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Machine
Detecting anomalies in financial learning
statements using machine algorithm

learning algorithm
The case of Vietnamese listed firms 181

Mark Lokanan and Vincent Tran Received 22 September 2018

Revised 29 May 2019
Faculty of Management, Royal Roads University, Victoria, Canada, and Accepted 15 June 2019
Nam Hoai Vuong
Faculty of International Economics, Foreign Trade University, Hanoi, Vietnam

Abstract
Purpose – The purpose of this paper is to evaluate the possibility of rating the credit worthiness of a firm’s
quarterly financial report using a dynamic anomaly detection method.
Design/methodology/approach – The study uses a data set containing financial statements from Quarter
1 – 2001 to Quarter 4 – 2016 of 937 Vietnamese listed firms. In sum, 24 fundamental financial indices are
chosen as control variables. The study employs the Mahalanobis distance to measure the proximity of each
data point from the centroid of the distribution to point out the extent of the anomaly.
Findings – The finding shows that the model is capable of ranking quarterly financial reports in terms of credit
worthiness. The execution of the model on all observations also revealed that most financial statements of
Vietnamese listed firms are trustworthy, while almost a quarter of them are highly anomalous and questionable.
Research limitations/implications – The study faces several limitations, including the availability of
genuine accounting data from stock exchanges, the strong assumptions of a simple statistical distribution, the
restricted timeframe of financial data and the sensitivity of the thresholds for anomaly levels.
Practical implications – The study opens an avenue for ordinary users of financial information to process
the data and question the validity of the numbers presented by listed firms. Furthermore, if fraud information
is available, similar research can be conducted to examine the tendency for companies with anomalous
financial reports to commit fraud.
Originality/value – This is the first paper of its kind that attempts to build an anomaly detection model for
Vietnamese listed companies.
Keywords Investors, Fraud
Paper type Research paper

1. Introduction
The vast amount of data and the increasing development in technology in recent years have
changed the way in which many industries operate and compete with each other. Millions of
bytes, commonly referred to as big data, provide valuable insights for companies to make
informed business decisions. Companies that conduct business in the financial service sector
employ big data to inform their investment practices and make strategic decisions. The
increased use and complexity of big data poses a challenge to users of financial information
when analyzing financial statements. This is especially applicable to users who possess
fewer financial resources and have inferior knowledge to conduct in-depth analysis of
financial statements (Lokanan, 2014). Companies that wants to present a rosy picture

© Mark Lokanan, Vincent Tran and Nam Hoai Vuong. Published in Asian Journal of Accounting
Research. Published by Emerald Publishing Limited. This article is published under the Creative Asian Journal of Accounting
Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create Research
Vol. 4 No. 2, 2019
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2443-4175
creativecommons.org/licences/by/4.0/legalcode DOI 10.1108/AJAR-09-2018-0032
AJAR of their financial position may exploit these users’ deficiencies through deliberate
4,2 misleading and omission of financial data in their annual reports (Rezaee, 2002; Albrecht
et al., 2006; 2014; Robinson and Lokanan, 2017).
Vietnamese companies were selected because of the high incidence of financial reports
manipulation (Tran, 2013). The number of listed companies reported by Hanoi Stock
Exchange (HNX) and Ho Chi Minh City Stock Exchange (HOSE) from 2000, when Vietnam’s
182 security market was in its infancy stage, has steadily increased till 2016. In 2016, there were
more than 1,000 listed companies on these exchanges. Growth and structural development in
Vietnam’s financial markets comes with intense competition in the marketplace and the
possibility of financial statement manipulation of listed companies on the HNX and HOSE
(Tran, 2013). Indeed, there has been an increasing number of failed companies and fraudulent
reporting in Vietnamese markets in the last few years: to be specific, 6,608 companies in the
first seven months of 2017, 12,478 companies in 2016 and 9,467 companies in 2015 (Agency of
Business Registration – Ministry of Planning and Investment, 2018). The volume and intensity
of fraudulent reporting have made it difficult for humans to process and analyze anomalous
transactions (Grace et al., 2017). Even some traditional statistic regression techniques cannot
be applied due to the complexity of data set (Fan and Li, 2006). Thus, we need embedded
analytical models with highly-automated operating structures to deal with the large volume,
variety of features and velocity of the data that the human brain cannot handle.
This is where big data techniques come into play. Big data have brought with it novel
techniques, such as machine learning and algorithms, which allow users to conduct in-depth
analysis and gain deeper understanding of anomalies in financial statements. The analysis
of big data using machine learning techniques can assist users of financial statements to
detect unusual patterns and transactions in companies’ financials. Big data are massive and
can be used by both users and companies to provide data-centric and data-driven insights
on financial statement anomalies.
This study is an attempt to use machine learning algorithms to detect anomalies in
financial statements in Vietnamese listed firms. As mentioned, the only resources available to
ordinary investors are quarterly reports, which may contain misleading financial information.
It is not enough just to look at the original state of such financial reports. Much research has
proved efficiency by analyzing financial ratios calculated from the values in companies’
reports (see Altman, 1968; Kotsiantis et al., 2006). Therefore, we approached the problem by
using financial ratios as a series of variables, also known as features. An important point in
this paper is that the values of financial ratios are assumed to follow a multivariate
distribution, which means each ratio varies around one specific mean value. This assumption
will allow us to point out anomalous data by measuring whether the distance of each datum to
the “centroid” (which will be explained in Research Methodology) exceeds a certain threshold.
Additionally, we will take the concept of distance further by regarding it as the degree or
extent of the anomaly. This extension of understanding enables us to rank the credit
worthiness of each company in each quarter: the more anomalous a datum, the less credit-
worthy it is. Therefore, the central question of this paper is as follows: is it possible to rate the
credit worthiness of a firm’s financial quarter using an anomaly detection method?
It is also worth noting that, up to this point, we have used the term “anomaly” instead of
“fraud” for the main theme of this paper. There is a slight difference between the two terms:
“anomaly” generally represents “an unusual and possibly erroneous observation that does
not follow the general pattern of a drawn population” (Morozov, 2016, p. 63), while “fraud” is
an intentional deceptive action perpetuated against a firm for financial gains (Lokanan,
2015). Because we did not have enough data about fraudulent companies or illegal activities
in Vietnam, we chose to use “anomaly” for simplicity and precision. However, we still looked
at the fraud detection literature, as it points to a more expansive understanding of existing
analytical techniques.
 The rest of the paper proceeds according to the following format. We first present a Machine
comprehensive review of financial fraud detection research using machine learning learning
methods. In this regard, we provide an analysis of the existing fraud detection literature algorithm
based on the most important machine learning algorithms and statistical methods employed
in the literature to date. Next, we outline the methodology and research design used to
collect and analyze the data. This is followed by an analysis of the empirical findings.
Finally, we present a conclusion and highlight some of the key issues associated with 183
current practices and highlight areas for future research.

