What is Forensic Accounting?
Forensic accounting employs a mix of accounting, auditing, and investigative acumen by recording of accounting documents, preparing report and performing financial analysis for use in legal proceedings. Thus, it provides an accounting analysis from a litigation perspective. Forensic accountants usually follow are a process that involves accumulating financial evidence, developing technical applications, organizing the information collected and communicating their findings in the form of reports or presentations suited for testimonies in court.
Why is Forensic Accounting required?
The blatant occurrences of financial frauds have raised questions on the integrity of accounting practices. These cases mean that the corporations have failed to show accurate information to their investors, and provided inappropriate disclosures of their financial statements. Scandals and frauds like this tarnish the image of the company, and they lose shareholders as well as public confidence. Quality financial reporting is crucial for the development of an efficient capital market. Therefore it is imperative to bring in a microscopic level of scrutiny for the detection and prevention of such frauds. Forensic Accounting, a term coined by in 1946, is a niche area of investigation, which has its own analytical procedure to unravel the stories behind these white-collar crimes.
Application of Forensic Accounting
The world of finance is vast, and so is the scope of Forensic accounting. While the basic premise remains the investigation of frauds or misrepresentations, the domains can be varied. The financial forensic investigation may fall into several categories. For example:
Business Fraud investigation
This is one of the most crucial applications of Forensic Accounting. Business investigations refer to a range of scrutiny involving asset identification and recovery, due diligence reviews, tracing misappropriated funds, forensic intelligence gathering through interviews, and other evidence.
On the other hand, employee fraud investigations usually involve procedures to determine the presence of the fraud, its nature, and quantum. It includes all the intelligence measures that may enable the identification of an offender. These investigations often require interviews of employees who had access to the funds, collection of other pieces of evidence, and a detailed review of the documentary confirmation.
Partnership and Shareholding Dispute
The most usual issue that often crops up is regarding the compensation and benefits received by each of the shareholders or partners in case of a dispute. The investigating process usually involves detailed scrutiny of many years accounting and financial records to quantify the issues brought out in the conflict.
Insurance policies across the globe differ primarily on account of terms and conditions. However, it is imperative to calculate the economic damage to settle the claims. Solving these cases involve a detailed analysis of the policy to examine coverage issues and the most appropriate method of quantifying the loss. A Forensic Accountant may be asked to assist either an insured or insurers in conducting the investigation for the settlement of a case. In corporate parlance, these types of assignments include; property & business losses and employee fidelity claims.
Business economic losses typically include breach of contract, construction claims, trademark and patent infringements, product liability claims, and losses resulting from a breach of a non-compete agreement. Forensic Accountants probe into the terms and conditions, the circumstances leading up to the dispute, and they work upon the quantification of the losses arising out of it.
Another area where Forensic Accounting finds a great deal of applicability is the Insurance sector for personal use. A forensic accountant has the ability to quantify the economic damages arising from a vehicle accident or a case of medical negligence. A Forensic investigation is usually preferred in these cases because they have thorough knowledge about the legislative process relating to the settlement of the claim in these cases. Forensic accounting covers the review of insurance policies to determine coverage issues and methodologies for calculating potential losses.
Forensic accounting assesses losses in cases where financial compensation is involved. Thus, it is also useful in some offbeat regions, such as cases of divorce. These establish adequate compensation required for spouse and child support.
According to the Association of Certified Fraud Examiners (ACFE), fraud types and changes in the median loss increased more during the period from 2008 to 2012. The median fraud loss indicates that financial statement frauds are the most common type of fraud in the U.S. Misstatements on this front have led to the highest average loss at the organizational level in the U.S.
Statistical Tools used
- Benford’s Law: It is a mathematical tool used in identifying whether a variable under study is an occurrence of mistake or fraud. Once the variable is determined, the left-most digit of the variable is extracted and summarised for the entire population. This is a slightly complex model but widely used amongst the Forensic Accountants.
