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Bayesian inference of local government audit outcomes

Author

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  • Wilson Tsakane Mongwe
  • Rendani Mbuvha
  • Tshilidzi Marwala

Abstract

The scandals in publicly listed companies have highlighted the large losses that can result from financial statement fraud and weak corporate governance. Machine learning techniques have been applied to automatically detect financial statement fraud with great success. This work presents the first application of a Bayesian inference approach to the problem of predicting the audit outcomes of financial statements of local government entities using financial ratios. Bayesian logistic regression (BLR) with automatic relevance determination (BLR-ARD) is applied to predict audit outcomes. The benefit of using BLR-ARD, instead of BLR without ARD, is that it allows one to automatically determine which input features are the most relevant for the task at hand, which is a critical aspect to consider when designing decision support systems. This work presents the first implementation of BLR-ARD trained with Separable Shadow Hamiltonian Hybrid Monte Carlo, No-U-Turn sampler, Metropolis Adjusted Langevin Algorithm and Metropolis-Hasting algorithms. Unlike the Gibbs sampling procedure that is typically employed in sampling from ARD models, in this work we jointly sample the parameters and the hyperparameters by putting a log normal prior on the hyperparameters. The analysis also shows that the repairs and maintenance as a percentage of total assets ratio, current ratio, debt to total operating revenue, net operating surplus margin and capital cost to total operating expenditure ratio are the important features when predicting local government audit outcomes using financial ratios. These results could be of use for auditors as focusing on these ratios could potentially speed up the detection of fraudulent behaviour in municipal entities, and improve the speed and quality of the overall audit.

Suggested Citation

  • Wilson Tsakane Mongwe & Rendani Mbuvha & Tshilidzi Marwala, 2021. "Bayesian inference of local government audit outcomes," PLOS ONE, Public Library of Science, vol. 16(12), pages 1-19, December.
  • Handle: RePEc:plo:pone00:0261245
    DOI: 10.1371/journal.pone.0261245
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    References listed on IDEAS

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    1. Ines Amara & Anis Ben Amar & Anis Jarboui, 2013. "Detection of Fraud in Financial Statements: French Companies as a Case Study," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 3(3), pages 40-51, July.
    2. Jerry W. Lin & Mark I. Hwang & Jack D. Becker, 2003. "A fuzzy neural network for assessing the risk of fraudulent financial reporting," Managerial Auditing Journal, Emerald Group Publishing Limited, vol. 18(8), pages 657-665, November.
    3. Salem Lotfi Boumediene, 2014. "Detection And Prediction Of Managerial Fraud In The Financial Statements Of Tunisian Banks," Accounting & Taxation, The Institute for Business and Finance Research, vol. 6(2), pages 1-10.
    4. Dootika Vats & James M Flegal & Galin L Jones, 2019. "Multivariate output analysis for Markov chain Monte Carlo," Biometrika, Biometrika Trust, vol. 106(2), pages 321-337.
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