Chen SpringerPlus (2016)5:89

DOI 10.1186/s40064-016-1707-6

RESEARCH Open Access

Detection of fraudulent financial

statements using the hybrid data mining
approach
Suduan Chen*

*Correspondence:
[email protected] Abstract
Department of Accounting The purpose of this study is to construct a valid and rigorous fraudulent financial state-
Information, National Taipei
University of Business, ment detection model. The research objects are companies which experienced both
No. 321, Sec. 1, Jinan Rd., fraudulent and non-fraudulent financial statements between the years 2002 and 2013.
ZhongZheng District, In the first stage, two decision tree algorithms, including the classification and regres-
Taipei 100, Taiwan
sion trees (CART) and the Chi squared automatic interaction detector (CHAID) are
applied in the selection of major variables. The second stage combines CART, CHAID,
Bayesian belief network, support vector machine and artificial neural network in order
to construct fraudulent financial statement detection models. According to the results,
the detection performance of the CHAID–CART model is the most effective, with an
overall accuracy of 87.97 % (the FFS detection accuracy is 92.69 %).
Keywords: Fraudulent financial statements, Decision tree CART, Decision tree CHAID,
Bayesian belief network, Support vector machine, Artificial neural network

Background
Financial statements are a company’s basic documents that reflect its financial status
(Beaver 1966; Ravisankar et al. 2011). The financial statement is the main basis for deci-
sion -making on the part of a vast number of investors, creditors and other persons in
need of accounting information, as well as a concrete expression of business perfor-
mance, financial status and the social responsibility of listed companies and OTC com-
panies. However, in recent years, cases of fraudulent financial statements have become
increasingly serious (Wells 1997; Spathis et al. 2002; Kirkos et al. 2007; Yeh et al. 2010;
Humpherys et al. 2011; Kamarudin et al. 2012). Since the Asian Financial Crisis in 1997,
there have been many cases of fraudulent financial statements in Taiwan and the United
States. Examples include the Enron case in 2001, the WorldCom case in 2003 in the
United States, and the ABIT Computer, Procomp, Infodisc and Summit Technology
cases in 2004 in Taiwan. Given these incidents, it has become important to be able to
detect fraudulent behavior prior to its occurrence.
Data mining is a key tool for dealing with complex data analysis and classification. It
identifies valuable events that are hidden in large amounts of data for analysis, and sum-
marizes the data in a structured model to provide a reference for decision-making. Data
mining has many different functions, such as classification, association, clustering and

© 2016 Chen. This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://
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Chen SpringerPlus (2016)5:89 Page 2 of 16

forecasting (Seifert 2004). The classification function is used most frequently. The classi-
fication results can be used as the basis for decision-making and for prediction purposes.
Fraudulent financial statements can be viewed as a typical classification problem
(Kirkos et al. 2007). The classification problem involves performing computation using
the variable characteristics of some known classification data, in order to obtain clas-
sification-related classification rules. Subsequently, the unknown classification data are
inputted into the rules in order to obtain the final classification results. Regarding the
issue of fraudulent financial statements, much of the past research has proposed the
use of the data mining method because of its superiority in terms of forecasting after
inputting large amounts of data for machine learning, as well as its accuracy in terms
of classification and forecasting, which is far higher than that of conventional regres-
sion analysis. For example, artificial neural network (ANN), decision tree (DT), Bayesian
belief network (BBN), and support vector machine (SVM) methods have been applied in
order to detect fraudulent financial statements.
It is therefore urgent that we establish an effective and accurate fraudulent financial
statement detection model, because conventional statistical models experience great
disadvantages in detecting fraudulent financial statements due to their relatively high
error rate. Some scholars have proposed using data mining techniques in order to judge
concerns about business operational continuity and thereby reduce judgment errors.
However, prior studies are neither sufficient nor complete. For example, most use only
1–2 statistical methods, without model comparison, Furthermore, most use a one-stage
statistical treatment in order to establish the detection model, which is not prudent. The
main purpose of this study is to propose a better model to detect potentially fraudulent
financial statements, so that the losses incurred by investors and caused by auditors can
be reduced. Compared with previous literature, this study adopts: (1) a two-stage statis-
tical treatment; (2) five data mining techniques to create the detection model for com-
parison of model accuracy; (3) tenfold cross validation which is thought to be prudent
and is commonly used in the academic field. In short, this study is not only prudent, but
is also innovative and makes significant contributions to the literature. This study selects
the major variables by applying the DT techniques of the Chi squared automatic interac-
tion detector (CHAID) and classification and regression trees (CART). Moreover, this
study establishes classification models for comparison by combining CART, CHAID,
BBN, SVM, and ANN data mining techniques.

