Benford’s Law provides just one small example of the way in which technology used to uncover accounting fraud has been growing in both sophistication and popularity. The growth hasn’t really been stimulated by technological innovation, which has mostly amounted to fine-tuning sleuthing programs. It is highly essential to mention here that the applying the Benford’s law should not be considered as a substitute for the applying of other digital analysis methods.

Benford’s law applied to bank frauds is simply a more complex form of the digital analysis. It looks at an entire set of the given data to determine if the number falls into expected distribution.

Background of Benford’s Law

Traditional fraud detection typically begins with an indication or anomaly that something isn’t right, such as anonymous tips, unusual financial statement relationships, or control overrides. These indicators, often called red flags, provide predication that fraud may exist.

Management or auditors investigate these indicators with additional efforts,indepth checking of the given data, or sometimes discussions with the employees to determine whether red flags represent simply suspicion, error , real fraud or other factors.   This is how the fraud detection audit procedure starts, it begins with anomalies brought to someone’s attention and continues by researching additional events and data until it is determined that fraud may be causing the indicators.

Identification of the anomalies is the first stage of any fraud detection audit; Identification of the red flags is the key success factor of any fraud detection audit. Benford’s law become important at this stage. It analyse huge data with some predetermined probabilities.

The Law

It is not absolutely unknown phenomenon but auditors lack the instinct to use it dynamically. When people are asked about the chances that the first digit of any number in a table will be the digit 9,most of the intelligent people readily assume that the odds are one in nine or 11.11%. But the Law of Benford deviates from this traditional understanding. According to Dr. Frank Benford the probability of 9 being the first digit is hardly 5% and 1 being the first digit is more than 30%.

Benford made this observation while working as a physicist at the GE Research Laboratories in New York. He noticed that the first few pages of his logarithm tables books were more worn than the last few and from this he surmised that he was consulting the first pages—which gave the logs of numbers with low digits—more often.

He tested this idea by looking at the first digits of 20 lists of numbers with a total of 20,229 observations. His lists came from varied sources, such as geographic, scientific and demographic data.

Numbers and Formulae

The law can be summarized with the help of a simple formula. The formulae are produced here in order to facilitate the construction of the excel sheets that works in detecting the frauds.

Probability of X being the first digit = Log ₁₀ (X+1) – Log ₁₀ (X)

This results into the probabilities of following digits appearing to be the first digit

1. 30.1%
2. 17.61%
3. 12.49% and so on.

Using this information the findings of the audit could be plotted on the graphs. The Variances could be analyzed for the given set of results.

Using the Riskpro App

Riskpro Technology team provides the Excel based utility for the Benford’s analysis which is available in the Indiaforensic Stores. While doing the CFAP registrations, you may download the same free of cost.