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CHAPTER 1:�INTRODUCTION TO THE WORLD OF FORENSIC ACCOUNTING

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Learning Objectives

Explain what forensic accounting is
Identify common types of forensic accounting engagements
Compare and contrast the role of the forensic accountant with the roles of transactional accountants and auditors
Identify the necessary skills of forensic accountants

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Learning Objectives

Recognize major providers of forensic accounting certification and continuing education
Identify potential careers in forensic accounting

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Introduction & History of Forensic Accounting

On April 23,1930: Chicago Crime Commission issued its first Public enemies List—top of the list was Alphonse Capone ,one of the most notorious

( dishonourable) gangsters in U.S. history

On October 18, 1931, Al Capone was convicted of tax evasion for years 1925 through 1927 and failure to file income tax returns for years 1928 and 1929
Al Capone was sentenced to 11 years in federal prison, fined $50,000, and charged $7,692 for court costs, in addition to a tax loss of $215,000 plus interest

On April 23, 1930, the Chicago Crime Commission issued its first Public Enemies List. At the top of the list was Alphonse Capone (also known as “Big Al,” “Scarface,” and “Big Shot”), one of the most notorious gangsters in U.S. history. Unable to convict Capone of murder, the U.S. Attorney’s Office aggressively pursued criminal prosecution against him in an effort to “restore respect for federal laws” that had been eroded by the gangster class. On March 13, 1931, a secret federal grand jury issued an indictment against Capone charging him with tax evasion for year 1924.
Capone maintained no bank accounts, kept no activity records, bought no property in his own name, conducted all his financial transactions in cash, and never filed a tax return. Moreover, Capone’s reputation for violence created a strong disincentive for any potential informants. Development of the case against Al Capone was assigned to IRS Special Agent Frank J. Wilson. Wilson’s assignment was to find evidence that would persuade a jury beyond a reasonable doubt.

The testimonial evidence gathered by Wilson was compelling, but not convincing beyond a reasonable doubt. The government’s challenge was to explain to the jury the complexities of accounting and tax in a manner that was not only persuasive, but could also withstand the test of cross-examination. Meeting this challenge head on, Wilson developed and presented to the jury a calculation of Capone’s unreported taxable income using what he called the “net worth method.” The net worth method is conducted using the following steps:
Step 1: Determine ending net worth
Step 2: Determine beginning net worth
Step 3: Calculate change in net worth
Step 4: Determine expenditures
Step 5: Calculate total acquisitions and consumption
Step 6: Determine reported income + legitimate sources
Step 7: Calculate unreported income

On October 18, 1931, Al Capone was convicted of tax evasion for years 1925 through 1927 and failure to file income tax returns for years 1928 and 1929. Shortly thereafter, he was sentenced to 11 years in federal prison, fined $50,000, and charged $7,692 for court costs, in addition to a tax loss of $215,000 plus interest.

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Introduction

Development of the case against Al Capone was assigned to IRS Special Agent Frank J. Wilson
Frank J. Wilson is commonly recognized as the first forensic accountant and rightfully credited with bringing down Al Capone
The judge sentenced him to a total of 10 years in federal prison and 1 year in the county jail. He was paroled (released) on November 16, 1939, and shortly thereafter returned to his home in Palm Island, Florida where died, on January 25, 1947, from cardiac arrest (Heart Attack)

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Explain What Forensic Accounting Is

Learning Objective 1

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Forensic Accounting Knowledge and Skills

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What Is Forensic Accounting?

Application of investigative and analytical skills for the purpose of resolving financial issues in a manner that meets standards required by courts of law
Forensic: Used in or suitable to courts of law or public debate
A discipline that is focused on: (1) the prevention, detection, and investigation of both occupational fraud and financial fraud; and (2) the rendering of other litigation-support services

The term forensic is defined in Black’s Law Dictionary as “used in or suitable to courts of law or public debate.”
Extending this concept, we can define forensic accounting as the use of accounting theories, principles, or analyses in a legal action, often through expert witness testimony.
Forensic accounting involves the application of accounting, finance, economics, statistics, law, research, and investigative methods in the collection, analyses, and communication of findings. Given the adversarial nature of litigation, the role of a testifying forensic accountant is not suitable for everyone.
The term forensic accountant was first used by Maurice Peloubet in 1946 in the Journal of Accountancy to recognize and celebrate IRS Special Agent Frank J. Wilson as the man who brought down Capone.

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What Is Forensic Accounting?

