Forensic Accounting

Over the years, the role of the certified public accountant (CPA) has changed dramatically, with some of today's CPAs becoming quasi-private investigators in order to keep up with demands for fraud examinations. These specialized individuals use investigative procedures in an effort to uncover fraudulent activities being perpetrated on a business. Forensic accounting is a term used to describe the work being performed by accountants in advance of litigation and may include bankruptcy, valuation, fraud, and a variety of additional services. It is estimated that each year approximately $400 billion is lost due to employee fraud. To determine the depth and scope of the crime, a fraud examination is conducted in order to find where it is being perpetrated and by whom. Often the auditor must delve into the psyche of the suspect to find a motive for the crime. There are three main reasons why an employee generally steals from his employer, making up what is termed a fraud triangle.

The key elements that comprise most every fraud triangle include opportunity, pressure, and rationalization. The first and most important segment of a fraud triangle is opportunity. Often, companies unknowingly and unwisely offer their employees the opportunity to commit fraud. Typically it is a lack of adequate control and monitoring of employee actions that afford the chance to steal. An example to demonstrate opportunity would be a cashier or accounts receivable person being responsible for the daily collecting and depositing of payments. Without adequate control measures to authenticate the employee's accuracy, funds could easily be embezzled without notice.

Of course, not all employees will seize the opportunity to steal, so what additional factors also figure in to a fraud triangle? Succumbing to pressure is very often the reason why someone chooses to steal when others do not. Financial pressure can arise from a myriad of sources such as personal debt, business losses, and lifestyle standards. Therefore, employees with known financial trouble should not be placed in positions involving money transactions or other duties that would offer a chance to commit fraud. Even peer pressure can be a factor in an employee choosing to steal.

Rationalization is the third element of the fraud triangle. Regardless of the reason for taking money, the thief must then try to rationalize why he or she committed the fraud. The employee who steals often attempts to justify the crime psychologically. Such rationalizations might include thinking the company has so much money that the theft would not be noticed, or the money is for a worthy endeavor such as college tuition or emergency medical expenses. In this way, the perpetrator often attempts to ease a nagging conscience about stealing. In most cases however, the employee makes a mistake or error that places a cloud of suspicion upon them. This is when the fraud examination is conducted.

A fraud examination generally consists of four successive segments: analyzing the available data, developing a fraud theory, revising it as necessary, and confirming the theory. The first step is analyzing financial information culled from the books and records. The particular type of fraud that is being investigated will determine which documents, files, records, and other information are needed for studying. Once the information has been gathered, sorted, and processed, the examiner begins to review and analyze the data in order to develop a theory of what could have happened and who was the perpetrator.

Usually the theory addresses one of three types of internal or occupational fraud: asset misappropriation, corruption, or fraudulent financial statements. The examiner goes through a series of tests and retests in order to determine if there is sufficient evidence to proceed further. The evidence must be substantial enough to stand up in a court of law. If the examination is sound and has merit, then the corporate legal counsel is apprised of impending litigation, interviews are ordered, and third-party and corroborative witnesses are questioned. The examination must be detailed, in depth, and substantiated with indisputable evidence in order to move to the next stage, which entails confronting the suspect or target. This procedure is called an admission-seeking interview, and involves a deliberate process that lays out the evidence to the target in a specific order. The questions must be precisely phrased and the answers correctly interpreted so as to avoid any confusion or misunderstanding. While these procedures help detect and find fraud, the more practical solution would be to prevent fraud from occurring.

The problem with prevention is that certified fraud examiners and forensic accountants cannot affect the internal and external controls that tend to lead to fraud. The problem of company fraud is a social issue, not an accounting issue, and without effective punishment measures, the practice is expected to rise. Punishment is often neither swift nor certain when is comes to fraudulent crimes. It is also difficult for courts and judges to determine the punishment when an accounting crime ended with the destruction of a company that had employed many individuals who lost pensions and retirement investments as well as jobs.

The idea of prevention would seem like the correct response to an ever-increasing crime wave. However, given the current methods of detection of fraud, the fraud examination, and employing the methodology of the fraud triangle, prevention suddenly becomes closer to invasion of privacy and targeting of persons. If the manager of a clinic tells his employer about his spouse being laid-off from work, should the employer then keep a close eye and ear on the manager in order to prevent the possibility of an opportunity to defraud the clinic by the manager? The idea of profiling an employee for any potential of defrauding a company is not consistent with ethical standards of business.

Fraud examination and the fraud triangle are two of the most effective and important procedures a CPA or auditor can use when determining the existence of fraudulent behavior or activities in a company. Both of these concepts constitute the science of forensic accounting and help to uncover any illegal activities. The modern day accountant must have working knowledge of forensic accounting in order to be a success in the field. The government binds an accountant by various laws and statutes in order to obligate them to report any financial mishaps or miscues on the part of the company.