FORENSIC ACCOUNTING

Learning Objectives

1. Describe forensic accounting and contrast it with ICFR and financial statement audits.

2. Understand internal audit activities and the role of the internal audit function within organizations.

3. Learn the extension of typical audit activities required when auditing state and local government entities.

4. Explain the purposes and activities of compilation and review engagements, applicable standards, and accountants’ reports.

5. Discuss the types of information for which accountants can issue attest reports, list the requirements for an attest service to be possible, and distinguish attest engagements from other services.

6. Identify other auditors’ services provided for public companies, explain the auditors’ work activities, and describe the resulting report.

FORENSIC ACCOUNTING

The term forensic accounting most commonly refers to fraud investigations and accounting work to support legal actions.

The Association of Certified Fraud Examiners (ACFE) is one of the premier organizations for forensic accountants.

Forensic accounting encompasses two major components: investigative forensic services and litigation support.

FORENSIC ACCOUNTING

Forensic accountants investigate many situations and suspected illegal acts including: Employee theft Vendor fraud Customer fraud Tax evasion Conflicts in divorce and bankruptcy proceedings Insurance claim filings Identity theft Organized crime

What is Forensic Accounting?

An orderly analysis, investigation, inquiry, test, inspection, or examination along a “paper trail” in the search for fraud, embezzlement, or hidden assets

Two parts: Investigative accounting Litigation support

Treats all figures as suspect until proven otherwise

The History of Forensic Accounting

1931 World War II 1980s: Real estate bankruptcies, junk bond

schemes, and lawsuits 1988 ACFE was formed in Austin, Texas Initially called “investigative accounting” Increase in regulatory, tax and criminal statutes

became law

The Need for Forensic Accountants

A 2001 survey found the following: 37% of the country’s top 100 accounting firms

are increasing their forensic and fraud services The average organization loses 6% of revenue

to employee fraud and abuse The typical perpetrator:

Colleges and universities are responding Many frauds are not reported There are 13,000 CFEs in the ACFE, compared to

2,300 just 10 years ago Wells Report

What Does a Forensic Accountant Do?

Attempt to obtain the truth and develop an expert opinion

Sniff out corruption Pore over financial documents,

reconstruct records, interview people, and present report interpreting and explaining complicated financial information

Solve a large puzzle

The Services a Forensic Accountant Provides

Damages Antitrust Analyses Accounting Valuation General Consulting Other Analyses

Motive

Rationalization Opportunity

The Fraud Triangle

Proactive Fraud Auditing

Going fishing Thinking like a fraud auditor Choosing a fraud type Procedures

Reactive Fraud Auditing

Symptoms Cost Variances Expected Costs Employee’s Lifestyle

Fraud vs. White-Collar Crime

“White collar crime is criminal conduct that does not involve violence or the threat of violence and usually takes place in a professional work place”

Fraud happens anywhere, white-collar crime is in the workplace

Fraud is perpetrated by anyone, white-collar crime is by business people/professionals.

Fraud is not always criminal, white-collar crime is mostly criminal

Fraud does not always involve something of value, white- collar crime does.

Red Flags

No Company Policy Manual Feeling of disorganized

bookkeeping, purchasing, receiving, and/or warehousing departments

Missing documents Unrecorded transactions No bank reconciliations Subsidiary ledgers out of

balance No physical inventory counts Checks written to cash Large related party loans Excessive other revenue Negative operating cash flow Downward earnings trend

Handwritten checks Extensive fund transfers Unusual transactions

(inconsistent) Deficient hiring policies and

procedures Employees’ lifestyles

inconsistent with salaries Employees who don’t take

vacations SPEs Excessive insider sales of stock Unexplained resignations of

upper management Excessive debt/equity ratio CPA switching Strange account titles

FORENSIC ACCOUNTING

During an interview, the forensic accountant may focus on a range of issues, including: The tone set by top management toward

ethical behavior Management’s values and beliefs Reward systems The potential for management override of

internal controls Forensic accountants may rely on evidence

obtained from real estate records, court records, corporate and partnership records, and other public records to uncover potential fraud motives.

