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Forensic and Investigative Accounting Chapter 1 Introduction to Forensic and Investigative Accounting © 2011 CCH. All Rights Reserved. 4025 W. Peterson.

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Presentation on theme: "Forensic and Investigative Accounting Chapter 1 Introduction to Forensic and Investigative Accounting © 2011 CCH. All Rights Reserved. 4025 W. Peterson."— Presentation transcript:

1 Forensic and Investigative Accounting Chapter 1 Introduction to Forensic and Investigative Accounting © 2011 CCH. All Rights Reserved W. Peterson Ave. Chicago, IL

2 Chapter 1Forensic and Investigative Accounting2 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.

3 Chapter 1Forensic and Investigative Accounting3 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.

4 Chapter 1Forensic and Investigative Accounting4 Forensic Accounting Defined Time: Forensic accounting focuses on the past, although it may do so in order to look forward. 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. 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). 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).

5 Chapter 1Forensic and Investigative Accounting5 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.

6 Chapter 1Forensic and Investigative Accounting6 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 opens. (continued on next slide)

7 Chapter 1Forensic and Investigative Accounting7 Historical Roots of Accounting 1902—Congress calls for audit reports for large corporations. 1913—Federal Reserve Board created. 1913—Federal income tax law was passed. 1914—Federal Trade Commission created. By 1921—All states had passed laws requiring exam for CPA certificate.

8 Chapter 1Forensic and Investigative Accounting8 History of Financial Reports and Legal Challenges Financial reports were created by accountants long before independent audits were mandated. Financial reports were created by accountants long before independent audits were mandated. Current system of accounting checks and balances is relatively recent. Current system of accounting checks and balances is relatively recent. (continued on next slide)

9 Chapter 1Forensic and Investigative Accounting9 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. 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. Practice of forensic accounting was common even before independent accountants were asked to certify financial statements in auditing engagements.

10 Chapter 1Forensic and Investigative Accounting10 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.

11 Chapter 1Forensic and Investigative Accounting11 Forensic Accounting in Print Articles on arbitration, fraud, investigation, and expert witnesses began appearing in the late 1800s. 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. 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.

12 Chapter 1Forensic and Investigative Accounting12 Phrase “Forensic Accounting” Is Born Maurice E. Peloubet coined the phrase in print in Maurice E. Peloubet coined the phrase in print in Max Lourie wrote an article and also claimed to coin the phrase, seven years after Peloubet. Lourie’s article voiced three important positions: 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 The first forensic accounting book appeared in 1982.

13 Chapter 1Forensic and Investigative Accounting13 FBI and Forensics During WWII, the FBI employed approximately 500 agents who were accountants. During WWII, the FBI employed approximately 500 agents who were accountants. In 1960, about 700 FBI agents were Special Agent 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. 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.

14 Chapter 1Forensic and Investigative Accounting14 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

15 Chapter 1Forensic and Investigative Accounting15 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.

16 Chapter 1Forensic and Investigative Accounting16 Panel on Audit Effectiveness In 2000, the Panel issues a 200-page report, Report and Recommendations, which includes a recommendation that auditors should perform forensic-type procedures during every audit to enhance the prospects of detecting material financial statement fraud.

17 Chapter 1Forensic and Investigative Accounting17 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 covers the professional standards that apply when forensic procedures are employed in an audit and explains the various means of gathering evidence through the use of forensic procedures and investigative techniques.

18 Chapter 1Forensic and Investigative Accounting18 Accountant’s Role in Fraud Detection In the early 1980s, companies began to use computers to perform their record keeping. In the early 1980s, companies began to use computers to perform their record keeping. Intense competition caused auditing fees to fall as much as 50% from the mid-1980s to the mid- 1990s. Intense competition caused auditing fees to fall 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. Auditors cut costs by reducing the process of reviewing hundreds of corporate accounts. They grew more reliant on internal controls. The Journal of Forensic Accounting was created. The Journal of Forensic Accounting was created. (continued on next slide)

19 Chapter 1Forensic and Investigative Accounting19 Accountant’s Role in Fraud Detection Top executives were able to circumvent internal controls and manipulate the records. 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. 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. 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)

20 Chapter 1Forensic and Investigative Accounting20 Accountant’s Role in Fraud Detection Some accounting experts believe that every audit engagement should include much more skepticism and detailed review of transactions. 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. 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. The Big Four and the next two accounting firms believe that every public corporation should have a forensic audit every three years.

