Forensic and Investigative Accounting

Chapter 1
Introduction to Forensic and
Investigative Accounting
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 The Accountant
The 2016 movie “The Accountant” is about an assassin
with an accounting day job. The overall premise of the
movie is that he is hired to investigate the
embezzlement inside a robotics company. He works
with the Treasury Department’s Crime Enforcement
Division to find that the company is siphoning money
($60 million) to put it back into the company to
increase profits before going public (like Crazy Eddie).

Chapter 1 Forensic and Investigative Accounting 2

Forensic Accounting vs. Fraud Auditing

Fraud Auditor: An accountant especially

skilled in auditing who is generally engaged
in auditing with a view toward fraud
discovery, documentation, and prevention.

Chapter 1 Forensic and Investigative Accounting 3

Forensic Accounting vs. Fraud Auditing
Forensic Accountant: A forensic accountant
may take on fraud auditing engagements and
may be a fraud auditor, but he or she will also
use other accounting, consulting, and legal
skills in broader engagements. In addition to
accounting skills, he or she will need a
working knowledge of the legal system and
excellent communication skills to carry out
expert testimony in the courtroom and to aid
in other litigation support engagements.
Chapter 1 Forensic and Investigative Accounting 4
 Forensic Accounting Defined
 Time: Forensic accounting focuses on the past,
although it may do so in order to look forward.
 Purpose: Forensic accounting is performed for a
specific legal forum or in anticipation of
presentation before a legal forum.
 Peremptory: Forensic accountants may be
employed in a wide variety of risk management
engagements within business enterprise as a
matter of right, without the necessity of
allegations (e.g., proactive).

Chapter 1 Forensic and Investigative Accounting 5

 Forensic Accounting Defined

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.

Chapter 1 Forensic and Investigative Accounting 6

 Historical Roots of Accounting

10,000 years ago—Temple priests took inventory of

village livestock.
3,000 B.C.—Scribes recorded ruler’s wealth.
1887—American Association of Public Accountants
(later becoming the AICPA) was formed.
1896—New York State legislated the first CPA law.
1900—School of Commerce, Accounts, and Finance
at New York University opened.
(continued on next slide)
Chapter 1 Forensic and Investigative Accounting 7
 Historical Roots of Accounting

1902—Congress called for audit reports for large

corporations.
1913—Federal Reserve Board was created.
1913—Federal income tax law was passed.
1914—Federal Trade Commission was created.
By 1921—All states passed laws requiring an exam
for CPA certificate.

Chapter 1 Forensic and Investigative Accounting 8

 History of Financial Reports and
Legal Challenges
 Financial reports were created by accountants
long before independent audits were mandated.
 Current system of accounting checks and
balances was relatively recent.
(continued on next slide)

Chapter 1 Forensic and Investigative Accounting 9

 History of Financial Reports and
Legal Challenges
 Before financials were audited by outside
experts, the courts often handled challenges
and brought in experts to give testimony.
 Practice of forensic accounting was common
even before independent accountants were
asked to certify financial statements in
auditing engagements.

Chapter 1 Forensic and Investigative Accounting 10

 Threads of Forensic Accounting

1817—Canadian court decision of Meyer v.

Sefton.
1824—James McClelland started his business
in Glasgow, Scotland.
1856—In England, the audit of corporations
became required.

Chapter 1 Forensic and Investigative Accounting 11

 Forensic Accounting in Print
 Articles on arbitration, fraud, investigation, and
expert witnesses began appearing in the late
1800s.
 After a comment in 1925 by the Chairman of
the U.S. Board of Tax Appeal, The Journal of
Accountancy proposed that educational
institutions should start including in their
curricula the study of the law of evidence.

Chapter 1 Forensic and Investigative Accounting 12

 Phrase “Forensic Accounting” Is Born
 Maurice E. Peloubet coined the phrase in print in 1946.
 Max Lourie wrote an article and also claimed to coin the
phrase, seven years after Peloubet. Lourie’s article voiced
three important positions:
– An accountant should not have to attend law school to
learn the art of expert testimony.
– Colleges and universities should deliver forensic
accounting training.
– Forensic accounting reference books and textbooks
should be developed for students.
 The first forensic accounting book appeared in 1982.
Chapter 1 Forensic and Investigative Accounting 13
 FBI and Forensics
 During WWII, the FBI employed approximately
500 agents who were accountants.
 In 1960, about 700 FBI agents were Special
Agent Accountants.
 Today, there are more than 600 FBI agents with
accounting backgrounds. The FBI has a
Financial Crimes Section that investigates
money laundering, Internet crimes, financial
institutions fraud, and any other economic
crime.

Chapter 1 Forensic and Investigative Accounting 14

 AICPA Practice Aid
In 1986, the AICPA broke forensic accounting into
two broad areas: investigative accounting and
litigation support.
The types of litigation services were further broken
down in Practice Aid 7, listing:
– damages
– antitrust analyses
– accounting
– valuation
– general consulting
– analyses
Chapter 1 Forensic and Investigative Accounting 15
 Panel on Audit Effectiveness
In 1998, the Public Oversight Board
appointed the Panel on Audit Effectiveness to
review and evaluate how independent audits
of the financial statements of public
companies are performed and to assess
whether recent trends in audit practices serve
the public interest.

