What is forensic accounting? Think Frank J. Wilson. He is a forensic accounting man from the U.S. Treasury Department accountant who put Al Capone away for evading taxes on income. Capone got away with dozens or perhaps hundreds of illegal conduct, but an aggressive bean counter brought him to heel through Capone’s own financial records!
Capone unsuccessfully ordered a hit on Wilson and his wife, who moved from hotel to hotel while the investigation went on. Undeterred, Wilson gathered evidence to prove that Capone had a total of $116,000 in nondeductible expenses after claiming no income. Capone was found guilty and sent to prison in 1931.
Okay, this is not a movie review at all. This post focuses on what forensic accounting means—what practitioners do in real business world, what the different with basic accounting is, where it works across the business-wide conduct, what skill is required to become a qualified forensic accountant and more…
What Is Forensic Accounting?
The Forensic Accounting Academy, part of the National Association of Certified Valuation Analysts, offers a definition that’s quite clear and succinct: “the art and science of investigating people and money.”
Forensic part of forensic accounting means—an examination after something undesirable has happened. But forensic accounting definitely involves more. It mixes accounting, auditing, and investigative skills to determine fraud or other hidden or mistaken activities in an organization’s (or person’s) finances.
Forensic accountants often work in tandem with attorneys (estate, bankruptcy, divorce, and corporate) and federal, state, and local law enforcement officials to uncover mistaken or illegal activities within organizations.
Wait, though — aren’t forensic accountants hired only for big-company situations? Not anymore. Where numbers are withheld, incomplete, questionable, or possibly fabricated, professionals with backgrounds in forensic accounting can be useful to businesses of all sizes. Even law enforcement officials involved in counter-terrorism measures use forensic accounting techniques to detect the tiny amounts of money funneled through cash-based shell businesses.
Unlike the fictional character Gil Grissom of CSI, though, forensic accountants tend to work in clean surroundings. Only the numbers are dirty!
Basic Vs Forensic Accounting
Most people think that forensic accounting is part of the basic accounting process. In most cases, the processes are very separate and distinct:
- An audit is a CPA’s commentary on the representation of financial statements produced by management. Typically, virtually no forensic accounting is applied.
- Basic accounting, such as the day-to-day assembly and reporting of a company’s financial transactions, requires virtually no forensic accounting.
- Forensic accounting typically assesses basic accounting reports and compares them with reality, identifying departures, undisclosed items, and related matters.
Basic accounting is scorekeeping according to a set of rules such professionals must follow. Forensic accounting is about investigation—it isn’t just about fraud; it’s also an essential component of accurate business valuation based on facts and circumstances.
Business Situations That Trigger Forensic Accounting
Forensic accounting is not all about illegal activity, though questionable financial behavior certainly is a major catalyst for many such investigations. Here are some of the kinds of situations that forensic accountants may be hired to investigate in organizations:
- Ownership – Evidence of improper or illegal manipulation of ownership within a company or hidden assets relevant to heirs, shareholders, or soon-to-be ex-spouses
- Succession planning – When there’s doubt that a new management team was formed with proper diligence and planning
- Bankruptcy – When there’s suspicion of illegal or incompetent financial manipulations that led to companies’ going into bankruptcy or liquidation
- A need for added oversight – When an owner or shareholder needs someone to assess a business valuation done at the request of the controlling shareholder
- Skimming and embezzlement – Anything from petty theft to scams that create massive financial losses within an organization
- Top-level corporate fraud – Companies such as Enron and WorldCom — two major firms that failed in the early 2000s — owed much of their demise to illegal and questionable acts by top management
- Mergers and acquisitions – Errors, either intentional or unintentional, may surface in the valuation of assets when companies are getting together
- Tax evasion – Evidence of hidden tax liability and possible illegal tax avoidance that can become a major liability for future management
- Money laundering – Suspicion that a company may be filtering ill-gotten money through a series of financial transactions so that the money looks as though it came from legitimate sources
- Contradictory financial reporting – When a company has reporting inconsistencies in its financial data, it may not be illegal, but it’s exceptionally important for a prospective buyer or seller to determine what the inconsistencies are and see that they’re fixed before a purchase or a sale
Can Small Companies Afford Forensic Accounting?