Fraudulent financial statements

Reviews on fraud
Regarding the processing of financial statements, Enron applied the highly controver-
sial Special Purpose Entities account in order to solve the problem of financing liabili-
ties. However, the company did not have to list its increased financing liabilities in the
balance sheet, which is known as off-balance sheet financing in accounting. The US
Committee of Sponsoring Organizations of the Treadway Commission (COSO) (Beas-
ley et al. 1999) and SAS No. 99, 2002 defined a fraudulent financial statement as either
intentional or reckless conduct based on false information or omissions that results in
significantly misleading financial reports. The cost of the prevention of fraudulent finan-
cial statements in the United States is estimated to be in the billions of dollars each year
Chen SpringerPlus (2016)5:89 Page 3 of 16

(Humpherys et al. 2011). The US Association of Certified Fraud Examiners (ACFE) clas-
sifies fraud into six types: (1) providing false financial information; (2) misuse or misap-
propriation of corporate assets; (3) improper support or loans; (4) improperly acquiring
assets or income; (5) improper circumvention of costs or fees; and (6) improper manipu-
lation of financing by executives or board members. The Taiwan Accounting Research
and Development Foundation released the Auditing Standards No. 43 communiqué
in 2006, in which fraud was defined as the management, control unit or one or more
employees deliberately using deception and other methods to acquire improper or illegal
benefits. Therefore, it could be concluded that the four elements of fraud are: (1) serious
erroneous expressions of the nature of transactions, (2) knowingly violating rules, (3) the
victim accepting a misstatement as fact; and (4) damage due to financial losses caused by
the above three situations. Misstatement fraud relating to financial statement auditing
includes financial report fraud and misappropriation of assets. Financial reporting fraud
refers to untrue financial statements which aim to deceive users. The US Security and
Exchange Commission (SEC) state that financial statements should “provide a compre-
hensive overview of the company’s business and financial condition and include audited
financial statements”.
Fraudulent financial statements are intentional and illegal acts that result in mislead-
ing financial statements or misleading financial disclosure (Beasley 1996; Rezaee 2005;
Ravisankar et al. 2011). Stakeholders are adversely affected by misleading financial
reports (Elliot and Willingham 1980). Most prior studies use conventional statistical
multivariate analysis, notably logistic regression analysis (Beasley 1996; Summers and
Sweeney 1998; Bell and Carcello 2000; Spathis et al. 2002; Sharma 2004; Uzun et al. 2004;
Chen et al. 2006; Humpherys et al. 2011). Conventional statistical methods require com-
pliance with the limitations of specific hypotheses, for example, the avoidance of collin-
earity of independent variables and the distribution of data (Chiu et al. 2002). However,
according to Chen (2005), regarding variables, empirical financial variables often can-
not comply with relevant statistical conditions, such as normal distribution. Therefore,
the machine learning method, which requires no statistical hypotheses of data combina-
tions, has emerged and been used by scholars as a classifier. The empirical results sug-
gest that the machine learning method has a positive classification effect.

Application of data mining in detecting fraudulent financial statements

Most previous research has used the conventional statistical method to make decisions
regarding operational continuity. However, this method causes a number of disadvan-
tages in terms of judgment and its error rate is relatively high. In recent years, some
studies have applied data mining techniques in order to detect fraudulent financial state-
ments and thereby reduce judgment errors. Studies applying DT techniques to detect
fraudulent financial statements include: Hansen et al. (1992), Koh (2004), Kotsian-
tis et al. (2006), Kirkos et al. (2007), and Salehi and Fard (2013). Studies applying BBN
techniques to detect fraudulent financial statements include: Kirkos et al. (2007), and
Nguyen et al. (2008). Studies that apply SVM techniques to detect fraudulent financial
statements include: Zhou and Kapoor (2011), Shin et al. (2005), Chen et al. (2006), Yeh
et al. (2010), Ravisankar et al. (2011), Pai et al. (2011). Studies applying ANN techniques
to detect fraudulent financial statements include: Hansen et al. (1992), Coats and Fant
Chen SpringerPlus (2016)5:89 Page 4 of 16