2. Contribution to theory and practice

Theoretically, the paper provides guidance on the machine learning technique and
algorithms to use when creating new models for detecting anomalies in financial statements.
Statistical methods have been the go-to method to evaluate information from financial
statement reports (Agarwal and Taffler, 2008; Altman et al., 2013; Tinoco and Wilson, 2013;
Lokanan, 2017). While a statistical method has been a success in detecting anomalies in
prior research (Beneish, 1997; Bell and Carcello, 2000; Lyandres and Zhdanov, 2013),
machine learning techniques have proven to be just as or even more effective in
classification performance (Feroz et al., 2000; Lin et al., 2003; Kotsiantis et al., 2006; Perols,
2011) because they make for easier processing of large data (Fan and Li, 2006) and have
proven to be neutral in decision making (West et al., 2005; Kotsiantis et al., 2006). Traditional
statistical analysis produces errors terms when there are many observations and the use of
longer time series data into the models (Feroz et al., 2000; Lin et al., 2003; Lokanan and
Sharma, 2018).
Practically, machine learning, with its many features, can allow users to handle large
datasets and improve upon statistical models (Kotsiantis et al., 2006; Perols, 2011). When
approaching a problem through traditional statistical methods, the human mind can come
up with many hypotheses and generate false prediction toward existing information
because hypotheses are never entirely accurate (Farber, 2005; Purda and Skillicorn, 2015).
The use of a machine learning tool will reduce the number of hypothesis tests in the
calculation by using only primary input data. In this regard, machine learning algometric
technique will address the shortcomings of hypothesis bias in traditional statistical data
analytics (Perols, 2011).
The results presented in this paper are one step closer to heed the calls for the
acceleration of technology in analyzing financial statement data and lay the groundwork for
further research on the automation of fraud detection (Kirkos et al., 2007; Song et al., 2014;
Lokanan, 2015). It is expected that the models employed in this paper will aid investors and
other users of financial information to use financial data, even the most technical ones, to
conduct informed analysis of companies’ financial performance. The models are built from
algorithms and a very large data set, which, together, can inform users’ intelligence about
red flags of fraud in financial statements.

3. Prior research
3.1 Financial statement irregularities
Over the past three decades, there has been an increased focus on irregularities in corporate
accounting reporting in general and financial statement fraud in particular (Beasley, 1996;
Beneish, 1997; 1999; Rezaee, 2005; Hogan et al., 2008; Cooper et al., 2013; Lokanan, 2015;
Morales et al., 2014). Generally, the literature on financial statement fraud focuses on the
individual factors that affect fraudulent behavior in organizations (Albrecht et al., 2004;
Bell and Carcello, 2000; Rezaee, 2005; Dellaportas, 2013); the procedures and expertise
of auditors to detect “red flags” of fraud (Albrecht and Albrecht, 2004; Rezaee, 2005;
Murphy and Dacin, 2011; Murphy, 2012; Power, 2013; Morales et al., 2014); the effects of
AJAR fraud risks assessment tools on high risks areas in audit engagements ( Johnstone and
4,2 Bedard, 2001; Rezaee, 2005; Davis and Pesch, 2013; Power, 2013; Lokanan, 2015;
Behzadian and Izadi Nia, 2017); and the role of auditing committees to detect red flags
associated with fraud ( Johnstone and Bedard, 2001; Kranacher et al., 2010; Lokanan, 2014).
Together, the academic research offers insights on financial statement fraud and facilitates
the development and enhancement of new technologies to detect anomalies in fraud
184 (Hogan et al., 2008; Albrecht et al., 2015; Morales et al., 2014).

