Forensic Accounting: Money plays a critical role in many scams or crimes, and it comes in various forms, from small value thefts up to all widespread corruption within global businesses.
Legal cases involving financial crime can be very lengthy and complicated, with many strands of evidence to investigate.
Generally, accounting is all about crunching numbers and working out what it means for you and your business, but sometimes numbers are not enough to show the whole truth clearly.
That’s when forensic accounting comes into the spotlight.
Forensic accounting is more than just figures to display a company’s financial status in legal terms fully.
Let’s explore Forensic Accounting in greater depth with this guide.
This blog post is divided into the following sections:
- What is Forensic Accounting?
- History of forensic accounting?
- Forensic Accounting VS Auditing?
- What Forensic Accountants Do?
- What Are The Objectives Of Forensic Accounting?
- How Does Forensic Accounting Actually Work?
- What Are The Key Areas Of Work For Forensic Accountants?
- What Are The Advantages Of The Forensic Accounting?
What is Forensic Accounting?
While the word “Forensic” seems like forensic accounting takes place at some crime scenes, but that’s not how it works.
Forensic accounting is the application of accountancy knowledge and skills in the circumstances having legal consequences. The term Forensic accounting is not defined in the statute.
There are many circumstances with legal consequences, fraud being the common one. Other such cases include economic damage calculations, money laundering, bankruptcies, computer forensics, securities fraud, breaches of warranties and list goes on.
Forensic accountants are often hired to prepare for litigation related to insurance claims, insolvency, divorces, fraud, skimming, and any type of financial theft.
History of forensic accounting
Forensic accounting was formally defined after 1940’s famous Al Capone case. Frank Wilson in the 1930s while working as a CPA for the US Internal Revenue Service was assigned to investigate famous gangster’s financial transactions. It was not Capone’s illegal activities that Frank Wilson was investigating, but rather it was his involvement in income tax fraud. Wilson’s analysis of the financial records of Capone indicted him for income tax evasion.
Capone, who owed USD 215k in income taxes, was subsequently found guilty of tax evasion and sentenced to 10 years in Federal Prison. This case, for the first time, established the significance of the forensic accounting
Forensic Accounting VS Auditing?
The key difference between forensic accounting and auditing is that in audits, there will be a clear audit process and framework to the work to be followed, but in forensic accounting, there is not any clear framework.
Significant differences between forensic accounting and external audit are:
- The company, provided it meets specific criteria, have a legal requirement to have an annual audit;
- The shareholders appoint auditors in the company’s annual general meeting,
- Auditors are not responsible for detecting fraud; and
- After the annual audit, auditors usually issue an opinion about whether financial statements present a true and fair view.
None of this applies in case of a forensic accounting assignment.
What Forensic Accountant Do?
Forensic accountants help management, shareholders, investors, governments, lawyers, law enforcement agencies and other financial institutions investigate fraud and take the case to court by using their specialist accounting knowledge.
The forensic accountant helps prosecutors punish the individuals responsible by providing litigation support. In the UK, the relevant legislation is contained in the Proceeds of Crime Act 2002.
Forensic accountants have various different tasks on a daily basis.
It is common for forensic accountants to identify assets so that they can be recovered by tracing funds.
These professionals will also perform financial analysis and prepare reports from the findings to help in legal cases.
If needed, the professional may also be asked to testify in court for the prosecution.
What is The Objective Of Forensic Accounting?
Finding out the proof of a crime and present it in a way that can stand up in a court of law is the main objective of forensic accounting.
How Does Forensic Accounting Actually Work?
To uncover the frauds and crimes, the Forensic accountant takes heed of numerous documents and information, such as:
- Speak to the associated parties
- Study the financial statements
- Study court records
- Study internal data
- Analyse audit trail
- Collaborate with lawyers or government officials
- Study bank statements, credit statements
- Study correspondence like invoices, letters, and emails
- As most of the transactions are executed electronically, forensic accountants use specialists’ tools to trace transactions. This often involves using sophisticated statistical techniques.
- Conduct interviews
What Are The Key Areas Of Work For Forensic Accountants?
Measurement Of Damages & Loss Of Profits
Assessing an effect on cash flow, profitability, income or value, that the party claims to have incurred, or may incur, as the result of either a breach in a contract, product liability, personal injury breaches of the Trade Practices Act or Fair Trading, and more.
A Forensic Accountant may also need to consider the impact of some other circumstances on the claimed loss, and the degree to which a loss was mitigated or could have been mitigated to determine the actual loss incurred.
Reviewing the actions and transactions, or inaction, of various professionals to determine whether the parties were negligent and, if so, to what extent.
When the review involves an accounting professional, the applicable accounting standards and the prevailing law are essential.
Therefore, the Forensic Accountant should have the ability to identify the impact and timing of changes in law and procedures.
Determining the value of businesses, shares, partnerships, intangibles, etc. in dispute, lost or destroyed.
A Forensic Accountant must review information as both the financial analyst and as the investigating accountant, making suitable adjustments, where necessary, and applying a generally accepted, or arguable, methodology to determine the value.
Investigating frauds and establishing procedures to detect fraud. For example, infamous Bernie Madoff’s Ponzi scheme.
The Forensic Accountants are frequently called upon to investigate frauds, identify the appropriate documentary evidence, quantify the loss & to assist in the prosecution of those involved.
What qualifications forensic accountants hold?
- Forensic accountants typically hold the following qualifications
- Certified Forensic Accounting Professional (CFA – Certified Forensic Auditors) (England & Wales) granted by the Forensic Auditors Certification Board of England and Wales (FACB)
- Certified Fraud Examiners (CFE – US / International)
- Certificate Course on the Forensic Accounting and Fraud Detection (FAFD) by Institute of Chartered Accountants of India (ICAI)
- The American Institute of Certified Public Accountants (CFF-Certified in Financial Forensics)
- Certified Management Accountants (CMA – Canada)
- Chartered Professional Accountants (CPA – Canada)
- Chartered Certified Accountants (CCA – UK)
- Certified Forensic Investigation Professionals (CFIP)
What Are The Advantages Of The Forensic Accounting?
Forensic accounting requires deeper specialism than standard accounting practice.
Well established companies will have a dedicated forensic accountant to ensure they are always compliant and ensure financial exchanges with other parties are executed correctly.
The advantages of forensic accounting include:
- Helps solve and prevent financial crimes
- Helps monitor your current processes and teams
- Helps evaluate the compliance of parties you are considering working with
In short, it is a specialist domain, and not every business requires one. Usually, it is best to hire forensic accountants on a project basis. Small companies typically don’t need their services. Remember that forensic accountants are also accountants. They are not law enforcers, prosecutors, judges or juries. Their role is to provide an expert opinion.