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Forensic Accounting

Updated on May 8, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is Forensic Accounting?

Forensic accounting is the investigation of fraud and misrepresentation. Forensic accountants conduct an in-depth analysis of financial data. They document the entire investigation and report findings to a court of law. Forensic accountants often testify to the veracity of their findings.

It is a widely applied accounting discipline that resolves financial conspiracies—money laundering, bankruptcyBankruptcyBankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt.read more, embezzlementEmbezzlementEmbezzlement refers to the act of secretly taking, withholding, or misappropriating money or other asset that is kept, maintained, or placed under an individual's responsibility by the company for which he or she works.read more, insurance claims, securities fraud, asset misappropriation, tax evasion, divorces, family disputes, financial frauds, and debt defaults.

Key Takeaways

  • Forensic accountants probe into financial information and other relevant details of a company or an individual to detect fraud or crime.
  • A forensic accountant is a Certified Forensic Accountant (CRFAC). They collect evidence and study it. They discover legal violations and prove them in a court of law.
  • In the investigation of financial allegations, the stakes are high—mere speculation of suspicion can cause massive business losses. The leaking of confidential information, therefore, is the biggest challenge faced by forensic accountants.

How Does Forensic Accounting Work?

What is Forensic Accounting

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Forensic accounting applies scientific techniques and accounting principles to detect fraudulent activities. Due to technological advancement, corporate scams have increased tremendously—the need for forensic accountants has increased. 

A single person cannot execute forensic processes—it is carried out by a structured team of professionals—Certified Public AccountantsCertified Public AccountantsIn the accounting profession, CPA stands for Certified Public Accountant. It is a professional accountant license certified by a state board of accountancy in the U.S. Becoming a CPA is an indicator of credibility and expertise in accounting. A CPA can hold all sorts of positions in the financial domain. Their extensive knowledge of accounting and ethics can work as reliable financial advisors, business consultants, accountants, auditors, and tax professionals. They can even hold high-level executive positions.read more (CPAs) and forensic accountants. The team is responsible for the following tasks:

  1. The forensic team collects facts and evidence pertaining to hidden assets.
  2. Forensic accountants interview associated parties and employees.
  3. Then they verify the collected data.
  4. This data is analyzed thoroughly.
  5. The conclusions are summarized into reports.
  6. The evidence is bundled into exhibits—to be presented in a court of law.
  7. Sometimes, forensic personnel is required to testify, defending the veracity of reports.

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Application of Forensic Accounting

The different types of felonies or misrepresentations that are investigated under forensic accounting are as follows:

Application of Forensic Accounting

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#1 – Business Fraud

Business investigations comprise asset identification, asset recovery, due diligence reviewsDue Diligence ReviewsDue diligence is a thorough examination of information and strict adherence to the applicable rules and regulations. It ensures asset protection as well as the avoidance of malpractices and conflicts.read more, tracing misappropriation, forensic intelligence, and suspect interviews. Forensic accountants strategize intelligence measures and identify offenders. These investigations require a detailed review of the documents.

#2 – Tax Fraud

Forensic accountants catch tax evasion. Often, businesses and individuals falsify income and other financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more to reduce tax liabilities. 

#3 – Securities Fraud

Misrepresentation of investments, commoditiesCommoditiesA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units.read more, and stocks is the most common white-collar crimeWhite-collar CrimeWhite-collar crimes are non-violent crimes. The principal intention is to make financial benefits through illegal routes. Such white-collar criminals use their position of power or prestige to conceal, deceive or violate trust for their gains. Such crimes result in financial losses of millions of dollars every year.read more. Late-day trading, pump and dump schemesPump And Dump SchemesPump and dumps refer to the scam of raising the price of vulnerable stocks using misleading promotions and selling off the shares once their price booms. After voluminous selling and the hype wearing off, the share price dips sharply, leaving many investors in heavy loss. read more, pyramid schemesPyramid SchemesPyramid Scheme is an investment scheme in which participants profit by recruiting other members under them, and each participant is required to recruit new participants, with each new entrant having to pay the entrance fees for entering the scheme, creating a hierarchy of people.read more, and Ponzi schemesPonzi SchemesA Ponzi scheme is an act of fraud in which potential investors invest with high expected returns and minimum or no expected risk, whereby returns are generally generated for early investors to attract new investors. The amount invested by new investors is used to pay off earlier investors.read more are felonies.

#4 – Asset Misappropriation or Hidden Assets

Often, Individuals and companies hide assets from tax authorities. Forensic accountants detect asset misappropriations—property theft, embezzlement, and payrollPayrollPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits.read more fraud.

#5 – Partnership and Shareholding Dispute

Accountants also examine conflicts pertaining to compensations and benefits received by shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more or partners. The investigation involves detailed scrutiny of accounting and financial records to quantify the issues brought out in the conflict.

