Self-organizing fuzzy and MLP approaches to detecting fraudulent financial reporting

Abstract

In the fields of accounting and auditing, detection of firms engaged in fraudulent financial reporting has become increasingly important, due to the increased frequency of such events and the attendant costs of litigation. Conventional statistical tools such as legit and probit have not been successful in detecting such firms. We employ seven redflags which are composed of four financial redflags and three turn over redflags in order to detect targets of the Securities and Exchange Commission's (SEC) investigation of fraudulent financial reporting. Two prominent nonlinear approaches, i.e. neural network and fuzzy sets, are applied to detection of SEC investigation targets and compared with the conventional statistical methods.