In civil disputes and criminal prosecutions involving monetary damages, attorneys will recommend that the client retain a forensic accountant. The litigant’s expectation is often that the accountant will be performing an “audit”. For litigation, the problem is that audit procedures alone will not meet the litigation’s objectives.
Forensic Accountant vs. Auditor
A common misconception is that the forensic accountant is an auditor. Audit procedures are often employed during a forensic investigation, but that is where the similarities end. The auditor’s objective is to provide a degree of assurance, typically in the form of an audit opinion, that a company’s financial statements are fairly presented, in all material respects, in conformity with U. S. GAAP.
The “forensic accountant” on the other hand, has a different mindset. The assignment is to apply accounting principles to financial disputes that are expected to result in litigation. This is an adversarial situation and by definition, there is an element of distrust on the part of both parties. Think of us as “financial detectives”. We are looking to put together pieces of a puzzle to tell the story of what happened to contested or misappropriated funds. We follow a twisting money trail to find these assets, often completing our assignments with incomplete, inaccurate, and invalid accounting records. These investigations are often further complicated by the ways in which the money or other assets are disbursed or transferred. An audit of records in this condition would be cost prohibitive.
The Forensic Accountant’s Role in Litigation
The purpose of a forensic engagement is to calculate and quantify economic damages. For civil matters, and particularly those involving misappropriated assets, doing so requires that the forensic report enable the Trier of Fact to determine the specific way in which the financial loss took place.
Forensic accountants focus on reconstructing the transaction and/or re-creating the accounting records. The objectives are to learn how much money was involved, determine where the money went, where it is now, and estimate the amount that can be recovered. We want to know who had access to the money, the financial records, and the computer systems.
According to the Association of Certified Fraud Examiners, each year, U. S. organizations lose approximately 7 percent of their revenues, approximately $900 billion dollars, to occupational fraud, defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.” Given these statistics, for a business dispute, we focus on deviations from any of the subject company’s established policies and procedures as well as industry standards.
However, we do not limit ourselves to an analysis of the records. We also may need information about company employees. If an employee appears to be living beyond his means, it may indicate that the employee is embezzling money. An employee that does not want to take a vacation may be afraid of what management would find in their computer or desk while they are away.
If the loss is the result of a fraudulent transaction, we will want to determine how the fraud was perpetuated and calculate the resulting economic damages. These findings will be documented in a report suitable for use in a court of law.
Finding the Money
Although no two cases are pursued the same way, there are some basic tools and procedures that enable forensic accountants to find the money.
The interview – Because financial documents rarely tell the entire story, all forensic engagements benefit from an interview of company management and employees. It facilitates an understanding of company operations and the working environment. For example, a shareholder dispute on which we were recently engaged involved health insurance fraud by the “in” shareholder. By interviewing the bookkeeper, we learned that the “in” shareholder had included his entire extended family in the company health insurance plan—parents, brothers, sisters, uncles, etc., This “find” led to questions about all the insurance policies; e.g., auto, life, building and contents, etc. The case ended in a very favorable settlement for our client.
Data-Mining Software – Forensic accounting often requires the identification of meaningful patterns in large volumes of data. With data mining software, data is extracted and analyzed to detect fraud, waste, and abuse. Forensic procedures are performed to identify hidden patterns and relationships. Transactions can be isolated by dollar amount, time of occurrence, alpha/numeric sequences, or any combination of these and other factors.
Several years ago, the use of this software enabled us to expose a kickback scheme. Several customer-service employees manipulated the order entry and billing systems. Purchasing agents paid a small fee to receive product for which they had paid less than full value or made no payment. One day, while working the front counter, a manager opened a desk drawer and found “thousands in cash”. Our forensic procedures, along with the use of this software, enabled us to isolate the improper transactions. Our client collected several million dollars in unrecorded receivables.
Business and consumers are always exposed to economic damages. Whether the case involves a shareholder dispute, a contractual breach, an estate challenge, embezzlement, etc., the litigants will depend on their attorney to obtain a recovery for their loss. The court may not be able to make them whole, but with the attorney’s and the forensic accountant’s help, these damages can be mitigated.
Shelley Brown, MBA, CPA/ABV/ CFF, CVA is a Partner at Paritz and Company, P. A. She can be reached at (201) 400-1503 or Forensic_cpa@comcast.net..