The application of financial facts to legal situations
Use of accounting theories, principles, or analyses in a legal action, often through expert witness testimony
Involves the application of accounting, finance, economics, statistics, law, research, and investigative methods in the collection, analyses, and communication of findings for a specific engagement
The term forensic accountant was first used by Maurice Peloubet in 1946 in the Journal of Accountancy to recognize and celebrate IRS Special Agent Frank J. Wilson as the man who brought down Capone.

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Mindset of the Forensic Accountant

Mindset is a person’s mental state, which evolved (developed)from education, experience, and prejudices Specifically, a mindset consists of mental processes that dictate how a person responds to situations or challenges
Forensic accountants are both researcher and problem solver
They are Intellectually curious, possesses a restless mind—one that is never satisfied with his or her understanding of an issue, regardless of experience and expertise

Forensic accountants are both researchers and problem solvers. As such, they need to be intellectually curious. An intellectually curious individual possesses a restless mind—one that is never satisfied with his or her understanding of an issue, regardless of experience and expertise.
Moreover, forensic accountants must have the instinct to explore problems that challenge conventional wisdom.
Perhaps most importantly, they must be willing to question their own preexisting judgments and conclusions.
In addition to a curious mindset, forensic accountants must also embrace systemic thinking. For example, forensic accountants recognize that problems are not always attributable to negligence or misconduct. Instead, these problems may be indicators of broader systemic failures within an organization.
Forensic accountants do not rush to judgment; they take a second look—and they look beyond the numbers! Finally, forensic accountants must exercise a healthy dose of professional skepticism. This reflects a proactive, questioning mindset, where nothing is as it seems and “trust, but verify” is the general rule.

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Mindset of forensic accounting

Forensic accountants must have the instinct (intelligence) to explore challenging problems
They must be willing to question their own preexisting judgments and conclusions
Forensic accountants must also embrace systemic thinking. For example, forensic accountants recognize that problems are not always attributable to negligence or misconduct.
Forensic accountants do not rush to judgment, they take a second look—and they look beyond the numbers

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Identify Common Types of Forensic�Accounting Engagements

Learning Objective 2

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Forensic Accounting Services

Broad scope

Includes business valuations, fraud investigations, litigation support, and so on

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Forensic accounting services

Forensic accounting services are commonly divided into two major components:
Investigative services
litigation services

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Figure 1-2—Categories of Forensic Accounting Services

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Common Phases in Engagements

Engagements share four common phases

Defining the engagement— (i.e., why are we doing this?)
Discovery—gathering evidence
Analysis—interpreting evidence
Communication—presenting evidence (opinions) orally or in writing

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Investigative Services

An investigation is defined as a systematic inquiry, search, or research to obtain facts regarding a specific or general concern or concerns
Include all forensic accounting engagements that do not involve actual or threatened litigation
Generally related to corporate investigations

Initiated for the purpose of protecting employee fraud, misappropriation of assets, financial statement fraud, or corruption
Types of forensic accounting investigations include fraud detection, fraud examination, and fraud deterrence

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Specific types include

Fraud Detection
Fraud detection is a set of activities to prevent money or property from being obtained through false
Fraud detection is simply the discovery of fraud
Includes a variety of techniques

Auditors cannot be relied on to detect fraud

Specific types of forensic accounting investigations include fraud detection,fraud examination, and fraud deterrence.
As the name implies, fraud detection is simply the discovery of fraud. Fraud detection includes a variety of strategies, such as internal control procedures, statistical analysis, financial statements analysis, and anonymous reporting channels (such as hotlines). Importantly, detective procedures are designed to identify an error or irregularity after it has occurred, whereas preventive procedures are designed to discourage such occurrences before they happen. But how are frauds actually detected?
Fraud studies consistently identify tips as the most common source of fraud detection, thus highlighting the need for reporting channels.
A fraud examination is conducted after the fact, that is, in response to some indication of a crime. Its purpose is to investigate specific allegations or suspicions of fraud. The primary focus of a fraud examination is to determine the following elements of the fraud: who committed the fraud, how they committed it (the fraud scheme), when it was committed (time frame and duration), how much was taken, and who else was involved. The forensic accountant employs a systematic and scientific approach in the discovery, analysis, and determination of alleged fraudulent activity. A forensic accountant may conduct the entire investigation from start to finish or may be retained to investigate only a specific component. In either situation, the forensic accountant commonly works together with other interested parties, including legal counsel, corporate security, internal and external auditors, and management representatives.

