Do models of discretionary accruals detect actual cases of fraudulent and restated earnings? An empirical analysis

We examine the association between the existence and the magnitude of a fraudulent event that overstated earnings, nonfraudulent restatements of financial statements, and nine competing models of discretionary accruals, accrual estimation errors (Dechow and Dichev 2002; McNichols 2002), and the Beneish (1997, 1999) M-score. We use the size of the downward earnings restatement following the discovery of the fraud to proxy for the degree of discretion exercised to perpetrate-the fraud. We find that the accrual estimation errors exhibit the strongest association with the existence and the magnitude of fraud and nonfraud restatements. Further, our results suggest that total accruals could be a low-cost alternative to many commonly used measures of discretionary accruals in detecting smaller fraud. The accrual estimation errors have incremental explanatory power over total accruals for both smaller and larger frauds.