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Forensic Accounting:

An Introduction


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

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.

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

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.

Types of Fraud
Financial statement schemes
Asset misappropriation : cash theft,

fraudulent disbursements, inventory theft Bribery and corruption Intellectual property

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

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 companys assets were inflated by as much as $80 million.

Examples of Fraud
Asset Misappropriation

A CEO conspired with a former employee to sell a

building to a company owned by the CEOs 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. Pune BPO scam was claimed to be the first scam in India. In April 2005, five employees of MsourcE in Pune were arrested for allegedly pulling off a fraud worth nearly $425,000 from the Citibank accounts of four New York-based account holders.

Examples of Fraud
Health Care Fraud
Dr. X billed a patients 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.

Examples of Fraud
Fraudulent Disbursements
An employee created over 1,000 false

refunds, all under the review limit of $15. 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.

Who Commits Fraud?

Frauds against organizations

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)

Who Commits Fraud?

Perpetrators Criminal Histories

Charged but not convicted Had prior convictions Never charged or convicted

4% 8% 88%


Why is Fraud Committed?

The Fraud Triangle
Perceived Pressure Perceived Opportunities


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

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

Individuals usually dont 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,



How do Forensic Accountants Search for Fraud?

Proactive fraud detection Reactive fraud detection


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.

Data-mining Software



Digital Analysis of Company Data

Benfords Law (first digit frequency)
35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 Percent


Deductive Approach
TO Detect Fraud
Involves a 5-step process:
Understanding the business environment
Understanding the kinds of fraud that can occur Determining the most likely symptoms Using databases and systems to search for the fraud

Following up on discoveries to determine likelihood

fraud exists

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.


Evidence Categories
Testimonial Evidence Documentary Evidence

Physical Evidence

Personal Observation

Testimonial Evidence
Interviewing Interrogatories

written questions that identify information needed from opposing party

Honesty tests

Graphology, polygraph


Documentary Evidence

Document examination Public records searches

Computer searches

Net worth calculations

Financial statement analysis

Physical Evidence
Tire marks

Stolen property Identification numbers or

markings on stolen objects


Personal Observation
Surveillance Covert operations


Demand for Forensic Accountants

One of the most secure career

One of the sizzling career areas in

25,000 50,000 new professionals

needed in this field in the next few years

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.

Preparation for Opportunities

The Association of Certified Fraud Examiners (ACFE) offers CPE courses, including a

course that helps candidates prepare for the Certified Fraud Examiner examination.
Other organizations, such as those involved

in business valuation and the American Institute of Certified Public Accountants (AICPA), offer courses at the elementary, intermediate, and advanced levels.

Preparation for Opportunities

On-the-job training can be accomplished by

working for the government : Division of Insurance Fraud, IRS For a CPA firm that has a forensic practice or a firm that specializes in a forensic area, such as business valuation Colleges and universities are beginning to offer courses in forensic accounting and fraud examination