Forensic Accounting:

An Introduction

George Young
 Overview
What is Forensic Accounting?
What is fraud?
Who commits fraud?
How do forensic accountants search for
fraud?
What’s the demand for forensic
accounting?
How can you prepare for opportunities in
this area?
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What is Forensic Accounting?
Forensic accounting is the practice of
utilizing accounting, auditing, and
investigative skills to determine whether
fraud has occurred.

It encompasses two main areas:

Litigation support
Investigation
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 Litigation Support
Is the factual presentation of economic
issues related to existing or pending
litigation.

The forensic accountant quantifies

damages sustained by parties involved in
legal disputes and assists in resolving
disputes, even before they reach the
courtroom.

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 Litigation Support
Arbitration assistance
Business valuation for divorce, stockholder disputes
Computation of damages resulting from personal
injuries, wrongful death, breach of contract, casualty,
and fidelity losses
Determination of lost profits due to business interruption
Testifying as an expert witness
Financial review of contractual obligations
Investigative services related to fraud and other illegal
acts

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 Investigation
Is the act of determining whether criminal
matters such as employee theft, securities
fraud (including falsification of financial
statements), and insurance fraud have
occurred.
Also includes searching for irregularities
associated with civil matters, such as a
search for hidden assets in divorce cases.

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 What is Fraud?

Fraud is an intentional misrepresentation

of a material point or issue on which a
victim relies.
This reliance usually results in one or
more victims suffering damages.

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 Types of Fraud
Occupational
– Financial statement schemes
– Asset misappropriation (e.g., cash theft,
fraudulent disbursements, inventory theft)
– Bribery and corruption
– Intellectual property

Source: Fraud Examiners Manual, 3 rd edition (2001)

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 Types of Fraud
Other Frauds
– Financial institution
– Check and credit card fraud
– Insurance fraud
– Health care fraud
– Bankruptcy fraud
– Tax fraud
– Securities fraud
– Money laundering
– Consumer fraud
– Computer and Internet fraud
– Governmental fraud
Source: Fraud Examiners Manual, 3 rd edition (2001)

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 Examples of Fraud
Financial Statement Schemes

A publicly-traded company engaged in

sham transactions for more than seven
years by using several shell companies.
The money transferred to the shell
companies as payments for assets were
returned as payments on accounts
receivable. The company’s assets were
inflated by as much as $80 million.
Source: Wells, J.T. (1997) Occupational Fraud and Abuse. Austin, TX: Obsidian Publishing Company

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 Examples of Fraud
Employee Embezzlement
A warehouse foreman and a parts
ordering clerk colluded to purchase
$300,000 of nonexistent supplies. The
parts ordering clerk initiated the
transactions by obtaining ordering
approval. The orders were sent to a
vender who prepared false invoices. The
foreman then verified receipt.
Source: Wells, J.T. (1997) Occupational Fraud an Abuse. Austin, TX: Obsidian Publishing Company

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 Examples of Fraud
Asset Misappropriation

A CEO conspired with a former employee

to sell a building to a company owned by
the CEO’s employer. The building was
sold for $1.2 million more than it had been
purchased by the former employee. All
transactions occurred on the same day.
Source: Wells, J.T. (1997) Occupational Fraud and Abuse. Austin, TX: Obsidian Publishing Company

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 Examples of Fraud
Health Care Fraud

Dr. X billed a patient’s insurance for the following

activities:
 Knee arthroscopy with debridement $1,650
 Diagnostic knee arthroscopy 1,625
Total billed $3,275
The second procedure listed above is
included in the first procedure. Therefore, the
correct amount of the bill is $1,650.
Source: Fraud Examiners Manual, 3 rd edition (2001)

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 Examples of Fraud
Divorce Fraud
John Dewey is the majority owner of a large
public relations firm. His wife, Mary, recently
filed for divorce and is asking for half John’s
assets. Prior to being served, John took some
trips to the Cayman Islands and Switzerland.
During the divorce proceedings, Mary was
shocked to learn that the value of the firm is
$50,000. Prior to the divorce, John had given
her $200,000 a year to cover their personal
expenses.
Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Examples of Fraud
Fraudulent Disbursements