- Relative Size Factor (RSF): RSF is the ratio of the largest number to the second largest number in a given set of data. This technique determines the highest number in the data but in some reference with the second-highest data in the number. As per this technique, the records that are outliers are considered for further investigation.
- Data mining techniques: These programs are designed to scan through vast volumes of data for new, unexpected, or implicit information or patterns, automatically. Data mining techniques can be done in three ways: Discovery, Predictive modeling and Deviation, and Link analysis.
Apart from these, there is various computerized software for Data Extraction and Financial Analysis, which are widely used by Forensic Accountants.
Skills required for Forensic Accounting
Below are the duties of a Forensic Accountant.
Forensic accountants demonstrate the following.
- Strong Knowledge of accounting and auditing;
- Maths Skills – This is helpful so that they can crunch numbers quickly and analyze correctly.
- Oral and written communication skills;
- Strong eye for details
- Expert with information and communication technology;
- Good understanding of laws and legal procedures;
- Must exhibit business and organizational expertise.
Qualifications of a Forensic Accountant
Below is a qualification requirement from a job posting for Forensic Accounting.
Necessary Qualification required for Forensic Accounting jobs –
- Bachelor’s degree in Accounting, Finance or Economics
- Should be proficient with MS Office Suite
- CPA, ABV, CFE, CVA, CFF, MAFF, ACA, ACCA is a plus
Differences between Audit and Forensic Accounting
On the surface, most people tend to blur the differences between Auditing and Forensic Accounting. However, the fact remains that these two are entirely different streams and cannot be mixed. Let us take a glance at the significant differences between the two:
|An audit usually checks the books of accounts according to the generally accepted auditing standards (GAAP)||Analyzing financial documents to search for illegal activity within an organization, specifically white-collar crime.|
|Objective||Aimed at error detection and prevention||Aimed at Fraud detection|
|Process||Mainly checks for conformance to Accounting standards hence follows a predefined process||The process is investigative. Rather than seeking conformance, Forensic Accountants look for outliers or specific patterns. Instead of the process, the outcome is more defined and quantitative|
|Universe in consideration||Checks a sample of transaction||Forensics scrutinize every detail, not just a sample|
|Litigation perspective||Does not involve litigation perspective||The investigation carried out has to be documented and presented for litigation purpose in most cases|
|Skillsets||Auditors focus more on accounting knowledge||Forensic Accountants need to possess skills beyond accounting such as Criminalistics, advanced data analytics, information technology, knowledge of legal proceedings|
Forensic Accounting Salary
- Forensic Accountant in the US earns a median salary of approx. $64,520.
- The lower end of the reported salary was around $41,000 and was at $111,000 on the higher end (depending on experience and education).
Top Forensic Accounting Firms
|S. No||Top Firms|
|1||PwC (PricewaterhouseCoopers) LLP|
|2||Ernst & Young LLP (EY)|
|5||Grant Thornton LLP|
|6||BDO USA LLP|
|7||RSM US LLP|
|8||Crowe Horwath LLP|
|9||Baker Tilly Virchow Krause, LLP|
|10||Moss Adams LLP|
Roadblocks for Forensic Accounting
We know that Forensic Accounting has significant advantages and applications; however, it is not devoid of disadvantages. While it would be incorrect to say that, these are actually disadvantages or demerits. These can be termed as roadblocks or disruptions. Though it is important, it is surely a cumbersome process and involves a great deal of technical knowledge. Not every situation can afford Forensic Accounting scrutiny. Some of the roadblocks :
Issues related to confidentiality
Forensic Accountants are external entities who scrutinize the books of accounts of a company. Hence, this also ripens the chances of leakage of confidential matters. Certainly, the professional’s ethics and code of conduct demand that they maintain complete confidentiality about their findings. However, isolated cases of breach of trust cannot be ruled out. Even though the cases are rare, once the confidential details are leaked out, it can play havoc for the company.
