Benford´s Law in Auditing

Auditing

BENFORD´S LAW IN AUDITING

The auditor, when conducting an ordinary examination, explores the possibility that fraud may be found, financial statements may be poorly presented due to irregularities or other causes. If the fraud is material, it may affect your opinion about the financial statements, and its examination, done in accordance with the generally accepted auditing standards, gives consideration to this contingency. The expression of an opinion on the financial statements is not aimed to reveal fraud and other similar irregularities, although its discovery may exist.

USE OF BENFORD´S LAW

The prevention and detection of fraud rests mainly on an adequate accounting system with an appropriate internal control. A good practice of the auditor is to evaluate the effectiveness of the internal control system through the application of Benford’s law which is a procedure used in auditing to detect possible cases of fraud in lists of numbers, data and mathematical sequences such as tax returns, disbursements , sales records of expenses, budgets, prices of shares and invoices, in other words all kinds of accounts that originate from transactions in which numbers are combined, by calculating the distribution of the first digits of the list, that is, the chances of a number being the first number is: 1-30%, 2-17.6%, 3-12.5%, 4-9.7%,5-7.9%, 6-6.7 %, 7-5.8%, 8-5.1% and 9-4.6%.

The first number 1 has more possibility than other numbers, since we start counting from 1 to 9, when each number has the same possibility. However, from 10 to 19 we only have 1 as the first number, and when we reach 99, all figures will have the same probability.

The hypothesis is that if someone is trying to adulterate data, he or she will necessarily have to invent some numbers. When it is done, is tended to use numbers that start with 5, 6, and 7. This is enough to violate what Benford’s Law predicts and start an audit of those numbers.

The Law is not infallible, but it serves to detect suspects.
In conclusion, if the objective of the auditor’s examination were to discover frauds, he would have to extend his work to a point where the procedure would be quite expensive, even so, one can not be sure that all types of fraud were detected, or they did not exist. The auditor is not a guarantor, if his/her examination is done with professional skill he has fulfilled all the obligations implicit in his commitment. When applying Benford’s Law, any result that does not enter these margins must be observed with discretion and investigate more than usual because these data can keep inside a kind of fraud or similar irregularities.
Mauricio Guillermo Díaz Villate (Auditool Webpage)