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Forensic accounting, forensic accountancy or financial forensics is the specialty practice area of
accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
that investigates whether firms engage in financial reporting misconduct. Forensic accountants apply a range of skills and methods to determine whether there has been financial reporting misconduct.


History

Forensic accounting was not formally defined until the 1940s. Originally Frank Wilson is credited with the birth of Forensic Accounting in the 1930s. When Wilson was working as a CPA for the US Internal Revenue Service, he was assigned to investigate the transactions of the infamous gangster
Al Capone Alphonse Gabriel Capone (; January 17, 1899 – January 25, 1947), sometimes known by the nickname "Scarface", was an American gangster and businessman who attained notoriety during the Prohibition era Prohibition is the act or prac ...
. Capone was known for his involvement in illegal activities, including violent crimes. However it was Capone’s Federal Income Tax fraud that was discovered by Forensic Accountants. Wilson’s diligent analysis of the financial records of Al Capone indicted him for Federal Income tax evasion. Capone owed the government $215,080.48 from illegal gambling profits and was guilty of tax evasion for which he was sentenced to 10 years in Federal Prison. This case established the significance of Forensic Accounting.


Application area

Financial forensic engagements may fall into several categories. For example: * Economic damages calculations, whether suffered through
tort A tort is a civil wrong that causes a claimant to suffer loss or harm, resulting in legal liability for the person who commits the tortious act. Tort law can be contrasted with criminal law, which deals with criminal wrongs that are punishab ...
or
breach of contract Breach of contract is a legal cause of action and a type of civil wrong, in which a binding agreement or bargained-for exchange is not honored by one or more of the parties to the contract by non-performance or interference with the other party' ...
; * Post-acquisition disputes such as earnouts or breaches of warranties; *
Bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debt ...
,
insolvency In accounting, insolvency is the state of being unable to pay the debts, by a Natural person, person or company (debtor), at Maturity (finance), maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: Cash flow ...
, and
reorganization A corporate action is an event initiated by a public company that brings or could bring an actual change to the Security (finance), securities—Stock, equity or debt—issued by the company. Corporate actions are typically agreed upon by a co ...
; *
Securities fraud Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the stock or commodity market, commodities markets that induces investors to make purchase or sale decisions on the basis of false information, frequentl ...
; *
Tax fraud Tax evasion is an illegal attempt to defeat the imposition of taxes by individuals, corporations, trust (property), trusts, and others. Tax evasion often entails the deliberate misrepresentation of the taxpayer's affairs to the tax authorities ...
; *
Money laundering Money laundering is the process of concealing the origin of money, obtained from illicit activities such as drug trafficking, corruption, embezzlement or gambling, by converting it into a legitimate source. It is a crime in many jurisdictions ...
; *
Business valuation Business valuation is a process and a set of procedures used to estimate the valuation (finance), economic value of an owner's interest in a business. Here Valuation (finance), various valuation techniques are used by financial market participants ...
; and *
Computer forensics Computer forensics (also known as computer forensic science) is a branch of digital forensics, digital forensic science pertaining to evidence found in computers and digital storage media. The goal of computer forensics is to examine digital med ...
/ e-discovery.