(1993), Fanning and Cogger (1998), Koh (2004), Chen et al. (2006), Kirkos et al. (2007),
Ravisankar et al. (2011), and Zhou and Kapoor (2011). The judgment accuracy rates of
using data mining techniques to detect fraudulent financial statements vary, and the
construction of the model is neither complete nor perfect. As stated above, most studies
only use 1–2 data mining techniques, without offering model comparison; and most use
one-stage statistical treatment to establish the detection model, which is not prudent.
Prior studies point out that using data mining techniques to detect fraudulent finan-
cial statements is superior to adopting a conventional regression analysis in terms of
accuracy. This study proposes using a two-stage fraudulent financial statement detection
model using the DT CART and CHAID algorithms in variable selection in order to iden-
tify influential variables. Next, this study applies CART, CHAID, BBN, SVM and ANN in
order to construct the fraud detection model and conducts a pairwise comparison of the
testing groups of each model in terms of classification accuracy, Type I errors, and Type
II errors to identify the model with the optimal accuracy.

Methods
This study utilizes several data mining techniques: DT, BBN, SVM, and ANN.

Decision tree
DT is the simplest inductive learning method (Arminger et al. 1997). As a data min-
ing technique, it is able to handle continuous and non-continuous variables (DT concept
diagram is shown as Fig. 1). The decision-making processes of the judgment tree method
are as follows: (1) draw tree diagram; (2) mark various status probabilities and income
and loss values on the probability branch; (3) calculate the expectancy value of each plan
and mark it on the corresponding status node of that plan; (4) trim the branches, com-
pare the expectancy value of each plan and mark it on the plan branch and trim the
small expectancy value; (5) the remaining plan is the best one. Establishing the tree dia-
gram and summarizing the rules primarily depends on classified and known facts. These
rules are mutually exclusive, and the generated DT can make out-of-sample predictions.
The most commonly used DT algorithms include CART, CHAID and C5.0 (Viaene et al.
2005). C5.0 (Quinlan 1993) is developed from ID3 (Quinlan 1986a, b). Since ID3 has
limitations in terms of use and cannot process continuous numerical data, Quinlan
improved it and developed C5.0 to enable it to process continuous and non-continuous
values. The difference between CHAID and CART, C5.0 is that CHAID is only limited
to the processing of category variables, in case of continuous variables, an interval must

Root Node

Branches
Leaf Node Leaf Node

Possible Outcomes Possible Outcomes

Fig. 1 DT concept diagram
Chen SpringerPlus (2016)5:89 Page 5 of 16

be used to convert it into other variables. Another difference relates to trimming; CART,
C5.0 is the first method to mechanically use data training excessively and then trim, but
CHAID is used to stop the spreading of branches before excessive mechanical use.
DT C5.0 is primarily divided into two parts. The first is the classification criteria. The
DT is constructed based on the computation of the gain ratio. The information gained
from Eq. (1) is used to compute the data set profits before and after the test. As in Eq. (2),
it is defined as the subtraction of the pre-test information from post-test information.
Entropy in Eq. (1) is used in order to compute the impurity of the computation data set,
herein referred to as the chaos degree. When the degree of chaos of the data set reaches
the highest level, the value will be 1. Therefore, when the chaos degree of the post-test
data set is lower, the information gain will be greater and is more beneficial to the con-
struction of the DT.

Information Gain(S, A)
Gain Ratio(S, A) = (1)
Entropy(S, A)

 |Sv |
Gain(S, A) = Entropy(S) − Entropy(Sv ) (2)
|S|
v∈values(A)

Values (A) is the set of all possible values of attribute A, Sv is the subset of values v of
attribute A in S. The first item of this equity is the entropy of the original set; and the sec-
ond item is the expectancy value of S after classification with A. The expected entropy
described in the second item is the weighted sum of each subset, and the weighted value
is the proportion |Sv|/|S| of samples belonging to Sv in the original sample S.
The second part is the pruning criteria, which uses error based pruning (EBP) to carry
out the appropriate pruning of the DT and thereby improve the classification accuracy
rate. EBP is from pessimistic error pruning (PEP), both are proposed by Quinlan. The
most important feature of EBP is its ability to make judgments according to the error
rate. It computes the error rate of each node and determines the nodes that cause a rise
in the error rate of the DT before engaging in appropriate pruning of these nodes to
improve the accuracy rate of the DT.

