CONCEPT OF FORENSIC ACCOUNTING:

INTRO TO FORENSIC ACCOUNTING:

The integration of accounting, auditing and investigative
skills yields the specialty known as Forensic Accounting.
"Forensic" means "suitable for use in a court of law".
Forensic accounting is the specialty practice area of
accountancy that describes engagements that result from
actual or anticipated disputes or litigation.
Forensic
accounting
is
the
application
of
a
specialized knowledge and specific skills to act upon the
evidence of fraudulent economic transactions.
Forensic Accounting utilizes accounting, auditing, and
investigative skills to conduct an examination into a
company's financial statements. Thus it provides an
accounting analysis that is suitable for court.
OTHER TERMINOLOGY:
FORENSIC INVESTIGATION:
The utilization of specialized investigative skills in carrying out an
inquiry conducted in such a manner that the outcome will have
application to a court of law. A Forensic Investigation may be
grounded in accounting, medicine, engineering or some other
discipline.
FORENSIC AUDIT
An examination of evidence regarding an assertion to determine
its correspondence to establish criteria carried out in a manner
suitable to the court. An example would be a Forensic Audit of
sales records to determine the quantum of rent owing under a
lease agreement, which is the subject of litigation.

FORENSIC ACCOUNTANT :
A Forensic Accountant is often retained to analyse, interpret,
summarize and present complex financial and business related
issues in a manner which is both understandable and properly
supported.
Forensic Accountants can be engaged in public practice or
employed by insurance companies, banks, police forces,
government agencies and other organizations.
Investigative Accounting : (I) Investigating and analysing financial
evidence. (II) Review of the factual situation and provision of
suggestions regarding possible courses of action. (III) Assistance
with the protection and recovery of assets. (IV)Co-ordination of
other experts, including: Private investigators, Forensic document
examiners, Consulting engineers. (V) Assistance with the recovery
of assets by way of civil action or criminal prosecution.
Litigation Support : Assistance in obtaining documentation
necessary to support or refute a claim.
Review of the relevant documentation to form an initial
assessment of the case and identify areas of loss.
Assistance with Examination for Discovery including the
formulation of questions to be asked regarding the financial
evidence.
Attendance at the Examination for Discover, to review the
testimony, assist with understanding the financial issues and to
formulate additional questions to be asked.
Review of the opposing expert's damages report and reporting on
both the strengths and weaknesses of the positions taken.
Assistance with settlement discussions and negotiations.
Attendance at trial to hear the testimony of the opposing expert
and to provide assistance with cross-examination.

Basic Accounting Principles and

Guidelines
Since GAAP is founded on the basic accounting principles and guidelines, we can better understand
GAAP if we understand those accounting principles. The following is a list of the ten main
accounting principles and guidelines together with a highly condensed explanation of each.
1. Economic Entity Assumption

2. Monetary Unit Assumption

3. Time Period Assumption

4. Cost Principle

5. Full Disclosure Principle

6. Going Concern Principle

7. Matching Principle

8. Revenue Recognition Principle

9. Materiality

10. Conservatism

What is fraud :
Fraud means different things to different people under different
circumstances. For instance, fraud can be perceived as deception. One might
say that fraud in the form of intentional deception (including lying and
cheating).
Fraud can also be associated with injury. One person can injure another
either by force or through fraud. The use of force to cause bodily injury is
frowned on by most organized societies; using fraud to cause financial injury
to another does not always carry the same degree of stigma or punishment.
Fraud is a word that has many definitions. Some of the more notable ones
are:
Fraud as a crime. Fraud is a generic term, and embraces all the multifarious
means that human ingenuity can devise, which are resorted to by one
individual, to get an advantage by false means or representations. No
definite and invariable rule can be laid down as a general proposition in
defining fraud, as it includes surprise, trick, cunning, and unfair ways by
which another is cheated.
Corporate fraud : Corporate fraud is any fraud perpetrated by, for, or against
a business corporation.
Management fraud. Management fraud is the intentional misrepresentation
of corporate or unit performance levels perpetrated by employees serving in
management roles who seek to benefit from such frauds in terms of
promotions, bonuses or other economic incentives, and status symbols.
Laypersons definition of fraud. Fraud : as it is commonly understood today,
means dishonesty in the form of an intentional deception or a wilful
misrepresentation of a material fact. Lying, the willful telling of an untruth,
and cheating, the gaining of an unfair or unjust advantage over another,
could be used to further define the word fraud because these two words
denote intention or willingness to deceive.
ACFEs definition of fraud : The Association of Certified Fraud Examiners
(ACFE) defines occupational fraud and abuse (employee frauds) as: the
use of ones occupation for personal gain through the deliberate misuse or
theft of the employing organizations resources or assets. The ACFE defines
financial statement fraud as: the deliberate misrepresentation of the
financial condition of an enterprise accomplished through the intentional

misstatement or omission of amounts or disclosures in the financial

statements in order to deceive financial statement users.