An employee created over 1,000 false

refunds, all under the review limit of
$15.00. He was caught because be began
processing refunds before store hours and
another employee noticed this. Before the
scheme was detected, he made off with
over $11,000.
Source: Wells, J.T. (1997) Occupational Fraud and Abuse. Austin, TX: Obsidian Publishing Company

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 Examples of Fraud
Governmental Services Association (GSA)
purchased $200M of furniture from a New
Jersey vendor. The furniture was
defective. A GSA regional supervisor was
suspected of taking bribes to ignore the
defects. He bought 11 racehorses for
$13K apiece during a four year period.
Source: Wells, J.T. (1997) Occupational Fraud and Abuse. Austin, TX: Obsidian Publishing Company

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 Examples of Fraud
Vendor Fraud: Defective Delivery
The low bidder was awarded a contract to
pave a parking lot. Upon examination,
several randomly-taken core samples
revealed 2” of paving whereas the contract
specified 4”. Also, the parking lot had not
been sealed as required by the contract.

Source: Davia et al. (2000) Fraud Detection and Control. New York: John Wiley &
Sons, Inc.

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 Examples of Fraud
Vendor Fraud: Unbalanced Bid
Bid was let to construct 3 buildings in the
following order: A, B, C.
Buildings
Bidder A B C Total
Avalon $510K $250K $240K $1M
St. James 375K 375K 375K 1.125M
Corinna 400K 400K 400K 1.2M
What’s the problem?
Source: Davia et al. (2000) Fraud Detection and Control. New York: John Wiley & Sons, Inc.

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 Examples of Fraud
Kickbacks: Unilateral
Mary, the employee responsible for
purchasing at JLH, was the recipient of
lavish gifts from a large supplier that she
did not disclose to her employer
(accepting these gifts was against
company policy).

Who is most responsible here?

Source: Davia et al. (2000) Fraud Detection and Control. New York: John Wiley &
Sons, Inc.

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 Examples of Fraud
Kickbacks: Bi-Lateral
Assume the cost of janitorial services ranges
from $1.50 to $2.50 per square foot (psf). BBK
Company has 1,000,000 sq. ft. to be serviced. If
JanServ charges 20 ¢ more psf than does an
honest service, JanServ will make an extra
$200K that can be used to pay a kickback to the
employee who helps JanServ obtain the
contract.

Source: Davia et al. (2000) Fraud Detection and Control. New York: John Wiley & Sons, Inc.

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 Who Commits Fraud?
Frauds against organizations (M = median)
40% by employees (M = $78,000)
41% by management (M = $218,000)
19% by owners (M = $1,000,000)

Males (61%, M = $250,000)

Females (39%, M = 102,000)

High school (33%, M = $100,000)

College (55%, M = $200,000)
Postgraduate (12%, M = 425,000)
Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse, pp. 42-43

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 Who Commits Fraud?
Median loss per age group
< 26 years $ 25,000
26 – 30 50,000
31 – 35 134,000
36 – 40 135,000
41 – 50 250,000
51 – 60 350,000
> 60 713,000
Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse. P. 45

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 Who Commits Fraud?
Perpetrator’s Criminal Histories

Charged but not convicted 4%

Had prior convictions 8%
Never charged or convicted 88%

Source: 2006 ACFE Report to the Nation on Occupational Fraud and Abuse, p. 55

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 Why is Fraud Committed?
The Fraud Triangle
perceived pressure, perceived opportunities, and
rationalization Source: SAS No. 99, Consideration of fraud in a financial statement audit

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 Perceived Pressure
Employees, managers, and owners can feel
pressure to commit fraud as a result of

 Greed or preoccupation with being successful

 Living beyond means
 High personal debts
 Unexpected financial needs
 Expensive vices
 Family-imposed pressures
Source: Carl Pacini, J.D., Ph.D., CPA

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 Perceived Opportunities
Opportunities to commit fraud exist when
levels of trust in an organization are reached
or when controls are weak.

