Forensic Accounting
By:
Olivia Bischoff
Justin Bost
Michael Kane
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Over the last decade the number of white collar crimes committed in the United States
has been increasing due to accounting frauds. Whether it was Enron or WorldCom in the early
2000’s, executives have been pressured into illegal activities by misstating their overall
company’s financial numbers. Due to the complicated nature of these problems, forensic
accountants are needed to diagnose accounting frauds behind each company’s illegal activities.
Once the forensic accountants diagnose the accounting errors used to miss lead the public, they
then need to present the information to the courts or the public. According to SmartMoney
Magazine, forensic accounting is counted as one of the ten hottest jobs in the next decade due to
the increase in white collar accounting crimes happening across the country. Clearly, forensic
accounting is an up and coming profession where accounting and detective work converge to
create a very intriguing profession.
Forensic accounting is when accountants use accounting, auditing, and techniques to dig
deep to undercover legal matters pertaining to fraud, to uncover illegal activities within a normal
business practice, and some civil matters. They are involved in investigating and analyzing
financial evidence, developing computerized applications to assist in the analysis and
presentation of financial evidence, communicating their findings in the form of reports, and
assisting in legal proceedings. Forensic accountants are usually retained by lawyers, police
forces, insurance companies, governmental regulatory bodies and agencies, banks, courts, and
the business community. Forensic accounting is broken down into two main areas: litigation
support and investigation.
Litigation support is when the forensic accountant presents the economic issues related to
any existing or pending litigation. This means the accountant must assess the damages sustained
by the parties involved in a given legal dispute. The accountant is there so he or she can assist in
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resolving the dispute before the case even reaches court. If the dispute does end up going all the
way to court then the forensic accountant can testify as an expert witness. Inside the courtroom
the forensic accountant must take all the accounting information and must present it in a way that
is clearly understandable to the public. The forensic accountant is also present in the courtroom
to cross-examine the opposing expert’s testimony as well as the opposing expert’s damage
reports.
The second part of a forensic accountant’s job is the investigation side, which is
determining whether criminal matters like fraud have taken place. Not only is it the jobs to
investigate certain matters, but the forensic accountants may also recommend certain actions to
be taken to minimize future risk of loss on each type of legal matter. Forensic accountants will
often use investigation on certain employee thefts, securities fraud, insurance fraud, falsification
of financial statements. The accountant is there to investigate and assist with the protection and
recovery of assets.
Forensic accounting involves a wide range of investigations happening within different
business industries. For example, forensic accountanting can be used in professional negligence.
In these instances, the accountant will see if there was a breach of GAAP or GAAS. The two
biggest examples of this type of case would be Enron and WorldCom, where executives did not
follow GAAP and committed accounting fraud to personally benefit from the accounting errors.
Forensic Accountants would also be called in if there were a dispute between shareholders or
partners. An example of this would be the compensation and benefits received by each of the
partners or shareholders in the dispute. The forensic accountant is there to investigate and apply
what he or she knows and to give an unbiased opinion on the dispute. A forensic accountant can
also be used in personal injury cases such as motor vehicle accidents. In these cases, the forensic
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accountant is there to calculate the economic damages associated with each party involved.
Another type of case where a forensic accountant will be in need of assistance is with insurance
claims. Here, the accountant must review the insurance policy and investigate coverage issues to
assess the amount of loss associated with it. Finally, forensic accountants can also be used in
civil matters like a divorce. In this case, the forensic accountant would investigate to see if any
spouse is hiding any assets on the other.
There is a detailed process of how a forensic accountant would go about doing a typical
assignment. First, the accountant meets with the clients in order to obtain the facts in the case.