Bayesian belief network

BBN, first proposed by Pearl (1986), plays an important role in issues of uncertainty and
inference, and has been extensively applied in many cases, such as natural resources
(Newton et al. 2007), and medical diagnosis and software cost evaluation (Stamelos et al.
2003). Its inference depends on the acquisition of new information. According to the
Bayes’ theorem, the probability values of the status of relevant nodes are adjusted. It is
a good method for establishing the model and is able to reflect the uncertain factors of
reality. The structure of the diagram presents causal relationships and infers final results
by the computation of probability. When given new information, BBN is able to regulate
probability (Tang et al. 2007). Namely, when the probability value is adjusted, all the rel-
evant nodes on the network can be adjusted according to the conditional probabilities.
BBN is a directed acyclic graph consisting of a series of nodes and arrows in between
nodes, and includes a number of decision-making variables (a BBN concept diagram is
Chen SpringerPlus (2016)5:89 Page 6 of 16

shown as Fig. 2). These decision-making variables are connected in the same direction to
form the parent-offspring relationship. The nodes represent the decision-making vari-
ables and the arrows represent the dependency relationship between various variables.
These variables can be discrete or continuous (Tang et al. 2007). If the arrow direction
is from A to B, this means that B originates from A, and that A is the parent node and B
is the offspring node. The arrows represent the causal relationship and strength. If each
node x contains different parent nodes (Parents(x)), then the conditional probability of
getting all parent nodes and node x is as shown in Eq. (3), hence the conditional prob-
ability table for node x can thus be developed. The probability combinations of n attrib-
utes (x1 , x2 , . . . , xn ) are as shown in Eq. (4)

P(x|Parents(x) ) (3)

n

P(x) = P(x1 , x2 , . . . , xn ) P(xi |Pai ) (4)
i=1

Support vector machine

SVM is a set of artificial intelligent learning methods proposed by Vapnik (1995). It is a
machine learning method based on statistical learning theory and SRM (structural risk
minimization). It primarily depends on using input training data to find an optimal sep-
arating hyperplane that can distinguish two or more types (class) of data through the
learning mechanism. It is a supervised learning, predication and classification method
for data mining.
The SVM concept diagram is shown in Fig. 3. SVM processing can be classified into
linear divisibility and linear non-divisibility.

Linear divisibility
Let the training set be (x1 , y1 ), . . . , (xl , yl ), x ∈ Rn , y ∈ {1, −1}, in which x is the input var-
iable, and the data will classify a super-plane into two categories, one is 1, and the other
is −1. If such data can be distinguished correctly, and the nearest vector of each classifi-
cation is at a maximum distance from the super plane, then the super plane is most suit-
able for divisibility. We express the super plane with the following formula:

Parent
X1 Node

X2 X3 X4 Nodes

Xn Nodes

Fig. 2 BBN concept diagram

Chen SpringerPlus (2016)5:89 Page 7 of 16

Fig. 3 SVM concept diagram

yi (w, x) + b ≥ 1, i = 1, . . . , l (5)

The maximum spacing of the two nearest vectors of Eq. (5) is as shown in Eq. (6):

p(w, b) = min d(w, b : xi ) + min d(w, b : xi )

xi ,yi =−1 xi ,yi =1
   
(w, xi) + b (w, xi) + b 2
= min + min = (6)
xi ,yi =−1 �w� xi ,yi =1 �w� �w�

The maximum distance (6) can be expressed as minimum �(w) = 21 �w�2 , Lagrange
relaxation is used to calculate the super plane most suitable for divisibility, as in Eq. (7):

l
 1 ∗
w∗ = b∗ = −

ai yi xi w , xr + xs (7)
2
i=1

where xr, xs are any support vectors that each classification can meet
αr , αs > 0, yr = −1, ys = 1. We acquire the clear hard classifier, as in Eq. (8):

f (x) = sgn w∗ , x + b
  
(8)

If the condition of incapable or complete classification is not considered, the soft clas-
sifier is as shown in Eq. (9):

� ∗ �  −1: z < −1
f (x) = h w , x + b where h(z) = z: − 1 ≤ z ≤ 1
 +1: z > 1
(9)

Linear non‑divisibility
Vapnik (1995) imports the concept of the cost function as related to wrong classifica-
tions in order to calculate the super plane most suitable for divisibility, which can be
expressed as Eq. (10):
Chen SpringerPlus (2016)5:89 Page 8 of 16

l
1 
min�(w, ξ ) = �w�2 + C ξi
2
i=1
s.t. yi [(w, x) + b] ≥ 1 − ξi , i = 1, . . . , l. (10)
where ξ ≥ 0

where ξi is the error item of wrong classification, C is a given parameter value, and
Lagrange relaxation can be obtained, as in Eq. (11) (Ribeiro et al. 1989; Larsson et al.
1996):

l l l
1       
�(w, ξ ) = �w�2 + C ξi − αi yi wT xi + b − 1 + ξi − βi ξi (11)
2
i=1 i=1 i=1

where α, β are Lagrange constants.