 Inappropriate segregation of duties

 Ineffective supervision
 Transaction authorization not required
 Lack of physical controls
 Lack of adequate audit trail
Source: Carl Pacini, J.D., Ph.D., CPA

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 Rationalization
Individuals usually don’t commit fraud unless
they can justify their actions in relation to
their own code of ethics.

 Feeling underpaid or overworked

 Desire to seek revenge
 Belief that taking the assets is a loan
 Belief they are helping others (family,
employees)
Source: Carl Pacini, J.D., Ph.D., CPA

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 How do Forensic Accountants
Search for Fraud?

Proactive fraud detection

Reactive fraud detection

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 Proactive Fraud Detection
Inductive approaches
Use of Data-mining software
Digital analysis of company data
Deductive approach
Determine what kinds of frauds can
occur. Search for symptoms of
these frauds.

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 Data-mining Software
Excel
ACL
IDEA
Microsoft Access

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Digital Analysis of Company Data
Benford’s Law (first digit frequency)
35

30

25

20

15 Percent

10

0
1 2 3 4 5 6 7 8 9

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 Deductive Approach
to Detecting Fraud
Involves a 5-step process:
 Understanding the business environment
 Understanding the kinds of fraud that can occur
in this environment
 Determining the most likely symptoms
 Using databases and systems to search for the
fraud symptoms
 Following up on discoveries to determine
likelihood fraud exists
Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Reactive Fraud Detection
Fraud accountants are often engaged after
someone in the entity suspects that fraud
has been committed.

Usually the area in which fraud has been

committed is known. Often, the entire
area is examined.

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 Evidence Categories

Testimonial Documentary
Evidence Evidence

Physical Personal
Evidence Observation

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 Testimonial Evidence

Interviewing
Interrogatories (written questions that identify
information needed from opposing party)
Honesty tests (e.g., graphology, polygraph)

Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Documentary Evidence
Document examination
Public records searches
Audits
Computer searches
Net worth calculations
Financial statement analysis

Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Physical Evidence
Fingerprints
Tire marks
Weapons
Stolen property
Identification numbers or markings on
stolen objects
Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Personal Observation

Invigilation
Surveillance
Covert operations

Source: Albrecht, W. S. 2003. Fraud Examination. Mason, OH: Thomson South-Western

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 Demand for Forensic
Accountants
One of the eight “most secure career tracks in
America” (U.S. News & World Report, February
8, 2002)
One of the “ten hottest jobs” for the next decade
with annual salary potential of over $100k
(SmartMoney Magazine, May 16, 2002)
One of the seven hot new “sizzling” career areas
in accounting, according to the AICPA
25,000 – 50,000 new professionals needed in
this field in the next few years

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 How can you prepare for the
opportunities in this area?
Self study (e.g., ACFE self-study courses)
On-the-job training
Formal education

Obviously, a combination of at least two of

these approaches will lead to optimal
preparation.

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Preparation for Opportunities
The Association of Certified Fraud Examiners
(ACFE) offers CPE courses, including a course
that helps candidates prepare for the Certified
Fraud Examiner examination.
Other organizations, such as those involved in
business valuation and the American Institute of
Certified Public Accountants (AICPA), offer
courses at the elementary, intermediate, and
advanced levels.

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Preparation for Opportunities
On-the-job training can be accomplished
by working for the government (e.g.,
Division of Insurance Fraud, IRS), for a
CPA firm that has a forensic practice (e.g.,
Berkowitz, Dick, Pollack, & Brant), or a
firm that specializes in a forensic area,
such as business valuation (e.g., Trugman
& Associates).

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Preparation for Opportunities
Colleges and universities are beginning to
offer courses in forensic accounting and
fraud examination.

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 Thank you!
If you have unanswered questions after you leave, you
may contact me at the following address and number.

George Young
Florida Atlantic University
Askew Tower 546
111 E. Las Olas Blvd.
Ft. Lauderdale, FL 33301

(954) 762-5610
gyoung@fau.edu
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