3.2 Detecting anomalies in financial statements using machine learning

Financial statement fraud is an issue with far reaching consequences (Rezaee, 2005;
Albrecht et al., 2015; Lokanan, 2015). Traditional methods involving manual detection,
while successful in certain areas (Eining et al., 1997; Farber, 2005; Beneish et al., 2013;
Hajek and Henriques, 2017; Lokanan, 2017), are not only time-consuming and expensive,
but, in the age of big data, they are also impractical and unable to deal with large
volumes of unstructured data (Perols, 2011). Largely driven by an increase in
instrumentation, the financial service industry has turned to automated processes
using statistical and computational methods to analyze financial statements data
(Anandakrishnan et al., 2017). Machine learning algorithms are not only useful in dealing
with big data, they can also mimic how users process unstructured data, text, speech
and image, to improve accuracy in interpreting financial statements (Feroz et al., 2000;
Beneish and Craig, 2007; Song et al., 2014).
Research that evaluates the effectiveness between machine learning and traditional
statistical methods typically compares fraud classification algorithms with regression
models (Green and Choi, 1997; Lin et al., 2003; Kirkos et al., 2007; Perols, 2011; Morozov,
2016; Lokanan and Sharma, 2018). This stream of research employed logistic regression,
artificial neural networks (ANN), fuzzy logic and ensemble-based methods, and found that
the techniques combined are useful for fraud detection even when fraud cases are rare or
unavailable. The distinguishing elements that make this stream of research unique,
however, is that there are many more companies that prepare accurate financial statements
than those that falsify their financial statements (Perols, 2011). The attributes (i.e. financial
ratios) used to classify the fraud are noisy, thereby making companies that falsify their
financial statement look similar to companies with accurate and clean financial statements
(Lin et al., 2003; Kotsiantis et al., 2006; Kirkos et al., 2007; Purda and Skillicorn, 2015).
Research using logistic regression models has found it to be rather unique when
comparing fraud and non-fraud firms (Lin et al., 2003; Kirkos et al., 2007; Hajek and
Henriques, 2017; Lokanan and Sharma, 2018). Bell and Carcello (2000) employed a logistic
regression model that estimates the likelihood of fraudulent financial reporting. Using a
sample of 77 fraud engagements and 305 non-fraud engagements, Bell and Carcello (2000)
found that their logistic regression model was significantly more accurate than practicing
auditors in assessing the risks of fraud for the 77 observations. In another study, Lokanan
and Sharma (2018) employed a logistic regression model to test for red flags of fraud in
banks that were involved in the LIBOR scandal. Using financial ratios and corporate
governance data relating to the sixteen banks that were involved in the LIBOR scandal with
a matched sample of non-fraud banks, the authors found supports for using financial ratios
and governance data to detect fraud in banks (Lokanan and Sharma, 2018). In a similar
study, Skousen et al. (2009) employed a logistic regression model to detect financial
statement fraud between a set of fraud firms and a matched sample of non-fraud firms. The
study revealed that the logistic regression model was effective in predicting which of the
sample firms committed fraud vs those that did not. Likewise, Spathis (2002) found that
multivariate logistic regression techniques were accurate in detecting false financial
statements, using a sample of fraud and non-fraud firms. In another study, Lin et al. (2003)
found that fuzzy neural network outperformed logistic regression model and ANN in the Machine
prediction of fraud cases. Hajek and Henriques (2017) also found that logistic regression was learning
also useful in detection of financial statement fraud. algorithm
Another stream of research focusing on evaluating the classification of machine learning
algorithms in detecting fraud in financial statement typically used different variations of
ANN (e.g. Eining et al., 1997; Green and Choi, 1997; Fanning and Cogger, 1998; Lin et al.,
2003). Green and Choi (1997) showed that there is support for ANN as a fraud-risk 185
assessment tool. Other studies found a high probability of detecting fraudulent financial
statements using ANN rather than probit or logit models (Eining et al., 1997; Fanning and
Cogger, 1998). Feroz et al. (2000) illustrated the application of ANN to test the ability of
selected Statement of Auditing Standards No. 53 to predict the targets of the Securities and
Exchange Commission’s (SEC) investigations and found that an analysis of financial ratios
from the trial balance does have predicted value. Harymawan and Nurillah (2017) employed
a multiple regression model to test for earnings management in financial reporting and
found that corporate reputation has a significant relationship with earnings quality. These
studies reinforced the efficiency for using machine learning algorithms as suggested
techniques to detect anomalies in financial statements.
Other research looked at classification algorithms to improve fraud classification
performance (Kotsiantis et al., 2006; Kirkos et al., 2007; Perols, 2011). These studies
explored the effectiveness of machine learning algorithms to detect firms that issue
fraudulent financial statements through various algometric classifications. Kotsiantis
et al. (2006) employed a sample of fraud and non-fraud firms and financial ratios to
examine the following classification algorithms: S, K2, C4.5, 3NN, RBF, Ripper, LR and
SMO. The findings revealed that the algorithmic classifications performed better than
logistic regression and ANN models. Kirkos et al. (2007) classified algorithms into
Decision Trees, ANN and Bayesian Belief, and examined their usefulness to detect fraud
in financial statements. Using financial statement ratios, the study employed a
sample of fraud firms with a matched sample of non-fraud firms and found that the
Bayesian Belief outperforms Decision Trees and ANN in financial statement fraud
detection. In another study, Hoogs et al. (2007) presented a genetic algorithm approach to
detecting financial statement fraud. Using a sample of fraud companies
accused of improper revenue recognition by the SEC and a matched sample of
non-fraud companies, the study found that genetic classification of algorithms has many
features well-suited for accurate fraud detection. More recently, Dbouk and Zaarour (2017)
employed a Bayesian Naïve Classifier (BNC), a supervised machine learning approach,
and found that the BNC’s approach outperforms conventional audit method in detecting
earnings manipulations.
Machine learning research has developed ensembles of predictors other than ANN and
logistic regression to generate hypothesis for testing in fraud research (Perols, 2011; Phua
et al., 2001). The research in this category used cluster algorithm (i.e. K-means clustering)
(Li, 2016), bagging (West et al., 2005) and support vector machine (SVM) (Shin et al., 2005) to
assess anomalies in financial fraud. Of particular interest with this stream of research is that
they used ensemble methodology to show that anomaly detection and predictive analytics
for financial risk management bring out the ideas of using some algorithms together.
In general, ensemble predictors were found to be superior to single machine learning and
statistical models for detecting fraud in financial statements (Phua et al., 2004; West et al.,
2005). Ensemble predictors are also able to extract optimal solutions with small and noisy
data set (Fan and Palaniswami, 2000; Shin et al., 2005).
The foregoing literature review highlighted the various statistical techniques and
machine learning models used to identify anomalies in financial statements. With respect to
fraud detection, there is a significant body of research that provides support for machine
AJAR learning and, to a certain extent, logistic regression models (Chen and Rezaee, 2012;
4,2 Albrecht et al., 2015). Overall, ANN outperforms logistic regression models in the literature;
however, both were found to be inferior when compared to ensemble-based and
classification algorithms methods. Despite this authoritative guidance on these statistical
models and machine learning techniques, there remains a significant gap between fraud
detection models and their application to large volume of time series and cross-sectional
186 data. This study is an attempt to address these gaps by using machine learning techniques
to detect red flags of fraud on a sample of Vietnamese companies.

