What Is Forensic Accounting

Ask any two practicing forensic accountants to define what forensic accounting is, and you are likely to
get two different answers. Both may be accurate, and there likely will be some similarities within the
responses, but still there is no one consistent answer recited by everyone who practices in this
specialized area of accounting. The responses provided will depend largely on the background,
experience, and areas of practice of each individual forensic accountant.

Forensic accounting definitions commonly refer to fraud, fraud prevention, and fraud investigations as
the role of the forensic accountant. While those definitions are not necessarily inaccurate, they provide
a definition of forensic accounting only within the specific context of fraud. Many books have even been
written about forensic accounting that focus the writing on fraud schemes, preventing them as well as
investigating them, and include a wealth of information relating to fraud. This is the case with A Guide to
Forensic Accounting Investigation by Golden, Skalak, and Clayton. It is an excellent publication and one I
rely heavily upon in my class as an adjunct professor at the University of Connecticut, but the issue is
this—the book is titled A Guide to Forensic Accounting Investigation and not A Guide to Fraud
Investigation. Fraud is only one context where the skills of forensic accounting can prove invaluable—
there are many, many other contexts beyond fraud to which forensic accounting applies.

In searching the materials available, the following definition is found within Forensic Accounting by
Hopwood, Leiner, and Young:

Forensic accounting is the application of investigative and analytical skills for the pur- pose of
resolving financial issues in a manner that meets standards required by courts of law.

Forensic accountants apply special skills in accounting, auditing, finance, quantita- tive methods, certain
areas of the law, research and investigative skills to collect, analyze and evaluate evidential matter and
to interpret and communicate findings.

Forensic Accounting and Fraud Examination by Kranacher, Riley, and Wells defines financial forensics
similarly, as follows:

Financial forensics is the application of financial principles and theories to facts or hy- potheses
at issue in a legal dispute and consists of two primary functions:

1. Litigation advisory services, which recognizes the role of the financial forensic pro-
fessional as an expert or consultant

2. Investigative services, which makes use of the financial forensic professional’s skills

and may or may not lead to courtroom testimony

(1) technical skills of accounting, auditing, finance, quantitative methods, and certain areas of
the law and research;

(2) investigative skills for the collection, analysis, and evaluation of evidentiary matter; and (3)
critical thinking to interpret and communi- cate the results of an investigation.2

Perhaps Crumbley, Heitger, and Stevenson Smith in their book Forensic and Investigative Account- ing,
Second Edition, provide the clearest and most concise definition of forensic accounting: “Forensic
accounting is the use of accounting for legal purposes.”3

They continue in their initial discussions about forensics and accounting to include a much longer but
equally understandable definition, as follows:

Forensic accounting is the action of identifying, recording, settling, extracting, sorting, reporting, and
verifying past financial data or other accounting activities for settling current or prospective legal
disputes or using such past financial data for projecting future financial data to settle legal disputes.4
THE ESSENCE OF FORENSIC ACCOUNTING

Forensic accounting involves the application of special skills such as accounting, auditing procedures,
finance, quan- titative methods, research, and investigations. It also involves knowledge of certain areas
of the law. This knowledge combined with these skills enable forensic accountants to collect, analyze,
and evaluate evidential matter and to interpret and communicate findings.

Key elements of this definition including the following:

● Accounting. Forensic accounting is a branch of accounting. At its most general level, accounting
involves the communication of financial information.

● Special skills. Forensic accounting requires special skills that are not required of accountants in
general.

● Law. Forensic means pertaining to the law. Forensic accounting deals with financial issues that may
come before a trier of fact in a court of law or other venue (such as arbitration).

● Evidential matter. Especially important to forensic accounting is evidential matter that may bear on
the truth or falsity of an assertion made before a trier of fact.

● Interpretation and communication. In many cases, forensic accounts interpret evidence and
communicate expert opinions for clients and a trier of fact.

Forensic accounting is typically divided into two areas:

● Litigation services. The forensic accountant serves as a testifying expert or non-testifying consultant
and pro- vides assistance for actual or potential legal or regulatory proceedings before a trier of fact in
connection with the resolution of disputes between parties. Litigation services include serving as an
expert witness, a litigation consultant (that is, a non-testifying expert), and in various other roles in
dispute-resolution or legal processes (for example, as a bankruptcy trustee.)

