Question 17.5: Application of the Beneish Model Exhibit 5 presents the vari......
Application of the Beneish Model
Exhibit 5 presents the variables and Beneish’s M-Score for XYZ Corporation (a hypothetical company).
1 . Would the results of the Beneish model lead an analyst, using a –1.78 M-score as the cutoff, to flag XYZ as a likely manipulator?
2 . The values of DSR, GMI, SGI, and DEPI are all greater than one. In the Beneish model, what does this indicate for each variable?
| EXHIBIT 5 XYZ Corporation M -Score | |||
| Value of Variable | Coefficient from Beneish Model | Calculations | |
| DSR | 1.300 | 0.920 | 1.196 |
| GMI | 1.100 | 0.528 | 0.581 |
| AQI | 0.800 | 0.404 | 0.323 |
| SGI | 1.100 | 0.892 | 0.981 |
| DEPI | 1.100 | 0.115 | 0.127 |
| SGAI | 0.600 | –0.172 | –0.103 |
| Accruals | 0.150 | 4.670 | 0.701 |
| LEVI | 0.600 | –0.327 | –0.196 |
| Intercept | –4.840 | ||
| M-score | –1.231 | ||
| Probability of manipulation | 10.91% | ||
to 1: Yes, the model could be expected to lead an analyst to flag XYZ as a likely manipulator. The M-score is higher than the cutoff of –1.78, indicating a higher-than-acceptable probability of manipulation. For XYZ Corporation, the model estimates the probability of manipulation as 10.91%. Although the classification of companies as manipulators depends on the relative cost of Type I errors and Type II errors, the value of 10.91% greatly exceeds the cutoff of 2.9% that Beneish identified as the relevant cutoff .
to 2: Indications are as follows:
A . The value greater than one for DSR indicates that receivables as a percentage of sales have increased; this change may be an indicator of inappropriate revenue recognition. XYZ may have shipped goods prematurely and recognized revenues belonging in later periods. Alternatively, it may be caused by customers with deteriorating credit-paying ability—still a problem for the analyst of XYZ.
B . The value greater than one for GMI indicates that gross margins were higher last year; deteriorating margins could predispose companies to manipulate earnings.
C . The value greater than one for SGI indicates positive sales growth relative to the previous year. Companies could be predisposed to manipulate earnings to manage perceptions of continuing growth and also to obtain capital needed to support growth.
D . The value greater than one for DEPI indicates that the depreciation rate was higher in the prior year; a declining depreciation rate can indicate manipulated earnings.