4. Research methodology
4.1 Data source and collection
In this study, we use financial statement ratios to build the algorithms. The financial ratios,
which are divided into seven groups, are obtained from Cophieu68 and Vietstock. These
sources contain quarterly and annual financial reports of all listed companies on the
Vietnamese stock market from 2011 to 2016. We used data for this period because it was
the period when the stock exchange in Vietnam had the largest volume of readily available
data (i.e. not too many missing data). The data used in this study contain both audited and
unaudited quarterly reports. Quarterly reports are not legally required to be audited in
Vietnam. Unaudited raw data have the advantage of showing the earliest anomalous
situation in financial statements.
Data were collected from the most reliable sources available in Vietnam: income and cash
flow statements from Cophieu68.vn and balance sheets from Vietstock finance. After having
excluded banks, financial, insurance companies as well as recently merged or acquired
firms, we obtained a total of 937 listed Vietnamese firms. Each document for a company was
stored in a matrix-like data structure whose columns are the indices and rows are
observations. We chose to conduct anomaly detection on a quarterly basis as we wanted the
result to eliminate the large possible time lag. Also, audited information could be booked,
thus covering the real financial situation of the companies. The timeframe of the data is from
Quarter 1 – 2011 to Quarter 4 – 2016, which spanned 24 quarters. The data values in each
quarter represent an observation. We were able to extract data from 1,090 companies listed
on Vietnam’s stock exchanges. However, 153 financial institutions were eliminated from the
sample due to their unique form of financial statements and business operation. The final
data set consisted of 937 companies and 22,488 observations.

4.2 Data Pre-processing

4.2.1 Financial indices calculation. We identified that there were 31 essential financial
indices. However, we excluded seven indices because of high correlation, whose thresholds
were greater than 0.8, to avoid multi- collinearity issues. Thus, we obtained 24 indices that
can be considered independent. Every index in the seven categories listed below has
different implications for detecting financial anomalies:
(1) liquidity ratios: used to determine how quickly a company can turn its assets into
cash if it is experiencing financial distress or impending bankruptcy;
(2) profitability ratios: are ratios that demonstrate how profitable a company is;
(3) activity ratios: are meant to show how well management is managing the company’s
resources;
(4) solvency ratios: depict how much a company relies upon its debt to fund operations;
(5) market ratios: measure investors’ response to owning a company’s stock and the
cost of issuing stock;
 (6) accrued income: is earned in a fund or by a company for providing a service or Machine
selling a product that has yet to be received; and learning
(7) cash flow: is the net amount of cash and cash-equivalents moving into and out of algorithm
the business.
The general overview of data collection process to obtain financial indices is illustrated
in Figure 1.
4.2.2 Data normalization. Due to different sizes of the companies, their financial indices
187
are on various scales. Without normalizing, the model will be biased. In order to proceed, it is
necessary to mention vector operations on the matrix-like data structure. In Figure 1, each
row is considered a vector. A vector can contain one or many components, and, in this
particular case, there are 24 components, which are the financial indices obtained from the
data collection process. Thus, when we say we conduct a vector operation on two vectors,
such as summing two vectors, we are just summing each corresponding component of two
vectors to create a new vector with the same number of components. Vector operations are
powerful and essential to perform gigantic calculations on matrix-like data structure.
In the scope of our research, we chose standardization as the method of normalizing our
training and testing data because we assumed that, over time, financial indices of a
company would stabilize and follow the standard normal distribution, which later will be
denoted as “∼N(0,1).” In the standardization method, we compute the values of each
financial index to have zero mean and unit variance. First, we calculated the mean and
standard deviation of the range of feature values. Next, we subtracted the mean from each
function’s value, then divided the result by the standard deviation. The process is
summarized in the following formula:
xm
x0 ¼ : (1)
s

Cophieu68 Vietstock

Financial statements
• Income statements
• Balance sheets
• Cash flow statements

Financial indices

Company A Q1 2011
Company A Q2 2011
…
…

Tickers list
Company B Q1 2011
Figure 1.
Company B Q2 2011 An abstract overview
of data collection
…
…

process
AJAR To implement this, we conduct the following steps:
4,2 (1) Obtaining the mean vector (MU) which represents the mean value of all financial
indices.
(2) Obtaining the standard deviation vectors (Std) of each company from the training
data set, which will be described in detail in the next section.
188 (3) We conduct a matrix operation according to Equation (1), with x as each
observation’s vector, μ as the mean vector and as the standard deviation vector of
each company. By doing this, we can obtain normalized data values for every
observation as x′ (Table I).
4.2.3 Pre-implementation. Before implementing the models, we add some fine-tunings
for missing data. For a company when there are completely no available data for a
financial index, that financial index is removed from the computation. Also, if values of a
financial index are partially missing (denoted in the data set as “N/A”), we replace them
with values generated from the standard normal distribution. Since we investigate
anomalies on a company basis, the procedure for a company does not affect the data
values of other companies.
It can be argued that, for every time a missing value is filled with a value from the
standard normal distribution, the result will be different. However, we must also be careful
not to fill in empty values with a fixed value, such as 0 (a common solution), because the
resulting data values will not align with the assumed distribution. A possible solution for
this issue is that, for every random value that needs to be filled in, we can set a “random
state,” which will cause the randomized function to always return the same random number
for every run. In doing so, interested readers or researchers can simulate the same
implementation to understand the findings and replicate the models in future research.
Table II presents a preview of the normalized training data frame.