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Fraud Detection

Fraud detection includes a variety of strategies, such as internal control procedures, statistical analysis, financial statements analysis, and anonymous reporting channels (such as hotlines)
Detective procedures are designed to identify an error after it has occurred, whereas preventive procedures are designed to discourage such occurrences before they happen

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Fraud Examination

Fraud Examination

Conducted after a crime has been committed
Primary focus is to investigate the allegations
Its purpose is to investigate specific allegations or suspicions of fraud
The primary focus of a fraud examination is to determine the following elements of the fraud: who committed the fraud, how they committed it (the fraud scheme), when it was committed (time frame and duration), how much was taken, and who else was involved

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Fraud Examination

A forensic accountant may conduct the entire investigation from start to finish or may be retained to investigate only a specific component
In either situation, the forensic accountant commonly works together with other interested parties, including legal counsel, corporate security, internal and external auditors, and management representatives

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Fraud Deterrence

Describes proactive, rather than reactive, strategies
Includes both short-term and long-term initiatives

Short-term strategies: Evaluation of hiring practices, internal controls, and performance monitoring
Long-term strategies: Address issues such as organizational culture and the tone set by top management
Examples of short-term (or procedural) strategies include evaluation of hiring practices, internal controls ,Proactive employee strategies include preemployment screening, employee training, employee monitoring

Fraud deterrence differs from fraud detection and fraud examination in that it describes proactive (rather than reactive) strategies. Such deterrence strategies include both short-term and long-term initiatives. Examples of short-term (or procedural) strategies include evaluation of hiring practices, internal controls, and performance monitoring. Because fraud requires individual actors (the offenders), a reasonable starting point for fraud deterrence is employee relations. Long-term strategies are more abstract in nature, addressing issues such as organizational culture and the tone set by top management (that is, “tone at the top”). Proactive employee strategies include preemployment screening, employee training, employee monitoring, perception of detection (through internal controls and external audits), and organizational culture.

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Fraud Deterrence

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Other Investigations

Forensic accountants are commonly engaged to conduct investigations unrelated to fraud. Examples of such investigations include:
Examples of such investigations include whistleblower complaints and financial viability concerns
Whistleblower complaints and financial viability concerns (for example, involving senior management)

Whistleblower complaint is a disclosure by a person of wrongdoing within the organization
Financial viability investigations include short- or long-term assessments of financial and managerial sustainability (related to concerns of customers, vendors, or investors)

In addition to the fraud-related investigations previously discussed, forensic accountants are commonly engaged to conduct investigations unrelated to fraud. Examples of such investigations include whistleblower complaints and financial viability concerns.

A whistleblower complaint is a disclosure by a person (usually an employee) of wrongdoing or misconduct within the organization.
Usually, a forensic accountant is utilized when the allegation is considered serious (for example, involving senior management) or when the appearance of independence is important. Financial viability investigations include short- or long-term assessments of financial and managerial sustainability (related to concerns of customers, vendors, or investors) or the reasonableness of insurance claims (such as lost profits or business interruption).

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Litigation Services

The process of filing claims in court and ultimately going to trial
Civil litigation is the process of resolving private disputes through the court system usually begins in a trial court where the parties to a lawsuit file their pleadings
Connection with actual, pending, or potential legal or regulatory proceedings—criminal or civil

Forensic accounting litigation services are provided in connection with actual, pending, or potential legal or regulatory proceedings—criminal or civil. These services are segregated into expert witness (testifying) services and consulting (nontestifying) services.
All evidence in a trial is presented by witnesses. A witness, as defined by Black’s Law Dictionary, is “one who gives testimony in a cause before a court.” There are two types of witnesses: fact witnesses and expert witnesses. As the name implies, a fact witness testifies about the facts—his or her first-hand knowledge about a fact in issue or person involved in the litigation. An expert witness, on the other hand, is an individual with scientific, technical, or other specialized knowledge who is engaged to assist the “trier of fact” (a judge or jury) to understand the evidence or to determine a fact in issue. Importantly, expert witnesses differ from fact witnesses in that they can express opinions.
A forensic accountant may also be engaged by an attorney as a consulting expert. In this role, unlike the role of a testifying expert, the consultant assists an attorney in advocating for the client. Consulting experts perform many of the same tasks as testifying experts, with the exception of offering expert testimony. Depending on the circumstances of the specific engagement, a consulting expert may serve only a peripheral role or may participate in several aspects of the case, including the development of key arguments.

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Litigation Services

Civil litigation is a legal action between individuals to resolve a civil dispute. Criminal prosecution is when the government prosecutes a defendant to punish illegal conduct
These services are segregated into expert witness (testifying) services and consulting (non-testifying) services
All evidence in a trial is presented by witnesses
These services are segregated into expert witness (testifying) services and consulting (no testifying) services.

