Forensic Accounting

What is Forensic Accounting?

Forensic accounting or financial forensics is the specialty practice area of accountancy that describes engagements that result from actual or anticipated disputes or litigation. “Forensic” means “suitable for use in a court of law”, and it is to that standard and potential outcome that forensic accountants generally have to work. Forensic accountants, also referred to as forensic auditors or investigative auditors, often have to give expert evidence at the eventual trial.

All of the larger accounting firms, as well as many medium-sized and boutique firms, have specialist forensic accounting departments. Within these groups, there may be further sub-specializations: some forensic accountants may, for example, just specialize in insurance claims, personal injury claims, fraud, construction  or royalty audits.

Financial forensic engagements may fall into several categories.

For examples:

  • Economic damages calculations, whether suffered through tort or breach of contract;
  • Post-acquisition disputes such as earnouts or breaches of warranties;
  • Bankruptcy, insolvency, and reorganization;
  • Securities fraud;
  • Business valuation; and
  • Computer forensics/e-discovery.

Forensic accountants often assist in professional negligence claims where they are assessing and commenting on the work of other professionals. Forensic accountants are also engaged in marital and family law of analyzing lifestyle for spousal support purposes, determining income available for child support and equitable distribution.

Engagements relating to criminal matters typically arise in the aftermath of fraud. They frequently involve the assessment of accounting systems and accounts presentation—in essence assessing if the numbers reflect reality.

Some forensic accountants specialize in forensic analytics which is the procurement and analysis of electronic data to reconstruct, detect, or otherwise support a claim of financial fraud. The main steps in forensic analytics are (a) data collection, (b) data preparation, (c) data analysis, and (d) reporting. For example, forensic analytics may be used to review an employee’s purchasing card activity to assess whether any of the purchases were diverted or divertible for personal use.[4]

Forensic accountants may be involved in recovering proceeds of crime and in relation to confiscation proceedings concerning actual or assumed proceeds of crime or money laundering. In the United Kingdom, relevant legislation is contained in the Proceeds of Crime Act 2002. In India there is a separate breed of forensic accountants called Certified Forensic Accounting Professionals. In other countries, some forensic accountants are also Certified Fraud Examiners, Certified Public Accountants with AICPA’s Certified in Financial Forensics (CFF) Credentials, Chartered Accountants or Chartered Certified Accountants.

Forensic accountants utilize an understanding of economic theories, business information, financial reporting systems, accounting and auditing standards and procedures, data management & electronic discovery, evidence gathering and investigative techniques, and litigation processes and procedures to perform their work. Forensic accountants are also increasingly playing more proactive risk reduction roles by designing and performing extended procedures as part of the statutory audit, acting as advisers to audit committees, fraud deterrence engagements, and assisting in investment analyst research.

“While Forensic Accountants usually do not provide opinions, the work performed and reports issued will often provide answers to the how, where, what, why and who. The FAs have and are continuing to evolve in terms of utilizing technology to assist in engagements to identify anomalies and inconsistencies. It is important to remember that it is not the Forensic Accountants that determine fraud, but instead the court.”

The Role Of Forensic Accountants In Matrimonial Law

It is no surprise that financial issues are among the most contentious in family law matters. The financial aspects associated with marital disputes and dissolution are often complex and consume most of the effort and attention of the parties. Forensic accountants possess unique skills that allow them to provide valuable support to divorcing spouses and their legal representatives. While lawyers have traditionally engaged accountants to assist with general financial issues related to divorce, they are increasingly relying upon forensic accountants to provide more in-depth forensic services.

A forensic investigation is advisable and should be considered in situations where one spouse is suspected of concealing income or assets or when it is the only means for procuring financial information. It may also be beneficial when there is a closely held business or a highly compensated spouse.

Detecting hidden, transferred or deferred income is complicated, however forensic accountants have several effective techniques for uncovering such income. These techniques include the analysis of the family’s … income (determining it) is sufficient to support the family’s expenditures; an examination of the couple’s net worth at two or more points in time; … and an analysis of bank deposits.

Closely held business is often a prime vehicle for hiding assets or income. A forensic examination of the business can be worthwhile where the opposing spouse is actively involved in the day-to-day operations and is suspected of using business assets or income for his or her personal benefit in excess of reported income. Often, the owner of a closely held business will take advantage of his position of control over the company’s finances in order to extract additional compensation by either the payment of personal obligations using corporate funds, engaging in non-arm’s length transactions with related entities, or through the payment of excessive perquisites such as homes, cars, airplanes, etc.

The investigation typically yields a financial road map to the hidden value of the business. Undertaking such an investigation on the client’s behalf can also protect the attorney from a future malpractice claim.

Since a closely held business is often the largest asset subject to equitable distribution in a marital dissolution, obtaining an accurate business valuation is essential. The business appraiser typically prepares a valuation for the entity based upon the “normalized” income for the business. That is, the appraiser’s valuation should be based upon the earnings that a third-party purchaser could theoretically expect to receive upon acquiring the business. However, an accurate valuation is unattainable if the income and expenses of the business are misstated and commingled with personal business activity. The work-product prepared by the forensic accountant can be provided to the appraiser and prove invaluable for obtaining a realistic value for the business.