5. Research design
5.1 Multivariate normal distribution and assumptions
Since the data have 24 independent financial indices, which correspond to 24 features, the
multivariate normal distribution (MVN) will be implemented in our model. In general, it is
the generalization of the univariate normal distribution to multiple variables (Fan and
Palaniswami, 2000; Lokanan, 2017). Although real data may never come from a right MVN,
the MVN provides a robust approximation and has many desirable mathematical
properties, such as the mean vector and covariance matrix. Furthermore, because of the
central limit theorem, many multivariate statistics converge to the MVN distribution as
the sample size increases. Overall, MVN has the following properties:
• Joint density.
• Shape: the contours of the joint distribution are n-dimensional ellipsoids.
• Mean, and covariance, specifies the distribution. The MN(µ, Σ) joint distribution is
determined by µ and Σ only.

Companies Financial indices

Table I.
A visualization of the Index 1 Index 2 –
mean vectors of the Company A (vector A) Mean of index 1(A) Mean of index 2(A) –
companies Company B (vector B) Mean of index 1(B) Mean of index 2(B) –
 payables_turnover cash_ROA ROA cash_flow_on_revenue book_value_per_share cash_ratio reinvestment cash_ROE net_profit_margin

AAA
Q1 2011 1.569563 −0.605933 1.465270 −0.532049 0.377707 −1.009985 0.485990 −0.633468 1.589029
Q1 2012 0.403633 0.111815 0.589110 0.143790 1.468297 −0.933268 −0.480826 0.205800 0.486731
Q1 2013 −1.212642 −0.483559 0.668519 −0.405450 −0.120294 0.341740 0.450969 −0.502922 0.983711
Q1 2014 −1.056517 −1.235540 −0.122068 −1.185015 0.063304 −0.552369 1.290759 −1.277581 −0.001672
Q1 2015 −0.854412 −1.615856 −2.420690 −1.920006 −1.299141 0.885708 0.702198 −1.571438 −2.592306
Q2 2011 2.857911 0.130310 −0.135469 0.225825 0.519688 −0.869617 −2.771562 0.230875 −0.022633
Q2 2012 0.555663 0.583030 −0.082492 0.761017 1.445435 −0.763903 −0.319130 0.675693 0.141685
Q2 2013 0.596634 0.005349 0.026183 0.080237 −0.252724 −0.561752 0.377966 −0.065049 0.085655
Q2 2014 −0.565054 0.684313 −0.010287 0.584314 0.122422 −0.485738 −0.110050 0.662314 −0.217191
Q2 2015 −0.369197 −0.538192 −1.328244 −0.468264 −1.269048 1.017459 0.470866 −0.553311 −1.178309
Q3 2011 0.863739 0.260351 1.325117 0.366799 0.803063 −0.539378 0.113013 0.435657 1.526498
Q3 2012 0.229783 1.131976 0.118419 1.066416 1.637285 −0.953882 −1.936275 1.147646 0.012660
learning
Machine

189

A preview of
algorithm

Table II.

data frame
normalized training
AJAR • Moment generating function: the MN (µ, Σ) distribution:
4,2  
1TX
M GFM ðt Þ ¼ exp m t þ t
T
t ; (2)
2

where t is a real n × 1 vector.

190 • Characteristic function: the MN (µ, Σ) distribution has:
 
1TX
CFcðt Þ ¼ exp m t t
T
t ; (3)
2

where t is a real n × 1 vector.

• Linear combinations.
• Independence.
With MVN, the following assumptions are made regarding our research case:
• Indices after calculation and scaling are Gaussian independently distributed. If not,
they are either transformed or omitted from the model.
• Some financial indices are too important to be overlooked. As such, we retained them
even if they were highly correlated with the others.
• In sum, 95 percent of “none - anomalous” data points stay within [μ−3σ; μ+3σ].
• Company indices change slowly and can be inferred from history and other indices.

5.2 Mahalanobis distance − statistical distance

One of the simplest methods to filter anomalous observations is the Mahalanobis distance
(Thongkam et al., 2008). The Mahalanobis distance will be employed in this study to
decide whether an observation is anomalous. Conceptually, the Mahalanobis distance
measures the proximity of a data point to the center of the distribution and is a direct
generalization of standard deviation. The Mahalanobis distance of a point x ¼ (x1, x2, …, xn)
is defined as follows:
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
X ffi
dðx; mÞ ¼ ðxmÞT ðxmÞ1 ; (4)

In Equation (2), μ ¼ (μ1, μ2, …, μn) is the mean vector of the distribution, and ∑ is the
covariance matrix of the features in the n-dimensional space. For the application of anomaly
detection, we will measure the distance of each test observation to the mean vector (μ) of
each company’s data in standard deviation unit. The formula is computed as follows:
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
X ffi
d M ðx; mÞ ¼ ðxmÞT ðxmÞ1 ; (5)

It is assumed that each feature ( financial index) ∼N(0, 1), each observation vector, x ∼ Nρ( μ, Σ)
with Σ ∨ 0 and ρ is the number of features. Therefore, the random variable D ¼ (x−μ)TΣ(x−μ)−1
has the χ2 distribution with ρ degrees of freedom (Bajorski, 2011). From this property, it is
inferred that:
 
