FORENSIC ACCOUNTING

Forensic accounting is defined as "the application of investigative and analytical skills for the

purpose of resolving financial issues in a manner that meets standards required by courts of law.

Forensic accountants apply special skills in accounting, auditing, finance, quantitative methods,

certain areas of the law, research and investigative skills to collect, analyze and evaluate

evidential matter and to interpret and communicate findings."[4]

Forensic accounting is the term used to describe the type of engagement. It is the whole process

of carrying out a forensic investigation, including preparing an expert’s report or witness

statement, and potentially acting as an expert witness in legal proceedings.

Forensic investigation is a part of a forensic accounting engagement. Forensic investigation is the

process of gathering evidence so that the expert’s report or witness statement can be prepared. It

includes forensic auditing, but incorporates a much broader range of investigative techniques,

such as interviewing witnesses and suspects, imaging or recovering computer files including

emails, physical searches of premises etc.

Forensic auditing is the application of traditional auditing procedures and techniques in order to

gather evidence as part of the forensic investigation.

APPLICATION

The major applications of forensic accounting include fraud investigations, negligence cases and

insurance claims.

An insurance claim would require determination of how much the client should claim from the

insurer.

STEP 1

The first step would be a detailed review of the insurance policy to determine ‘coverage’, ie what

is insured and any clauses that might restrict the amount that can be claimed or invalidate the

claim.

STEP 2

The second step would be to gather evidence to quantify the loss, ie the amount to be claimed.

Insurance claims might include claims following misappropriation of assets, ie theft of goods or

money. In such cases, the forensic accountant will review inventory or cash records and details

of sales and purchases to reconcile the amounts held and determine the value of the goods or

cash stolen. They will also test the reliability of the information held by counting a sample of

inventory or cash currently held in comparison with the client’s records. The forensic accountant

will not assume that there has been a theft; they will consider other possibilities such as an error

in the data held.

Insurance claims may however, be much more complicated than this, such as in the case of

business interruptions arising as a result of fire or flood. In these types of engagements the

forensic accountant will review prospective financial information in comparison with reported

outturn to evaluate the loss of profit arising as a result of the business interruption. The forensic

accountant will not assume that there has been any loss of profit due to the business interruption;

they will consider other possibilities such as a straightforward loss of market share to a

competitor.

FORENSIC ENGAGEMENTS

Forensic engagements often require the forensic accountant to quantify a loss. One such

engagement is in professional negligence claims, ie when another accountant has breached their

duty of care to a client or third party resulting in a loss for that client. In these types of

engagement, the forensic accountant would also provide an opinion on whether the duty of care

owed has been breached, ie whether the audit or other accountancy service was performed in

accordance with current standards in practice, legislation and techniques. In relation to an audit,

this would require consideration of whether the International Standards on Auditing were

followed.

Financial forensic engagements may fall into several categories. For example:

- Economic damages calculations, whether suffered through tort or breach of contract;

- Post-acquisition disputes such as earnouts or breaches of warranties;

- Bankruptcy, insolvency, and reorganization;

- Securities fraud;

- Tax fraud;

- Money laundering;

- Business valuation; and

- Computer forensics/e-discovery.

NEED FOR A FORENSIC ACCOUNTANT

The need for a forensic accountant may also arise because two parties cannot agree on the

amount owed by one party to another, and the accountant is engaged to provide an expert

valuation, of a business for example.

This might be the case in a matrimonial dispute, where a divorcing couple whose assets include

shares in a company or partnership, engage a forensic accountant to value the company so that a

settlement can be reached. A similar process might apply in partnerships, when one partner

wishes to leave the partnership and is being bought out by the remaining partner(s).

THE ROLE OF AN EXPERT WITNESS

An expert witness is quite different to any other witness in court proceedings. Most witnesses are

'witnesses of fact', ie they can only provide evidence on what they saw, did or heard. Most

importantly, they cannot give their opinion on any of the matters about which they give

evidence. By contrast, an expert witness is specifically called to give their opinion on a particular

matter.

An accountant can be called to give evidence as a professional witness, ie a witness of fact, or an

expert witness. In order to give evidence as an expert witness they must be just that, an expert.

They must be able to demonstrate a level of expertise that means their opinion is valuable to the

court. This means not only expertise in accountancy, but also expertise in the particular area of

accountancy that they are giving evidence on.

A witness will provide a written report/statement to the court, and may also be required to attend

court to give live evidence, in person, and be cross-examined by the ‘other side’.

However, not all forensic engagements will require evidence to be submitted to a court. Often,

the engagement will simply require a report for the client’s own purposes or sometimes a report

for use by the insurer.

Either way, a key skill necessary in being a successful forensic accountant is the ability to

explain complex accounting concepts in simple terms to someone who is not themselves an

accountant, whether that be as an expert witness explaining matters to the judge or jury, or when

explaining matters to the client. Forensic accounting integrates investigative, accountancy, and

communication skills.

PLANNING

Forensic accounting engagements are agreed-upon procedures engagements, not assurance

engagements. The forensic accountant will not provide an assurance opinion – that is the role of

the auditor when reviewing the amount of loss included in the financial statements.

This will normally involve determining an appropriate value or quantifying a loss as discussed

above; this is quite distinct from an assurance engagement in which the engagement team would

review an amount determined by the client.

As an agreed-upon procedures engagement, the forensic accountant will normally prepare a

report for the client that sets out their findings, based on the scope agreed in the engagement

letter. This report may be addressed to management, often in the case of a fraud, or to the insurer.

