Do bankrupt companies manipulate earnings more than the non-bankrupt ones?

Financial fraud is defined as the deliberate misrepresentation of the financial condition of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users. Insolvency is defined as the state in which the company is not capable of honoring some commitment. The 2008’s Deloitte Forensic Center Report states that companies filing for bankruptcy protection are three times more likely than non-bankrupt companies to face enforcement action by the Securities and Exchange Commission (SEC) relating to alleged financial statement fraud. The report concludes with the thesis that companies facing a potential insolvency are more likely to act fraudulent. But the study being carried out is just based on the information being provided by the SEC and lacks an analysis of the financial statements. The presented research carries out the missing step with an academic prove of the correlation of insolvency and fraud using Beneish’s approach to detect earnings manipulation tested on a sample of 30 bankrupt and 30 non-bankrupt Small and Medium-sized enterprises. The results are consistent with prior research suggesting income decreasing earnings behavior of firms approaching bankruptcy. It is shown that earnings manipulation in bankruptcy firms decreases substantially in the years prior to failure. Furthermore, we will propose an Information Systems (IS) approach