P ðd M ðx; mÞpkÞ ¼ Gr k2 ; (6)
where Gρ is the cumulative distribution function (CDF) of the χ2 distribution with p degrees Machine
of freedom. learning
By choosing the value of k and referring to the χ2 distribution table, we can obtain the algorithm
probability of an observation having its distance to the mean vector less than k standard
deviations. This probability is also the proportion of data observations having their
distances to the mean vector less than k standard deviations. The application for anomaly
detection, which will be discussed in the next part, is mostly based on the conclusion above. 191
5.3 Anomalies detection with Mahalanobis distance
After collecting data, a correlation matrix was formulated for each company. This approach
allows us to measure the correlation between the companies’ indices. We also categorized the
original data set into two parts: 83 percent for training and 17 percent for testing. Table III
shows that the one-dimension (1D) tensors or vectors are represented for calculating
Mahalanobis distance:
1
f x ðx1 ; x2 ; . . .; xk Þ ¼ qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
Pexp: (7)
ð2kÞk  
This function can be generalized for the vector of 1 row × 24 columns (1×24). However, to
visualize the multivariate Gaussian distribution, we will use a vector of size 1×2, as shown
in Table IV.
The visualization of a 1D tensor with the size of 1×2 example can be seen in Figure 2.
The contour of this bivariate normal distribution is visualized in Figure 3. Importantly,
when we squash three-dimension data points into two-dimension ones, the data set will lose

Table III.
Input: 1-D tensors ~
Company A’s current ratio Company A’s quick ratio – Company A’s total net accruals vectors as below for
Note: [Current ratio, quick ratio, …, total net accrual] calculating

Table IV.
1×2 matrix for better
Company A’s current ratio Company A’s quick ratio visualization on three-
Note: [Current ratio, quick ratio] dimension space

Multivariate Normal Distribution

0.0012
0.001
0.0012
0.0008
0.001
0.0006
0.0008 0.0004
0.0002
0.0006
0
0.0004

0.0002 100
90
70
80 Figure 2.
0
0
10 50
60 The visualization
20 30 40 50 30
40
Y
of a 1D tensor
60 70 20 with size 1×2
X 80 90 10
100 0
AJAR Z2
4,2
u1
u2

192
1
2

Figure 3.
2D visualization of 1D
tensor with size 1×2 Z1

valuable information. As we can see in the function and visualization in Figure 3, the output
of the MVN is a learned model from the training data set, while f(X) is the probability of
whether a data point is part of the normal distribution. We have to set a value of epsilon (ε)
to compare with f(X). If f(X) o ε, the data point is anomalous, and vice versa.
However, because of computational complexity, we will not deploy calculations on f(X)
directly. Instead, we deal with MVN in another way: given the assumption of the central
limit theorem, we will calculate the loss, the Mahalanobis distance, as the product between
test data point and the mean. If the loss ⩾3σ, we can conclude the level of anomalies is high,
and vice versa. As mentioned above, we can calculate the Mahalanobis distance for each
observation. If any of these distances is greater than a certain threshold Lmax, we consider
that observation an anomaly. To calculate Lmax, we check how likely it is that the most
significant Mahalanobis distance is greater than Lmax using the following equation:
X
Y i ¼ ðX i mÞT  ðX i mÞ1 ; i ¼ 1; :::; n: (8)

From the section Mahalanobis distance − statistical distance, each Yi follows the χ2
distribution with ρ features − ρ degrees of freedom. Now, we can calculate the probability
that the largest Y is larger than L2 using the following equation:
    Yn  
P max1 p i p n Y i 4 L2 ¼ 1P max1 p i p n Y i pL2 ¼ 1 i¼1 P Y i pL2
h  in
¼ 1 Gp L2 ; (9)

where Gρ is the CDF of the χ2 distribution with ρ degrees of freedom.

For this probability to be equal to a small value, we need:
rffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
 ffi
1=n
L ¼ wr ð1aÞ
2 : (10)

In this study, we choose the value to be equal to 5 percent, which is a traditionally preferred
value when refining significance level in academics (Torbeck, 2010). Any observation whose
distance to the mean vector is greater than this value of L(α ¼ 0.05) will be considered an
anomaly. As mentioned earlier, we set the fixed Lmax with p ¼ 95 percent and 24 features
as 2.64E+15. If the responding Mahalanobis distance of a specific quarter is greater than
the Lmax value, we can be sure that the quarters of the specific company’s financial indices Machine
were anomalous. Furthermore, as mentioned in the Introduction, we consolidate the learning
distances into ordered categories to rank the companies’ credit worthiness. The projected algorithm
anomaly ratings are defined in Table V.

6. Empirical results
Training classification was formed to display the data (Perols, 2011). Out of the 22, 488 193
observations, the training group consists of 18,740 observations, while the test group
consists of 3,748 observations (e.g. see Spathis, 2002; Lin et al., 2003; Kirkos et al., 2007;
Lokanan and Sharma, 2018). We first employ the Mahalanobis distance and consider each
firm in a quarter as a data point. The summary of the Mahalanobis distance of the testing
data set is shown in Table VI. The mean and the standard deviations for the distance from
one datum to central limit come from the 3,748 observations. The mean distance measuring
average length from firm-quarter data point to the center was 5.65E+20. The maximum and
minimum Mahalanobis distances from the testing data set are 3.1E+21 and 1.25E+24,
which represent observations with the largest and smallest degree of anomaly, respectively.
These findings indicate that, for the most part, a significant proportion of the companies
were within the normal (vs “anomaly”) standard deviation range in their financial
statements. A closer look at the results in Table VI shows that most of the observations were
closer to the mean and that there was not much variance (i.e. larger standard deviations)
among companies.
For more details, the company ratings defined above can be applied to every observation
or firm-quarter in the data set. As an example, Tables VII–IX show the Mahalanobis
distance values by quarters for Vietnamese listed companies represented by their respective
tickers for 2016. As can be seen in Table VII, for the entire 2016 financial year, Type A
companies from stock ticker AAA had a small number of anomalies in their financial
statements. These results were predicted as it was expected that companies with A ratings
will have small variance in their financial statements. On the other hand, with the exception

Type Definition dM range

Table V.
A Good company with no or few anomalies, predictable outcome [0; 1E+15] Company rating types
B Normal company with average anomaly, quite predictable outcome (1E+15; 5E+15] for all observed
U Unranked company with many anomalies, unpredictable outcome (5E+15; +infinity) companies

Number of observations Mean Std Min

3,748 5.65E+20 2.49E+22 −3.1E+21 Table VI.

