Forensic Accounting

What Is Forensic Accounting?

Forensic accounting is the application of investigative and
analytical skills for the purpose of resolving financial issues in a
manner that meets standards required by courts of law.
The Forensic Accountant
Forensic accountants apply special skills in accounting,
auditing, finance, quantitative methods, certain areas of the law,
research, and investigative skills to collect, analyze, and
evaluate evidential matter and to interpret and communicate
findings
• Knowledge and Skills of the Forensic Accountant Auditing,
investigative, and communication skills; criminology; legal;
psychology; IT; and Accounting
• Opportunities in Forensic Accounting; Fraud prevention and
investigation, litigation support, computer forensics
• Forensic Accounting Organizations
1. Association of Certified Fraud Examiners,
2. the American College of Forensic Examiners,
3. the Association of Certified Fraud Specialists,
4. the National Association of Certified Valuation Analysts,
5. the National Litigation Support Services Association,
6. the Institute of Business Appraisers, and
7. the American Institute of Certified Public Accountants.
• IT skills are very important to the forensic accountant.
• The main areas of forensic accounting include auditing and
investigation.
• Both these areas involve computers and information technology.
• Examples:
A. forensic auditing in an IT environment,
B. security consulting,
C. expert testimony in computer crimes,
D. recovering erased data from computers used in computer crimes,

E. tracing the source of an email message relating to a computer crime .

• The forensic accountant constantly works in the legal
environment and for this reason must have a broad, basic
understanding of the legal systems.
• Civil and criminal procedures are especially important to the
forensic accountant because they define the logical steps that
are followed in investigations and criminal and civil litigation,
and forensic accountants can be called to participate in almost
all of the major steps.
 Various elements of fraud within the
organization.

• Various types of fraud include, for example,

• theft of assets, theft of information,
• improper purchases, and
• improper hiring.
• Assets can be stolen by their unauthorized conversion to personal use and
embezzlement.
• Information can be stolen in a variety of ways; examples of such ways include by
smuggling disks out of the office and by emailing information to unauthorized.
• Improper hiring may include, for example, hiring friends or family without disclosing
the relationship, or by hiring friends or family and improperly inflating their salaries or
wage rates.
 Forensic Auditing and Investigation

• Financial statement fraud involves the intentional misstatement of

financial statements so that they do not present accurately the
financial position, results of operations, and cash flows of the entity.
• When financial statement fraud is not suspected, auditors use the
following audit procedures: confirmation, observation, physical
examination, re-performance, performance of analytical procedures,
inquiry of client, and documentation.
• These procedures can identify financial statement fraud if it exists.
Analytical review procedures can point to areas that the forensic
accountant should investigate for the presence of possible fraud.
 Inflation Accounting

• Inflation refers to the continual increase in prices.

• The value or purchasing power of money refers to the amount of goods or services one birr can buy.
• Inflation means the value of money is falling because prices keep rising. When the general price level rises; the
value of money decreases.

• A Stable Measuring Unit

• Money is the measuring unit used in the preparation of financial
statement.
• The birr, or any other monetary unit, represents a unit of value.
• It measures the amount of purchasing power available to acquire goods
and services.
• Implicit in the use of money as a measuring unit is the assumption that
the birr is a stable unit of value, just as the mile is a stable unit of
distance and an acre is a stable unit of area.
• But unlike the mile and the acre, the birr is not a stable measuring unit.
Inflation accounting –general purchasing power and
current cost accounting approaches
Inflation accounting –differences in standards
worldwide
• Objectives
1.Explain the concepts underlying two methods of accounting for
changing prices (inflation)—general purchasing power
accounting and current cost accounting.
2. Describe attempts to account for inflation in different
countries, as well as the rules found in International Financial
Reporting Standards (IFRS) related to this issue.
 Inflation Accounting –Conceptual
Issues

• Impact of inflation on financial statements

• Understated asset values
• Overstated income and overpayment of taxes
• Demands for higher dividends
• Differing impacts across companies resulting
in lack of comparability.
• Historical cost ignores purchasing power gains
and losses.
• Purchasing power losses result from holding
monetary assets, such as cash and accounts
receivable.
• Purchasing power gains result from holding
monetary liabilities, such as accounts payable.
• The two most common approaches to inflation
accounting are general purchasing power
accounting and current cost accounting.
• General Purchasing Power (GPP) Accounting
• Updates historical cost accounting for changes in the
general purchasing power of the monetary unit
• Also referred to as General Price-Level-Adjusted
Historical Cost Accounting (GPLAHC)
• Nonmonetary assets and liabilities, stock holders’
equity and income statement items are restated using
the General Price Index (GPI).
• Requires purchasing power gains and losses to be
included in net income
 Inflation Accounting --Methods

