Abiding by the Law? Using Benford’s Law to Examine the Accuracy of Nonprofit Financial Reports

Abstract

Benford’s Law asserts that the leading digit 1 appears more frequently than 9 in natural data. It has been widely used in forensic accounting and auditing to detect potential fraud, but its application to nonprofit data is limited. As the first academic study that applies Benford’s Law to U.S. nonprofit data (Form 990), we assess its usefulness in prioritizing suspicious filings for further investigation. We find close conformity with Benford’s Law for the whole sample, but at the individual organizational level, 34% of the organizations do not conform. Deviations from Benford’s law are smaller for organizations that are more professional, that report positive fundraising and administration expenses, and that face stronger funder oversight. We suggest improved statistical methods and experiment with a new measure of the extent of deviation from Benford’s Law that has promise as a more discriminating screening metric.