Top 25% Top 50% Top 75% Max A summary of
−2.4E+15 0.612693 3.69E+15 1.25E+24 Mahalanobis distance

Time Mahalanobis distance Anomaly rating

First quarter 2016 −3.1E+15 A Table VII.

Second quarter 2016 3.7E+14 A Financial anomaly
Third quarter 2016 2.7E+14 A analysis result of
Fourth quarter 2016 −1.4E+16 A stock ticker AAA
AJAR of the first quarter, the unranked companies in stock tickers AAM (Table VIII) had a higher
4,2 number of anomalies with very unpredictable outcomes. The companies in the stock ticker
DGH (Table IX) had fluctuating results throughout the 2016 fiscal year. For quarters 2 and
4, there was very little anomaly detection and a strong indication that companies were
producing reliable financial statements. In quarter three, the results from the Mahalanobis
distance reveal the companies had average anomalies and quite predictable outcome.
194 For the unranked companies in the DHG stock ticker, there were many anomalies with very
unpredictable outcome in the first quarter of 2106. Overall, it may not be to a company’s
advantage to manipulate their financial statements, especially when the company already
has a good reputation (Harymawan and Nurillah, 2017).
Table X shows the number of rated firm-quarter. A closer look at Table VI shows that
68.89 percent of firm-quarter data is rated A. This means that most of the companies were
performing very well with few anomalies in their financial statements. Considering the
concerns regarding fraudulent financial statements in Vietnam, these findings are
significant for two reasons. First, it shows that there are no overall financial statement level
(OFSL) threats and users can feel confident in using these financial statements to make
informed financial decision. In other words, the findings reduced OFSL risk, that is, the risk
of material misstatement for the financial statement as a whole (see also Behzadian and
Izadi Nia, 2017). Second, and partly synonymous with the first, is that the results directly
enhance the relevance and reliability of information provided in the financial statements for
strategic investment decision making. The rated B companies account for about 7.6 percent
of anomalies. This is a minimal amount compared to 23.51 percent of unranked firm-
quarters that have significant anomalies with very unpredictable results. This is a serious
concern and Vietnamese regulators need to take stock of these results. That fact that
23.51 percent of unranked companies have significant anomalies in their financial
statements raises serious questions concerning the efficiency of the audit approach and
procedures used to audit these financial statements (Figure 4).

Time Mahalanobis distance Anomaly rating

Table VIII. First quarter2016 3.19E+14 A

Financial anomaly Second quarter 2016 2.15E+16 U
analysis result of Third quarter 2016 1.48E+16 U
stock AAM Fourth quarter 2016 3.44E+16 U

Time Mahalanobis distance Anomaly rating

Table IX. First quarter 2016 1.56E+16 U

Financial anomaly Second quarter 2016 5.16E+14 A
analysis result of Third quarter 2016 2.29E+15 B
stock ticker DHG Fourth quarter 2016 4.92E+14 A

Type Number of companies Percentage

Table X. Number of type A – rated firm-quarter 2,582 68.89

The summary of Number of type B – rated firm-quarter 285 7.6
company ratings Number of type U – rated firm-quarter 881 23.51
 Machine
learning
23.51 algorithm

7.6
68.89
195
Figure 4.
Visual breakdown of
companies in each
rating type
(in percentages)
Type A Type B Type U

