Forensic Accounting: An Introduction

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Forensic AccountingAn Introduction

• George Young

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Overview

• What is Forensic Accounting?
• What is fraud?
• Who commits fraud?
• How do forensic accountants search for fraud?
• Whats 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, 3rd 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, 3rd edition
  (2001)

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Examples of FraudFinancial 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 companys 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 FraudEmployee 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 FraudAsset Misappropriation

• A CEO conspired with a former employee to sell a
  building to a company owned by the CEOs
  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 FraudHealth Care Fraud

• Dr. X billed a patients 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, 3rd edition
  (2001)

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Examples of FraudDivorce 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 Johns
  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 FraudFraudulent 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 FraudVendor 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 FraudVendor 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
• Whats the problem?
• Source Davia et al. (2000) Fraud Detection and
  Control. New York John Wiley Sons, Inc.

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Examples of FraudKickbacks 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 FraudKickbacks 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
• lt 26 years 25,000
• 26 30 50,000
• 31 35 134,000
• 36 40 135,000
• 41 50 250,000
• 51 60 350,000 gt 60
  713,000
• Source 2006 ACFE Report to the Nation on
  Occupational Fraud Abuse. P. 45

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Who Commits Fraud?

• Perpetrators 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 dont 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 AccountantsSearch 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 DataBenfords Law
(first digit frequency)
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Deductive Approachto 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
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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
• [phone]
• gyoung_at_fau.edu