● Investigative services. The forensic accountant serves as a consultant in cases that do not involve
actual or threatened litigation, but do involve performing analyses or investigations that may require the
same skills used in litigation services.

FORENSIC ACCOUNTING VERSUS TRADITIONAL ACCOUNTING

Traditional accounting involves recording, classifying, analyzing, and reporting financial data and
information. The emphasis is on converting raw financial data into information useful for decision
makers by using an applicable financial reporting framework. The useful information is typically
presented to decision makers in the form of financial statements. In summary, the work product of the
traditional accountant is one or more financial statements. On the other hand, the typical work product
of forensic accountants tends to be much different from that of traditional accountants. The scope of
each forensic accounting project is unique and the work product flows from the scope of the particular
project. Such work products often consist of a written or oral report of findings or recommen- dations or
both. When testifying before a trier of fact as an expert witness, forensic accountants ordinarily express
their findings as expert opinions. In this use, “opinion” is a term of art in judicial guidelines on evidence
and the law, and differs from its use in the accounting literature

FORENSIC ACCOUNTING VERSUS AUDITING

In some respects, forensic accounting is very much like auditing. Forensic accountants generally use
procedures and exercise professional skepticism in a manner similarly used by auditors. For instance,
both examine evidence (usu- ally financial related) and form professional judgments on what they
observe. But the overall objectives of these two kinds of engagements are very different. The objective
of audit engagements usually is to express an audit opinion on whether financial statements, taken as a
whole, are fairly presented. In contrast, forensic accounting engagements tend to be focused on one or
more particular areas. Speaking simply, virtually all audit engagements have a single objective of
expressing one opinion on a set of financial statements whereas each forensic accounting project is very
uniquely focused on a client’s particular needs and the objective is usually to report recommendations
or findings. All forensic accounting work performed by CPAs1 is subject to Consulting Services (CS)
section 100, Consulting Services: Definitions and Standards (AICPA, Professional Standards). In addition,
forensic accounting services may be subject to other requirements such as applicable laws and
regulations, rules of evidence, civil or criminal procedures, and other professional pronouncements such
as other applicable professional standards. These other requirements are discussed in detail in
subsequent chapters.

Forensic accountants sometimes engage in auditing work, but for purposes other than providing an
opinion on an entity’s financial statements. For example, a forensic accountant may conduct a forensic
engagement as part of an occupational fraud investigation. The result of such an investigation will likely
be a report that identifies, for example,

the amount of the fraud loss and any control weaknesses that led to the fraud. These fraud
engagements are per- formed as consulting engagements and are governed by CS section 100. Forensic
accountants apply specialized skills (in the form of specialized procedures) that differ from those used by
auditors of historical financial statements. For example, auditors may use observation techniques
whereas forensic accountants may use surveillance techniques. The differences between techniques
used by traditional auditors and forensic accountants are discussed in chapter 11, “Digital Forensics.”

Unlike traditional auditors, not all forensic accountants are required to be “independent” of their clients
in the way the term is used in other accounting literature. Independence is required, though, when
forensic accountants participate in attest engagements such as audits of financial statements for the
purpose of opining on the fairness of their presentation and reviews of financial statements.
FORENSIC ACCOUNTING KNOWLEDGE AND SKILLS

Forensic accounting requires knowledge and skills in many different areas. Although these areas are
discussed indi- vidually, keep in mind that they overlap each other.

ACCOUNTING

Forensic accounting spans many areas of accounting, therefore broad accounting knowledge and skills
are required. However, certain accounting knowledge and skills are required within specialized areas of
forensic accounting. For example, a forensic accountant specializing in investigating occupational fraud
might not need to be an up-to-date expert in international accounting standards, but would likely need
specialized knowledge and skills relating to accounting information systems, digital forensics, and
accounting information systems auditing procedures. Similarly, a forensic accountant specializing in
estimating economic damages may need business valuation skills. The many specialized areas within
forensic accounting are discussed in subsequent chapters.