7. Conclusion, limitations and areas for future research

The paper produces two meaningful outcomes regarding anomalies detection and anomaly
rating of financial statements. First, a significantly high proportion (68.89 percent) of Type
A firms had very few anomalies and this is a healthy sign that they are in compliance with
legal and ethical standards. For a user’s perspective, they can feel confident in using these
financial statements to make investment decisions. Second, and more concerning, is that
23.51 percent of the unranked companies had significant anomalies in their financial
statements. This is a worrying sign as it indicates that there are risks in the financial
statements as a whole and there is a likelihood of fraud or error in the financial statements.
In both cases, the first outcome laid a solid foundation for users to analyze and understand
financial statements, while the second outcome indicates that, as an aggregate, regulators
need to start paying more attention to the audited financial statements of unranked
companies for potential fraud or error.
From a practical perspective, the results presented here can be used to provide
guidance to audit committees and senior executives concerned about the increased
possibility to deter potential accounting fraud or misstatements in financial reporting.
Just as there is a need for higher ethics in organizational research, so too is the need for
managers to recognize the importance of the fraudulent mechanics of an imperfect system
that promotes unethical financial reporting (Lokanan, 2015). If, as seems to be the case,
unethical behavior by managers gives a competitive advantage to a company, then
monitoring their activities becomes an important strategic objective for firms and external
auditors to report them to regulators and publicize the irregularities to all users of their
financial information.
People working in the corporate sector regularly spend a lot of time in financial districts,
which, despite the best regulatory efforts by regulators, offer regular opportunities to
engage in fraud and/or experience sources of friction, which may lead to fraud (Lokanan,
2015; Morales et al., 2014). An accountant, for example, may address the friction caused from
not meeting financial targets by manipulating the financial statements (Behzadian and Izadi
Nia, 2017; Lokanan and Sharma, 2018). A chief executive officer may address the friction
caused from not meeting financial targets by manipulating his compensation bonuses
(Perols, 2011). As these individuals repeat their behaviors, questions arise over the
materiality of the OFSL risks in these statements. The model employed in this paper is
capable of addressing these issues in the specific details of a single company or set of
companies. Moreover, the model can detect anomalies in a quarterly format and will give
managers and users of the report a more consistent update of the materiality of companies’
financial statements. Note also that each company’s quarter is ranked with anomaly ratings,
which measures how anomalous the company’s indices are at a given point in time.
AJAR The insights from the anomaly ratings provided in Table V have the potential to play a
4,2 significant role in understanding companies’ financial statements. A financial architecture
that can manage OFSL risks will go a long way to protect the public interests and users of
financial statements. Dishonest accounting practices could be of interest to some users in
struggling companies and, as such, they may entertain the possibility that fraudulent
accounting is permissible. However, company managers and regulators needs to be
196 cognizant of the fact that users want accurate and relevant information to make informed
strategic decision; as such, anomaly detection models can prove useful in detecting
anomalies in financial statements and offset deception, misreporting and the falsification of
financial reports. In particular, the anomaly rating can be used to measure the level
of accuracy of companies’ financials by users of financial statements (e.g. see Fanning and
Cogger, 1998; Lyandres and Zhdanov, 2013). These findings provide meaningful insights to
financial institutions when determining lending decisions and to investors when evaluating
companies’ financials to make investment decisions (Bell and Carcello, 2000; Beneish et al.,
2013; Behzadian and Izadi Nia, 2017; Lokanan, 2017).
At a more macro level, Vietnam has witnessed accelerated economic changes in its
financial regulatory landscape in recent years (Narayan and Zheng, 2010; Phan et al., 2018).
With such changes come pressures for companies to compete in one of the strongest
growing markets in East Asia (World Bank, 2017; Phan et al., 2018). With such growth, the
problem of financial statement manipulation has once again raised its ugly head in financial
reporting (Hiep, 2017; Phan et al., 2018).
The results from this study also provide insights for government agencies to control and
reduce the degree of financial statement fraud. As mentioned earlier, a very significant 23.51
percent of the testing data set was shown to be anomalous. This result implies that
regulators must focus more on enhancing transparency and compliance in financial
reporting (Phan et al., 2018). In Vietnam, the Vietnamese Standards on Auditing regulate the
procedure for reviewing the quality of financial statements before they are released to
the public. From both an audit and a user’s point of view, the models employed in this study
can provide insights on best practices to improve the accuracy of audited financial
statements. As the management may want to manipulate earnings, the use of machine
learning algorithms can be employed by regulators, preparers, auditors and users to detect
errors in financial reports and mitigate the prevalence of false representations cause by
fraudulent reporting (Dbouk and Zaarour, 2017).
Due to the eclectic nature of anomaly detection in financial statements, a general model of
outlier detection simply does not exist. As such, the regulatory apparatus must strive to
identify models that can offer insights into different types of unethical (and at times
fraudulent) behavior in financial reporting. In this regard, the paper advances research in
anomaly detection by presenting a model that will assist individuals to analyze complex
unethical behavior in accounting manipulation and, at the same time, offer deeper insights
into fraud detection in financial statements. More importantly, and especially for the
unranked companies, the paper can prove useful to examine managerial intent to act
unethically (and sometimes fraudulently) while prioritizing and integrating interests of
certain users in the decision-making process.

7.1 Limitations of the model

The machine learning algorithm employed in this paper suffers from several limitations.
First, the missing values were treated in the same way in the financial statements. It was
biased to do so because the missing values are the result of restriction to private data.
In fact, the input data for this research are free and available, which mimics perfectly the
insights that can be seen by ordinary stakeholders. This is very important as it not only
intensifies human weakness when dealing with big data, but also reveals data imparity and
scarcity in the Vietnamese market. Second, we had to employ statistical assumptions and Machine
treat the data as stemming from the normal distribution. The high dimension data require learning
more advanced models, which are far beyond the scope of the data set we are working with algorithm
(e.g. Fan and Palaniswami, 2000; Spathis, 2002; Shin et al., 2005). Third, the timeframe under
study ranged from 2010 to 2016, which is a relatively short interval. Machine learning
techniques require data acquired from a longer timeframe to ensure a better fitted model
(Hoogs et al., 2007; Perols, 2011). Fourth, the threshold levels of anomalies are difficult to 197
determine. As a result, the model is too sensitive to anomalies. With 23.51 percent of the
companies’ data points considered to be highly anomalous, it can be said that they were not
practical enough when compared to the historical record of the Vietnamese market.

7.2 Future research

The present paper results in two significant findings which can serve as guidelines for
further research on machine learning and detecting anomalies in financial statements. First,
the data pre-processing methods used in this paper lay a good foundation for future
research. Further research can examine how data pre-processing can transform raw data,
which will be useful to users of financial information. Second, the result of the anomalous
financial analysis can be contextualized in a more meaningful way than just finding out
whether they are anomalous or not. One avenue is to pursue further research to see if
companies that report anomalous data were cited for fraud or went on to commit fraud in
the future.

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About the authors
Mark Lokanan is Associate Professor in the Faculty of Management at Royal Roads University.
He is a graduate from Simon Fraser University, Canada, and is an expert in fraud, forensic
and investigative accounting. Mark Lokanan is the corresponding author and can be contacted at: 201
mark.lokanan@royalroads.ca
Vincent Tran received the Bachelor of Business Administration Degree (major) in Sustainability
from Royal Roads University. Vincent is currently Research Assistant for Professor Mark Lokanan
(Royal Roads University) in forensic accounting studies about Canadian investment industry
regulators. Vincent is an expert in data collection, manipulation and analysis; background in Finance
and Accounting.
Nam Vuong received the Bachelor of International Economics Degree (major) from Foreign Trade
University. Nam is currently Student & researcher. Nam is an expert in information retrieval,
simulation, game theory and causal inference.

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