FRAUD TRIANGLE
In order to properly prevent, detect, and respond to fraud, antifraud
stakeholders need to understand why fraudsters commit a fraud. No model
or framework has been more useful than Cresseys Triangle in providing that
understanding.
Fraud Triangle : In the 1950s, Donald Cressey was encouraged by Edwin
Sutherland, who was serving on his dissertation committee, to use a thesis
of why a person in a position of trust would become a violator of that trust.
Sutherland and Cressey decided to interview fraudsters who were convicted
of embezzlement. Cressey interviewed about 200 embezzlers in prison. One
of the major conclusions of his efforts was that every fraud had three things
in common: (1) pressure (sometimes referred to as motivation, and usually a
non-shareable need); (2) rationalization (of personal ethics); and (3)
knowledge and opportunity to commit the crime. These three points are the
corners of the fraud triangle.
OPPORTUNITY

PRESSURE

RATIONALISATION

Pressure : Pressure (or incentive, or motivation) refers to something

that has happened in the fraudsters personal life that creates a stressful
need that motivates him to steal.
Usually that motivation centers on some financial strain, but it could be the
symptom of other types of pressures. For example, a drug habit or
gambling habit could create great financial need in order to sustain the
habit and thus create the pressure associated with this aspect of the fraud
triangle. Sometimes a fraudster finds motivation in some other incentive.
For instance, almost all financial statement frauds were motivated by some

incentive, usually related to stock prices or performance bonuses or

both. Sometimes an insatiable greed causes relatively wealthy people to
commit frauds.
Beyond the realm of competitive and economic survival, what other
motives precipitate fraud? Social and political, survival provide
incentives, too, in the form of egocentric and ideological motives,
especially in financial statement frauds. Sometimes people commit fraud to
aggrandize their egos, put on airs, or assume false status. Sometimes they
deceive to survive politically, or have a burning desire for power.
They lie about their personal views or pretend to believe when they do not.
Or they simply cheat or lie to their political opponents or intentionally
misstate their opponents positions on issues.
Motives to commit fraud in business usually are rationalized by the old
saying that all is fair in love and warand in business, which is amoral,
anyway. There is one further category of motivation, however. It might be
called psychotic, because it cannot be explained in terms of rational
behavior.
Rationalization : Most fraudsters do not have a criminal record. In the ACFE
Report to the Nation (RTTN) 2008,10 93 percent of the reported fraudsters
had no prior criminal convictions. In fact, white-collar criminals usually have
a personal code of ethics. It is not uncommon for a fraudster to be religious.
So how do fraudsters justify actions that are objectively criminal?
They simply justify their crime under their circumstances. For instance, many
will steal from employers but mentally convince themselves that they will
repay it (i.e., I am just borrowing the money). Others believe it hurts no
one so that makes the theft benign. Still others believe they are entitled to
the benefits of the fraud and are simply taking matters into their own hands
to administer fair treatment (e.g., they deserve a raise or better treatment).
Many other excuses could serve as a rationalization, including some
benevolent ones where the fraudster does not actually keep the stolen
funds or assets but uses them for social purposes (e.g., to fund an
animal clinic for stray animals).
Opportunity : According to Cresseys research (i.e., the Fraud Triangle),
fraudsters always have the knowledge and opportunity to commit the
fraud. The former is reflected in known frauds, and in research studies such
as the ACFEs RTTNs that show employees and managers tend to have a
long tenure with a company when they commit the fraud. A simple
explanation is that employees and managers who have been around for
years know quite well where the weaknesses are in the internal controls
and have gained sufficient knowledge of how to commit the crime
successfully.