Chapter 1 Forensic and Investigative Accounting 16

 Panel on Audit Effectiveness

In 2000, the Panel issued a 200-page report,

Report and Recommendations, which
included a recommendation that auditors
should perform forensic-type procedures
during every audit to enhance the prospect of
detecting material financial statement fraud.

Chapter 1 Forensic and Investigative Accounting 17

 AICPA Fraud Task Force Report
In 2003, the AICPA’s Litigation and Dispute
Resolution Services Subcommittee issued a report
of its Fraud Task Force entitled, “Incorporating
Forensic Procedures in an Audit Environment.”
The report covered the professional standards that
apply when forensic procedures are employed in
an audit and explained the various means of
gathering evidence through the use of forensic
procedures and investigative techniques.

Chapter 1 Forensic and Investigative Accounting 18

 Accountant’s Role in Fraud Detection
 In the early 1980s, companies began using computers to
perform their record keeping.
 Intense competition caused auditing fees to decrease by
as much as 50% from the mid-1980s to the mid-1990s.
 Auditors cut costs by reducing the process of reviewing
hundreds of corporate accounts. They grew more reliant
on internal controls.
 The Journal of Forensic and Investigative Accounting
was created.
(continued on next slide)

Chapter 1 Forensic and Investigative Accounting 19

 Accountant’s Role in Fraud Detection
 Top executives were able to circumvent internal
controls and manipulate the records.
 This lead to situations such as Enron, WorldCom,
Xerox, Adelphia Communication, and the fall of
Arthur Andersen in the early 2000s.
 Due to the financial disaster of companies, such as
Enron and WorldCom, there has been an increased
use of forensic techniques in audits and an increase
in fees.
(continued on next slide)

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Accountant’s Role in Fraud Detection
 Some accounting experts believe that every audit
engagement should include much more skepticism
and detailed review of transactions.
 Other accounting experts suggest that only special
engagements specifically targeting fraud can
adequately and effectively root out the problem.
 The Big Four and the next two accounting firms
believe that every public corporation should have
a forensic audit every three years.

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 Big-Six's Position
 A forensic audit is akin to a police investigation.
 All public companies would have a forensic audit on a regular
basis. Companies would be required to have such an audit
every three or five years or face audits on a random basis.
 Forensic auditors would scrutinize any records of companies,
including e-mails, and would be able, if not required, to
question all company employees, and to require statements
under oath.
 Might be necessary for an audit network or a specialized
forensic auditor to complete a forensic audit with the aid of an
independent attorney (not one who has represented the audit
client in other engagements).
Source: “Serving Global Markets and the Global Economy: A View from the CEOs of the International Audit
Networks,” November 2006, p. 13.

Chapter 1 Forensic and Investigative Accounting 22

 More Differences
Two practitioners have suggested these additional procedures may
be used in a forensic audit:
 Extensive use of interviews and leveraging techniques
designed to elicit sufficient information to prove or
disprove a hypothesis.
 Document inspection that may extend to authentication
procedures and handwriting analysis.
 Significant public records search to uncover, for
example, unexpected title or ownership, other known
addresses, and prior records of individuals.
 Legal knowledge regarding rules of evidence, including
chain of custody and preservation of evidence integrity.
Source: Annett Stalker and M.G. Ueltzen, “An Audit Versus a Fraud Examination,” CPA Expert,
Winter 2009, p. 4.

Chapter 1 Forensic and Investigative Accounting 23

 Inexperienced Forensic Auditors
 Find out who did it. Do not worry about all the
endless details.
 Be creative, think like a fraudster, and do not be
predictable. Lower the auditing threshold without
notice.
 Take into consideration that fraud often involves
conspiracy.
 Internal control lapses often occur during
vacations, sick outages, days off and rest breaks,
especially when temporary personnel replace
normal employees.
H. R. Davia, Fraud 101, New York: John Wiley & Sons, 2000, pp. 42-45.

Chapter 1 Forensic and Investigative Accounting 24

 Contrasting Auditing, Forensic
Accounting, and Fraud Examination
Characteristic Audit Fraud Examination Forensic Accounting

Time perspective: Historical Historical Future and historical

Primary focus: Periodic Reactive Proactive and ongoing

Investigation scope: Narrow Narrow Broad ranging

Main work product is: Audit opinion Fraud case report Forensic audit report

Main responsibility to: Company and Defrauded party Concerned principal or

public third party
Guidelines are: Rules-based Principles-based; under audit Principles-based
rules, it is rules-based
Purpose of report: Ensure GAAP Identify perpetrator of fraud Fraud risk assessment and
is followed strategic services
Professional stance: Non- Adversarial Adversarial and non-
adversarial adversarial

Chapter 1 Forensic and Investigative Accounting 25

 Some White Collar Crimes
 Antitrust.
 Bankruptcy fraud.
 Corporate/securities fraud.
 Health care fraud.
 Insurance fraud.
 Mass marketing fraud.
 Money laundering.
 Mortgage fraud.

