The Use of financial ratios in detecting fraudulent financial reporting: the case of companies listed on the Nairobi Securities Exchange

Abstract

This study sought to investigate the use of financial ratios in detecting fraudulent financial reporting (FFR) among companies listed on the Nairobi Securities Exchange. This was done by determining whether selected financial ratios of fraudulent firms differed from those of non-fraudulent firms. Stepwise logistic regression was utilized in analyzing audited annual financial statements over a ten- year period, 2007 to 2016. The study adopted descriptive research design in analyzing findings from primary data. Categorization of firms as fraudulent was based on findings from the CMA annual reports on firms reported to have engaged in FFR between 2006 and 2017. 9 fraudulent firms were matched with 28 non-fraudulent firms on the basis of industry and financial year under consideration. 118 questionnaires were distributed to 37 listed companies representing 80% of the targeted population. Overall, profitability ratios, asset composition ratios, earnings quality ratios, management quality ratios and liquidity ratios were found to be significant in detecting FFR. This study highlighted the need for listed Kenyan companies to adopt efficient FFR detection and management techniques. The study also demonstrated the ability of financial ratios in detecting FFR. Findings from this study will help both internal and external auditors in improving on their effectiveness when it comes to detecting FFR. This study differentiated firms listed on the NSE that had engaged in FFR from those that had not engaged in FFR using financial ratios.