Using Benford’s Law to Detect Business Tax Fraud

Analysis Problem: detecting business fraudUsing Benford’s Law to Detect Business Tax FraudThis exercise is a significant assignment in Introduction to Business. It is worth 50 points. You will have two weeks to complete the exercise. However, please see below for the consequences of late submittals. The exercise is designed to incorporate quantitative reasoning into the Business course. We are going to see if we can detect the possibility of tax evasion by a company that makes lawn and picnic supplies.The company is Shady, Inc., and it manufactures picnic and beach umbrellas, barbecue grilling equipment, picnic coolers, and items for outdoor recreational use.Shady, Inc., is a relatively new company, incorporated on January 1, 2018. The company employees approximately 25 people and has a manufacturing facility and offices on Shady Grove Road in Gaithersburg, MD.Indications are that Shady, Inc., is profitable. However, the company paid only $750 of corporate income tax in 2018 and $750 again in 2019, the most recent tax year. Prior to launching a full investigation of the company’s finances, however, it might be useful to perform an analysis using Benford’s Law to see if Benford’s law indicates the possibility of some shady accounting practices.***As you know from our lecture on Benford’s law, Benford’s Law relates to the frequency with which the integers 0, 1, 2 … 9 appear as digits in large sets of numbers. For example, in large numerical data sets, certain integers, like the number 1, appear as the first digit in a number with more frequency that other integers. [ Remember the exercise on the numbers of students enrolled at Community Colleges in Maryland. ]Benford’s law can be used to make predictions about the distribution of second digits, third digits, digit combinations, and the last digit in a number. Therein lies Benford’s Law’s use in business tax inquiries. For our purposes in carrying out this exercise, we are going to look at the last digit in a large set of numbers.Benford’s law is quick and easy to use as an early indicator. Thus, an application of Benford’s law can be used to indicate areas where more investigation may be warranted.***     Your assignment: Attached is the 2019 US Corporate Income Tax Return for Shady, Inc. Please perform a Benford’s Law analysis for the last digit of the deduction amounts reported on the supplemental “Statement for Other Deductions.” The Statement provides supporting documentation for Line 26, Other Deductions, on Form 1120, the US Corporation Income Tax Return.NOTE: A high frequency of numbers whose final digit is “0” or “5” may be an indicator of financial deceit or dishonesty. Therefore, you should check the frequency of the integers “0” or “5’ appearing in what Shady Inc. claims is its list of business expense deductions. As mentioned, this information appears on the tax form “Statement of Other Deductions” attached to Shady Inc.’ 2019 tax return as supporting documentation for line 26.Once you have determined the frequency of the integers “0” and “5”, construct a column graph showing the distribution of all of the integers from 0 through 9.Having completed your Benford’s Law analysis, please answer the question of whether Benford’s Law presents indicia of possible fraud in Shady, Inc.’s 2019 federal income tax return.The additional information you need – the Statement of Other Deductions in support of Line 26 of Shady, Inc.’s Form 1120, for its 2019 tax return – is attached.***What to submit. Please submit a two-to-three page report [ 12-point font, double spaced ] containing the following components.  1. 2.3.4.5. 6.of whether, when you applied Benford’s Law to Shady, Inc.’s 2019 income tax return, indicia of fraud exist.Brief Descriptions of:a. the Taxpayer – Shady, Inc.b. Benford’s law in your own words.c. your Analytical Methodology – i.e., how you completed the Benford’s Law analysis.Table showing the frequency distribution of each of the integers 0 through 9 as they appear as the last digit in the number.(you can easily find on-line how to prepare a column chart)describing what you concluded from examining the frequency of the integers “0” and “5” as they appear in Shady, Inc.’s “Statement of Other Deductions.”Description of the Problem Answer to the Question  Column graph Your ConclusionHow to submit. Your report must include your name and be typed, double-spaced with no errors of grammar, punctuation, or spelling.   Benford’s Law Business Tax Fraud ProjectDetecting Business Tax FraudThis is the supporting information for the exercise in using Benford’s Law as an investigative technique for detecting business tax fraud.INSTRUCTIONS: Using the “Statement for Other Deductions,” below, determine the freequency for each integer between 0 and 9 appearing as the final integer in the dollar “Value” column of the Statement of Deductions. Construct a table showing each integer between 0 and 0 and the frequency of its appearance as the last digit. Then, construct a bar graph that plots each integer and its frequency.Please use the Statement for Other Deductions (below) for the business Shady, Inc.***Tax Return for Shady, Inc. Statement for Other DeductionsShady, Inc. Employer Identification Number 52-200-100 US Corporation Income Tax ReturnForm 1120Line 26 Other Deductions        DeductionValue ( $ US )Physical Facilities Building maintenance2,335Heat1,214Electricity2,226            Water303Security guards23,529Closed Circuit TV3,698Alarms1,777Lock maintenance1,351Office cleaning1,521Office furniture2,786Telephone2,300Subtotal physical facilities43,040Office Electronics Computer hardware5,300Computer software1,197Software licenses4,555Internet service6,323Subtotal Office Electronics17375Insurance Professional liability10,000Vehicle3,455Comprehensive2,000Fire2,505Subtotal Insurance17960Office Supplies Paper1,422Copying3,500Office decorations721Notebooks200Pens and pencils105Coffee maker258                                 Coffee519Utensils200Subscriptions to periodicals1,340Postage924Holiday gifts for employees1,005Employee spot awards504Artwork2,200Meals for employee events10,332Subtotal Office Supplies23,230Charitable Contributions Cancer research1,000Feed the Homeless6,555Subtotal Charities16,555Transportation Air fare8,731Taxi fares660Parking362Rail travel fares343Gasoline12,936Vehicle repairs1,945Tires635Batteries551Tolls310Subtotal Transportation26,473Total Deductions135,633

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