It may be that a witness statement/report for submission to the court/arbitrator is required in

addition to or instead of a report to the client.

However, planning the investigation is likely to be similar to planning an audit or any other

assurance engagement.

Planning will commence with a meeting with the client in which the engagement team will

develop an understanding of the issue/events (the fraud, theft etc) and actions taken by the client

since it occurred.

A key part of planning is to confirm exactly what format the output is required in, and exactly

what matters are required to be covered within it.

At this stage any key documentation will be obtained and scrutinised – for example, the

insurance policy, the partnership agreement, the evidence that led to the discovery of the fraud,

etc.

The team will agree with the client, what access to other information or personnel will be

required and this will be arranged.

Based on the above, the team will design procedures that enable them to meet the requirements

of the client, as agreed. This may or may not include test of controls, depending on the

circumstances. There would be no need to tests control when valuing a business for a

matrimonial dispute. However, testing controls will be key to determining how a fraud took

place.

PROCEDURES AND EVIDENCE

Any method of obtaining evidence can be used in a forensic accounting engagement – this is not

a limited assurance engagement in which procedures are likely to be restricted to enquiry and

analytical procedures.

Forensic engagements will include a detailed and wholesale review of all documentation and

electronic evidence available. The opinion given by the expert accountant must be reasoned, and

backed up by evidence. Their opinion cannot be objective if only based on what they are told;

they must corroborate that information.

To be awarded marks in the exam, your procedures cannot be vague. They must be specific

enough that the engagement team could actually follow your instructions.

For example, it would not be sufficient to write 'interview the suspect'. You must suggest

questions that should be asked of the suspect in interview, depending on the circumstances in the

scenario. For example, the suspect could be asked to explain their job role and what access that

gives them to systems, cash, inventory etc.

This also applies when recommending enquires of or discussions with management – it must be

clear in your answer what it is the engagement team should ask of them, eg have they informed

the police, has the suspect been suspended, have they informed the insurer etc.

Equally it is not sufficient to suggest the use of computer assisted auditing techniques (CAATs).

You must specify how the CAATs could be used. For example, data matching bank accounts

used for paying suppliers with bank accounts for paying employees, exception reports

identifying employees who are not taking holiday, etc.

In order to design appropriate procedures you must identify the type of forensic accounting

engagement, and the specific type of fraud, insurance or negligence claim. For example,

quantifying the theft of goods will be very different from quantifying a loss from payroll or

‘ghost employee’ fraud or loss of profits following a business interruption (as discussed above).

RULES OF EVIDENCE IN COURT PROCEEDINGS

The potential forensic accounting expert witness should keep the following in mind the

following requirements:

- Opinions must be disclosed in an oral or written report.

- The basis for all opinions must be identified.

- The report must include a list of information that was considered in forming the opinions

and exhibits used as supporting documentation for the opinions.

- Qualifications including articles written for publication and history of expert witness

testimony must be listed.

In many trials, including those involving fraud, there may be forensic accounting expert

witnesses brought by both sides of the case. Representing the actual “innocent” party in the case

is not a guarantee that the expert witness for the opposition cannot hurt your case. The next part

of this series will delve further into the skills and background a forensic accounting expert

witness may bring to the table.

The various forms of evidence that can be used during a criminal trial are

Documentary evidence

In order for a document to be admissible during criminal proceedings, the following conditions

must be met

(a) The original document must be produced and

(b) The document must be authenticated.

Real evidence

Real evidence is an object which, upon proper identification, becomes, of itself, evidence.

If the evidence is properly identified and relevant and if there is no other rule of evidence that

excludes it as evidence, it will be included as an exhibit that will be duly labelled and numbered

and available for the court to inspect.

Electronic Evidence

It is stated that a data message that was made by a person during the ordinary course of their

business, or a certified copy thereof, is admissible as evidence

Difference between the audit report and a forensic accounting expert report

A forensic accounting report differs considerably from an audit report. The audit report contains

audit opinions that are issued under International Financial Reporting Standards (IFRS), while

the forensic accounting report is not constrained by the required language of a governing

standard and forensic reports differ from one investigation to another, and one firm to another,

depending on the client‘s needs.

The following table illustrates the difference between auditing and a forensic accounting

investigation

FUNDAMENTAL ETHICAL PRINCIPLES

The range of ethical and professional issues will be similar to any other type of engagement.

However, the importance of ethics is arguably much greater in relation to forensic

accountancy. Often both ‘sides’ will bring an expert witness to the hearing where they do not

agree. The decision maker must decide which evidence they ‘prefer’ – the credibility of the

witness is often the primary factor on which they can base that decision and the credibility of an

accountant is reliant on their compliance with the fundamental ethical principles.

In the exam, you will also need to note whether the client requesting the forensic accounting

service is an audit client, if so, this will present an additional and particularly important threat to

objectivity; a self-review threat. The investigation is likely to involve the quantification of an

amount, which will then be reviewed as part of the financial statements audit. The significance

of the threat will be affected by the materiality of the amount and the subjectivity involved in

quantifying it, eg if for loss of profits following business interruption this will be more subjective

than quantification of the value of stolen inventory.

Remember that the decision to prosecute is a matter for the client. Often, clients do not want to

prosecute for fear of damaging their reputation. The forensic accountant can provide the client

with an analysis of all of the facts, but must not make the decision to prosecute (a management

threat to objectivity). The forensic accountant has a duty of confidentiality, unless it is in the

public interest to do so, they must not disclose the fraud to any third party including the police,

without client permission