The accountant may also meet with other people involved in the issue. Next he or she should
perform what is called a conflict check. The conflict check is when the accountant sees if there
is actually a legitimate conflict between the relevant parties. Once the accountant has established
that there is a conflict between the parties, he or she then performs an investigation. Once the
investigation stage has been completed the forensic accountant develops a plan of action. This is
combing their investigation results and their interactions with the client to come up with a set of
objectives and the methods to accomplish these objectives. The next step is to obtain the relevant
evidence in the case. This step differs from case to case but it could involve certain assets,
documents, a person, company, or economic information. Once this is done, the forensic
accountant can then perform the analysis on the case. This may involve doing a sensitivity or
regression analysis, tracing assets, computing economic damages, presenting value calculations,
and summing up a large amount of transaction that took place. Once the accountant has finished
the analysis process then he or she can prepare and issue a report. The report will have in it the
nature of the assignment at hand, scope of the investigation, the certain approach taken, and the
most important part of all: their opinion on the issue.
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Large-scale scandals aside, it is commonly lower-level employees that pose a threat of
fraud and asset misappropriation, especially when internal controls are weak. In these cases,
many companies bring in forensic accountants in attempts to keep things quiet. John O’Connor,
the head of the New England forensic accounting practice at Deloitte & Touche said, “The
charter in virtually any issue is, ‘Tell me how big my problem is, how I got there, who’s
involved, and how to fix it. And fix it so we don't have to go through this a second time. And ... I
don't want to read about this in the newspaper.’ ” Most companies would prefer to handle smaller
situations, such as employee theft of cash and other assets, internally and keep it out of the public
eye. Corporations may decide to not bring a case against the perpetrator in these cases to avoid
the embarrassment of management appearing to not be in control of the company. (Pope)
Under regulations of the Sarbanes-Oxley Act of 2002 (SOX), Section 302, CEOs and
CFOs must certify that the financial statements are free of material misstatement to the best of
their knowledge, that they are responsible for establishing and maintaining a set of internal
controls to ensure that financial disclosures are complete and accurate, that they have recently
evaluated the effectiveness of the controls (within 90 days), and that they have communicated
any deficiencies to the auditors and audit committee. (Sarbanes-Oxley) In order to protect
themselves, senior management at publicly held companies may see it necessary to use forensic
accountants as a proactive measure to establish strong internal controls and detect fraud. By
using this approach, CEOs and CFOs could sign the required certifications more confident that
the financial statements were not materially misstated. (About Forensic Accounting)
In recent years, corporations have found a greater incentive to bring in forensic
accountants. “(Companies) understand that if the corporation investigates (a problem) thoroughly
and brings it to the attention of regulators, then the company hopes to be dealt with as a
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cooperating entity,” said Rhea Dignam, a partner at the forensic division of Ernst & Young U.S.
LLP. (Pope) The WorldCom fraud showed how important the cooperation of a company is.
When the government intervenes, cooperating parties involved in the fraud can avoid going to
trial and receive much short sentences, as shown by the five year sentence Scott Sullivan,
WorldCom’s CFO, received after cooperating compared to the twenty-five year sentence CEO
Bernard Ebbers received. The judges in the case against Bernard Ebbers stated the fact that
Ebbers did not plead guilty or cooperate as others had was “a reasonable explanation of the
different sentences.” (Cooper 335-338) Since this precedent, companies have found that it is in
the best interest of all parties involved in large-scale fraud to cooperate, and many companies do
this in the form of hiring forensic accountants.
Forensic accounting, like any other field, does have some issues or problems.
Professionals, committees, and government regulators are all taking steps toward improving
current systems or procedures to fully maximize the potential of forensics in fraud detection.
Many of the larger concerns are not exclusive to forensic accounting. The differences between a
financial statement audit and a forensic audit are being outlined by many and weaknesses
addressed. Globalization is increasing awareness in international issues within fraud
investigations. Emerging technology is making headway and changing the way forensic
accounting is being utilized.
