1990s, further validating the measure since neither industry experienced major fraud scandals during that period.  The deviation for IT streaked up between 1998-2002 exactly during the dotcom bubble, and manufacturing experienced a more muted increase during the same period.

via Studies in Everyday Life: Benfords Law and the Decreasing Reliability of Accounting Data for US Firms.

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