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Witness

A witness, as defined by Black’s Law Dictionary, is “one who gives testimony in a cause before a court
The forensic accounting expert witness services have been used in court rooms ofthe country
The forensic accountant’s role as an expert witness in a trial is to provide crucial financial evidence in a particular case

There are two types of witnesses: fact witnesses and expert witnesses

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Two types of witnesses

:

Fact witnesses and expert witnesses. As the name implies, a fact witness testifies about the facts—his or her knowledge about a fact in issue or person involved in the litigation
An expert witness, on the other hand, is an individual with technical, or other specialized knowledge who is engaged to assist the “trier of fact” (a judge or jury) to understand the evidence or to determine a fact in issue. expert witnesses differ from fact witnesses in that they can express opinions

Consulting expert Services (no testifying)

Forensic accountant may also be engaged by an attorney as a consulting expert

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Compare and Contrast the Role of the Forensic Accountant with the Roles of Transactional Accountants and Auditors

Learning Objective 3

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Table 1-2—Comparative Analysis: Accountant, Auditors, and Forensic Accountant

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Table 1-2—Comparative Analysis: Accountant, Auditors, and Forensic Accountant

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Identify the Necessary Skills of Forensic Accountants

Learning Objective 4

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Forensic Accounting Skills

Three essential characteristics or skills identified in the study are critical thinking, reasoning, and communication
Critical thinking:

Rational—Considers all known evidence in an unbiased manner
Skeptical—Suspends judgment to allow proper consideration of evidence, context, and methodologies

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Forensic Accounting Skills

Reasonable—Measures behaviors and conclusions with sound judgment and common sense
Well-informed—Possesses adequate and reliable information
Open-minded—Free of bias and receptive to new information and ideas from others
Self-aware—Cognizant of one’s own emotions and biases and how they impact decisions
Persistent—Resists jumping to conclusions

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Critical thinking

John Dewey (1933), who is widely recognized as the father of modern critical thinking defined it as “active, persistent, and careful consideration

Critical thinking is a productive and positive activity that requires active engagement with life.
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Critical thinking

Critical thinkers continuously question assumptions; therefore, critical thinking is a process and not an outcome.
The thinking processes of critical thinkers vary enormously according to the contexts in which it occurs.
Critical thinking results from individuals experiencing positive and negative events that can initiate the process of questioning previously trusted assumptions.
Critical thinkers find emotions central to the critical thinking process, allowing them to be emotive and rational with their assumptions.

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Forensic Accounting Skills

Reasoning:

Problem-solving skill that involves drawing inferences or conclusions from known or assumed facts

Reasoning is closely associated with critical thinking in that it is a rational process of attempting to understand an event or behavior

Forensic accountants use:

Deductive reasoning—reasoning from the general to the specific, or from the premises to a logically valid conclusion
Inductive reasoning—draws conclusions from patterns (that is, bottom up)

Reasoning is a problem-solving skill that involves drawing inferences or conclusions from known or assumed facts.
Reasoning is closely associated with critical thinking in that it is a rational process of attempting to understand an event or behavior.
Forensic accountants use both deductive and inductive reasoning to identify clues and patterns of behavior, gather and evaluate evidence, question arguments, and develop conclusions.
Let’s first consider deductive reasoning, which is defined as “reasoning from the general to the specific, or from the premises to a logically valid conclusion. In other words, you first identify two or more general premises (either known or assumed to be true) and then apply these accepted truths to a specific situation. Importantly, deductive conclusions are statements of certainty that imply 100% confidence.
In contrast to deductive reasoning, inductive reasoning draws conclusions from patterns. The inductive reasoning process flows from a set of specific observations, facts, or data to a working hypothesis and then a general conclusion (that is, bottom up).

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Forensic Accounting Skills

Communication:

Forensic accountants are expected to have strong communication skills, both written and oral
Written reports must be clear, concise but comprehensive, and grammatically correct, with a professional tone
A forensic accountant must also be skilled in oral communication. Whether the communication is with an attorney, a client, a law enforcement officers
Must be able to relate findings in a simple, professional, and convincing manner

In forensic accounting, where there is often a wide knowledge gap between the expert and the audience, this may be the most challenging component of the process. Thus, forensic accountants are expected to have strong communication skills, both written and oral.
Forensic accountants expect their reports, and every word contained therein, to be closely examined and challenged. Thus, all written reports must be clear, concise but comprehensive, and grammatically correct, with a professional tone.
A forensic accountant must also be skilled in oral communication. Whether the communication is with an attorney, a client, a law enforcement officer, or a judge/jury, the ability to relate findings in a simple, professional, and convincing manner is a critical success factor.
Communication failure is often caused by a misunderstanding of the relative importance of the three components of oral communication: (1) body language, which accounts for roughly 55% of the message; (2) voice tone, which accounts for roughly 35% of the message; and (3) words, which account for only 10% of the message. Thus, nonverbal cues are critical: How you say it is more important than what you say.

