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Unformatted text preview: Forensic and Investigative Accounting Forensic Chapter 1 Introduction to Forensic and Investigative Accounting
© 2009 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com 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. discovery, Chapter 1 Forensic and Investigative Accounting 2 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. in
Chapter 1 Forensic and Investigative Accounting 3 Forensic Accounting Defined Time: Forensic accounting focuses on the past, although it may do so in order to look forward. although Purpose: Forensic accounting is performed for a specific legal forum or in anticipation of presentation before a legal forum. presentation Peremptory: Forensic accountants may be Peremptory: 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). allegations
Forensic and Investigative Accounting 4 Chapter 1 Forensic Accounting Defined
Forensic accounting is the action of Forensic 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. financial Chapter 1 Forensic and Investigative Accounting 5 Historical Roots of Accounting
10,000 years ago—Temple priests took inventory of —Temple village livestock. village 3,000 B.C.—Scribes recorded ruler’s wealth. 1887—American Association of Public Accountants 1887—American (later becoming the AICPA) was formed. (later 1896—New York State legislated the first CPA law. 1900—School of Commerce, Accounts, and Finance 1900—School at New York University opens. at
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Chapter 1 Forensic and Investigative Accounting 6 Historical Roots of Accounting
1902—Congress calls for audit reports for large 1902—Congress corporations. 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 By for CPA certificate. for Chapter 1 Forensic and Investigative Accounting 7 History of Financial Reports and History Legal Challenges Legal
Financial reports were created by accountants Financial long before independent audits were mandated. long Current system of accounting checks and Current balances is relatively recent. balances (continued on next slide) Chapter 1 Forensic and Investigative Accounting 8 History of Financial Reports and History Legal Challenges Legal
Before financials were audited by outside Before experts, the courts often handled challenges and brought in experts to give testimony. and Practice of forensic accounting was common Practice even before independent accountants were asked to certify financial statements in auditing engagements. auditing Chapter 1 Forensic and Investigative Accounting 9 Threads of Forensic Accounting
1817—Canadian court decision of Meyer v. —Canadian Sefton. Sefton. 1824—James McClelland started his business 1824—James in Glasgow, Scotland. in 1856—In England, the audit of corporations 1856—In became required. became Chapter 1 Forensic and Investigative Accounting 10 Forensic Accounting in Print
Articles on arbitration, fraud, investigation, and Articles expert witnesses began appearing in the late 1800s. 1800s. After a comment in 1925 by the Chairman of After the U.S. Board of Tax Appeal, The Journal of Accountancy proposed that educational Accountancy institutions should start including in their curricula the study of the law of evidence. curricula Chapter 1 Forensic and Investigative Accounting 11 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 Max phrase, seven years after Peloubet. Lourie’s article voiced three important positions: three – An accountant should not have to attend law school to An learn the art of expert testimony. learn – Colleges and universities should deliver forensic Colleges accounting training. accounting – Forensic accounting reference books and textbooks Forensic should be developed for students. should The first forensic accounting book appeared in 1982.
