Forensic Accounting:

An Introduction
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 Overview
 What is Forensic Accounting?
 What is fraud?
 Who commits fraud?
 How do forensic accountants search for
fraud?
 What’s 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

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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

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 Examples of Fraud
Financial 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 company’s assets were
inflated by as much as $80 million.

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 Examples of Fraud
Employee 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.

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 Examples of Fraud
Asset Misappropriation

A CEO conspired with a former employee

to sell a building to a company owned by
the CEO’s 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.

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 Examples of Fraud
Health Care Fraud

Dr. X billed a patient’s 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.

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 Examples of Fraud
Divorce 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 John’s
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.

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 Examples of Fraud
Fraudulent 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.

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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.

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 Examples of Fraud
Vendor 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.

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 Examples of Fraud
Vendor 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
What’s the problem?

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 Examples of Fraud
Kickbacks: 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?

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 Examples of Fraud
Kickbacks: 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.

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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)

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 Who Commits Fraud?
 Median loss per age group
< 26 years $ 25,000
26 – 30 50,000
31 – 35 134,000
36 – 40 135,000
41 – 50 250,000
51 – 60 350,000
> 60 713,000

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 Who Commits Fraud?
 Perpetrator’s Criminal Histories

Charged but not convicted 4%

Had prior convictions 8%
Never charged or convicted 88%

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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

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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
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 Rationalization
Individuals usually don’t 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)

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 How do Forensic Accountants
Search 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 Data
Benford’s Law (first digit frequency)
35

30

25

20

15 Percent

10

0
1 2 3 4 5 6 7 8 9

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 Deductive Approach
to 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
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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

Testimonial Documentary
Evidence Evidence

Physical Personal
Evidence Observation

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 Testimonial Evidence

 Interviewing
 Interrogatories (written questions
that identify information needed
from opposing party)
 Honesty tests (e.g., graphology,
polygraph)
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 Documentary Evidence
 Document examination
 Public records searches
 Audits
 Computer searches
 Net worth calculations
 Financial statement analysis

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 Physical Evidence
 Fingerprints
 Tire marks
 Weapons
 Stolen property
 Identification numbers or markings on
stolen objects

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 Personal Observation

 Invigilation
 Surveillance
 Covert operations

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 How can you prepare for the
opportunities in this area?
 Self study
 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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 JOIN KHALID AZIZ
 ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
B.COM.
 FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4
ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
 COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP
MODULE D, BBA, MBA & PIPFA.

 CONTACT:
 0322-3385752
 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN.

43