Forensic accountants

Forensic accountants, investigative accountants or expert accountants may be involved in recovering proceeds of serious crime and in relation to confiscation proceedings concerning actual or assumed proceeds of crime or
money laundering Money laundering is the process of concealing the origin of money, obtained from illicit activities such as drug trafficking, corruption, embezzlement or gambling, by converting it into a legitimate source. It is a crime in many jurisdictions ...
. In the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
, relevant legislation is contained in the Proceeds of Crime Act 2002. Forensic accountants typically hold the following qualifications; Certified Forensic Accounting Professional ertified Forensic Auditors(CFA - England & Wales) granted by the Forensic Auditors Certification Board of England and Wales (FACB), Certified Fraud Examiners (CFE - US / International), Certificate Course on Forensic Accounting and Fraud Detection (FAFD) by Institute of Chartered Accountants of India (ICAI), Certified Public Accountants (CPA - US) with AICPA's ertified in Financial Forensics est. 2008(CFF) Credentials, Chartered Accountants (CA - Canada), Certified Management Accountants (CMA - Canada), Chartered Professional Accountants (CPA - Canada), Chartered Certified Accountants (CCA - UK), or Certified Forensic Investigation Professionals (CFIP). In India there is a separate breed of forensic accountants called Certified Forensic Accounting Professionals. The Certified Forensic Accountant (CRFAC) program from the American Board of Forensic Accounting assesses Certified Public Accountants (CPAs) knowledge and competence in professional forensic accounting services in a multitude of areas. Forensic accountants may be involved in both litigation support (providing assistance on a given case, primarily related to the calculation or estimation of economic damages and related issues) and investigative accounting (looking into illegal activities). The American Board of Forensic Accounting was established in 1993. Large accounting firms often have a forensic accounting department. All of the larger accounting firms, as well as many medium-sized and boutique firms and various police and government agencies have specialist forensic accounting departments. Within these groups, there may be further sub-specializations: some forensic accountants may, for example, just specialize in
insurance Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to Hedge ( ...
claims Claim may refer to: * Claim (legal) A cause of action or right of action, in law, is a set of facts sufficient to justify suing to obtain money or property, or to justify the enforcement of a legal right against another party. The term also re ...
, personal injury claims,
fraud In law, fraud is intentional deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud can violate civil law (e.g., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover monetary compe ...
, anti-money-laundering,
construction Construction is a general term meaning the art and science to form Physical object, objects, systems, or organizations,"Construction" def. 1.a. 1.b. and 1.c. ''Oxford English Dictionary'' Second Edition on CD-ROM (v. 4.0) Oxford University Pr ...
, or royalty
audit An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon.” Auditing ...
s. Forensic accounting used in large companies is sometimes called financial forensics.  Forensic accountants combine knowledge of the law with their accounting skills.  They can assess companies, and help companies resolve issues.  This can help companies prevent corruption, fraud, embezzlement, etc. A forensic accountant performing an audit of a company should remain neutral.  Large companies mainly use forensic accountants when performing audits; however, there are other uses for forensic accountants in companies Forensic accountants often assist in professional
negligence Negligence (Lat. ''negligentia'') is a failure to exercise appropriate and/or ethical ruled care expected to be exercised amongst specified circumstances. The area of tort law known as ''negligence'' involves harm caused by failing to act as a ...
claims where they are assessing and commenting on the work of other professionals. Forensic accountants are also engaged in marital and family law of analyzing lifestyle for spousal support purposes, determining income available for child support and equitable distribution. Forensic accounting and fraud investigation methodologies are different than internal auditing. Thus forensic accounting services and practice should be handled by forensic accounting experts, not b
internal auditing
experts. Forensic accountants may appear on the crime scene a little later than fraud auditors, but their major contribution is in translating complex financial transactions and numerical data into terms that ordinary laypersons can understand. That is necessary because if the fraud comes to trial, the jury will be made up of ordinary laypersons. On the other hand, internal auditors move on checklists that may not surface the evidence that the jury or regulatory bodies look for. The fieldwork may carry out legal risks i
internal auditing
checklists are employed instead asking to a forensic accountant and may result serious consultant malpractice risks. The main goal of Forensic accountants is to determine if financial crime has been committed and if so, to what extent. They are often used as expert witness to assist the judge or jury in forming the verdict. It is important that forensic accountants possess skills such as microeconomics, cost-center accounting systems, coming up with conclusions with little data, report writing, research skills and interview skills. This process can employ one or more of the following techniques: Review of
Public records Public records are documents or pieces of information that are not considered confidential and generally pertain to the conduct of government. For example, in California, when a couple fills out a marriage license application, they have the op ...
, Background investigations, Interviews of knowledgeable parties, Analysis of
Real evidence In evidence law, physical evidence (also called real evidence or material evidence) is any material object that plays some role in the matter that gave rise to the litigation, introduced as Evidence (law), evidence in a judicial proceeding (such ...
to identify possible
Forgery Forgery is a white-collar crime that generally refers to the false making or material alteration of a legal instrument with the specific mens rea, intent to wikt:defraud#English, defraud anyone (other than themself). Tampering with a certain ...
and/or document alterations,
Surveillance Surveillance is the monitoring of behavior, many activities, or information for the purpose of information gathering, influencing, managing or directing. This can include observation from a distance by means of electronic equipment, such as c ...
and inspection of business premises, Analysis of individual
Financial transaction A financial transaction is an Contract, agreement, or communication, between a buyer and seller to exchange goods, Service (economics), services, or Asset, assets for payment. Any transaction involves a change in the status of the finances of two ...
s or statements, and Review of Business records to identify fictitious vendors, employees, and/or business activities. Forensic accountants are also increasingly playing more proactive risk reduction roles by designing and performing extended procedures as part of the statutory audit, acting as advisers to audit committees, fraud deterrence engagements, and assisting in investment analyst research.