Chapter 1 Forensic and Investigative Accounting 12 FBI and Forensics
During WWII, the FBI employed During approximately 500 agents who were accountants. accountants. In 1960, about 700 FBI agents were Special In Agent Accountants. Agent Today, there are more than 600 FBI agents Today, with accounting backgrounds. The FBI has a Financial Crimes Section that investigates money laundering, Internet crimes, financial institutions fraud, and any other economic crime. crime. Chapter 1 Forensic and Investigative Accounting 13 AICPA Practice Aid
In 1986, the AICPA broke forensic accounting into In two broad areas: investigative accounting and litigation support. litigation The types of litigation services were further broken The down in Practice Aid 7, listing: down – damages – antitrust analyses – accounting – valuation – general consulting – analyses
Chapter 1 Forensic and Investigative Accounting 14 Panel on Audit Effectiveness
In 1998, the Public Oversight Board In 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. the Chapter 1 Forensic and Investigative Accounting 15 Panel on Audit Effectiveness
In 2000, the Panel issues a 200-page report, In Report and Recommendations, which includes Report which a recommendation that auditors should perform forensic-type procedures during every audit to enhance the prospects of detecting material financial statement fraud. detecting Chapter 1 Forensic and Investigative Accounting 16 AICPA Fraud Task Force Report
In 2003, the AICPA’s Litigation and Dispute In 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. procedures
Chapter 1 Forensic and Investigative Accounting 17 Accountant’s Role in Fraud Detection In the early 1980s, companies began to use In computers to perform their record keeping. computers Intense competition caused auditing fees to fall as Intense much as 50% from the mid-1980s to the midmuch 1990s. 1990s. Auditors cut costs by reducing the process of Auditors reviewing hundreds of corporate accounts. They grew more reliant on internal controls. grew The Journal of Forensic Accounting was created. The Journal
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Chapter 1 Forensic and Investigative Accounting 18 Accountant’s Role in Fraud Detection Top executives were able to circumvent internal Top controls and manipulate the records. controls This lead to situations such as Enron, WorldCom, This Xerox, Adelphia Communication, and the fall of Arthur Andersen in the early 2000s. Arthur Due to the financial disaster of companies such as Due Enron and WorldCom, there has been an increased use of forensic techniques in audits and an increase in fees. in
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Chapter 1 Forensic and Investigative Accounting 19 Accountant’s Role in Fraud Detection Some accounting experts believe that every audit Some engagement should include much more skepticism and detailed review of transactions. and Other accounting experts suggest that only special Other engagements specifically targeting fraud can adequately and effectively root out the problem. adequately The Big Four and the next two accounting firms The believe that every public corporation should have a forensic audit every three years. forensic
Chapter 1 Forensic and Investigative Accounting 20 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.
Sarah Johnson, “Auditors: Nearly 25% of Companies May Not Be Going Concerns,” CFO, CFO April 22, 2009, www.cfo.com/article.cfm/13525910/c_2984368/?f=archives www.cfo.com/article.cfm/13525910/c_2984368/?f=archives 2 Dan Weil, “Expert: Stimulus Fraud May Hit $50 Billion,” Newsmax.com, June 16, 2009, http://mmoneynews.newsmax.com/printTemplate.html http://mmoneynews.newsmax.com/printTemplate.html
1 Chapter 1 Forensic and Investigative Accounting 21 Big-Six's Position A forensic audit is akin to a police investigation. forensic police All public companies should have a forensic audit on a regular All basis. Companies would be required to have such an audit every three or five years or face these audits on a random three basis. basis. Forensic auditors scrutinize all records of companies, including Forensic all emails, and would be able, if not required, to question all company employees, and to require statements under oath. company Might be necessary for an audit network or a specialized Might audit forensic auditors to complete a forensic audit with the aid of independent attorneys (not those who have represented the independent audit client in the other engagements). audit Source: “Serving Global Markets and the Global Economy: A View from the CEOs of Source: the International Audit Networks, November 2006, p. 13. the Chapter 1 Forensic and Investigative Accounting 22 More Differences
Two practitioners have suggested these additional procedures may Two be used in a forensic audit: be Extensive use of interviews and leveraging techniques Extensive designed to elicit sufficient information to prove or disprove a hypothesis. disprove Document inspection that may extend to authentication Document procedures and handwriting analysis. procedures Significant public records search to uncover, for Significant public example, unexpected title or ownership, other known addresses, and prior records of individuals. addresses, Legal knowledge regarding rules of evidence including Legal rules chain of custody and preservation of evidence integrity. chain
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 Find endless details. endless Be creative, think like the fraudster, and do not be Be predictable. Lower the auditing threshold without notice. notice. Take into consideration that fraud often involves Take conspiracy. conspiracy. Internal control lapses often occur during Internal vacations, sick outages, days off, and rest breaks, especially when temporary personnel replace normal employees. normal H. R. Davia, Fraud 101, New York: John Wiley & Sons, 2000, pp. 42-45. H. New Chapter 1 Forensic and Investigative Accounting 24 ...
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