• assets (cash and receivables) give rise to

purchasing power losses and
• monetary liabilities (payables) give rise to
purchasing power gains.
• Current Cost (CC) Accounting
• Updates historical cost of assets to the current
cost to replace those assets
• Also referred to as Current Replacement Cost
Accounting (CRC)
• Nonmonetary assets are restated to current
replacement costs and expense items are based
on these restated costs.
• Holding gains and losses are included in equity.
• Historical costs of nonmonetary assets
(inventory, fixed assets, intangibles) are
replaced with current replacement cost and
• expenses (cost of goods sold, depreciation,
amortization) are based on these current costs.
• The amount by which nonmonetary assets are
revalued to replacement cost on the balance
sheet is also reflected in stock holders’ equity
as a revaluation surplus (or reserve).
 Monetary items

• Monetary items consists of cash, notes

receivable, accounts receivable, investments in
bonds that will be held to maturity, and most
liabilities.
• Monetary items represent current purchasing
power or legal obligations to pay fixed number
of birrs or dollars.
• Positive monetary position
• It is a situation in which monetary assets are
larger in amount than monetary liabilities.
• A positive monetary position results in a
purchasing power loss when pricing are
increasing.
• Purchasing power gains and losses

• It results from the holding of monetary assets or

having outstanding monetary liabilities during
periods of changing general price levels.
• A positive monetary position results in a
purchasing power loss during an inflationary
period, and in a gain during a deflationary
period.
 Inflation Accounting Internationally

• United States and United Kingdom

• SFAS 33, Financial Reporting and Changing Prices briefly
required large U.S. companies to provide GPP and CC accounting
disclosures.
• This information is now optional (SFAS 89) and few companies
provide it.
• In the U.K., SSAP 16 required current cost information, but this
was later rescinded.
• Both countries have experienced low rates of inflation since the
1980s, which is why the inflation accounting requirements were
lifted.
• Latin America
• Latin America has a long history of significant
inflation.
• Brazil, Chile, and Mexico have developed sophisticated
inflation accounting standards over time.
• Like the U.S. and U.K., Brazil has abandoned inflation
accounting.
• Mexico’s Bulletin B-10, Recognition of the Effects of
Inflation in Financial Information, is a well-known
example.
 Inflation Accounting Internationally

• International Financial Reporting Standards

• IAS 15, Information Reflecting the Effects of Changing
Prices was issued in 1981.
• This standard has been withdrawn due to lack of support.
• The relevant standard now is IAS 29, Financial Reporting
in Hyperinflationary Economies.
• IAS 29 is required for some companies located in
environments experiencing very high levels of inflation.
• IAS 29 includes guidelines for determining the
environments where it must be used.
• Nonmonetary assets and liabilities and stock
holders’equity are restated using a general price
index.
• Income statement items are restated using a general
price index from the time of the transaction.
• Purchasing power gains and losses are included in
net income.
• IAS 15, “Information Reflecting the Effects of Changing
Prices,” required supplementary disclosure of the
following items reflecting the effects of changing prices:
• the amount of adjustment to depreciation expense,
• the amount of adjustment to cost of sales,
• the amount of purchasing power gain or loss on monetary
items,
• the aggregate of all adjustments reflecting the effects of
changing prices, and
• if current cost accounting is used, the current cost of
property, plant, and equipment.
• The standard only applied to enterprises “whose levels
of revenues, profits, assets or employment are
significant in the economic environment in which they
operate,” and
• allowed those enterprises to choose between making
adjustments on a GPP or a CC basis.
• Because of a lack of international support for inflation
accounting disclosures, in 1989, the IASC decided to
make IAS 15optional.
• However, the IASB encourages presentation of
inflation-adjusted information as required by IAS 15.
• IAS 29, “Financial Reporting in Hyperinflationary
Economies ,” was issued in 1989 and applies to the primary
financial statements of any company that reports in a
currency of a hyperinflationary economy.
• IAS 29requires the use of GPP accounting.
• IAS 21, “The Effects of Changes in Foreign Exchange
Rates ,” requires application of IAS 29to restate the foreign
operation’s financial statements to a GPP basis.
• The GPP adjusted financial statements are then translated
into the parent company’s reporting currency using the
current exchange rate. This approach is referred to as the
restate/translate method.
•