A prerequisite to opportunity is that the perpetrator be in a position

of trust. Remember Cresseys thesis was about trust violators. And it is
difficult to commit a fraud without being in a trusted position over assets.
But the main factor in opportunity is internal controls. A weakness in or
absence of internal controls provides the opportunity for fraudsters to
commit their crimes. It is noteworthy that the Treadway Commission (later
known as the Committee of Sponsoring Organizations, or COSO) was formed
to respond to the savings and loan frauds and scandals of the early 1980s.
The committees conclusion was that the best prevention was strong
internal controls, and the result was the COSO model of internal controls,
which was incorporated into financial auditing technical literature as SAS 78,
Consideration of Internal Control in a Financial Statement Audit. Then the
Sarbanes-Oxley Act (SOX) focused on an annual evaluation of the internal
controls by management with an independent opinion of that evaluation by
the financial auditorsSection 404 of the act. Again, if the purpose of SOX
was to minimize fraud, internal control is the effective way to accomplish
that goal. In fact, it could be argued that this aspect of the triangle is the
only one that auditors can easily observe or control.
The opportunities to commit fraud are rampant in the presence of loose or
lax management and (concomitant) inadequate attention to internal
controls. When motivation is coupled with such opportunities, the potential
for fraud is increased.

Fraud Triangle fraud examination methodology

Intro to financial statements
financial statements frauds
frauds in FIs
responsibility of management & auditors
intro to & prevalence of fraud
perpetrators & fraud triangle
theory of fraud perpetrators

--------------------------------------

Financial statements frauds :

Timing Differences (Improper Treatment of Sales) : There are a variety
of ways to perpetrate a timing differences scheme to exaggerate revenues
for the current fiscal period. One way is to push excess inventory to
salespeople or consignment whereupon the inventory is treated as a
sale, knowing full well that much of it will be returnedbut in a subsequent
period. This method is known as channel stuffing. Sales also can be
booked in other violations of generally accepted accounting principles
(GAAP) (e.g., early revenue recognition). For instance, a three-year
contract to provide services across the period can all be booked as
revenue in the current year to inflate profits for the next set of financials,
at the expense of future financials, and obviously not in compliance with
GAAP and the matching principle.
Enron used a similar method in its special purpose entities (SPEs) to
account for all of the revenue from long-term agreements in the current year.
In another fraud, the CFO for a bankrupt company (as a result of a financial
statement fraud) admitted in his deposition that many sales were booked
before they were actually consummated. His reason: If you knew in your
heart it was a sale, then we booked it.
Fictitious Revenues : Fictitious revenues are created simply by recording
sales that never occurred. They can involve real or fake customers. The end
result is an increase in
revenues and profits, and usually assets (the other side of the fictitious
accounting entry).
For example, the infamous Equity Funding scandal used a fictitious revenues
scheme to inflate both revenues and accounts receivable. Equity Funding
was an insurance company, to be specific, a reinsurer. To create fictitious
revenues, the CEO simply created phony insurance policies. After seven
years, the fraud was finally exposed in 1973 by a recently fired and
disgruntled employee. At that time, $2 billion of the $3 billion in receivables
was phony.
Concealed Liabilities (Improper Recording of Liabilities) : One way to
perpetrate this fraud scheme is to simply postpone the recording of liabilities
in the twelfth month of the fiscal year so that the current year will have less
expenses, and record that liability in the first month of the next fiscal year. It
is precisely because of this possibility that financial auditors perform
subsequent-period substantive testslooking for invoices that are dated the
year under audit but posted in the first month of the subsequent year.
Another way to commit this fraud is to move those liabilities somewhere
else. If the company is large and has subsidiaries, this objective can be
accomplished by moving the liability to a subsidiary, especially if that
company is either not audited or audited by a different audit firm (an
intentional decision to hide the fraud). This scheme probably is used often by

