Using Benford’s Law for Fraudulent Activity

Posted on Wednesday, September 05, 2018

Fraud is always a concern in nonprofit organizations.  One tool that can help spot and stop fraudulent activity is the application of Benford’s Law.

                          (Journal of Accountancy)

In 1938 Frank Benford discovered a mathematical theory on the of how often certain numbers appear naturally in a data set, resulting in a set curve.  For example, the number 1 will be the leading digit in a genuine data set of numbers 30.1% of the time with each subsequent number (2-9) at a lower percentage of time. 

1          30.1%

2          17.6%

3          12.5%

4          9.7%

5          7.9%

6          6.7%

7          5.8%

8          5.1%

9          4.6%

By applying Benford’s Law to a set of data within your organization, you can determine the possibility of manipulated data (fraud).  A few things to keep in mind…

Benford’s Law applies best to large sets of data. 

• The data must be numeric (no letters). 
• The numbers should not be restricted by maximums or minimums.  For example, hourly payroll rates would not be ideal because there is a minimum and maximum amount.
• The numbers should be randomly generated.  For example telephone numbers that have a specific area code assigned for the first three digits or data that is limited to multiples of 10 (10, 20, 30, etc.).

There are lots of data sets that would be ideal within nonprofit organizations. These could include general ledger detail, journal entries, credit card transactions, purchase orders, receivable balances, expense reimbursements, or inventory listings.

By using Excel to analyze your organization’s data, you can compare your results to the Benford’s Law curve.  Does it follow the curve?  If it doesn’t, you’ll want to investigate further to determine if data was in fact manipulated, but this gives you an analytical tool to determine if additional steps should be taken.

Posted by: Carrie Minnich, CPA

Posted in Mission Minded Nonprofits

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.