A cost-oriented affair
Owing to the length of time needed, forensic accounting can turn out to be a huge cost-oriented affair. Though this isn’t necessarily an issue with large corporations, small businesses with limited means find it very difficult to spend funds on Forensic Accounting. It can make their budget go haywire. The expenditure involves high fees of the accountants, high-end accounting software, and if the findings are presented in court, then it also involves the legal fees.
Losing Employee Trust
Forensic Accounting can be a big dampener to employee morale. If the scrutiny does not reveal any negative results, employees may begin to feel that there is a lack of trust from the employer. In fact, they may not even be comfortable working in such tight inspection. Moreover, the co-operation or additional information required from employees may divert their focus from their core jobs.
Chances of negative corporate image
If the findings of the Forensic Accounting reveal the involvement of a certain individual, and he is charged with the offense, that employee might threaten to defame the company in order to escape a trial. The company in such a case is at crossroads. On the flip side, if the trailer for the financial fraud begins, it still faces a loss of reputation from outsiders and investors.
Case studies of Forensic Accounting
Enron: Early 2000
In the early 2000s, the notorious Enron accounting scandal shook the world. Enron borrowed money in order to maintain its rate of growth, which had propelled rapidly in 1999 and 2000. Reports suggest that they chose to hide debt from their books and investors by collaborating with certain fake companies and Special Purpose Vehicles. There was a lot of secret information being exchanged, and gradually everyone grew skeptical as to how Enron is making money. In late 2001, the SEC initiated investigation Enron’s partnerships, and it soon became apparent they owed over $6 billion in debt. The company had apparently adopted the “Mark-to-Market Accounting “technique, where it hid all its losses and inflated its profits.
The Forensic Accounting team investigated that there were complex accounting practices, misrepresentation of financials, and dubious partnerships. However, the huge scandal enforced the Sarbanes and Oxley Act in 2002. Sarbanes-Oxley brought in an entirely new field of investigation for Forensic Accountants. This Act imposed stringent penalties for tampering, altering or fabricating company financial records, and for trying to mislead shareholders through fraudulent accounting practices.
Tyco International: Late 2000
Tyco International was a company that grew manifold through inorganic measures. The company’s corporate scandal of 2002 stresses the issue of unethical business practice and related issues. Tyco’s case shows that ethics issues can occur in different parts of an organization. Even outsiders or third parties could get involved in these ethics issues. The major ethical issues in Tyco’s case were Unethical Leadership, Unethical business practice of subordinates, and Unethical auditing practice on Tyco’s business. Forensic Accountants were deployed to scrutinize the story behind major and minor audit loopholes.
Organizations for Forensic Accountants
- Association of Chartered Certified Forensic Accountants
- Forensic CPA Society
- National Association of Forensic Accountants
- The Institute of Certificate Forensic Accountants
- Association of Certified Fraud Examiners
Forensic Accounting Video
Despite all odds, Forensic Accounting is here to remain as long as there are financial crimes. According to PricewaterhouseCoopers, in 2014, 37.0% of global businesses have reported being impacted by economic crime, indicating a significant rise from 30.0% in 2009. The increase in the economic crime rate moderately justifies the industry’s rising demand, as the Forensic Accounting Services industry entails fraud prevention, detection, and other offerings, among other products.
Financial frauds and misappropriations occur irrespective of the size of the organization, and these have been on the rise. According to IBIS, over the past five years, companies have increasingly relied on third-party consultants, rather than in-house employees, to investigate on their behalf. Consequently, the revenue for the Forensic Accounting industry is expected to grow over the five years to 2021. However, not all firms involved with Forensic Accounting will grow at the same rate. There will always be a distinction between mediocre players and high profile players. Nevertheless, this remains a niche segment, and in the future, there may be new investigative techniques used to probe the cases.
This has been a guide to Forensic Accounting. Here we discuss applications, skills, and qualifications required for forensic accounting along with its case studies. You may learn more about accounting from the following articles –