companies. Our assumption is based on the fact that the shifting of liabilities
is difficult to detect in audits. However, if it is occurring, there should be
changes in certain ratios: earnings per share (EPS), debt/equity, and so on.
The fraudsters at Parmalat used this method to hide liabilities and perpetrate
a financial statement fraud of more than $1.3 billion, moving liabilities to
subsidiaries in the Caribbean, far from corporate headquarters in Italy, and
to companies audited by a different financial audit firm. The executives at
Parmalat also invented assets and forged documents to back up entries for
them, which illustrates the complexity of many frauds: The fraudster begins
perhaps with a single fraud scheme but sometimes expands to multiple
schemes. Adelphia used the same fraud method, moving liabilities to
offbalance- sheet affiliates.
Finally, a simple failure to record liabilities accomplishes the same purpose.
Without the liability, there is no additional expense, no reduction in assets,
or no decrease in equity that normally occurs.
Improper Disclosures : One principle of fraud is that it is always clandestine.
The fraudster will attempt to cover up for frauds in the books. (This is not
necessary for off-the-book schemes.) This cover-up extends to disclosures.
While Enron was technically GAAP compliant in disclosing SPEs in the
financial statements and annual report, it was fraudulent in handling the
associated revenues, and it was clandestine in its disclosures. Enron did
make disclosures regarding the SPEs, as required, but they were so
obfuscated that even financial experts could not read them and understand
exactly the financial ramifications of those SPEs, which is what was intended.
Also, Andrew Fastow, CFO, reportedly hid his association with the SPEs from
the board to further obfuscate their disclosure. Other methods include
omission in disclosures of liability, significant events, and management
fraud. An inadequate disclosure can be a way to hide evidence of a fraud.
Improper Asset Valuation :
By inflating the amounts of assets (commonly receivables, inventory, and
long-lived assets), capitalizing expenses, or deflating contra accounts
(allowance for doubtful accounts, deprecation, amortization, etc.), the
financials will show a higher than truthful equity and profit. HealthSouth
exaggerated assets balances to cover insufficient profits over a period of
years. A transaction that debits an asset and credits an equity or revenue
account magicallycreates profits.
In the case of the WorldCom financial statement fraud, leases of telephone
lines were clearly an expense. Yet WorldComs CEO convinced accountants
internally and financial auditors externally to treat them as assets. Thus by
moving millions of dollars of expenses to the balance sheet, the income
statement suddenly looked much better.

Basic Accounting Principles and Guidelines

Since GAAP is founded on the basic accounting principles and
guidelines, we can better understand GAAP if we understand
those accounting principles. The following is a list of the ten main
accounting principles and guidelines together with a highly
condensed explanation of each.
1. Economic Entity Assumption
The accountant keeps all of the business transactions of a sole
proprietorship
separate
from
the
business
owner's personal transactions.
For legal purposes,
a
sole
proprietorship and its owner are considered to be one entity, but
for accounting purposes they are considered to be two separate
entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only
transactions that can be expressed in U.S. dollars are recorded.
Because of this basic accounting principle, it is assumed that the
dollar's purchasing power has not changed over time. As a result
accountants ignore the effect of inflation on recorded amounts.
For example, dollars from a 1960 transaction are combined (or
shown) with dollars from a 2014 transaction.
3. Time Period Assumption
This accounting principle assumes that it is possible to report the
complex and ongoing activities of a business in relatively short,
distinct time intervals such as the five months ended May 31,
2014, or the 5 weeks ended May 1, 2014. The shorter the time
interval, the more likely the need for the accountant to estimate
amounts relevant to that period. For example, the property tax
bill is received on December 15 of each year. On the income
statement for the year ended December 31, 2013, the amount is
known; but for the income statement for the three months ended
March 31, 2014, the amount was not known and an estimate had
to be used.

It is imperative that the time interval (or period of time) be shown

in the heading of each income statement, statement of
stockholders' equity, and statement of cash flows. Labeling one of
these financial statements with "December 31" is not good
enoughthe reader needs to know if the statement covers
the one week ended December 31, 2014 the month ended
December 31, 2014 the three months ended December 31, 2014
or theyear ended December 31, 2014.
4. Cost Principle
From an accountant's point of view, the term "cost" refers to the
amount spent (cash or the cash equivalent) when an item
was originally obtained, whether that purchase happened last
year or thirty years ago. For this reason, the amounts shown on
financial statements are referred to as historical cost amounts.
Because of this accounting principle asset amounts
are not adjusted upward for inflation. In fact, as a general rule,
asset amounts are not adjusted to reflect any type of increase in
value. Hence, an asset amount does not reflect the amount of
money a company would receive if it were to sell the asset at
today's market value. (An exception is certain investments in
stocks and bonds that are actively traded on a stock exchange.) If
you want to know the current value of a company's long-term
assets, you will not get this information from a company's
financial statementsyou need to look elsewhere, perhaps to a
third-party appraiser.
5. Full Disclosure Principle
If certain information is important to an investor or lender using
the financial statements, that information should be disclosed
within the statement or in the notes to the statement. It is
because of this basic accounting principle that numerous pages of
"footnotes" are often attached to financial statements.
As an example, let's say a company is named in a lawsuit that
demands a significant amount of money. When the financial
statements are prepared it is not clear whether the company will
be able to defend itself or whether it might lose the lawsuit. As a
result of these conditions and because of the full disclosure
principle the lawsuit will be described in the notes to the financial
statements.

