EARNINGS FRAUD AND FINANCIAL STABILITY

DOI: 10.21532/apfj.001.17.02.01.010 ABSTRACT Earnings can be the goal for firms which desire to commit financial fraud. This study is propounded to show fraudulent earnings reporting and its relationship with the company’s financial stability. The samples used in this study are manufacturing firms listed on the Indonesian Stock Exchange during the period of 2010-2013. The data consisting of financial statements are processed using descriptive statistics, and the hypotheses are tested using logistic regression. The results of this study reveal that 22 financial statements are indicated earnings fraud. Of all the financial statements, 68 percent suffers from financial distress. This study shows that the firms with the improved financial stability tend to restrain themselves from committing earnings fraud. This study also finds that the firms which experience financial distress have a greater incentive to commit the fraud.


INTRODUCTION
Fraudulent financial reporting has become an issue for years and attracted many researchers to explore its determinants. The increasing number of companies sanctioned by Financial Services Authority (hereinafter referred to as OJK) has encourage some researchers in Indonesia to contribute empirically (Mardiana, 2015;Nugraha and Henny, 2015;Puspatrisnanti and Fitriany, 2014;Putra and Fitriany, 2015;Ratmonoet al., 2014;Sukirman and Maylia, 2013). Inconsistency continues to emerge in line with the limited number of cases disclosed.
Therefore, some researchers have not been able to focus on which financial reporting referred to as fraud because the sanctions for the rule violation imposed by OJK are specified by some cases only such as late submission of financial statements, of financial data misstatements and unrevised, stock trading manipulation, and other financial Volume 2, No.1 st Edition (January-June 2017) Ahmad Abbas : Earnings fraud and financial stability ..... Page 117 -134 information. Some of them are trying to emphasize the violations on the basis of the misstatements in financial reports or in the presentation and the disclosure of financial reports, but their outlook still provides the same study design and they just add different variables so that the results continue to produce inconsistencies between other studies.
In financial fraud, earnings will always be the target for opportunists to set the pattern through income-increasing / decreasing or referred to as earnings management (Scott, 2009), or even the earnings is manipulated to make the performance of the financial statements look good, such as the case of Enron (Warshavsky, 2012). Manipulation through the distortion of earnings is a pattern that becomes their focus (Ahmed and Naima, 2016;Anh and Linh, 2016;Dalnial at al., 2014;Kaur at al., 2014;Mahama, 2015;Omar at al., 2014;Paolone and Magazzino, 2014). Their findings appear to be more useful as a medium of knowledge. The model may be considered modest, but their perspective encourages such studies to be conducted in Indonesia. In some countries, researchers are increasingly enthusiastic to reveal a total inclination of corporate financial fraud practices with forensic tools using the formula of Beneish M-Score and digital analysis of Benford's Law (Warshavsky, 2015). By using forensic analysis of M-score as the contributions of some previous studies, this study aims to reveal fraudulent financial reporting, particularly on the corporate earnings.
Furthermore, the awareness of the influence of financial stability experienced by a company has allow the company to depressively conduct earnings fraud practices. Therefore, this study needs to prove and analyze the relationship between the two. Some previous studies are less contributive to prove the relationship between the two under the framework of the theory of fraud (Halioui and Chellouf, 2013;Skousen at al., 2009;Suyanto, 2009;Tiffani and Marfuah, 2015). In general, companies with good financial stability tend to avoid from the pressure so that they control themselves not to commit fraudulent practices, while the companies with financial distress tend to have a greater pressure to commit fraudulent practices. Therefore, this study seeks to analyze the existence of financial stability in affecting fraud. Since the concept of fraud was modeled, it has been encouraging scientists to continue to innovate, and thus inconsistencies continue to arise. Finally, their findings seem to be rhetoric. Through this study, the results are expected to encourage the creation of rhetoric that is consistent with the theories and practices related to fraud.
The main purpose of the study is to reveal the financial statements that contain manipulative earnings (fraud). In addition, this study also seeks to classify companies constructively based on the tendency of their financial stability so that the next purposes are needed by testing the effect of financial stability on earnings fraud.
This study attempts to explore the fraudulent practices by highlighting the company's earnings in the financial statements.
This study also provides extra contribution to the financial study relating to fraud. First, the findings of this study are used as the media by presenting scientific evidence, in which some manufacturing companies that experience financial difficulties are likely to engage in fraudulent practices by providing good-looking financial statements. Second, the results of this study also become persuasive signal addressed to stakeholders, particularly investors and creditors, due to the discovery that the companies that experience financial difficulties have greater possibility to commit financial fraud. Third, the results of this study provide universal contributions to science in the study of fraud. When faced with the tendency of financial stability, financial distress turns out to be a situational motive for companies to commit financial reporting fraud.
Next, this study is presented in four parts. Theoretical framework and hypothesis development are presented in part two, while research methods are presented in part three, and analysis and discussion are in part four.
This study is terminated at the conclusion in part five accompanied by the implications and limitations of the study

