The need for forensic accounting is at an all-time high.
Just this year, the Federal Trade Commission (FTC) says millions of consumers reported losing over $5.8 billion to fraud in 2021. Fraud categories contributing to this figure include job and business opportunities and internet services, the federal agency reports. According to the FTC, this is a staggering leap from 2020, when the amount totaled over $3 billion.
Fraud is nothing new — it has existed since ancient civilization.
Because of its enduring prevalence, human beings have devised methods to spot it. And a relatively new way to spot it is through forensic accounting, one of the most important types of accounting today. See those figures up there in the second paragraph? That wouldn’t have been determined without the help of forensic accountants.
So what is this accounting type, and how do forensic accountants investigate? We’ll discuss this — and more — in this article.
A Brief Look into Forensic Accounting
Forensic accounting is accounting with an investigative and legal slant.
Instead of simply noting down a business’s transactions and making big-picture plans to grow a business’s finances, forensic accounting finds its purpose in determining the facts and existence of a crime, which often involves financial fraud. But as you will see later on, forensic accounting gets involved in many other types of legal cases.
The role of forensic accountants becomes material to something as serious as legal proceedings.
They can serve as expert witnesses who have both the legal and accounting knowledge to defend or negate arguments. Through their expertise, forensic accountants know where to look, what to look for, and who to look for to gain a better understanding of the case.
And because forensic accounting deals with sensitive and technical information, forensic accountants have to carefully follow investigative procedures and know how to actually perform forensic accounting.
How to Do Forensic Accounting
Sniffing out fraud involves rigorous and meticulous work. Forensic accountants tend to go through various investigative processes and enormous types of data before making an official report of their findings.
But although it’s complex, the bare bones of forensic accounting follows a simple three-step method.
Fact-finding or evidence gathering
Before anything, it’s important for forensic accountants to conduct an investigation and gather relevant data on the case. This is also known as an audit.
To obtain this data, forensic accountants may look into several sources of information, including:
- Audit trail, which helps determine the network of transactions of a case as well as the validity of financial records
- Paper and digital trail, which can include contracts, tax returns, and even social media activities
- Financial and accounting trends
- Interviews with involved parties
Forensic accountants can turn to bookkeeping software the involved parties use to go through their list of transactions. They can also look at contracts and other important documents. And during interviews, they can take note of interviewees’ behaviors aside from their answers.
In essence, this is the stage where verifying the existence of fraud, talking to the parties involved, and collecting and checking the validity of information take place.
Once investigators and accountants have finished collecting evidence, it’s time to take a closer look at the data.
To do this, forensic accountants employ various tools and techniques. This could include data analytics software, such as Statistical Analysis System; analytical methods like time-series analysis and inferential analysis; and graphical tools like charts.
What’s important is that the forensic accountant applies these to the data and documents gathered, whether that be financial trends, transaction records, and financial statements.
In this case, financial statements are perhaps the most important thing to analyze.
According to Colleen Honigsberg, as Nina Jokovic mentions in her paper, analyzing financial statements requires two approaches, namely statistics and accounting-based predictions. Analyzing financial statements from a statistical point of view includes the use of Benford’s Law and target beating. On the other hand, accounting-based predictions primarily rely on “accrual accounting and audit-based predictions.”
Reporting & presentation of evidence
Then comes the crucial part of forensic accounting, when forensic accountants present their findings.
The Corporate Finance Institute notes there are two different avenues through which a forensic accountant can present their evidence and findings. One is directly to the client, who will decide on whether to bring the case to court; and the other in court, with the accountant as an expert witness.
When Forensic Accounting Is Needed
Forensic accounting has helped take down some of the greatest schemes in history.
The case of Bernie Madoff is one you’ll often encounter when looking for landmark cases of financial fraud. In this case, Madoff defrauded thousands of investors and clients. For a while, these investors had entrusted large sums of money to the former American financier, which eventually totaled $65 billion.
However, forensic accountant and fraud investigator Harry Markopolos raised suspicions early on.
After looking at Madoff’s investments and at market trends, Markopolos believed there was something off with the amount of money Madoff was making, according to a thesis on the importance of forensic accounting in finance. This is one of the data points forensic accountants and investigators use to verify financial fraud.
However, fraud cases are not the only ones that benefit from this field.
- Divorce cases, particularly when assets are suspected to be hidden or have been used illegally
- Cases where financial statements have been falsified
- Identity theft
- Cases of misappropriated assets
- Questionable insurance claims
Forensic accountants, or professional accountants who employ investigative skills to look into cases of potential financial fraud or money-related disputes, generally follow a three-step process:
- Gathering evidence
- Analyzing evidence
- Reporting findings
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