Forensic Accounting and Fraud Investigation for Non-Experts

Howard Silverstone, Michael Sheetz, Stephen Pedneault, Frank Rudewicz

• Publisher: Wiley
• Year: 2012
• ISBN:
  9781118234808
• Edition: 3
• Topic: Betriebswirtschaft
• Subtopic: Finanzbuchhaltung

Fully revised, the proven primer on forensic accounting with all-new cases

A must-have reference for every business professional, Forensic Accounting and Fraud Investigation for Non-Experts, Third Edition is a necessary tool for those interested in understanding how financial fraud occurs and what to do when you find or suspect it within your organization. With comprehensive coverage, it provides insightful advice on where an organization is most susceptible to fraud.

• Updated with new cases and new material on technology tools in forensic accounting
• Covers the core accounting, investigative, and legal aspects of forensic accounting for professionals new to the field
• Covers investigative and legal issues along with accounting schemes

Written by a team of recognized experts in the field of forensic accounting, Forensic Accounting and Fraud Investigation for Non-Experts, Third Edition is essential reading for accountants and investigators requiring the most up-to-date methods in dealing with financial fraud within their organizations.

PART I

Forensic Accounting and Fraud Overview

CHAPTER 1
Forensic Accounting

What Is Forensic Accounting?

Ask any two practicing forensic accountants to define what forensic accounting is, and you are likely to get two different answers. Both may be accurate, and there likely will be some similarities within the responses, but still there is no one consistent answer recited by everyone who practices in this specialized area of accounting. The responses provided will depend largely on the background, experience, and areas of practice of each individual forensic accountant.

Forensic accounting definitions commonly refer to fraud, fraud prevention, and fraud investigations as the role of the forensic accountant. While those definitions are not necessarily inaccurate, they provide a definition of forensic accounting only within the specific context of fraud. Many books have even been written about forensic accounting that focus the writing on fraud schemes, preventing them as well as investigating them, and include a wealth of information relating to fraud. This is the case with A Guide to Forensic Accounting Investigation by Golden, Skalak, and Clayton. It is an excellent publication and one I rely heavily upon in my class as an adjunct professor at the University of Connecticut, but the issue is this—the book is titled A Guide to Forensic Accounting Investigation and not A Guide to Fraud Investigation. Fraud is only one context where the skills of forensic accounting can prove invaluable—there are many, many other contexts beyond fraud to which forensic accounting applies.

In searching the materials available, the following definition is found within Forensic Accounting by Hopwood, Leiner, and Young:

Forensic accounting is the application of investigative and analytical skills for the purpose of resolving financial issues in a manner that meets standards required by courts of law. Forensic accountants apply special skills in accounting, auditing, finance, quantitative methods, certain areas of the law, research and investigative skills to collect, analyze and evaluate evidential matter and to interpret and communicate findings.¹

Forensic Accounting and Fraud Examination by Kranacher, Riley, and Wells defines financial forensics similarly, as follows:

Financial forensics is the application of financial principles and theories to facts or hypotheses at issue in a legal dispute and consists of two primary functions:

1. 1. Litigation advisory services, which recognizes the role of the financial forensic professional as an expert or consultant
2. 2. Investigative services, which makes use of the financial forensic professional’s skills and may or may not lead to courtroom testimony.

Financial forensics is the intersection of financial principles and the law and, therefore, applies the (1) technical skills of accounting, auditing, finance, quantitative methods, and certain areas of the law and research; (2) investigative skills for the collection, analysis, and evaluation of evidentiary matter; and (3) critical thinking to interpret and communicate the results of an investigation.²

Perhaps Crumbley, Heitger, and Stevenson Smith in their book Forensic and Investigative Accounting, Second Edition, provide the clearest and most concise definition of forensic accounting: “Forensic accounting is the use of accounting for legal purposes.”³

They continue in their initial discussions about forensics and accounting to include a much longer but equally understandable definition, as follows:

Forensic accounting is the action of identifying, recording, settling, extracting, sorting, reporting, and verifying past financial data or other accounting activities for settling current or prospective legal disputes or using such past financial data for projecting future financial data to settle legal disputes.⁴

Why Has Forensic Accounting Become the Buzz?

Forensic accounting is not a new specialized area of accounting. On the contrary, the skill set and activities encompassing forensic accounting have been around for quite a while, although it wasn’t necessarily always called forensic accounting. As far back as 1554, an individual by the name of Hercules De Cordes, a schoolmaster and bookkeeper, testified on three occasions as an expert witness.⁵ By the late 1800s, articles relating to fraud, investigations, and expert witnessing began to appear. The person credited for likely being the first to coin the phrase forensic accounting was Maurice E. Peloubet, a partner in the public accounting firm Pogson, Peloubet & Company in New York.⁶

Law enforcement agencies at the federal, state, and local levels historically have recruited and trained individuals to investigate financial matters, as have many other governmental and nongovernmental agencies and organizations. Recruiters continue today to appear on college campuses around the country seeking to attract accounting and finance graduates into the field of forensic accounting and fraud, and schools across the country and around the world have started offering courses and in limited cases undergraduate and graduate degrees specific to forensic accounting.