A company usually lists its significant accounting policies as the

first note to its financial statements.
6. Going Concern Principle
This accounting principle assumes that a company will continue
to exist long enough to carry out its objectives and commitments
and will not liquidate in the foreseeable future. If the company's
financial situation is such that the accountant believes the
company will not be able to continue on, the accountant is
required to disclose this assessment.
The going concern principle allows the company to defer some of
its prepaid expenses until future accounting periods.
7. Matching Principle
This accounting principle requires companies to use the accrual
basis of accounting. The matching principle requires that
expenses be matched with revenues. For example, sales
commissions expense should be reported in the period when the
sales were made (and not reported in the period when the
commissions were paid). Wages to employees are reported as an
expense in the week when the employees worked and not in the
week when the employees are paid. If a company agrees to give
its employees 1% of its 2014 revenues as a bonus on January 15,
2015, the company should report the bonus as an expense in
2014 and the amount unpaid at December 31, 2014 as a liability.
(The expense is occurring as the sales are occurring.)
Because we cannot measure the future economic benefit of
things such as advertisements (and thereby we cannot match the
ad expense with related future revenues), the accountant charges
the ad amount to expense in the period that the ad is run.
(To learn more about adjusting entries go to Explanation of
Adjusting Entries and Quiz for Adjusting Entries.)
8. Revenue Recognition Principle
Under the accrual basis of accounting (as opposed to the cash
basis of accounting), revenues are recognized as soon as a
product has been sold or a service has been performed,
regardless of when the money is actually received. Under this
basic accounting principle, a company could earn and report

$20,000 of revenue in its first month of operation but receive $0

in actual cash in that month.
For example, if ABC Consulting completes its service at an agreed
price of $1,000, ABC should recognize $1,000 of revenue as soon
as its work is doneit does not matter whether the client pays
the $1,000 immediately or in 30 days. Do not
confuse revenue with a cash receipt.
9. Materiality
Because of this basic accounting principle or guideline, an
accountant might be allowed to violate another accounting
principle if an amount is insignificant. Professional judgement is
needed to decide whether an amount is insignificant or
immaterial.
An example of an obviously immaterial item is the purchase of a
$150 printer by a highly profitable multi-million dollar company.
Because the printer will be used for five years,
the matching principle directs the accountant to expense the cost
over the five-year period. The materiality guideline allows this
company to violate the matching principle and to expense the
entire cost of $150 in the year it is purchased. The justification is
that no one would consider it misleading if $150 is expensed in
the first year instead of $30 being expensed in each of the five
years that it is used.
Because of materiality, financial statements usually show
amounts rounded to the nearest dollar, to the nearest thousand,
or to the nearest million dollars depending on the size of the
company.
10. Conservatism
If a situation arises where there are two acceptable alternatives
for reporting an item, conservatism directs the accountant to
choose the alternative that will result in less net income and/or
less asset amount. Conservatism helps the accountant to "break
a tie." It does not direct accountants to be conservative.
Accountants are expected to be unbiased and objective.
The basic accounting principle of conservatism leads accountants
to anticipate or disclose losses, but it does not allow a similar
action for gains. For example, potential losses from lawsuits will
be reported on the financial statements or in the notes,

but potential gains will not be reported. Also, an accountant may

write inventory downto an amount that is lower than the original
cost, but will not write inventory up to an amount higher than the
original cost.

Motives for Financial Statement Fraud

a. To make a company's earnings look better on paper.
b To covers up the embezzlement of company funds.
To encourage investment through the sale of stock
To demonstrate increase earnings per share thus allowing increased dividend/distribution
payouts
To cover inability to generate cash flow To dispel negative market perceptions
To obtain financing, or to obtain more favourable terms on existing financing
h. To receive higher purchase prices for acquisitions
To demonstrate compliance with financing covenants
To meet company goals and objectives
To receive performance-related bonus