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 Sarbanes–Oxley Legislation
1. Title 1 establishes the Public Company Accounting Oversight Board
(PCAOB) under the SEC to regulate auditing and to discipline auditors.
2. Title 2 contains a series of rules to ensure that auditors are independent
from their clients. For example, neither the primary nor reviewing
partner may audit the same client for more than five consecutive years,
and the auditor must report all material written communication to the
audit committee.
3. Title 3 requires publicly traded companies to have an audit committee,
as well as financial statements certified by the CEO and CFO; and
provides rules for the conduct of officers and their attorneys.
4. Title 4 prohibits personal loans and requires certain financial
disclosures.
5. Title 5 mandates rules for financial security analysts (i.e., research
analysts) to avoid conflicts of interest.
6. Titles 6, among other provisions, allows federal courts the power to bar
individuals who violate security laws from participating in penny
stocks.

Chapter 1 Forensic and Investigative Accounting 27

 Sarbanes–Oxley Legislation
7. Title 7 requires reports and studies on consolidation of accounting
firms, credit rating agencies, enforcement actions, and investment
banks.
8. Title 8 provides protection for whistleblowers and mandates penalties
and fines for certain acts not dischargeable by bankruptcy. For
example, failure of an auditor to keep working papers for 5 years is
subject to fines and 10 years in prison, and a fine or imprisonment of up
to 25 years for anyone knowingly defrauding shareholders of publicly
traded companies. A person can receive 20 years in prison and fines for
altering, destroying, mutilating, concealing, covering up, falsifying or
making a false entry in any record, document, or tangible object.
9. Title 9 increases maximum prison sentences for mail and wire fraud
from 5 to 20 years. Willfully and knowingly certifying financial reports
not in compliance with the Act is now a criminal offense.
10. Title 10 says that it is the “Sense of the Senate” to require the CEO to
sign the corporate tax return.
11. Title 11 provides a possible 20-year prison sentence for anyone
altering, destroying, mutilating, or concealing a record, document, or
other object (or otherwise impeding) for an official proceeding.

Chapter 1 Forensic and Investigative Accounting 28

 Committee on Sponsoring
Organizations
Providing thought leadership through
comprehensive frameworks and guidance.
COSO internal control framework used by
many companies.
COSO Cube and Updated COSO Cube (See
Chapter 4).

Chapter 1 Forensic and Investigative Accounting 29

 Foreign Corrupt Practices Act
 Purpose is to combat corrupt business practices such as bribes and
kickbacks.
 First provision, anti-bribery, prohibits corrupt payments to foreign
officials.
 Books and records provision requires keeping books, records, and
accounts that accurately reflect the issuer’s transactions and
disposition of assets.
 Covers both issuers and domestic concerns.

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 Securities Whistleblower Incentive and
Protection Provisions of Dodd-Frank Act
 Provides financial incentives for
employees and others to report to SEC
suspected securities violations.
 Directs SEC to pay awards and provide
job protection to whistleblowers.
 Eligible whistleblowers may receive
awards equal to 10% to 40% of
monetary sanctions imposed by SEC.
Chapter 1 Forensic and Investigative Accounting 31
Organization for Economic Cooperation
and Development (OECD)
 Goal to help administer the Marshall Plan.
 Both civil and criminal sanctions may be imposed on 34 member
countries.
 Compares and measures data on a wide variety of topics.
 Uses peer pressure to implement and improve policies and set
standards.

Chapter 1 Forensic and Investigative Accounting 32

 Yates Memo
 On June 9, 2015, Deputy Attorney General Sally Yates issued guidelines
to DOJ attorneys indicating the importance of individual accountability
in DOJ prosecutions.

 The memo outlined six key steps to guide and strengthen

prosecution. See EY’s 14th Global Fraud Survey
explantation the next slide.

 DOJ wants corporations to “carry out a thorough investigation tailored

to the scope of the wrongdoing,” and to “continue to turn over
information to the prosecutor as they receive it.” (Yates)

 Targets include C-suite and Board members.

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 Key Principles of theYates Memo

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 Panama Papers
• A whistleblower, so-called John Doe, leaked 11.5
million documents (40 years) of a Panamanian law
firm and a corporate service provider Mossack
Fonseca.
• Contained personal financial information and
public officials for at 214,488 offshore entities.
• Some shell companies were used for such illegal
purposes as fraud, tax evasion, and evading
international sanctions.
• Exposed financial dealings of 140 politicians,
fraudsters, billionaires, drug traffickers, and sports
stars.
• Prime Minister of Ireland, president of Ukraine, a
King of Saudi, and Vladimir Putin were only some
of the offshore holdings
Chapter 1
exposed by the
Forensic and Investigative Accounting 35
whistleblower.