Forensic audits and financial statement audits are similar in many ways. The differences
however are what make the forensic audit a much more powerful tool in fraud detection. Much
like any fraud detection there is a significant reliance on “whistleblowers” to initiate
investigations. Most fraud in the country requires some sort of inside initiative to get around
collusion and elaborate transactions. Often times the resources needed for victims to recover are
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no longer available by this point. This leads to one of the most important differences between
financial and forensic audits; that a forensic audit is not proactive but reactive. There needs to be
improvements in earlier detection before such schemes and damages get beyond the point of
recoverable.
While progression in the field is moving quickly, especially in the wake of such highprofile cases like WorldCom, Enron, and Bernie Madoff, it is still failing to exceed the
complexities of what makes fraud so difficult to investigate. Technologies are not only helping
the cause of fraud detection but it is also being used to alleviate it. Like so many other
regulations or laws that are put into place, it seems that for every one that is created a way
around it is as well. There is an increasing need for information technology specialists in the
field and these are almost becoming more desired than accounting specialists. It is expected that
there will be more hiring of professionals with backgrounds in information/ computer science
engineering who can be taught business skills like accounting, rather than the firms trying to
teach forensic technology skills to traditionally trained accountants (Hydoski).
There are also international issues that should be considered as well. There is the ever
increasing globalization of many companies and industries as well as personal finances being
diversified among international markets. The tracking of money within fraud investigations will
often lead beyond domestic finances. This is expected to be the case in the recent Madoff
scandal. Ken Yormark, managing director and forensic accountant at LECG, consultants in New
York, says “I would be surprised if we don’t find [Madoff] has money someplace other than the
U.S., since he took trips overseas on a regular basis” (Scherer).
With such problems that stem from the inadequacies within fraud detection there is the
question of, “where is the industry headed?” One has to wonder what do these changes in the
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field, as well as the typical business environment, mean for those who are involved. Some
advances in modern technology that assist forensic accountants today may even be considered
boarder line science fiction. One system that may tackle the problem with early detection as
opposed to post-detection is artificial intelligence. “Artificial intelligence will prove particularly
valuable in this area, letting systems get progressively “smarter” as they detect patterns that were
not noticed before.” Systems will be able to take given information and predict, with reasonable
certainty, a fraudulent situation or at the least raise a red “flag”. (Hydoski)
There is also a shift in how data is gathered and analyzed. Terms like “data mining” and
“data extraction” sound as if accountants are sorting huge mountains of information. It has been
said that the documents that needed to be sorted through during the Enron scandal could fill
entire rooms ceiling to floor. Now those amounts of information can be kept in virtual servers
that could be controlled, altered, and even stolen remotely. This is creating a shift in focus to
information management, data analytics, and an emphasis on reliable internal controls. The gap
between reliability of the information and reliability of control/ access of the information is
getting smaller as advances such as these continue.
Fraud detection and forensic accounting can not keep up with emerging markets and their
complexities on its own. Some may even argue that intrinsically can not be understood
regardless of how much help they have. It is widely accepted that the resources of private
industry far exceed the resources government has available to monitor those industries. There are
regulatory bodies taking a proactive look at these issues even more so since the Sarbanes-Oxley
Act of 2002 which created the Public Company Accounting Oversight Board. In 2007, the
Standing Advisory Group of the PCAOB conducted a panel discussion on forensic audit
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procedures. Differences among financial statement audits and forensic audits were outlined and
options on merging the two were discussed.
The lack of established standards set within a forensic audit makes it very effective. An
investigator may not be subject to a pre-designed audit plan that is designed with considerations
such as budgeted cost. The auditor determines what is relevant based on evidence that is being
gathered and works on more of a case by case basis. Professional judgment holds a heavy weight
on a forensic audit but can also be more difficult to predict by those committing the fraud. The
benefits of forensics in an audit may not be substantial enough to make it required in all
circumstances and is not currently mandated by the PCAOB. Some options were considered for
using forensic accounting to improve fraud detection and close the expectation gap. The option
to conduct a forensic audit on a regular basis could be too costly to the Board and too intrusive to
parties involved. There is also the option to conduct the audit on a random basis allowing the
process to be less costly and burdensome, yet less effective. Other options discussed were
“choice-based” allowing the choice of stakeholders to decide on conditions of the forensic audit
process or to conduct such an audit at all.