For many companies, professional bookkeeping and accounting services can be a significant expense. Here are some appropriate questions to ask yourself about affordability:
- Do you have a concern about the financials of a target company or a company you already own and think that an investigation is necessary? Assess the reasons you think a forensic investor would be appropriate in this situation.
- If the first point is relevant, what are the potential costs of not doing an investigation?The company may face possible civil or criminal charges, or cash may be disappearing at a rate that threatens the viability of the business.
- What are the costs in your area for forensic accountants with the correct training and certification, and do they work for companies of your size?
- The more complicated the investigation — and whatever chores are tied to the investigation, such as valuation — the more the investigation will cost. Professionals typically don’t charge fixed fees in such complex matters, but fees are worth asking about.
An effective way to manage fees is to instruct the forensic accountant to conduct the work in phases. A legitimate specialist will advise you to stop when there appears to be no reason to continue.
Where Forensic Accountants Work
Many accounting firms are dedicated to the practice of forensic accounting or have forensic accounting divisions. Some of the biggest employers of forensic accountants are the U.S. government and corporate America.
The Internal Revenue Service, Federal Bureau of Investigation, and many state and local police departments have forensic accountants on staff to address local law enforcement needs, whereas corporations may have forensic accountants on their own payrolls to stem internal fraud.
Some major accounting firms may say that they have forensic departments, but you still need to check an accountant’s experience. Checking a forensic accountant’s qualifications and training is critical.
How Do I Know If Someone Is a Qualified Forensic Accountant?
What should any forensic accountant you hire know? Some of the items in the following list may be somewhat familiar, because they’re the same qualifications you require of a valuation professional:
- Expert knowledge of accounting and control systems
- Solid investigative skills
- Good instincts and training in legal and illegal human behavior
- Knowledge of the industry in which an investigation subject operates, including knowledge of key stakeholders such as customers, suppliers, regulators, shareholders, and lenders
- Knowledge of technology that criminals use to steal money and goods
- Understanding of banking practices and issues related to the flow of money into and out of an organization
- Understanding of commercial, civil, and criminal laws in the pertinent jurisdiction that could affect a particular organization’s valuation
- Awareness of differences in business practices and restrictions in various countries
- Creativity, speed, and accuracy
Forensic accountants may work in concert with investigators and other covert players in the investigative process, but they need to know the legal restrictions on certain investigative tactics.
Therefore, you need to confirm that your forensic accounting professional understands the laws that are likely to apply. If you’re hiring a forensic accountant, ask what her investigative limits would be for your situation, and ask what things she would and wouldn’t do. If she indicates that she operates without limits or is unable to answer your question specifically, go with a candidate who can.
The Road To a Qualified Forensic Accountant?
Forensic accountants begin as trained Certified Public Accountants (CPAs), but most have something extra: a taste for the discovery and presentation of evidence to fill in the blanks in valuations, divorce proceedings, corporate investigations, and dozens of other kinds of cases and projects. They may spend plenty of time in court testifying on their findings, so they have to think faster than the lawyers who are peppering them with questions.
Forensic accountants are often asked to investigate cases that involve fraud, shareholder lawsuits, insurance claims, personal injury, business valuations, and other proceedings involving money transactions. Since 2001, counterterrorism has also been a fast-growing segment of most skilled practices.
Most forensic accountants may have experience in auditing: reviewing the accuracy of a company’s or person’s figures along accounting guidelines.
Beyond basic accounting training that leads to CPA certification, the forensic accounting field (like most industries) is exploding with certifications in a variety of forensic accounting–related skills. Here are a few:
- Certified Fraud Examiner (CFE) – This designation comes from the Association of Certified Fraud Examiners in Austin, Texas. Though many CPAs have this designation, you don’t have to be a CPA to earn it; indeed, the CFE was designed for members of the law enforcement and security communities who lacked CPA certificates.
- Certified Forensic Financial Analyst (CFFA) – This designation is provided by the National Association o f Certified Valuation Analysts.
- American College of Forensic Examiners – This organization offers a cornucopia of certification courses in a variety of areas, including consulting, accounting, nursing, medical investigation, homeland security, information security, and disaster preparation.