Artificial neural network

ANN is a system that imitates a biological neural network’s computational capabilities
(the ANN concept diagram is shown in Fig. 4) because biological vision and hearing
capabilities are superior to computer systems at the time. Therefore, it is expected to
gain powerful computational capabilities by imitation. In the 1940s, scientists imitated
the simplest neural cell modes in order to establish the most primitive ANN. McCulloch
and Pitts (1943) propose a simplified neural cell mathematical model in order to simu-
late the human brain’s computational capabilities.
The neural cell is the most basic unit of ANN. Assuming there is a neural cell, j, which
obtains an input variable, x, respectively, from the n neural cells in the upper layer; each
input variable has a linkage weight, w. The neural cell combines all the input variables
according to their weights into the combination function. The neural cell’s activation
function reuses the combination function to convert it into the output signal. The theory
of ANN neuron is represented in Fig. 5, in which n represents the number of input vari-
ables, Xi is the ith input variable, Wij is the weight of the ith variable of the jth neural
cell, and Pj is the combination function of the jth neural cell. If represented by activation
function f(x), then Yj = f (Pj) is the output value of the jth neural cell.
In the evolutionary process of neural networks, it is necessary to have a parameter
with a training model in order to train the required weight for the forecast variable at the
outset, and such parameters are randomly generated. Given this, the parameters used

Hidden Layer
Input Layer

Output Layer

Outputs
Inputs

Fig. 4 ANN concept diagram

Chen SpringerPlus (2016)5:89 Page 9 of 16

X1 W1j

X2 W2j Yj
Pj
W3j
X3
Wnj

.…
Xn
Fig. 5 ANN neural cell

in each training model differ. Finally, the weights of forecast variables generated by the
neural network are also different, but the error will meet a minimal value, so the neural
network is a deduction acquired through a trial-and-error method, and its purpose is to
minimize errors in the model forecast results. For the same data, the weighs trained are
not equal, and so the essence of a neural network is to emphasize the training model.
Therefore, there will be no judgment formula for the result of the neural network model,
rather only the judgment result is obtained.

Sample and variable selection

Data sources
This study investigates Taiwan’s listed and OTC companies who released fraudulent
financial statements during the period of 2002–2013. From companies listed in the Secu-
rities and Futures Investors Protection Center, and among the major securities criminal
prosecution and judgment publications by the Securities and Futures Bureau, from those
companies that violated the term of “misrepresented expression of financial statements”,
Articles 155 and 157 of the Securities Transaction Act, and No. 43 Bulletin of Auditing
Standards, this study selected 44 fraudulent companies. Those companies included one
in the building and construction industry, two in the food processing industry, two in
the textile and fiber industry, seven in the semiconductor industry, nine in the electron-
ics industry, four in the photoelectric industry, one in the telecommunications industry,
six in other electronics industries, two in the steel industry, one in the rubber industry,
one in the shipping industry, three in the software services industry, two in the electric-
mechanical industry, one in the electric appliance and cable industry, and two in other
industries. The financial statements of the financial industry are not comparable to other
industries and the financial ratio is different from that of general industries, and thus the
financial industry was eliminated.
In order to control numerous external environmental factors such as time, industry,
and company size, the matching method can be adopted. Hence, this study adopted the
matching sample design concept proposed by Kotsiantis et al. (2006) in order to match
one fraudulent company with three normal companies. This study selects normal com-
panies with similar total assets in the same industry in the previous year of the fraudu-
lent financial statements as the matching sample. A total of 176 companies are selected,
including 44 fraudulent companies and 132 normal companies who have not engaged in
fraudulent behavior.
Chen SpringerPlus (2016)5:89 Page 10 of 16

Variable definition
The dependent variable is used to classify companies into normal companies, repre-
sented by 0, and fraudulent companies, represented by 1. This study uses 30 independent
variables including 23 financial variables and seven non-financial variables. The research
variables and definitions are shown in Table 1.

