Forensic accounting
Forensic accounting, forensic accountancy or financial forensics is the specialty practice area of accounting that investigates whether firms engage in financial reporting misconduct,[1] or financial misconduct within the workplace by employees, officers or directors of the organization.[2] Forensic accountants apply a range of skills and methods to determine whether there has been financial misconduct by the firm or its employees.[3]
History[edit]
Forensic accounting was not formally defined until the 1940s. Originally Frank Wilson is credited with the birth of forensic accounting in the 1930s. When Wilson was working as a CPA for the US Internal Revenue Service, he was assigned to investigate the transactions of the infamous gangster Al Capone. Capone was known for his involvement in illegal activities, including violent crimes. However it was Capone's federal income tax fraud that was discovered by forensic accountants. Wilson's diligent analysis of the financial records of Al Capone indicted him for federal income tax evasion. Capone owed the government $215,080.48 from illegal gambling profits and was guilty of tax evasion for which he was sentenced to 10 years in federal prison. This case established the significance of forensic accounting.[4]
Forensic accountants are necessary for a variety of reasons. They can be useful for criminal investigations, litigation support, insurance claims, and corporate investigations.[5]
Financial forensic engagements may fall into several categories. For example:
Methods[edit]
Forensic accounting combines the work of an auditor and a public or private investigator. Unlike auditors whose goal is focused on finding and preventing errors, the role of a forensic accountant is to detect instances of fraud, as well as identify the suspected perpetrator of the fraud.[2] Some of the most common types of fraud schemes include overstating revenues, understating liabilities, inventory manipulation, asset misappropriation, and bribery/corruption. To discover these, forensic accountants apply a variety of techniques.[21]
Forensic accounting methods can be classified into quantitative and qualitative. The qualitative approach studies the personal characteristics of the individuals behind financial fraud schemes. A popular theory of fraud revolves around the fraud triangle, which classifies the three elements of fraud as perceived opportunity, perceived need (pressures), and rationalization.[22] This theoretical construct was first articulated by behavioral scientist Donald Cressey.[23] More recently, forensic accountants have gone beyond incentive effects and focused on behavioral characteristics, a branch of accounting known as accounting, behavior and organizations, or organizational behavior. Certain predictive factors, like being labeled as “narcissistic” or committing adultery, are common traits among fraud perpetrators.[1] These characteristics are often not conclusive enough on their own to identify the culprit, but can help forensic accountants to narrow down a suspect list, sometimes based on behavioral or demographic factors.[24]
The quantitative approach focuses on financial data information and searches for abnormalities or patterns predictive of misconduct.[1] Today, forensic accountants work closely with data analytics to dig through complex financial records. Data collection is an important aspect of forensic accounting because proper analysis requires data that is sufficient and reliable.[25] Once a forensic accountant has access to the relevant data, analytic techniques are applied. Predictive modeling can detect potentially fraudulent activities, entity resolution algorithms and social network analytics can identify hidden relationships, and text mining allows forensic accountants to parse through large amounts of unstructured data quickly.[26] Another common quantitative forensic accounting method is the application of Benford's law. Benford's law predicts patterns in an observed set of accounting data, and the more the data deviates from the pattern, the more likely that the data has been manipulated and falsified.[27]
Analytical techniques[edit]
Forensic accountants utilize an understanding of economic theories, business information, financial reporting systems, accounting and auditing standards and procedures, data management & electronic discovery, data analysis techniques for fraud detection, evidence gathering and investigative techniques, and litigation processes and procedures to perform their work.[28]
When detecting fraud in public organizations accountants will look in areas such as billing, corruption, cash and non-cash asset misappropriation, refunds and issues in the payroll department. To detect fraud, companies may undergo management reviews, audits (both internally and externally) and inspection of documents.[29] Forensic accountants will often try to prevent fraud before it happens but searching for errors and in-precise operations as well as poorly documented transactions.[29]
The process begins with the forensic accountant gathering as much information as possible from clients, suppliers, stakeholders and anyone else involved in the company. Next, they will analyze financial statements in order to try and find errors or mistakes in the reporting of those financial statements as well as they will analyze any background information provided. The next step involves interviewing employees in order to try and find where the fraud may be occurring. Investigators will look at company values, performance reviews, management styles and the overall structure of the company. After this is complete the forensic accountant will try to draw conclusions from their findings.[30]