Forensic Accounting: An Introduction

Forensic Accounting:An Introduction

JOIN KHALID AZIZECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

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OverviewWhat is Forensic Accounting?What is fraud?Who commits fraud?How do forensic accountants search for fraud?Whats the demand for forensic accounting?How can you prepare for opportunities in this area?

What is Forensic Accounting?Forensic accounting is the practice of utilizing accounting, auditing, and investigative skills to determine whether fraud has occurred.

It encompasses two main areas:Litigation supportInvestigation

Litigation SupportIs the factual presentation of economic issues related to existing or pending litigation.

The forensic accountant quantifies damages sustained by parties involved in legal disputes and assists in resolving disputes, even before they reach the courtroom.

Litigation SupportArbitration assistanceBusiness valuation for divorce, stockholder disputesComputation of damages resulting from personal injuries, wrongful death, breach of contract, casualty, and fidelity lossesDetermination of lost profits due to business interruptionTestifying as an expert witnessFinancial review of contractual obligationsInvestigative services related to fraud and other illegal acts

InvestigationIs the act of determining whether criminal matters such as employee theft, securities fraud (including falsification of financial statements), and insurance fraud have occurred. Also includes searching for irregularities associated with civil matters, such as a search for hidden assets in divorce cases.

What is Fraud?Fraud is an intentional misrepresentation of a material point or issue on which a victim relies.This reliance usually results in one or more victims suffering damages.

Types of FraudOccupationalFinancial statement schemesAsset misappropriation (e.g., cash theft, fraudulent disbursements, inventory theft)Bribery and corruptionIntellectual property

Types of FraudOther FraudsFinancial institutionCheck and credit card fraudInsurance fraudHealth care fraudBankruptcy fraudTax fraudSecurities fraudMoney launderingConsumer fraudComputer and Internet fraudGovernmental fraud

Examples of FraudFinancial Statement SchemesA publicly-traded company engaged in sham transactions for more than seven years by using several shell companies. The money transferred to the shell companies as payments for assets were returned as payments on accounts receivable. The companys assets were inflated by as much as $80 million.

Examples of FraudEmployee EmbezzlementA warehouse foreman and a parts ordering clerk colluded to purchase $300,000 of nonexistent supplies. The parts ordering clerk initiated the transactions by obtaining ordering approval. The orders were sent to a vender who prepared false invoices. The foreman then verified receipt.

Examples of FraudAsset MisappropriationA CEO conspired with a former employee to sell a building to a company owned by the CEOs employer. The building was sold for $1.2 million more than it had been purchased by the former employee. All transactions occurred on the same day.

Examples of FraudHealth Care FraudDr. X billed a patients insurance for the following activities: Knee arthroscopy with debridement$1,650Diagnostic knee arthroscopy 1,625Total billed$3,275The second procedure listed above is included in the first procedure. Therefore, the correct amount of the bill is $1,650.

Examples of FraudDivorce Fraud John Dewey is the majority owner of a large public relations firm. His wife, Mary, recently filed for divorce and is asking for half Johns assets. Prior to being served, John took some trips to the Cayman Islands and Switzerland. During the divorce proceedings, Mary was shocked to learn that the value of the firm is $50,000. Prior to the divorce, John had given her $200,000 a year to cover their personal expenses.

Examples of FraudFraudulent DisbursementsAn employee created over 1,000 false refunds, all under the review limit of $15.00. He was caught because be began processing refunds before store hours and another employee noticed this. Before the scheme was detected, he made off with over $11,000.

Examples of Fraud Governmental Services Association (GSA) purchased $200M of furniture from a New Jersey vendor. The furniture was defective. A GSA regional supervisor was suspected of taking bribes to ignore the defects. He bought 11 racehorses for $13K apiece during a four year period.

Examples of FraudVendor Fraud: Defective DeliveryThe low bidder was awarded a contract to pave a parking lot. Upon examination, several randomly-taken core samples revealed 2 of paving whereas the contract specified 4. Also, the parking lot had not been sealed as required by the contract.