The American Institute of Certified Public Accountants (AICPA) has taken the position
that external auditors shouldn’t be required to perform specific forensic audit procedures, but
instead “provide guidance on how to include forensic auditing techniques within the processes
outlined in SAS No. 99.” The AICPA thought it would be more cost-effective for public
accounting firms to use forensic accountants in establishing the best approaches for planning and
fieldwork in all audits, requiring them to help on individual audits for high-risk clients only. This
will keep audit costs down, but it may not be the most effective way to detect fraud. It is
important to use forensic accounting resources whenever potential fraud is detected, not just for
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high-risk clients. To do otherwise would put into question the auditing team’s due diligence.
(Rezaee)
While regulatory bodies have yet to require forensic audits, scandals in the past decade
(Enron, WorldCom, Madoff) clearly show the importance of earlier detection of fraud. A study
was performed surveying 253 participants regarding the addition of forensic skills to the audit
process. Of the participants, 102 were account academics, 73 were auditors, and 78 were forensic
accountants. The study tested the level of agreement to different statements. The highest
agreement found was for the statement, “The current regulatory environment, The SarbanesOxley Act of 2002, Statement on Auditing Standards No. 99 (SAS 99), The Public Company
Accounting Oversight Board, and the augmented responsibility for detecting management or
employee fraud has increased the need for auditors to possess foundational forensic accounting
skills.” The costliness of forensic audits has currently prevented them from becoming mandatory,
but this study shows the need for all auditors to possess a greater level of forensic accounting and
fraud education. Increasing the forensic accounting skills of all auditors could increase the
effectiveness of the audit, ensuring that experienced forensic accountants could be called in at
the first sign of fraud. The education of these forensic accounting skills should be integrated into
both college curriculums and job training at firms to best ensure that auditors are prepared to
identify the early signs of fraud. (DiGabriele)
The second highest level of agreement was the statement, “If the future demand for audits
will depend on the auditor’s ability to detect & deter fraud, forensic auditing procedures
(focusing on exceptions, oddities, accounting irregularities and patterns of conduct) should be
added to current audit programs (sampling for material misstatements and focusing on errors,
omissions) in a cost efficient manner.” Adding these procedures would certainly increase the cost
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of audits, but at the benefit of all stakeholders. The frauds at Enron and WorldCom showed the
massive impact the failure of large corporations can have. Investors, employees, suppliers,
customers, and communities are all affected by fraud in large corporations and these parties
demand accurate financial information and assurance of this information, which is not cheap.
However, the additional costs of including forensic audit procedures in audits pales in
comparison of the losses fraud can create. (DiGabriele)
The current economic climate has increased the incentives of both top management and
low-level employees to commit fraud. Technological advancements and globalization have made
it harder to detect. The result is a greater need than ever before for forensic accounts to help
prevent and detect fraud, analyze the results, and present the case to a court if necessary. In the
past decade, there has been an increasing need for forensic accounting to be used proactively.
However, regulatory bodies have been hesitant to mandate forensic audits due to cost-benefit.
Many companies have started to seek forensic accountants on their own for many different
reasons that include determining the size of fraud and necessary restatements, handling smaller
situations internally, SOX compliance, and to appear like a cooperating entity. Despite this, it is
still not enough for forensic accounting to be used by only some companies. Surveys show that
the accounting community holds the position that auditors should have increased forensic
knowledge and that forensic procedures should be incorporated into financial audits. Prevention
through internal controls and early detection through forensic audits remain the best ways to
minimize losses due to fraud. Until regulating bodies require forensic procedures, the accounting
profession should increase forensic education at all levels to best protect stakeholders.