Table 1 Research variables and definitions

Variables No. Variable description Definition/formula (the year
before the year of fraud)

Financial variables X1 Accounts receivable ratio Accounts receivable ÷ total assets

X2 Current assets ratio Current assets ÷ total assets
X3 Fixed assets ratio Fixed assets ÷ total assets
X4 Operating income to total assets Operating income ÷ total assets
X5 Net income to total assets Net income ÷ total assets
X6 Net income to fixed assets Net income ÷ fixed assets
X7 The proportion of cash against total Cash ÷ total assets
assets
X8 Natural logarithm of total assets ln total assets
X9 Natural logarithm of total liabilities ln total liabilities
X 10 Gross profit ratio Gross profit ÷ net sales
X 11 Operating expenses ratio Operating expenses ÷ net sales
X 12 Debt ratio Total liabilities ÷ total assets
X 13 Current ratio Current assets ÷ current liabilities
X 14 Quick ratio Quick assets ÷ current liabilities
X 15 Inventory turnover Cost of goods sold ÷ average inventory
X 16 Cash flow ratio Operating cash flow ÷ current liabilities
X 17 Pre-tax profit ratio Pre-tax profit ÷ net sales
X 18 Accounts receivable turnover Net sales ÷ average accounts receivable
X 19 Sales growth rate (Current year’s sales − last year’s
sales) ÷ last year’s sales
X 20 Debt-to-equity ratio Total liabilities ÷ total equity
X 21 Returns on assets before tax, interest, andIncome before tax, interest and depre-
depreciation ciation ÷ average total assets
X 22 The ratio of current liabilities against total Current liabilities ÷ total assets
assets
X 23 Total asset turnover Net sales ÷ average total assets
Non-financial variables X 24 The major stockholders’ stockholding Number of stocks held by the major
ratio shareholders ÷ total number of com-
mon stocks outstanding
X 25 Duality of board director and CEO If duality of board director and CEO
existed, it is set as 1; otherwise, 0
X 26 Size of the board of directors Number of directors
X 27 The ratio of pledged stocks held by Number of pledged stocks held by
directors and supervisors directors and supervisors ÷ number of
stocks held by directors and supervi-
sors
X 28 The ratio of stocks held by directors and Number of stocks held by directors and
supervisors supervisors ÷ total number of com-
mon stocks outstanding
X 29 Audited by BIG4 (the big four CPA firms) 1 for companies audited by BIG4, other-
wise, it is 0
X 30 Number of outside supervisors Number of outside supervisors
Chen SpringerPlus (2016)5:89 Page 11 of 16

Research design
Previous research is susceptible to the following disadvantages: (1) Most only use 1–2
statistical methods without model comparison; (2) Most only use one-stage statistical
treatment to establish the detection model, which is not prudent. Therefore, a two-stage
statistical treatment is used in this research (data mining techniques are used), and the
tenfold cross validation generally thought to be prudent in the academic field is also
used. The accuracy of the model is also compared in order to establish a relatively pru-
dent “Fraudulent Financial Statements” detection model. This study selects 30 variables
that can affect fraudulent financial statements from the literature and applies the DT
CART and CHAID algorithm in variable selection in order to identify influential vari-
ables. Next, CART, CHAID, BBN, SVM and ANN are applied in order to establish fraud
warning models, and a pairwise comparison of the testing groups is conducted in terms
of detection accuracy, Type I errors, and Type II errors. The research design and proce-
dure are shown in Fig. 6.

Results and discussion

This study selects 30 variables in order to determine the variables with the greatest
impact on fraudulent financial statements. The selected variables are processed in the
second stage using BBN, SVM and ANN modeling and classification performance tests.

Variable selection
Since this study selects relatively more variables, DT is applied in order to identify the
important and representative variables. In this study, SPSS Clementine is used as the soft-
ware for DT variable selection, and CART and CHAID are used for variable selection.

CART algorithm selection

The CART is a data mining algorithm developed by Breiman et al. (1984). It is a binary
segmentation DT technique used for application with continuous or classified non-
parameter data. Segmentation condition selection is determined by the data classes
and their attributes. Segmentation conditions are determined by Gini rules. Segmenta-
tion divides the data into two subsets, and the conditions for the next segmentation are
found in the subset.
Table 2 illustrates the results of using the CART algorithm in selection. Only 4 of the 30
variables were left after selection by the CART algorithm, including: X02 current assets
ratio, X09 natural logarithm of total liabilities, X16 cash flow ratio, and X19 sales growth
rate. The sequence in terms of the importance of the variables is X16, X02, X19 and X09.