Examples of FraudVendor Fraud: Unbalanced Bid Bid was let to construct 3 buildings in the following order: A, B, C.Buildings Bidder A B C TotalAvalon $510K $250K $240K $1MSt. James 375K 375K 375K 1.125M Corinna 400K 400K 400K 1.2M Whats the problem?

Examples of FraudKickbacks: Unilateral Mary, the employee responsible for purchasing at JLH, was the recipient of lavish gifts from a large supplier that she did not disclose to her employer (accepting these gifts was against company policy).

Who is most responsible here?

Examples of FraudKickbacks: Bi-LateralAssume the cost of janitorial services ranges from $1.50 to $2.50 per square foot (psf). BBK Company has 1,000,000 sq. ft. to be serviced. If JanServ charges 20 more psf than does an honest service, JanServ will make an extra $200K that can be used to pay a kickback to the employee who helps JanServ obtain the contract. .

Who Commits Fraud?Frauds against organizations (M = median)40% by employees (M = $78,000)41% by management (M = $218,000)19% by owners (M = $1,000,000)

Males (61%, M = $250,000)Females (39%, M = 102,000)

High school (33%, M = $100,000)College (55%, M = $200,000)Postgraduate (12%, M = 425,000)

Who Commits Fraud?Median loss per age group< 26 years$25,000 26 30 50,00031 35 134,00036 40 135,00041 50 250,00051 60 350,000> 60 713,000

Who Commits Fraud?Perpetrators Criminal HistoriesCharged but not convicted 4% Had prior convictions 8%Never charged or convicted88%

Why is Fraud Committed? The Fraud Triangleperceived pressure, perceived opportunities, andrationalization Source: SAS No. 99, Consideration of fraud in a financial statement audit

Perceived PressureEmployees, managers, and owners can feelpressure to commit fraud as a result of

Greed or preoccupation with being successfulLiving beyond meansHigh personal debtsUnexpected financial needsExpensive vicesFamily-imposed pressures

Perceived OpportunitiesOpportunities to commit fraud exist whenlevels of trust in an organization are reachedor when controls are weak.

Inappropriate segregation of dutiesIneffective supervisionTransaction authorization not requiredLack of physical controlsLack of adequate audit trail

RationalizationIndividuals usually dont commit fraud unlessthey can justify their actions in relation totheir own code of ethics.

Feeling underpaid or overworkedDesire to seek revengeBelief that taking the assets is a loanBelief they are helping others (family, employees)

How do Forensic AccountantsSearch for Fraud?

Proactive fraud detectionReactive fraud detection

Proactive Fraud DetectionInductive approachesUse of Data-mining softwareDigital analysis of company dataDeductive approach Determine what kinds of frauds can occur. Search for symptoms of these frauds.

Data-mining Software ExcelACLIDEAMicrosoft Access

Digital Analysis of Company DataBenfords Law (first digit frequency)

Sheet:

Percent

Deductive Approachto Detecting FraudInvolves a 5-step process:Understanding the business environmentUnderstanding the kinds of fraud that can occur in this environmentDetermining the most likely symptoms Using databases and systems to search for the fraud symptomsFollowing up on discoveries to determine likelihood fraud exists

Reactive Fraud DetectionFraud accountants are often engaged after someone in the entity suspects that fraud has been committed.

Usually the area in which fraud has been committed is known. Often, the entire area is examined.

Evidence Categories

Testimonial Evidence

InterviewingInterrogatories (written questions that identify information needed from opposing party) Honesty tests (e.g., graphology, polygraph)

Documentary EvidenceDocument examinationPublic records searchesAuditsComputer searchesNet worth calculationsFinancial statement analysis

Physical EvidenceFingerprintsTire marksWeaponsStolen propertyIdentification numbers or markings on stolen objects

Personal Observation

InvigilationSurveillanceCovert operations

How can you prepare for the opportunities in this area?Self study On-the-job trainingFormal education

Obviously, a combination of at least two ofthese approaches will lead to optimalpreparation.

Forensic Accounting: An Introduction

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