Current Issue

Volume 15: Issue 1, January–June 2023

Table of Contents

• An Examination of Non-Linearity in Financial Statement Data Using Topological Tests
• Is Audit Committee Chairs’ Compensation Related to Financial Reporting Quality?
• Impact on Corruption from Enforcement Around Personal Financial Disclosure
• A Saga of Clean Coal Electric Power: The Multibillion Dollar Southern Company Fraud
• Types of Hospital Frauds: Nature and Methods of Prevention
• Exploring Embezzlement by Catholic Priests in the United States: A Content Analysis of Cases Since 1963
• Exempting Small Firms from Anti-Fraud IRS Disclosures: Investor Perceptions
• Are Companies Exploiting a Loophole in Reg FD?
• Fraudulent Financial Reporting as Identified by the SEC’s AAERs: A Pedagogical Technique
• Book Reviews

An Examination of Non-Linearity in Financial Statement Data Using Topological Tests | Full Article (PDF)
Kathleen A. Kaminski
Eileen A. Hogan

Abstract: Evidence exists that ratios of financial statement data are the result of non-linear chaotic dynamics and that the use of linear models is not appropriate for predicting fraud (e.g., Kaminski and Wetzel, 2004). Despite this evidence and the importance of detecting fraud and the call for analytical procedures that effectively predict fraud, much research still focuses on the use of linear models to examine differences between fraudulent and non-fraudulent firms. The purpose of the present study was to attempt to triangulate the results of a previous study by Kaminski and Wetzel (2004). Using chaos theory methodology, they used metric tests to examine the time-series behavior of ten financial ratios calculated from quarterly balance sheets and income statements for thirty matched pairs of firms. This study extends that work by exploring an alternate chaos theory methodology, topological tests, on the same data. Results underscore the findings that ratios comprised of financial data as reported on the balance sheet are the result of non-linear chaotic dynamics, regardless of whether statistical or topological analysis is used. The use of linear models comprised of these financial ratios is inappropriate; such models do not robustly represent the system and result in low explanatory power.

Keywords: Chaos theory; topological tests; ratio analysis; fraud

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Is Audit Committee Chairs’ Compensation Related to Financial Reporting Quality? | Full Article (PDF)
Lin Chen
Linh Le
Dongfang Nie
Yuan Shi

Abstract: This study examines the association between the audit committee chair’s (ACC’s) cash and equity-based compensation and financial reporting quality. We find that the ACC’s cash compensation is negatively associated with the likelihood of misstatement and the extent of earning management measured by discretionary accruals. We fail to find such an association for the ACC’s equity-based compensation. The findings suggest that higher cash compensations incentivize ACCs to exert more effort in monitoring the financial reporting process.This study is one of the first to reveal the positive association between the level of ACC’s cash compensation and financial reporting quality.

Keywords: Compensation; earnings management; audit committee chair; misstatement

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Impact on Corruption from Enforcement Around Personal Financial Disclosure | Full Article (PDF)
Renee Flasher
Mark Myring
Chubo Peng

Abstract: Most states and the federal government require elected and/or people employed in certain government positions to file financial disclosures. This anti-corruption control brings transparency about potential and actual conflicts of financial interest to the public view through online disclosure or through open records laws. This article leverages variation around enforcement practices to investigate the impact of this control on corruption. We hypothesize that general deterrence arises from enforcement of the personal financial disclosure filing requirements to impact state-level corruption. The results of our analysis are consistent with enforcement investigations being less impactful on corruption than a governmental entity having significant subpoena powers. Our findings suggest that enforcement levels around financial disclosures could be strengthened to have a more significant impact on corruption in the respective state. This study expands on the limited empirical research into state ethics commission functions.

Keywords: Corruption; financial disclosure; ethics commission; investigations state and local government; enforcement

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A Saga of Clean Coal Electric Power: The Multibillion Dollar Southern Company Fraud | Full Article (PDF)
Amanda M. Grossman
Steven D. Grossman
D. Larry Crumbley

Abstract: From a wanton lack of proper accounting disclosures in its public annual reports from 2013 until 2020, Southern Company is accused of perpetrating a fraud regarding the construction of a “clean coal” power plant near De Kalb, Mississippi, with a population of 947. Southern Company lost close to $7 billion from the ill-fated project. Evidence suggests that the company knowingly, and with intent to deceive, misrepresented the costs and time associated with the plant construction. The ongoing deception fostered the company’s ability to maintain tax credits and receive millions of dollars in funding from the Department of Energy. Southern Company was sued by shareholders, and recently, Deloitte & Touche, LLP, the company’s external auditors, also have been sued. Deloitte provided unqualified audit opinions over the aforementioned timeframe, although every indication suggested that Southern Company was hiding the financial condition of the power plant. This article presents and discusses the acts and financial disclosures of Southern Company, and based on these data, one could conclude that Deloitte appears grossly negligent.

Keywords: Southern Company; Mississippi Power Company; Deloitte & Touche; Kemper Power Plant; Base Load Act; fraud; external auditors; carbon recapture

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Types of Hospital Frauds: Nature and Methods of Prevention | Full Article (PDF)
Kevin Pan
Cameron Pearce
Steven T. Jones
Zhenyu Lai

Abstract: To help auditors prevent hospital frauds, in this study we examined 80 cases of hospital frauds published by the United States Department of Justice between 2010 and 2021. We seek to understand four issues. First, what are the natures of hospital frauds? Second, what is the role of the perpetrator, and does the perpetrator’s role affect the nature of fraud? Third, do frauds of greater dollar amounts result in longer sentences for perpetrators? Fourth, what strategies can auditors use to prevent hospital frauds, based on the mechanisms of past frauds?