21 Chapter 1Forensic and Investigative Accounting21 Recent Events Economic recessions often increase fraud, since executives may engage in more “cooking the books” techniques to improve financial results, and financially strapped employees will steal business funds or commit other types of fraud and abuse. In April 2009, Audit Analytics predicted that 3,589 companies (nearly 25%) will report that their auditors doubt they will continue as going concerns. In 2001, the percentage was only 19.2 percent. 1 The Federal Government’s $787 billion economic stimulus and bailout programs will be breeding grounds for fraud, waste, and abuse. Dan Weil estimates that up to $50 billion of the total (or 5 to 10 percent) will be susceptible to fraud. FBI Director Robert Mueller warns of fraud stemming from the stimulus packages. 2 There should be much work for forensic accountants. 1 Sarah Johnson, “Auditors: Nearly 25% of Companies May Not Be Going Concerns,” CFO, April 22, 2009, 2 Dan Weil, “Expert: Stimulus Fraud May Hit $50 Billion,” Newsmax.com, June 16, 2009,

22 Chapter 1Forensic and Investigative Accounting22 Big-Six's Position A forensic audit is akin to a police investigation. A forensic audit is akin to a police investigation. All public companies should have a forensic audit on a regular basis. Companies would be required to have such an audit every three or five years or face these audits on a random basis. All public companies should have a forensic audit on a regular basis. Companies would be required to have such an audit every three or five years or face these audits on a random basis. Forensic auditors scrutinize any records of companies, including s, and would be able, if not required, to question all company employees, and to require statements under oath. Forensic auditors scrutinize any records of companies, including s, 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 auditors to complete a forensic audit with the aid of independent attorneys (not those who have represented the audit client in the other engagements). Might be necessary for an audit network or a specialized forensic auditors to complete a forensic audit with the aid of independent attorneys (not those who have represented the audit client in the other engagements). Source: “Serving Global Markets and the Global Economy: A View from the CEOs of the International Audit Networks, November 2006, p. 13.

23 Chapter 1Forensic and Investigative Accounting23 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.

24 Chapter 1Forensic and Investigative Accounting24 Inexperienced Forensic Auditors Find out who did it. Do not worry about all the endless details. Find out who did it. Do not worry about all the endless details. Be creative, think like the fraudster, and do not be predictable. Lower the auditing threshold without notice. Be creative, think like the fraudster, and do not be predictable. Lower the auditing threshold without notice. Take into consideration that fraud often involves conspiracy. 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. 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

25 Chapter 1Forensic and Investigative Accounting25 Contrasting Auditing, Forensic Accounting, and Fraud Examination CharacteristicAudit Fraud Examination Forensic Accounting Time perspective: HistoricalHistorical Future and historical Primary focus: PeriodicReactive Proactive and ongoing Investigation scope: NarrowNarrow Broad ranging Main work product is: Audit opinion Fraud case report Forensic audit report Main responsibility to: Company and public Defrauded party Concerned principal or third party Guidelines are: Rules-based Principles-based; under audit rules, it is rule-based Principles-based Purpose of report: Ensure GAAP is followed Identify perpetrator of fraud Fraud risk assessment and strategic services Professional stance: Non- adversarial Adversarial Adversarial and non- adversarial

26 Chapter 1Forensic and Investigative Accounting26 Some White Collar Crimes Antitrust. Antitrust. Bankruptcy fraud. Bankruptcy fraud. Corporate/securities fraud. Corporate/securities fraud. Health care fraud. Health care fraud. Insurance fraud. Insurance fraud. Mass marketing fraud. Mass marketing fraud. Money laundering. Money laundering. Mortgage fraud. Mortgage fraud.

27 Chapter 1Forensic and Investigative Accounting27 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, the CEO and CFO must certify their company’s financial statements, 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.

28 Chapter 1Forensic and Investigative Accounting28 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 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.


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