Analysis of “Predicting Material Accounting Misstatements”

I chose to analyze the article called “Predicting Material Accounting Misstatements” co-authored by Patricia Dechow, Weili Ge, Chad Larson, and Richard Sloan. The authors of this article had the goal of showing its intended audience how they developed a database, recognized similar characteristics among misstating firms, and used the information gathered to develop a model to predict accounting misstatements. The subject of misstating financial statements (also know as earnings management) is a very relevant subject in the accounting field. When companies misstate their financial reports, they are in essence misleading the stakeholders of the company about the pecuniary performance of the company. It is an auditor’s job to find these misstatements so companies that use these fraudulent techniques can be penalized accordingly.
Earnings management and creative accounting are names for an accounting practice in which managers will artificially alter revenue, profit, or earnings per share of the company. This is done for many different reasons, however, no matter what reason, earnings management is still considered fraud. In this article, 2,190 Security and Exchange Commission Accounting and Auditing Enforcement Releases (AAERs) were examined between 1982 and 2005. “Our examination identifies 676 unique firms that have misstated at least one of their quarterly or annual financial statements” (Dechow et al., 2011). After that, they examined five different variables for each firm that had a misstatement. The variables were as follows: Accrual quality, financial performance, nonfinancial measures, off-balance sheet activities, and market-based measures. These variables were used to formulate a probability that a certain company has misstatements. The probability was coined “F-score” by the authors. Overall, this article is seems to be clearly written, informative, and useful to the subject.
After reading this article, I feel that this is very relevant to