We found five types of frauds: (1) fraudulent billing of medical services (including billing for unnecessary medical services and upcoding); (2) illegal patient referrals (including Stark law violations) (3) vendor managers receiving bribes; (4) checks or credit card schemes; (5) fraudulent invoices. We found that most frauds committed by medical professionals fell into the category of fraudulent billing, whereas frauds committed by administrative professionals were distributed much more evenly across the five major categories. Frauds of larger dollar amounts result in longer sentences. Finally, based on how these past frauds occurred, we provide strategies that accountants can use to prevent and detect these five types of hospital frauds.

Keywords: Fraud; hospital; healthcare; detection; prevention.

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Exploring Embezzlement by Catholic Priests in the United States: A Content Analysis of Cases Since 1963 | Full Article (PDF)
Robert A. Warren
Timothy J. Fogarty

Abstract: The diversion of organizational resources to personal purposes occurs in every occupation and industry. A major religion like Catholicism is no exception. This study offers research questions designed for this arena, grounded in the logic of an elaborated fraud triangle. Using a content analysis of embezzlement, 95 cases involving Catholic priests in the U.S. over the last 59 years, expected archival support for the importance of opportunity was found. More importantly, unique types of pressure/incentive and rationalization were identified. Most specifically, the articles make the case for the use of moral licensing as a motivational explanation for fraud by this occupational group.

Keywords: Catholic priest; moral licensing; fraud; fraud triangle; church

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Exempting Small Firms from Anti-Fraud IRS Disclosures: Investor Perceptions | Full Article (PDF)
Norman Massel
Jungeun ‘JP’ Park
KC Rakow

Abstract: We examine the market reaction to the IRS announcement on May 10, 2013, exempting firms with total assets between $10 million and $50 million from Schedule M-3. We conduct this analysis to shed further light on the ongoing debate as to whether the IRS should rely more on Schedule UTP rather than Schedule M-3, or entirely do away with Schedule UTP as was proposed in a 2018 Treasury Inspector General for Tax Administration (TIGTA) report. We find that investors perceived the exemption from Schedule M-3 as increasing shareholder wealth. We conclude from our analysis, as well as the results from prior research by Abernathy, Davenport, and Rapley (2013), Honaker and Sharma (2017), and Howard and Massel (2019), and the conclusions from the 2018 TIGTA report, that the IRS should increase their reliance on Schedule M-3 rather than Schedule UTP to help close the “tax gap.”

Keywords: Tax aggressiveness; book-tax income gap; Schedule Uncertain Tax Position (UTP); IRS audit tools; Schedule M-3; tax shelters; IRS disclosure policies

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Are Companies Exploiting a Loophole in Reg FD? | Full Article (PDF)
ElioAlfonso
Andrey A. Simonov

Abstract: Prior to Regulation Fair Disclosure (Reg FD), many firms regularly gave valuable private information about firm performance to financial analysts. Like earnings management, the end result would allow firms to meet or beat earnings targets. Although Reg FD banned the disclosure of material information to analysts, the SEC acknowledges that it is still permissible for firms to privately review and comment on analysts’ earnings models directly to analysts. This exception creates an opportunity for firms to communicate material information to analysts while technically not triggering Reg FD’s disclosure requirements. We contact the investor relations departments of firms listed in the S&P 500 to determine whether they engage in this specific type of private interaction. Surprisingly, approximately 43% of firms in our sample communicate privately with analysts concerning their earnings models. Overall, we show that analysts who follow firms which communicate privately have greater forecast accuracy than analysts who follow firms which do not. Firms which privately communicate also are more likely to walk analysts’ forecasts downward during the quarter to achieve a positive earnings surprise. Our findings have important implications for regulators since firms could be exploiting an exception to a broader set of rules to opportunistically guide quarterly earnings targets and mislead investors.

Keywords: Private communication; financial analysts; forecast accuracy; expectations management; earnings management

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Fraudulent Financial Reporting as Identified by the SEC’s AAERs: A Pedagogical Technique| Full Article (PDF)
Leisa L. Marshall

Abstract: The author presents a pedagogical technique that includes the recommendations of the Treadway Commission to integrate fraudulent financial reporting with analytical and critical thinking skills in accounting education. The technique was implemented in a Fraud Examination and Forensic Accounting course with positive student feedback. The pedagogical technique requires students to retrieve information from the Securities and Exchange Commission’s (SEC) Accounting and Auditing Enforcement Releases (AAER). Students then identify from the AAER an individual and a company charged with alleged fraud. Subsequently, students research the fraud and relate concepts from the PCAOB’s AS 2401 Consideration of Fraud in a Financial Statement Audit, the COSO’s Internal Control-Integrated Framework, and the AICPA Code of Professional Conduct to their AAER individual and company. In addition, students perform analytical procedures on the financial statements for several periods surrounding the alleged fraud. The research culminates in an oral presentation.

Keywords: Fraudulent financial reporting; AS2401 Consideration of Fraud in a Financial Statement Audit; AICPA Code of Professional Conduct; COSO Internal Control-Integrated Framework; forensic accounting; fraud examination; accounting education; fraud education; analytical procedures