An Overview of Forensic Accounting

Although it has gained widespread recognition in recent years, the term “forensic accounting” is generally not well understood by the layperson. While many believe it is related to the investigation of white collar crime, it still remains somewhat of a mystery to  many as  I hope to demystify forensic accounting by providing a brief history, discussing common misconceptions, and the application of forensic accounting in modern times.

There is a misconception that the term “forensics” relates to medical examinations of crimes. Actually, the term “forensics” originated from the Greeks, who organized public debates and contests for speakers. These contests were labelled “for ensis,” which is the Latin term for “public forum.” The plethora of recent white collar crimes has brought the term “forensic accounting” to the mainstream. However, some historians suggest that the word “forensics” entered the English language in the 1600s, and some trace the origins of forensic accounting to a court case in 1817 (Meyer v. Sefton) in which an accounting expert witness was called upon to testify in a bankruptcy case. Seven years later, a chartered accountant in Scotland, James McClelland, was probably the first to hold himself out as a forensic accountant. Although he did not use the term “forensic accountant,” he advertised that his practice provided accounting services on disputed accounts that can be used in court. In the United States, the term “forensic accounting” was not developed until 1946. However, the FBI and IRS used forensic accounting techniques as early as 1931 in connection with the investigation of Al Capone. With all of the law enforcement officers investigating Mr. Capone, it ultimately took a forensic accountant named Elmer Irey to bring him to justice. Today, the term “forensics” refers to evidence that is “suitable for use in a court of law.” Consequently, the forensic accountant must undertake the investigation of the financial and accounting evidence with the anticipation that the work product will be used in litigation.

Forensic accounting, therefore, is the integration of accounting, auditing, business acumen, and investigative experience to provide a financial analysis and conclusion that may be suitable for use in a court of law. In addition to possessing the standard financial skill sets of accountants, auditors, and fraud examiners, the forensic accountant must be familiar with legal concepts and procedures. Failure to do so may render the forensic accounting evidence unusable.

Another common misconception is that fraud investigation and forensic accounting are synonymous; they are not. In criminal law, fraud is defined as the intentional deception made for one’s personal gain or to damage another individual. Fraud is a civil violation and a crime. Therefore, a fraud investigation is the investigation of a crime. A fraud investigation may or may not involve the use of forensic accounting techniques. In the case of certain types of corruption, such as the acceptance of illegal gratuities, it may not be necessary to employ forensic accounting techniques; the mere observation of the acceptance of the illegal gratuity may be sufficient. In other cases, such as embezzlement, the fraud investigator would likely use forensic accounting Techniques extensively.

On the other hand, in forensic accounting engagements, fraud may or may not be present. In the case of embezzlement, it is clearly involved. However, in commercial litigation, fraud may not be an issue. For example, two parties to a contract may have a disagreement over the appropriateness of financial calculations, or the interpretation of accounting records. The forensic accountant is not engaged to uncover fraud, but to render an opinion on the interpretation of financial calculations or accounting records. Consequently, the terms “fraud investigation” and “forensic accounting” should not be used interchangeably. Not all fraud investigations involve the use of forensic accounting techniques, and not all forensic accounting engagements involve allegations of fraud.

Another distinction worth examining is the comparison of a conventional financial statement audit to a forensic accounting investigation. The purpose of an audit is to render an opinion on the fairness of financial statements, and to make process improvement recommendations to the auditee. There is a healthy level of professional scepticism, but the working relationship is generally not adversarial. The forensic accountant’s job is to get the facts, find out what happened, and gather evidence.

 There is a heightened level of professional scepticism, and the working relationship is clearly more adversarial. The forensic accountant, unlike the traditional accountant, is trained to gather and preserve evidence that can be used in litigation. In addition, he must be prepared to testify under oath. A final misconception is that forensic accounting is focused solely on white collar crime. Although forensic accountants are often involved in investigations of asset misappropriation, they are also engaged in many other services including the following:

• Shareholders’ and partnership disputes

• Business interruption and other insurance claims

• Matrimonial disputes

• Business economic losses

• Tax controversies

• Professional negligence

• Fraudulent financial reporting

• Financial analysis

• Mergers and acquisitions

• Discovery assistance

Once you have determined that you require the services of a forensic accountant, there are several factors to consider before selecting one. To start, you will want to examine a potential forensic accountant's credentials. Ideally, he or she will be a CPA with at least one other forensic/fraud related credential. Some of the credentials you should look for include Certified Fraud Examiner, Certified Forensic Accountant and Certified in Financial Forensics. You will also want to make sure your forensic accountant is highly experienced. While a person with one or two years of experience is fine for performing certain accounting or auditing functions, they lack the street smarts and heightened level of professional scepticism required to look beyond the numbers and evaluate substance over form. They also lack the ability to recognize nonverbal signs during interviews that may indicate deception.

 Finally, a forensic accountant can bring a number of resources to the table. Most forensic accounting engagements require a wide range of skills and expertise examples are :

·        Forensic Accounting Services

·        Misappropriation and diversion of assets

·        Employee fraud and embezzlement

·        Business interruption and insurance claims

·        Reconstruction of financial records

·        Special accounting investigations

·        Review of corporate transactions

·        Fraudulent financial reporting

·        Discovery assistance

·        Calculation of damages

·        Expert testimony

·        Trial preparation services

·        Financial Analysis

·        Rebuttal advisory

·        Mitigation assessment

·        Mergers and acquisitions

In conclusion the need for forensic accountants can’t be over emphasised in today’s world where corruption is the order of the day as they aid in curbing this menace to a large extent.