CHAID algorithm selection

The CHAID is a method that applies the Chi square test in the computation of the
P-values of the broken nodes of the branches and leaves of the DT in order to determine
whether or not segmentation should be continued. CHAID can prevent the excessive
use of data and allow the DT to stop segmentation. In other words, CHAID is able to
complete pruning before the establishment of the model.
Table 3 illustrates the results of applying the CHAID algorithm in selection. Only 6 of
the 30 variables were left after the CHAID algorithm selection, including: X02 current
Chen SpringerPlus (2016)5:89 Page 12 of 16

Original data of the year before the year of fraud

Nonfinancial variables Financial variables

CHAID CART

ANN SVM BBN CHAID CART

Classification results evaluation

Find the optimal classification model

Fig. 6 Research design and procedure

Table 2 Selection results of decision tree CART

Variables Variable importance

X16 (cash flow ratio) 0.496

X02 (current assets ratio) 0.480
X19 (sales growth rate) 0.016
X09 (natural logarithm of total liabilities) 0.008

assets ratio, X11 operating expenses ratio, X12 debt ratio, X14 quick ratio, X16 cash flow
ratio, and X21 returns on assets before tax, interest, and depreciation. The sequence of
variables by degree of importance is X12, X16, X14, X02, X21 and X11.

Construction of the models and cross validation

This study applies SPSS Clementine for modeling purposes and uses CART, CHAID,
BBN, SVM and ANN in order to construct models and evaluate the classification per-
formance of the variables selected by the two algorithms’ DTs. After normalization of
the selected variables, random sampling without repetition is conducted. The rigorous
tenfold cross validation is also adopted in this study for testing classification accuracy.

CART models
As shown in Table 4, the fraudulent financial statement detection accuracy and overall
accuracy of the CART–CART model were the highest at 88.59 and 83.19 %, respectively.
This study also discloses each model’s Type I and Type II errors, as shown in Table 5.

Table 3 Selection results of decision tree CHAID

Variables Variable importance

X12 (debt ratio) 0.2347

X16 (cash flow ratio) 0.2181
X14 (quick ratio) 0.2119
X02 (current assets ratio) 0.1337
X21 (returns on assets before tax, interest, and depreciation) 0.1282
X11 (operating expenses ratio) 0.0734
Chen SpringerPlus (2016)5:89 Page 13 of 16

Table 4 Detection accuracy of CART models—tenfold cross validation

Model FFS (%) Non-FFS (%) Overall accuracy (%)

CART–CART 88.59 77.78 83.19

CART–CHAID 81.88 79.51 80.70
CART–BBN 77.18 73.22 75.20
CART–SVM 75.17 74.19 74.68
CART–ANN 75.84 74.16 75.00

Table 5 Type I error and Type II error of CART models

Model Type I error rate (%) Type II error rate (%) Overall error rate (%)

CART–CART 11.41 22.22 16.81

CART–CHAID 18.12 20.49 19.30
CART–BBN 22.82 26.78 24.80
CART–SVM 24.83 25.81 25.32
CART–ANN 24.16 25.84 25.00

Type I errors indicate fraudulent financial statements that have been mistakenly labeled
as not being fraudulent. Type II errors indicate fraudulent financial statements which
have been classified as fraudulent financial statements. Logically, a Type I error is a
major mistake. Therefore, in addition to comparison with the accuracy of the testing
group, the model’s Type I error rate is also considered. The CART–CART model has the
lowest Type I error rate at 11.41 % and an overall error rate of 16.81 %.

CHAID models
As shown in Table 6, the fraudulent financial statement detection accuracy and overall
accuracy of the CHAID–CART model are the highest at 92.69 and 87.97 %, respectively.
Each model’s Type I and Type II errors are shown in Table 7. The CHAID–ANN model

Table 6 Detection accuracy of CHAID models—tenfold cross validation

Model FFS (%) Non-FFS (%) Overall accuracy (%)

CHAID–CART 92.69 83.24 87.97

CHAID–CHAID 79.19 71.37 75.28
CHAID–BBN 81.88 80.13 81.01
CHAID–SVM 79.87 78.23 79.05
CHAID–ANN 83.20 81.59 82.40

Table 7 Type I error and Type II error of CHAID models

Model Type I error rate (%) Type II error rate (%) Overall error rate (%)

CHAID–CART 7.31 16.76 12.03

CHAID–CHAID 20.81 28.63 24.72
CHAID–BBN 18.12 19.87 18.99
CHAID–SVM 20.13 21.77 20.95
CHAID–ANN 16.80 18.41 17.60
Chen SpringerPlus (2016)5:89 Page 14 of 16

has the lowest Type I error rate at 7.31 %; the Type II error rate is 16.76 %, and the over-
all error rate is 12.03 %.