Theory of Fraud
This theory evolves after Cressey (1953) Albrect at al. (1984) introduces the 'fraud scale model' which considers that rationalization is difficult to be measured so that personal integrity is more appropriate to replace it.
Integrity emphasis on the ethical behavior of a person in decision-making.
Based on the framework of fraud triangle model, the development of financial fraud model began to have more attention. Wolfe and Hermanson (2004) add one more angle, capability, and then the shape changes into diamond, or "fraud diamond theory". They believe that the three determinants of financial fraud must be supported by the expertise and competence, or capability. Abdullahi at al. of the previous initiators, such as opportunity which is adopted from the fraud triangle model, motivation which is adopted from the MICE model (Money, Ideology, Coercion, and Ego), capability which is adopted from fraud diamond, and fraud scale with its personal integrity. The emergence of various innovations in the design of fraud model will not be separated from Cressey (1953) ) as the pioneer of the fraud model.

Earnings Fraud and Financial Stability
Since the Enron case that manipulatively reported an increase its earnings from 13.3 billion dollars in 1996 to 100.8 billion dollars in 2000 with estimated revenue growth of 151 percent, Warshavsky (2012) attempted to detect Enron's earnings quality which had been distorted from its actual earnings using the M-score model of Beneish (1999). The result of the distortion was 1.89, which is far from the standard of -2.22. This means that the firm performed extreme earnings manipulation. Enron itself was regarded as a successful and innovative energy company in the United States at that time, because it always appeared with impressing financial statements.
The information provided in the financial statements is very crucial for the users (Ozcan, 2016). Investors are one of the main targets for increasing company value. They would rely on information related to the statement of financial position (Vlad at al., 2011). Income settings may become an initiative for the company.
Delaying recognition of expenses, utilizing the recognition of receivables or depreciation rates, and other accounting tricks encourage the management to be creative in setting the financial performance display, because the company's financial statements presented are the result of accounting methods. It might be simpler to do than performing fictitious recording. However, if the financial difficulty occurs for several periods, it can be done.
The tendency of financial stability gives the companies a pressure to get involved in fraud. Vona (2008) states that the motive to commit fraud is often associated with personal or corporate pressure. If a corporate, with a threatened financial stability, should perform a good reputation, the external pressure becomes a proper motive for committing fraud (Kassem and Higson, 2012). Undeniably, Enron also faced financial difficulties and the external pressures had encouraged the company to commit financial fraud.
Several previous studies have attempted to examine the relationship between financial stability and fraud. What were hypothesized, by seeing the positive influence of the pressure of financial stability tendency on fraud, is not consistent with the findings (Skousen at al., 2009). Their findings are not in line with the expectations of the ideal concept of fraud so that there is inconsistency from one study to another (Nugraha and Henny, 2015;Oktaviani at al., 2014;Putra and Fitriany, 2015;Sukirman, 2013;Tiffany and Marfiah, 2015).
Empirically, fraud theory may explain the relationship between financial stability and fraud. Wolfe and Hermanson (2004) argue that although the pressure can emerge along with the opportunity and rationalization, the capability can be an additional element. This study agrees with such view. With the capability, fraud will be obscured well by the external users.
However, this capability should not be an angle that aligns with the pressure, opportunity, and rationalization. It automatically always attaches to each of the three angles of the fraud triangle model. Based on the theoretical framework of fraud, this study will rely on the angle of pressure. The pressure can emerge along with the opportunity and rationalization. The emergence of pressure allows the opportunity sought by rationalization to provide goodlooking financial statements (manipulation).
Furthermore, the tendency of financial stability is likely to cause external pressure.
The external pressure, as proxied by Kassem and Higson (2012) in fraud triangle model, becomes the dominant motive to commit fraud.
In his study, Ozcan (2016) reveals empirically that the decline in financial performance encourages financial fraud. It can be understood that when performance is good and growing, a company tends to avoid from the pressure. The companies, with better financial stability, will provide a negative effect on earnings fraudulent practices. In other words, the companies with good financial stability will ideally be able to prevent themselves from manipulating earnings in their financial statements. The existence of negative influence of good financial stability on earnings fraud is the expected results in this study.