#6 – Insurance Claims

Forensic accountants quantify economic damages in vehicular accidents and medical negligence cases. They review insurance policies, coverage issues, claim settlements, and the calculation of potential losses. On behalf of insurance companies and policyholders, they investigate property losses,  business losses, employee fidelity claims, and similar lawsuits.  

#7 – Economic Losses and Bankruptcy

Business losses typically include breach of contract, construction claims, trademark infringements,  patent infringements, product liability claims, and non-compete agreement breaches. Forensic accountants probe into the terms and conditions of the circumstances leading up to the dispute. They quantify the losses. In addition, accountants carry out recovery procedures in bankruptcy cases.

#8 – Money Laundering

Forensic accountants identify illegitimate sources of money – money laundering practices and undisclosed bank accounts.

#9 – Marital and Family Disputes

After quantifying losses, accountants assess financial compensation for divorces, property disputes, and family disputes. They quantify compensation for alimonyAlimonyAlimony is court-ordered financial support given to a spouse in case of divorce or separation and is given to the spouse with a lower level of income or no income at all.read more and child support. For family and property disputes, accountants execute property distribution.

Forensic Accounting Techniques

Benford’s law (mathematical tool) is used to differentiate between a mistake and a deliberate fraud. Also, based on the  Relative Size Factor (RSF) technique, the outliers in records are subject to further investigation.

Data-mining programs automatically scan through vast volumes of data for new, unexpected, or implicit information or patterns. Forensic Accountants use various computerized software for data extraction and financial analysis.

Issues

Forensic accountants face the following challenges:

  • Forensic procedures require a lot of technical and financial expertise.
  • These investigations can potentially leak confidential details—can affect a suspect’s reputation.
  • Even mere speculation of an alleged felony generates unwanted negative publicity.
  • Depending on the duration of the investigation, forensic accounting can become a very expensive process. 
  • Even after proving suspects not guilty, employees remain suspicious.

Differences Between Audit and Forensic Accounting

Auditing and forensic accounting are two entirely different streams—the terms cannot be used interchangeably. The significant differences  are as follows:

BasisAuditingForensic Accounting
PurposeIt checks books of accounts compliance with Generally Accepted Accounting Principles (GAAP).It analyzes the financial documents to detect illegal activity within an organization, specifically white-collar crime.
ObjectiveError identification and prevention.Detecting frauds and felonies.
ProcessA predefined and systematic process of reviewing accounts as per GAAP.The Investigative process looks for outliers and specific patterns.
InvestigationAuditors analyze the financial transaction samples.Forensic Accountants scrutinize every detail.
Litigation PerspectiveNoThe investigation is documented and presented in a court of law.
Skills SetRequires accounting knowledge.Requires skills beyond accounting—criminalistics, advanced data analytics, information technology, and law.
FrequencyRegular—companies are mandated by law to appoint an auditor.Uncommon—done only when suspected of fraud.
Carried Out ByCertified Public Accountant (CPA)Professional team of experts, including CPAs.
Appointed ByCompany shareholdersDirectors, owners, third parties, and counsels.

Examples

Best Forensic Accounting Firms

According to the FIRSTHAND report in 2022, some of the best forensic accounting firms in the United States are as follows:

  1. PwC (PricewaterhouseCoopers) LLP
  2. Deloitte
  3. Ernst & Young LLP (EY)
  4. KPMG LLP
  5. Grant Thornton LLP

Case Study

Jorge Alberto Garcia was recently investigated under a forensic accounting case. On November 22, 2021, Garcia was proven guilty of tax offenses and fraud. He was charged with wire fraud—he illegally acquired property and money under a home repair scheme—he made false representations and promises. In addition, Garcia failed to submit his income tax returns.

The US District Court sentenced Garcia to 12 months of imprisonment. He was made to pay $ 4,043,397.52 as compensation.

Frequently Asked Questions (FAQs)

Why forensic accounting?

Forensic accounting is the systematic investigation of facts. It helps solve frauds, mysteries, and financial irregularities. Thus, it predicts, proves, and prevents financial felonies from being committed in the first place.

How to become a forensic accountant?

A forensic accountant needs a bachelor’s and master’s in either accounting, forensic accounting, finance, or other related streams. In addition, candidates require a Certified Public Accountant (CPA) license. Some accountants acquire Certified Forensic Accountant (CRFAC) certification issued by the American Board of Forensic Accounting. Other certifications include Certified Fraud Examiner (CFE) and Certified in Financial Forensics (CFF).

How does a forensic accountant find hidden assets?

Forensic accountants are responsible for uncovering undisclosed assets and facts. They dig into bank records, financial evidence, tax returns, insurance policies, property papers, financial documents, and other written or visual evidence to find hidden assets.

Forensic Accounting Video

 

This has been a guide to what is Forensic Accounting and Its Meaning. Here we discuss forensic accounting firms, applications, techniques, and examples. You may learn more about accounting from the following articles –

Reader Interactions

Comments

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