Detecting Cosmetic Earnings Management Using Benford's Law

This paper introduces a method for detecting a special form of Earnings Management called Cosmetic Earnings Management (CEM) in firms’ financial reporting. Recent studies in U.S.A using benford’s law have showed that cosmetic earnings management has occurred before implementation of Sarbanes-Oxley Act 2002 in U.S.A. Using benford’s law, this paper also addresses the occurrence of CEM in the firms listed in Tehran stock exchange (TSE) during 1999 and 2009. To analyze and compare the difference between actual and expected frequencies of profit and loss digits of 363 listed companies, the Standard Z and Chi Square were used. The results show that as a whole, CEM has not occurred in TSE. However we suggest users of financial reports evaluating firms’ profitability to consider this method for probable manipulation in earnings and use its results as a start point for further investigation.