Certainly the opportunity to apply accounting and auditing knowledge, training, and experience to careers in preventing and investigating financial crimes has created much excitement among accounting majors, potentially driving more students toward a degree in accounting who otherwise would have pursued a different major.

It seems it wasn’t until several major financial statement fraud schemes occurred in the early part of this century, dominating the headlines for months if not years—most notably the massive financial and accounting scandals involving Enron and WorldCom—that the term forensic accounting became commonplace. US News and World Report in 2002 issued its top 20 hottest jobs list, and topping the list was “forensic accountant.” Congressional hearings, press conferences, and news stories regularly focused on the work of the forensic accountants engaged to uncover the truth in the widely publicized frauds. Since then references have become common in books, television shows, and movies relating to forensic accounting. One show in particular, Law and Order, has referenced forensic accounting in numerous episodes. Shows have now been developed focusing mainly on financial crimes, most notably USA network’s White Collar.

Interesting enough, although forensic accounting has captured the attention of Hollywood and the like, the context in which forensic accounting has been used within their shows has not always been accurate. So exactly what does forensic accounting entail?

Introduction to a Profession

What might have started with traditional accountants, tax preparers, and auditors participating in litigation-type client engagements, drawing upon their accounting training and experience to help resolve some type of dispute or other matter, has developed into the need for individuals with specialization. Today, individuals and even entire firms are focused solely on forensic accounting, litigation support, and/or business valuation. Courts, counsel, and clients seek experts who have specialized training and experience specific to the skills needed to resolve their issue, and in response colleges and universities have started offering courses at the undergraduate and graduate levels specific to forensic accounting. Auditing texts have incorporated fraud-related topics and forensic accounting techniques into the traditional auditing literature to begin to close the gap between financial statement auditors and fraud auditors.

Students today have a choice when deciding on a school to attend as well as their major: to follow the traditional accounting program or to specialize right from the beginning in the forensic accounting field. The customary route to becoming a CPA also is changing in response to this specialization. In Connecticut, for example, until 2010 individuals who wanted to become CPAs were required to work in the audit or attest area for a minimum of six months as part of their experience requirement. That requirement forced students to enter the world of public accounting, if for no other reason than to gain their six months of experience. Everything changed in Connecticut in 2010 when the State Board of Accountancy modified the experience requirement, eliminating the minimum of six months of attest experience, thereby allowing candidates to go directly from school into a boutique accounting firm to gain experience within their desired specialization. Candidates do have to gain their experience under the direct supervision of a CPA; however, the experience areas are much broader and also allow candidates working in private industry to qualify for their CPA certificate.

Applications for Forensic Accounting

Although fraud seems to receive the most coverage, there are several other common applications for forensic accounting. In 2008, after recognizing the need for a credential in forensic accounting beyond the widely recognized Certified Fraud Examiner (CFE) designation, the American Institute of Certified Public Accountants (AICPA) announced a new credential for those CPAs who focus on forensic accounting and litigation support. The credential, Certified in Financial Forensics (CFF), became effective in September 2010, and the AICPA defined the field of forensic accounting to include a fundamental basis of knowledge along with specific practice areas or applications for forensic accounting.

Fundamental Knowledge

• Laws, Courts, and Dispute Resolution
• Planning and Preparation
• Information Gathering and Preserving
• Discovery
• Reporting, Experts, and Testimony

Specialized Forensic Knowledge

• Bankruptcy, Insolvency, and Reorganization
• Computer Forensic Analysis
• Economic Damages Calculations
• Family Law
• Financial Statement Misrepresentation
• Fraud Prevention, Detection, and Response
• Business Valuation

Bankruptcy, Insolvency, and Reorganization

Forensic accountants can be retained on behalf of the debtor, the individual or organization contemplating or already in bankruptcy, or for the creditors, those individuals or entities that remain to be paid. The role for the work may be to assist the trustee in managing the financial affairs, searching for hidden assets, identifying pre-bankruptcy transfers, recovering funds and assets to be used to satisfy creditors, or performing business valuations to be used in resolving the bankruptcy filing. Forensic accountants also can be retained by creditors seeking to determine whether additional assets exist, or whether there were any payments made immediately prior to filing. Each creditor stands to collect less than the full amount due, so the more funds and assets that can be located and returne...