AUDITING

Auditors are specialists in collecting, interpreting, and evaluating data and information. Such skills are
essential to forensic accounting. As previously discussed, when forensic accountants testify before a
trier of fact as an expert wit- ness, they ordinarily express their findings as expert opinions. Their
findings must be based on evidence, and evi-dence must be collected and interpreted. Therefore,
forensic accountants should be skilled in collecting and interpret-ing evidence. Finally, as previously
mentioned, forensic accounting requires knowledge and skills using specialized evidence gathering
procedures.

INVESTIGATIVE

Special skills and knowledge are required to conduct forensic accounting investigations. These special
skills and knowledge include an understanding of how to structure and manage investigations, the types
of evidence that may be collected, how to maintain the chain of custody, the legal rights of those under
investigation, how to identify differ- ent types of fraud schemes, how to conduct interviews, and how to
detect deception.

CRIMINOLOGY AND DIGITAL FORENSICS

For criminal investigations, the forensic accountant should have a basic understanding of the various
roles played by crime scene investigators, digital forensics experts, forensic scientists, forensic
laboratories, prosecutors, and attorneys. Almost all crimes these days involve digital devices, including
computers.2 Therefore it is helpful for the forensic accountant investigating fraud to have a basic
understanding of digital forensics in both the areas of computer fo- rensics and network forensics. In
addition, advanced digital forensics are employed by, for example, using computer- assisted audit tools
and techniques (CAATTs) to extract and analyze digital data from enterprise resource planning (ERP) and
accounting systems.
ACCOUNTING INFORMATION SYSTEMS

Key elements of accounting information systems include internal control and business processes.
Internal fraud schemes typically involve the violation of weak or nonexistent internal controls within
specific business processes. Therefore, the forensic accountant must have a good understanding of
internal control processes and how they in- terface with business processes and the accounting
information system. For example, a sales-skimming fraud scheme may involve the absence of
reconciliation controls in the revenue cycle.

RISK ANALYSIS

Fraud risk management is an issue commonly dealt with by forensic accountants.3 Fraud risk
management activities include fraud prevention, detection, and response. This type of management
begins with fraud risk assessment.

COMMUNICATION

Communication skills are essential in all areas of accounting. However, such skills can become even
more critical in the area of forensic accounting. Forensic accountants serving as testifying experts often
write expert reports that are likely to be subject to intense scrutiny in depositions and cross-
examinations at trial. Furthermore, forensic accoun- tants may need to explain their opinions on direct
examination at trial, which requires effective presentation skills.

PSYCHOLOGY

Understanding the suspect and, in particular, his or her motivations can aid forensic accountants who
perform inves- tigations. Motivation can, for instance, help identify the areas that should be
investigated. For example, a CEO may be motivated to compete successfully with a sibling by attempting
to increase the market price of stock by artificially inflating net asset values and income. The law
enforcement community has long known that one of the best ways to solve a fraud case is by obtaining
a confession. The process of obtaining a confession in financial fraud cases is a very carefully
orchestrated one that begins with collecting documentary evidence, proceeds to interviews with non-
suspects, and often terminates with an interview with the prime suspect. The key to success in
interviewing involves the ability to assess honesty versus de- ception. Consequently, forensic
accountants, at times, are aided by the employment of techniques rooted in psychol- ogy, such as the
analysis of body language and eye movements.

INFORMATION TECHNOLOGY

The importance of information technology to forensic accountants is closely related to the importance
of digital forensics and accounting information systems. Information technology is constantly evolving
and is an inescapable aspect of many types of forensic accounting work. Not only do forensic
accountants use the latest in technology in their investigations, they must also be aware of evolving
technological advances to maintain up-to-date professional skills.
PROBLEM SOLVING

If there is any one skill that stands out among the others, it is problem solving. Forensic accountants
constantly deal with puzzles and mysteries that offer opportunities to sharpen their critical-thinking
skills. In fraud investigations and litigation and dispute resolution, there is always an opposing side, and
in many cases the opposing side is highly intelligent and seeks to deceive and cover up the truth. The
opposing side might, for example, be a fraudster in an embezzlement investigation, a spouse hiding
assets in a divorce, a debtor hiding assets in a bankruptcy, or a potential corporate acquisition target
providing false financial statements in order to inflate its value.