Methods

Forensic accounting combines the work of an
auditor An auditor is a person or a firm appointed by a company to execute an audit.Practical Auditing, Kul Narsingh Shrestha, 2012, Nabin Prakashan, Nepal To act as an auditor, a person should be certified by the regulatory agency, regulatory authority o ...
and a private investigator. Unlike auditors whose goal is focused on finding and preventing errors, the role of a forensic accountant is to identify instances of fraud. Some of the most common types of fraud schemes include overstating revenues, understating liabilities, inventory manipulation, and asset misappropriation. To discover these, forensic accountants apply a variety of techniques. Forensic accounting methods can be classified into quantitative and qualitative. The qualitative approach studies the personal characteristics of the individuals behind financial fraud schemes. A popular theory of fraud revolves around the fraud triangle, which classifies the three elements of fraud as perceived opportunity, perceived need (pressures), and rationalization. More recently, forensic accountants have gone beyond incentive effects and focused on behavioral characteristics. Certain predictive factors, like being labeled as “narcissistic” or committing adultery, are common traits among fraud perpetrators. These characteristics are often not conclusive enough on their own to identify the culprit, but can help forensic accountants to narrow down a suspect list. The quantitative approach focuses on financial data information and searches for abnormalities or patterns predictive of misconduct. Today, forensic accountants work closely with data analytics to dig through complex financial records. Data collection is an important aspect of forensic accounting because proper analysis requires data that is sufficient and reliable. Once a forensic accountant has access to the relevant data, analytic techniques are applied. Predictive modeling can detect potentially fraudulent activities, entity resolution algorithms and social network analytics can identify hidden relationships, and
text mining Text mining, also referred to as ''text data mining'', similar to text analytics, is the process of deriving high-quality information from text. It involves "the discovery by computer of new, previously unknown information, by automatically extra ...
allows forensic accountants to parse through large amounts of unstructured data quickly. Another common quantitative forensic accounting method is the application of Benford’s law. Benford’s law predicts patterns in an observed set of accounting data, and the more the data deviates from the pattern, the more likely that the data has been manipulated and falsified.


Analytical techniques

Forensic accountants utilize an understanding of
economic theories Economics () is the social science Social science is one of the branches of science, devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. The term was formerly ...
, business information,
financial reporting Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
systems, accounting and auditing standards and procedures,
data management Data management comprises all List of academic disciplines, disciplines related to handling data as a valuable resource. Concept The concept of data management arose in the 1980s as technology moved from sequential access, sequential processing ...
&
electronic discovery Electronic discovery (also ediscovery or e-discovery) refers to discovery in legal proceedings such as litigation - A lawsuit is a proceeding by a party or parties against another in the Civil law (common law), civil court of law. The archa ...
, data analysis techniques for fraud detection,
evidence Evidence for a proposition is what supports this proposition. It is usually understood as an indication that the supported proposition is true. What role evidence plays and how it is conceived varies from field to field. In epistemology, evid ...
gathering and investigative techniques, and litigation processes and procedures to perform their work. When detecting fraud in public organizations accountants will look in areas such as billing, corruption, cash and non-cash asset misappropriation, refunds and issues in the payroll department. To detect fraud, companies may undergo management reviews, audits (both internally and externally) and inspection of documents. Forensic accountants will often try to prevent fraud before it happens but searching for errors and in-precise operations as well as poorly documents transactions. The process begins with the forensic accountant gathering as much information as possible from clients, suppliers, stakeholders and anyone else involved in the company. Next, they will analyze financial statements in order to try and find errors or mistakes in the reporting of those financial statements as well as they will analyze any background information provided. The next step involves interviewing employees in order to try and find where the fraud may be occurring. Investigators will look at company values, performance reviews, management styles and the overall structure of the company. After this is complete the forensic accountant will try to draw conclusions from their findings.


See also

*
Benford's law Benford's law, also known as the Newcomb–Benford law, the law of anomalous numbers, or the first-digit law, is an observation that in many real-life sets of numerical data, the leading digit is likely to be small.Arno Berger and Theodore P ...
* Certified Fraud Examiner *
Association of Certified Fraud Examiners The Association of Certified Fraud Examiners (ACFE) is a professional organization of fraud examiners. Its activities include producing fraud information, tools and training. Based in Austin, Texas, the ACFE was founded in 1988 by Joseph T. Wells ...


References


External links


International Institute of Forensic Investigation Professionals IncAssociation of Certified Fraud ExaminersCertified in Financial ForensicsForensic Accountants, Forensic Accounting Certifications, and Due Diligence
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Accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
Accounting terminology