H1. The better the financial stability of a company, the lower the tendency of the company to commit earnings fraud
Conversely, poor financial conditions tend to encourage management to take unethical action to manipulate the performance of its financial position report in order to look good (Bell at al., 1991). But so far, Halioui and Chellouf (2013), Mardiana (2015) empirically have revealed that financial distress through the Z-score has a negative influence on fraud. Whereas, when a company faces financial distress, the company will positively be encouraged to commit fraud. Therefore, this study still agrees that the companies facing financial difficulties would ideally be more motivated to commit fraud. As a result, the positive effect will be generated.
When a company experiences distress, the possibility to commit fraud will increase (Rezaee, 2005). Beasley (1996) states that the company experiencing financial distress will more likely to manipulate its finance so that the financial condition existing in the financial statement looks good. In line with the statement, Dichev at al. (2016) reveals that the general reasons to perform earnings misrepresentation is a desire to influence the stock. Poor quality of reported earnings will certainly affect the stock price and the cost of capital (Dichev at al., 2013).
When faced with financial distress, the pressure to make earnings quality look good is greater.
In his study, Arshad at al. (2015)  H3. The pressure to commit earnings fraud is experienced more by companies during unstable financial condition than during stable financial condition. with the criteria as shown in Table 1: The observation period of this research is three years from 2011 to 2013. The data of 2011 is required to measure the earnings fraud (t-1).

Research Variables
The  Table 2 below. Source: Beneish (1999), Warshavsky (2015) The measurement of financial stability is conducted using Z-score of Altman (1968). Z-score model provides the best predictions only for modeling manufacturing companies (Chouhan at al., 2014). In Z-score model, the high value means that the company is in the safe zone. Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 Tabel 3 Z-Score Indicator X1 = Working capital/total assets X2 = Retained earnings/total assets X3 = Earnings before interest and taxes/total assets X4 = Market value of equity/book value of total liabilities X5 = Sales/total assets Source: Altman (1968) The results of Z-Score model is categorized into three zones. Z > 2.99 is the safe zone, 1.81> Z > 2.99 is the gray zone, and Z > 1.81 is the distress zone. Previous study conducted by Chouhan at al., (2014) utilizes Z-score for reviewing the company's financial stability in each period by setting Z > 2.99 with the safe zone is considered a safe condition, 1.81 > Z > 2.99 with gray zone is considered stable, and Z > 1.81 with the distress zone is considered to be headed for bankruptcy. Actually, the company's financial stability is more representatively reviewed from the tendency for some periods, and not in that period alone is said to be stable.
Understanding such condition, this study reviews the company's financial stability by utilizing Z-Score measurement and classifies based on the zone and then establishes the company representatively with the category of stable or not. The tendency of the Z-Score owned by companies in each period must be obtained in advance. By relying on the cutoff of Z-score of Altman (1986), this study establishes that the company with a Z-score Since the earnings which are indicated manipulative influence stock returns (Beneish at al., 2013) in which the earnings of probability are related to stock returns (Chan at al., 2006;Larson at al., 2011), this study utilizes stock return as control variables. Stock returns are obtained from the difference between the stock price of the current period and the previous period (P t -P t-1 /P t-1 ).    it is possible because the company has shifted the revenue recognition to the next period. In the shrinkage index, some sample companies have altered the estimated economic life. Overall, it is only the asset quality index that is still maintained. There is no reduction in the asset quality of the sample companies. Warshavsky (2012) states that the asset quality which is greater than 1 or close to fraud index indicates that the company is improving its suspension costs or intangible assets, and is encouraged to commit earnings manipulation.