LEGAL

By definition, forensic work is affected by the legal system. In performing litigation services, forensic
accountants as- sist in the legal and dispute resolution processes. Therefore the forensic accountant is
familiar with the court systems, applicable federal and state rules of procedure, and rules of evidence.
The forensic accountant often needs a basic understanding of various types of common-law and
financial crimes such as conspiracy, money laundering, and embezzlement.
Applications for Forensic Accounting

Although fraud seems to receive the most coverage, there are several other common applications for
forensic accounting. In 2008, after recognizing the need for a credential in forensic accounting beyond
the widely recognized Certified Fraud Examiner (CFE) designation, the American Institute of Certified
Public Accountants (AICPA) announced a new credential for those CPAs who focus on forensic
accounting and litigation support. The credential, Certified in Financial Forensics (CFF), became effective
in September 2010, and the AICPA defined the field of forensic accounting to include a fundamental
basis of knowledge along with specific practice areas or applications for forensic accounting.

Bankruptcy, Insolvency, and Reorganization

Forensic accountants can be retained on behalf of the debtor, the individual or organization
contemplating or already in bankruptcy, or for the creditors, those individuals or entities that remain to
be paid. The role for the work may be to assist the trustee in managing the financial affairs, searching for
hidden assets, identifying pre-bankruptcy transfers, recovering funds and assets to be used to satisfy
creditors, or performing business valuations to be used in resolving the bankruptcy filing. Forensic
accountants also can be retained by creditors seeking to determine whether additional assets exist, or
whether there were any payments made immediately prior to filing. Each creditor stands to collect less
than the full amount due, so the more funds and assets that can be located and returned to the trustee,
the greater the potential disbursement to the creditors. Unfortunately, bankruptcy fraud is common,
and the forensic accountant’s role often works toward corroborating and supporting both the
disclosures and the claims.

Computer Forensic Analysis

Two main applications for computer forensics are preservation and recovery of electronic information
for evidence purposes, and electronic discovery for litigation support. Today more and more
transactions are being completed electronically within both business and social settings. Valuable
information and evidence can be found in files maintained in places beyond the traditional computer
and server hard drives. As technology moves toward “cloud” computing, whereby information is
maintained and accessed through the Internet, the physical location of the data will exist outside of the
business, and likely outside of the country. The latest gadgets, including Blackberries, iPhones, iPads,
laptops, netbooks, and cell phones, all have the ability to connect to the Internet and transmit electronic
information. Knowing the types of electronic information that may exist, what form and format it
possesses, where it could be located and accessed, and, most important, how to gain access to it, could
be the most significant factor in prevailing in litigation or proving your case.

Economic Damage Calculations

Damages are a key component of every lawsuit. If a party believes it has been harmed or wronged, but
cannot identify or prove it has suffered damages, the likelihood of the party prevailing in litigation is not
good. Two key terms for this area of litigation are causation and damages. Causation simply means the
actions or inactions of one party caused the injury or loss of the other party. Damages refer to the
calculated loss suffered as a result of causation. Forensic accountants are called upon to calculate losses
in many contexts, including lost earnings, lost profits, lost business, and the physical loss of property
(e.g., fire, flood, theft). The forensic accountant often will rely upon historical information, conduct
interviews,

physically inspect property, and perform trending in order to complete the damage calculation.

Forensic accountants are called upon regularly to work either side of a matter, supporting either the
plaintiff or the defendant. Regardless of who the retaining party is, the forensic accountant must remain
objective and unbiased, becoming an advocate only for the truth. To illustrate, forensic accountants
regularly are engaged to perform damage calculations as well as review and refute damage calculations
put forth by the opposing party. Two common contexts for damage calculations are litigation (lawsuits)
and insurance claims. Starting with litigation, a party believes it has suffered a loss of some kind. The loss
could be related to a physical incident, such as a fire or theft, or it could be related to the actions or
inactions of another individual or organization. In any event, the grieved party (known as the plaintiff)
initiates litigation (retains an attorney who files a lawsuit) against another party (known as the
defendant), seeking to recover damages (money) from the defendant in the amount of the calculated
loss. The plaintiff’s claim may be relatively simple and straightforward, or it may involve detailed
calculations. It is common for either party, or both parties, to retain the services of a forensic accountant
to calculate the amount of potential or actual damages. The calculations may be used by the client and
counsel to determine whether in fact damages actually were incurred and whether litigation should be
commenced based on the damages, and, during the course of litigation, to negotiate some type of
settlement in lieu of a trial.