Statistical test
In terms of statistical tests, this study employs the t-test and the Wilcoxon rank-sum
test. The t-test and the Wilcoxon rank-sum test of the various models, including CART–
CART, CART–CHAID, CHAID–CHAID, CHAID–CART, CART–BBN, CART–SVM,
CART–ANN, CHAID–BBN, CHAID–SVM, and CHAID–ANN, all reveal statistically
significant levels (significant at P < 0.01), as shown in Table 8 (the t-test) and Table 9 (the
Wilcoxon rank-sum test).

Conclusions
A company’s financial statement is the key basis for all investor judgments, and is the last
line of defense for investor interests. If management attempts to withhold information,
even when independent CPAs, investment banking and securities analysts are involved,
investors can experience significant losses. The most well-known scandal is the Enron
bankruptcy case. Top management intentionally misled investors so as to profit by one
billion USD. This caused bankruptcy for many investors and employees, and impacted
the accounting and business community heavily.
The Enron case caused investors to lose confidence in financial statements and led to
the establishment of the Sarbanes–Oxley Act (1992), which mandates that companies
form auditing committees headed by independent directors. The Enron case resulted in
the reform of accounting standards and the reconstruction of regulatory mechanisms.
In fact, unusual signs in financial statements often occur before the outbreak of a scan-
dal. For example, signs of revenue situations, cash flow conditions and the ratio of liabili-
ties and assets can all exist. Irrationalities can be found in financial statements from a

Table 8 The t-test of the models

Model CART CHAID df P value

CART 134.147*** 155.612*** 9 0.000

CHAID 190.738*** 115.696*** 9 0.000
BBN 117.247*** 307.987*** 9 0.000
SVM 117.391*** 193.874*** 9 0.000
ANN 169.994*** 223.735*** 9 0.000
* Significant at P < 0.1; ** significant at P < 0.05; and *** significant at P < 0.01

Table 9 The Wilcoxon rank-sum test of the models

Model Mean rank Z score P value
CART CHAID

CART 7.1 13.9 −2.5324 0.0057

CHAID 15.1 5.9 3.4395 0.0003
BBN 5.5 15.5 −3.7418 <0.0001
SVM 5.5 15.5 −3.7418 <0.0001
ANN 5.5 15.5 −3.7418 <0.0001
Chen SpringerPlus (2016)5:89 Page 15 of 16

few quarters to 1 year before the event. Fraudulent financial statements may look highly
presentable, and many investors may be cheated. However, it is better to prevent fraud,
protect investors from being cheated, and ensure that criminals are punished. Whether
legal norms and supervision requirements are stringent enough and whether or not cor-
porate governance can prevent intentional and deliberate acts of stealing company assets
by manipulating financial statements are therefore issues that need to be addressed.
An increasing number of cases of fraudulent financial statements are able to damage
companies and result in major losses for investors. People pay a heavy price to compen-
sate for this damage. Therefore, establishing an effective fraudulent financial statement
detection model is considerably important.
This study aims to provide a non-conventional analysis method by using multiple data
mining techniques, including: the DT, BBN, SVM and ANN in order to construct a more
accurate fraudulent financial statement detection model. In the first stage, this study
applies the DTs of CART and CHAID to select the important variables. CART, CHAID,
BBN, SVM and ANN are then combined in order to construct a classification model for
comparison. According to the research results, the detection performance (overall accu-
racy) of the CHAID–CART model is the best at 87.97 % (the FFS detection accuracy
is 92.69 %). It also has the lowest Type I error rate of 7.31 %. The sequences for overall
accuracy are 83.19 % for the CART–CART model, 82.40 % for the CHAID–ANN model,
81.01 % for the CHAID–BNN model, 80.70 % for the CART–CHAID model, 79.05 %
for the CHAID–SVM model, 75.28 % for the CHAID–CHAID model, 75.20 % for the
CART–BNN model, 75.00 % for the CART–ANN model, and 74.68 % for the CART–
SVM model.
Based on the empirical results of this study, the accuracy of the DT CHAID, combined
with CART, in detecting fraudulent financial statements, is relatively high. It can there-
fore be used as a tool to help auditors in the detection of fraudulent financial statements.
The research findings can provide a reference for investors, shareholders, company man-
agers, credit rating institutions, auditors, CPAs (certified public accountants), securities
analysts, financial regulatory authorities, and relevant academic institutions.

Acknowledgements
The author thanks the editor-in-chief, editors, and the anonymous reviewers of SpringerPlus, for their insightful com-
ments, which helped to improve the quality of this paper.

Competing interests
The author declare that no competing interests.

Received: 31 August 2015 Accepted: 12 January 2016

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