INTERNAL AUDITING

Accountants who work within entities as internal auditors also perform important functions for companies, not-for-profit organizations, and government units

The Institute of Internal Auditors (IIA) is the most notable professional organization for internal auditors.

The internal auditor’s goal is to help improve the organization’s operations, risk management, internal controls, and governance.

INTERNAL AUDITING

Internal auditors assist in SOX compliance

INTERNAL AUDITING

Internal auditors assist in SOX compliance

STATE AND LOCAL GOVERNMENT AUDITS

Financial statement audits of state and local governments are performed by external auditors who work either for public accounting firms or separate government-related units.

Single Audit Act

This legislation called for audits to be conducted on an entity-wide basis replacing requirements for multiple audits of one entity on a grant-by-grant basis.

When a governmental entity meets the $500,000 expenditure threshold, it is subject to a single audit of both its financial statements and its compliance with the provisions of any federal awards it received.

The schedule of audit findings summarizes the results of the audit.

GOVERNMENT AUDITING STANDARDS AND THE YELLOW BOOK

Audits of government entities, including those under OMB Circular A-133, are conducted according to generally accepted government auditing standards (GAGAS) issued by the Government Accountability Office (GAO).

The Yellow Book contains standards covering financial statement audits, attestation engagements, and performance audits.

The GAO’s primary role is to support congressional oversight of the executive branch of the U.S. government.

Work of the GAO

COMPILATION AND REVIEW ENGAGEMENTS

EXHIBIT 16-1

Hierarchy of FinancialStatement AssuranceActivities

Compilations

In a compilation engagement, an accountant drafts financial statements of an entity based on information provided by the management or owners.

The accountant needs to establish an understanding with the client about the terms of the engagement, any limitations on the use of the financial statements, and must document the understanding through a written communication with management.

Illustrative Compilation Engagement Letter

EXHIBIT 16-2

Illustrative Compilation Engagement Letter

EXHIBIT 16-2

Illustrative Compilation Engagement Letter

EXHIBIT 16-2

Standard Compilation Report

Reviews

An engagement to review a nonpublic company’s financial statements provides some assurance regarding the fairness of the financial statements.

The level of assurance provided by the accountant’s report falls between an audit and a compilation.

Elements of an Engagement Letter for a SSARS Financial Statement Review Engagement

Elements of an Engagement Letter for a SSARS Financial Statement Review Engagement

Inquiries Made During a Review

EXHIBIT 16-3

Independent Accountant’s Review Report

ATTEST ENGAGEMENTS

Targets of attest engagements include financial forecasts and projections, compliance with laws and regulations, effectiveness of internal controls for nonpublic companies, the accuracy and reliability of reported performance measures, and the compliance with SEC regulations of a company’s management discussion and analysis.

Examples of Attest Engagements

Availability of Criteria

EXHIBIT 16-4

Types of Attest Engagements and Reports

EXHIBIT 16-5

Independent Accountant’s Attest Examination-Level Report

SEC-RELATED ENGAGEMENTS

CPAs perform many services in connection with SEC filings such as issuing comfort letters to underwriters, performing interim reviews, and conducting activities related to registration statements for public offerings of securities.

Letters for underwriters are commonly called comfort letters because of the concept that they provide “comfort” on specific issues in a company’s financial information.

Auditor’s Review Report on Interim Financial Statements

Review QuestionForensic accounting(a) is best described by the term fraud audit.(b) includes investigative services and litigation support.(c) can only be carried out by CPAs.(d) follows the same approach as traditional auditing except that materiality thresholds arelower.

Review QuestionThe independence of internal auditors andthe internal audit function is enhanced by(a) avoiding conflicts of interest.(b) being placed high in the organizational hierarchyand having access to the audit committee.(c) conducting their tasks in an objective manner.(d) all of the above.

Review QuestionAn examination attest engagement provides:(a) positive assurance.(b) moderate or limited assurance.(c) no assurance.(d) agreed upon procedures assurance.

CopyrightThanks You ~ Rahul MaganCorporate Treasurer , EXL Service Holdings , Inc. ( NASDAQ Listed )91-9899242978 , Skype ~ Rahul5327 , Twitter @ Rahulmagan8