Insurance claims work very similarly, where a party believes it suffered some type of loss and, depending
on the insurance coverage it maintains, files an insurance claim to recover the loss. Here too the loss
could be related to a physical loss, such as a fire, flood, or theft, or it could be related to the actions or
inactions of another party.

In both contexts of damage calculations, the potential exists for fraud to be committed as well as for
errors to occur. It is not uncommon for parties to include items, costs, and calculations within their
damages claim that either have no bearing on the loss at hand or are unsubstantiated. In fact,
unsubstanti- ated and intentionally inflated insurance claims are common; hence, the need for
insurance fraud investigators.

Forensic accountants often are retained to prepare as well as review and refute submitted damage
calculations, both in litigation and with insurance claims. The forensic accountant would seek all the
supporting and corroborating information, potentially perform on-site inspections, and conduct
interviews of witnesses to support and corroborate the information included in the damage calculation.
These are measures not dissimilar to those employed in fraud investigations

Family Law

The forensic accountant can have a number of roles within marital dissolution (divorce and post-divorce)
engagements, starting with the role of a strategist working with counsel and the client before the
divorce is even filed. The forensic accountant may work with counsel to uncover hidden or undisclosed
sources of income or assets that should have been appropriately included on a party’s financial affidavit.
Earnings and expenses of each party, along with earning potential, will come into play in calculating
alimony and child support. It is very common for one divorcing party to be an owner or shareholder
within a business, requiring a business valuation to be performed to determine the value for dividing
their assets. The forensic accountant must be knowledgeable about taxes and the different tax forms, as
often these may be the only documents disclosed. The ability to determine whether the financial
information produced is reliable is also a very important role. The forensic accountant can expect to be
disclosed as an expert witness in these cases, usually requiring testimony through deposition and trial.
Due to the very nature of these personal and highly emotionally charged matters, fraud and
nondisclosure are both common.

Financial Statement Misrepresentation

This area would entail the forensic accountant being retained to examine the financial statements and
disclosures of publicly traded and privately held entities and organizations, to determine whether the
financial statements properly reported the balances, results, and required disclosures. If found to be
improper, the forensic accountant could identify the improprieties of the financial statements, such as
overstatements, understatements, omissions, and improper accounting treatments, as well as calculate
the effect such identified issues would have on the financial statements. The forensic accountant also
could identify any standards, rules, procedures, and regulations that were violated; assist in determining
who was involved; and reveal any underlying schemes or motives for intentional misrepresentations
Fraud encompasses a large area of opportunity for forensic accountants, in preventing fraud schemes
fromoccurring, investigating fraud schemes that have occurred, and assisting owners and organizations
in implementing better controls and procedures in response to a fraud scheme having been committed.
The forensic accountant can be retained by an organization to proactively evaluate its systems of
internal controls, financial policies, and accounting procedures before any thefts are identified, as well
as to seek indications of fraud within specific areas even when no “red flags” or indications of fraud
exist. However, once fraud has been identified, the forensic accountant can prove invaluable in
investigating and determining what happened, who was involved, how the scheme was committed, how
long the scheme went on, and other important aspects required in order to resolve the matter. There
are many types of fraud and many contexts in which the forensic accountant can apply all of these
services, and a detailed discussion follows further emphasizing this.

Business Valuation

Forensic accountants are called upon to conduct business valuations within a number of contexts. The
valuation may be required for purposes of dividing assets in a divorce, as discussed earlier, or may be
part of some other type of litigation, such as a shareholder dispute. Conversely, valuations can be
completed in nonlitigation contexts as well, such as within business transactions, in estate planning, for
post-mortem estate purposes, and for gifting. In business transactions, such as purchases and sales of
companies, and shareholder buy-ins and partner buy-outs, the value of the business likely may be the
driving force behind the dollar amount (e.g., sales price or buy-out amount) and other terms of the
transaction. Federal and state tax regulations for estates and gifts revolve around the value of each
transaction. In the case of estate and gift taxes, values below a certain amount have no tax effect, but
once the value exceeds the amount, taxes are due, often significant in amount. Planning for such
transactions before they occur can minimize the taxes due.