Description of the Data
Asset quality index is still maintained on the sample of companies because they are not indicated abnormal indexes. Furthermore, Table 7  Based on the observations, the sample firms that are indicated distress and not involved in fraud have a Z-score almost close to nondistress zone so that the pressure experienced is not so great. In addition, pressure may arise along with the opportunity and rationalization.
They may be at a pressure that does not have Volume 2, No.1 st Edition (January-June 2017) In

Hypothesis Testing Results
In Table 9  This means that the encouragement to commit earnings fraud is greater in difficult financial conditions than in stable financial condition.
From the odds ratio indicated by exp (B) in Table 9, the value is the logit coefficient of 5,507 which interprets that the encouragement to commit earnings fraud when the company experiences distress is 5,507 times greater than in stable condition (H2 is accepted).

Furthermore, the variable of UNSTABLE
shows positive results. The results show that the pressure of earnings fraud during unstable financial condition is 1.251 times as great as in stable financial condition. However, the results do not have an impact. Thus, H3 is rejected. As a control variable, RETURN appears to have no effect on earnings fraud. This allows the stock returns do not become a decisive motive for companies to get involved in fraud.

Additional Analysis
For additional analysis, Cramer's V test analysis is required to determine the robustness of the power of encouragement of distress, unstable, and stable condition on fraud.  (Table 6), the index shows a very high value, four times as high as the index of fraud.
This condition indicates the company's gross margin, in real terms, has decreased to the extreme so that the company attempts to distort its gross profit through sales and cost of sales. Warshavsky (2012) states that the decline in the index is associated with the company's prospects. The decline in the index has come under heavy pressure so that the company could improve its financial performance. As a result, the distressed company attempts to provide prospective-looking financial statements.
On the other hand, Arshad at al. (2015) states that the distressed company has greater incentive or encouragement to commit fraud than non-distressed company. This study finds that the pressure to do is 5,507 greater during distress than during stable. If a stable company wants to commit fraud, the distressed company will strive about 51/2 times motivated to do so.
Thus, the financial distress has greater effect on earnings fraud than the financial stability. In contrast, the study finds that the difference in pressure between unstable financial condition and stable financial condition has no effect on earnings fraud. The non-existence of the difference is because the companies, as the research samples, which are experiencing financial fluctuation tend to move toward stable zone.

CONCLUSION
In addition to the elaboration of the theories and concepts of fraud that become the initial consideration to achieve the purpose of study, the research model specification and the data quality are also highly considered in this study to generate inference that could have implications for the outsider in practice and the researchers in academic. The good-looking financial statements allow the outsider stuck with the company's prospects. M-score is able to be a signal to them as a forensic tool for detecting fraud, especially if associated with a Z-score. Both succeed in providing their influence in this study which elaborates the theories and concepts of fraud.
This study has reached its goal to analyze earnings fraud and its relation to financial stability. The success of this study, in relation to earnings fraud, provides a relevance to financial stability. Of the 22 financial statements containing earnings fraud, about 68 percent is in the face of distress. The results of this study underline that the pressure, in the viewpoint of the theory of fraud, turns out to be situational.
The pressure depends on the tendency of financial stability. The better the company's financial stability, the smaller the possibility to commit earnings fraud. In other words, the more distressed the company, the more inclined to engage in fraud. Distress turns out to have a greater impetus to commit earnings fraud.
When the companies are experiencing distress, they are more motivated to commit earnings fraud 5 1 / 2 times as great as non-distress.
This study is aware of the company's financial stability that is still in relatively short term so that in 3-5 years ahead there will possibly be changes in financial stability. It becomes the limitations imposed in this study for the purpose of further study.