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Forensic Accounting Skills

Communication failure is often caused by a misunderstanding of the relative importance of the three components of oral communication:
(1) body language, which accounts for roughly 55% of the message;
(2) voice tone, which accounts for roughly 35% of the message; and
(3) words, which account for only 10% of the message. Thus, nonverbal cues are critical: How you say it is more important than what you say

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Different Skills of Forensic Accounting

Forensic accounting demands different skills from those employed by a traditional accountant
In addition to core accounting skills, forensic accountants must have a working knowledge of the judicial process (the legal environment) and the underlying concepts of evidence, discovery, and legally sufficient opinions
Moreover, successful forensic accountants must have specialized knowledge in a variety of practice areas, such as business valuation and fraud investigation

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Figure 1-3—Pyramid of Forensic Accounting Skills

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Recognize Major Providers of Forensic Accounting Certification and Continuing Education

Learning Objective 5

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Forensic Accounting Certifications�and Supporting Organizations

American Accounting Association (AAA) recently created the Forensic and Investigative Accounting (FIA) Section

Dedicated to the continued improvement of forensic accounting research and education

AICPA’s Forensic and Valuation Services (FVS) Section offers:

Certified in Financial Forensics (CFF) credential
Accredited in Business Valuation (ABV) credential

The AICPA estimates that 25,000 CPAs currently provide forensic accounting services. This group of specialized practitioners is expected to increase in size, as demand for these services continues to grow. In a 2011 AICPA member survey, the vast majority of respondents (79%) expect a greater demand for forensic accounting services in the next two to five years. Of these respondents, 67% attributed this growth to economic damages calculations, 56% to marital disputes, and 54% to fraud investigations. Moreover, the survey confirmed that CPAs represent the vast majority (94%) of forensic experts hired. Strong demand for forensic accounting services implies a need for practitioners with specialized education and training. Recognizing this need, the American Accounting Association (AAA) has recently created the Forensic and Investigative Accounting (FIA) Section, which is dedicated to the continued improvement of forensic accounting research and education. A number of professional associations offer specialized forensic certifications, continuing education, and networking opportunities. The three most prominent of these associations are identified in Table 1-3.

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Table 1-3—Forensic Accounting Credentials

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Identify Potential Careers in Forensic Accounting

Learning Objective 6

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Careers in Forensic Accounting

As previously highlighted, professionals with forensic accounting qualifications are in high demand
Salary range for entry-level position is $30,000 to $60,000 per year ,Those at the top of this profession earn between $250,000 and $500,000 per year.
Offers great variety, including roles for individuals with different skills and talents
Foundational knowledge is widely applicable in many other professions

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Table 1-4—Careers in Forensic Accounting

Continued…

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Table 1-4—Careers in Forensic Accounting

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Chapter End Questions

Explain what forensic accounting is
Identify common types of forensic accounting engagements
Identify the necessary skills of forensic accountants
Explain unrelated-fraud investigations, that forensic accountants commonly engaged in?
Write a short note on value of critical thinking for forensic accountants
Define the following terms:
Fraud deterrence strategies
fraud detection
fraud examination

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Chapter End Questions

For what crime was Al Capone convicted and sent to
prison?
What is meant by a forensic accountant’s mindset?
Discuss the types of investigative services provided by forensic accountants.
What are the three essential characteristics/skills possessed by a forensic accountant?

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Chapter End Questions

1.Who is widely recognized as the first forensic accountant?
a. Al Capone
b. Elliot Ness
c. Frank J. Wilson
d. J. Edgar Hoover
2.Which statement best describes the mindset of a forensic accountant?
a. A stubborn attitude based on life lessons
b. An instinct to explore problems that challenge conventional wisdom
c. A preconceived idea about how a fraud was conducted
d. A conservative approach to conducting an Investigation

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Chapter End Questions

3.Which of the following is NOT a service provided by forensic accountants?
a. Business valuations
b. Fraud detection
c. Fraud examination
d. Financial statement reporting
4.Which of the following is NOT a critical skill of Forensic accountants?
a. Critical thinking ability
b. Reasoning ability
c. Prosecution ability
d. Communication ability

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