Following the Money: forensic accounting explained

Jun 9

Introduction

“ [customers lost] more than 12.5 billion dollars to fraud in 2024, which represents a 25 % increase over the prior year.” This eye-opening statistic, single handedly reveals the reason for the emergence in the field of forensic accounting in order to combat financial crimes. It also addresses the rising frequency of occupational fraud (fraud committed by an organization's employees), unethical and dishonest practices, which can all be mitigated in terms of likelihood. Forensic accounting is a beneficial tool helping to combat financial crimes, corruption and frauds through the various forensic auditing techniques. Additionally, it's important to mention that the evidence collected by forensic accountants, are often used by prosecutors in legal proceedings to punish all types of fraud. In this article, I will go over what forensic accounting is, why it is crucial in times of fraudulent activities are more frequent, and the techniques used by forensic accountants in order to solve financial crimes/misconduct.

1. What is forensic accounting?

Forensic accounting utilizes 3 main skills in order to properly analyze the finances of a business or individual, being accounting, investigative, and auditing skills. Forensic accountants are Certified Public Accountants, who examine crimes in search for evidence and work for insurance companies, financial institutions and other organizations. Forensic accountants also play an important role in courts, by reviewing financial records for legal evidence and even testify in court as expert witnesses. They are also normally asked to estimate economic damages or provide evidence of the details surrounding a financial crime.

Additionally, in court forensic accounts may be required too :-

● “Clarify financial regulations”

● “Explain complex financial records”

● “Provide written statements regarding their expert opinions”

● “Respond to questions from a judge and/or lawyers”

● “Summarize their investigative findings”

(ohio university, october 3rd 2024)

Along with testifying, analyzing documents, transactions and other records to create detailed reports for use. They work for crimes like embezzlement and fraud and often help explain the nature of these crimes to the court, as they are experts in the field. They focus more on the legal and investigative side of accounting rather than the financial reporting aspect.

2. Why is forensic accounting important?

The role of financial accounts is significantly more imperative, due to the increased sophistication of financial crimes. Fraudsters now use complex technology as well as elaborate schemes to cover their tracks, making jobs of forensic accountants much more difficult. The utilisation of encrypted communication technology, digital forgeries, and intricate financial structures, including shell companies, fraud can be exceptionally hard to detect and combat.

Occupational fraud is the most common type of fraud faced by organizations, and is defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”, according to the ACFE (association of certified fraud examiners). This includes things like asset misappropriation, which is when cash and inventory is stolen, as well as corruption like bribery or conflict of interest (when an employee's personal interests interfere with their duty to the organization/company). A report by the ACFE (occupation fraud 2024 - A Report to the Nations), states that global organizations lose about 5 % of their annual revenue because of occupation fraud. The report is based on 1921 authentic cases of occupational fraud and the cases are across 138 companies and territories. The median loss per case is a whopping 145,00 USD, and the total reported losses in the studied cases sum to about 3.1 billion USD. It is necessary to state that, countless fraud cases go undetected and so the number 3.1 billion USD, could be significantly understated.

As seen in the graph, asset misappropriation is the most common type of occupational fraud, occupying 88 % of total fraud cases. This includes the theft or misuse of organizations assets by employees, and taking cash, inventory or property. Forensic accountants detect asset misappropriation by going through accounting records and using the Fraud Triangle (motive, opportunity, rationalisation), and identifying red flags in financial data or employee behaviour. With the advancements of technology used by fraudsters, the role of forensic accountants becomes an increasingly important job in society, helping to defend organizations and companies around the world.

3. How do forensic accountants solve financial crime?

When a financial crime occurs, many forensic accountants start by answering 3 questions :

● What happened?

● Who is responsible?

● How much is the damage?

Additionally, questions like What data is available? Is the data complete and useful? Are there non-financial records (emails, phone logs, building access) that can be analyzed?, are also helpful to answer. Forensic accountants create something called an approach memorandum, which is basically an outline of the steps they may take to solve a case, an estimated cost, and phases. This helps to manage and not exceed costs and manage client requirements.

Forensic accounts carry hard copy and electronic records (emails, spreadsheets, chatlogs, and text messages). With the rise of digital data, forensic accountants can collect saved text messages and emails to uncover fraud. Since forensic accountants also play a large role in the court, it's important to keep a chain of custody (clear record of how evidence is handled from when it's collected to when it's shown in the court) for signed checks and hard drives, so their integrity is guaranteed in court.

They use analytical techniques to find questionable trends or irregularities like -

● Contrasting operation and financial data (eg. revenue vs production levels) - Checking if a company’s reported finances match with the actual operations. For example, if a company reports a major boost in revenue, but its scale of production and number of employees has faced no increment, then it raises red flags for forensic accountants.

● Comparing data with historical data/periods - If a company’s total costs are cut down by half in a year, without any cause then costs may be hidden.

● Comparing company statements against text returns or competitor benchmarks - Forensic accountants can compare company finance records with records submitted to tax authorities by the company, and industrial and competitor standards.

● Finding odd journal entries or transactions related-parties - Forensic accountants can review company accounting entries to spot suspicious activities, as records can be altered to hide theft, inflate revenues or conceal expenses. Additionally, they also check for deals with “related parties”, as they can funnel money out of the company.

Forensic accountants can conduct structured interviews with suspects, employees, and whistleblowers, to gain leads to solve a case. Normally they start with the lower-level employees and end with a prime suspect if they have one or senior executives of the company. The techniques they employ are consistently challenging lies, showing interviewees gathered evidence and repeating questions in paraphrased ways. Once they have the results gathered they construct written reports (necessary for court or insurance claims) or oral presentations (when confidentiality is essential).

They report usually includes points like -

● The extent of the inquiry

● Methods used to solve the case

● Evidence gathered throughout the case

● The findings and observations

Forensic accountants refrain from deeming the case as fraud as only the court has the authority to decide that.

Conclusion

In all, Forensic accounting is a crucial tool helping to combat numerous financial crimes that take place each and every single day. It revolves around the 3 skills, accounting, investigating, and auditing. They also play an important role in courts, testifying as special witnesses, clarifying financial regulations or explaining complex financial records. The role of Forensic accountants is even more critical as fraudsters now rely on complex technology like, encrypted communication tools, digital forgeries, and complex financial structures (like layered shell companies) making financial crime even more difficult to detect. Occupation fraud is “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets” according to the ACFE (association of certified fraud examiners). It causes global organizations to lose about 5 % of their annual revenue. Next forensic accountants begin by answering questions like, What happened? Who is responsible? How much is the damage?, to gain clarity on the case. They then analyze trends to find irregularities and other red flags. Along with analysation, they may even hold interviews with low and high level employees to collect evidence and use interrogation techniques to aid with their investigation. Lastly, Forensic accountants construct written reports or oral presentations to conclude the case.