Benford's law is an advanced digital analysis technique that involves examining the actual frequency of the digits in the data. Benford's law calculates that numbers in sets of data with low first digits, such as 1, occur with more frequency than numbers with high first digits, like 8 or 9. Valid, unaltered data, without exceptional transactions, will follow the projected frequencies.
Benford's law has been found to apply to many sets of financial data, including corporate disbursements. Audit software can employ digital analyses using Benford's law to identify fraud and other irregularities in accounts payable, income tax forms, claims payments and other disbursements. Audit software, compatible with Excel, is available at no charge to so this analysis.
Conversely, data that meets the Benford's law criteria, but fails to follow the expected frequencies, may include fraudulent items. It is very difficult for people to make up credible numbers, as invented numbers are unlikely to follow Benford's law. Thus, Benford's law can be tested by the audit staff to spot irregularities, including possible error, fraud detection, or other anomalies. Audit software is available, including both Excel and a command language process for larger volumes.
The technique has been used in a variety of environments, including:
1. Detecting Irregularities in Insurance Claims
2. Highlighting Unusual Employee Expense Reports
3. Detecting possibly fraudulent tax returns
4. Fraud detection in medical insurance claims
Benford's law provides the internal auditor with an efficient means of fraud detection by measuring an expected population distribution against the actual distribution. By highlighting selected transactions, vendors or other groups, the internal auditor/researcher is better able to isolate and focus on a target group, and therefore potentially be more productive in identifying errors or unusual transactions.
The fraud detection techniques used are based upon mathematical theories which are explained in detail in various referenced articles. Because transaction volumes are often very significant, and needed computations would be tedious if done manually, the use of audit software , especially a command language, is generally recommended for fraud detection.
Suggested Audit Approaches
Benford's Law formulae and values in Excel
Downloads (audit software and papers)
Limitations and Cautions
Examples of Application of Benford's Law
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