Forensic Accounting: When Do You Need It?

Chris Banta, CPA, CFE – Partner

Brown, Edwards & Company, LLP

Session Goals

Warning Signs of Fraud

Who do I call? Auditor or a Forensic Accountant

Fraud Awareness

As management, employees, or governance of any organization, you should understand the risk of fraud in your organization.

Awareness of the risk of fraud and the extent of fraud in the environment that your organization operates is important.

Resources:

Association of Certified Fraud Examiners (ACFE) provides many tools.

Report to the Nations on Occupational Fraud and Abuse – Statistics on fraud.

Warning Signs of Fraud

FINANCIAL

Unusual or unexplainable trends from year to year, period to period, or over time:

• Cash balances diminishing, but profits are stable.

• Expenses are increasing, but not in relation to your understanding of operations.

• Expenses that are not expected to fluctuate from period to period wildly fluctuate

• Results are drastically different than budget.

• Calls from vendors claiming they are not being paid.

COMBINED WITH…….

Warning Signs of Fraud (Continued)

OPERATIONAL Employees in key positions are disgruntled.

Employee compensation unusually high.

Employees with extravagant lifestyles that do not match expectations.

Employees not complying with defined controls.

Employees with unusually high levels of credit card or employee expense transactions.

Finance individuals who work on weekends when that is not common (i.e. not an AUDITOR ).

Employees with controlling personality or secretive behavior.

Untimely closing process or reconciliation preparation.

Warning Signs of Fraud (Continued)

All of the above may be signs of fraud, but are commonly a result of the Fraud Triangle:

Pressure – Motivation or intent.

Rationalization – Justification.

Opportunity – Ability to carry out misappropriation.

What Do I Do?

Question:

I’m having sleepless nights…. Something doesn’t add up… who do I call, my Auditor or a Forensic Accountant?

Answer:

Probably both… but for different reasons.

An Auditor’s Role

Common misconception: The Auditor’ primary objective is to detect fraud.

What is an audit:

Process for determining whether financial position and financial performance presented in financial statements are fairly stated in accordance with defined standards.

Auditors help provide confidence and provide assurance that financial statements that management is presenting are reasonably correct.

A Forensic Investigation is…

An examination of specific records

and information to help determine

facts related to a suspicion or

allegation of fraud.

THE DIFFERENCES BETWEEN AN AUDIT AND A FORENSIC

INVESTIGATION

Objectives and Responsibilities

Audit Obtain reasonable assurance about whether financial statements as a whole

are free from material misstatement, whether due to fraud or error.

Expression of an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework.

Gain an understanding of internal controls to understand how the balances and financial statements were derived.

Not required to test controls in all audits.

Communicate audit findings to management and governance.

Must consider multiple types of users: Investors, grantors, management, lenders, etc.

Objectives and Responsibilities (Continued)

Audit (Continued)

Must consider fraud risks in planning audit.

Must make inquiries with employees, management, and governance concerning knowledge of fraud and incorporate responses into planning of audit.

Must perform brainstorming sessions of audit team to identify fraud risks.

As fraud risks are identified, audit procedures should be specifically tailored to those risks.

If fraud detected, auditor has a responsibility to report to various responsible parties, including governance, possibly management, possibly granting agencies, etc.

If fraud detected, must determine impact on ability to opine on financial statements.

Objectives and Responsibilities (Continued)

Forensic Investigation

Performed to assist an entity in gathering sufficient relevant data to assist in determining whether or not fraud was committed.

Objectives include:

• Gathering evidence to identify the type of fraud.

• Quantify the amount of loss.

• Determine who was involved.

• Determine when it began.

• Determine why it was able to be perpetrated.

• Determine how it was concealed.

Objectives and Responsibilities (Continued)

Forensic Investigation (Continued)

Avoid an opinion.

Report on evidence objectively, succinctly, and with a sufficiently explained foundation.

Services are not for various users (such as an audit). Instead work is usually directed through legal counsel and is defined explicitly in scope of services in engagement letter.

Professional Standards

Auditors follow standards for performance of audits per:

Generally Accepted Auditing Standards (GAAS) issued by the AICPA

Office of Management and Budget Uniform Guidance – Single Audit

Government Auditing Standards

HUD Audit Guide

APA Audit Specs on Authorities, Boards, and Commissions and Specs on Cities, Counties, and Towns.

PCAOB (Public Companies)

Others.

Professional Standards (Continued)

Forensic Investigation

Considered a consulting service by the AICPA

May also be subject to:

• Requirements of the Department of Justice

• Federal Rules of Civil Procedure

• State Court or other jurisdiction requirements.

• Should be clarified by legal counsel

Other Notable Differences

Timing – Audits – planned periodically and on a recurring basis.

Forensic investigations – Unforeseen and nonrecurring.

Predication – Forensic investigations – Begin with the allegation or suspicions of fraud.

Audits – Suspicion of Fraud is NOT the basis of an audit.

Obligatory –

An audit is an obligatory engagement for which an entity must hire an auditor to provide an opinion on its financial statements.

Forensic investigations are typically conducted voluntarily because an entity has suspicion or allegation of fraud.

Other Notable Differences (Continued)

Performance –

Audits – Performed by auditors who are CPAs with experts needed to assist in opining on significant balances or transactions. Can include:

• Engineers

• Actuaries

• IT auditors

• Valuation specialists

Forensic investigation – Typically performed by a team of experts that can include:

• Certified Fraud Examiners

• CPAs

• Information technology specialists

• Others

Other Notable Differences (Continued)

Appointment –

Audits – Appointment of auditor is made by governing body (or equivalent) of the entity.

Forensic investigation – Appointed by management, governing body, or a third party.

Reporting Format

Auditor – Standard opinion on the financial statements.

Must be written.

Standard report and all modifications are prescribed by AICPA.

Must be signed by the CPA Firm, not an individual.

Forensic investigations – No mandated format unless litigation is expected.

Federal Rules of Civil Procedure require experts to prepare and sign a written report that legal counsel must disclose to other parties before the court will allow the expert to testify at trial.

Reporting Format (Continued)

Forensic investigations (continued) –

Reports must include:

• Statement of the conclusions to be expressed

• Basis and reasons for conclusions

• Data or other information considered in forming conclusions

• Witness or expert qualifications

• Signature of expert

Form, timing, and format of report will be at the direction of legal counsel or client.

In many cases, such an engagement is segmented into phases and in many cases, it may never get to the final stage.

Questions to Ask…

What exactly is my concern?

Detecting fraud or

External opinion on reasonableness of financial records

Are there external parties that are requiring the specific engagement?

Financial institution, granting agency, etc. or

Legal counsel

Who Do I Call for a Forensic Investigation?

Auditors may provide some of the skillset to accomplish some of the requirements of a forensic investigation. However….

Certified Fraud Examiners are more specific experts in the field of: Internal controls

Fraud deterrence

Fraud detection

Expert testimony

Litigation support.

Who Do I Call for a Forensic Investigation? (Continued)

Certified Fraud Examiners required to take CFE Exam: Financial Transactions and Fraud Schemes — tests your comprehension of the

types of fraudulent financial transactions incurred in accounting records. Includes basic accounting and auditing theory, fraud schemes, internal controls to deter fraud and other auditing and accounting matters.

Law — Ensures your familiarity with the many legal ramifications of conducting fraud examinations, including criminal and civil law, rules of evidence, rights of the accused and accuser, and expert witness matters.

Investigation — Includes interviewing, taking statements, obtaining information from public records, tracing illicit transactions, evaluating deception and report writing.

Fraud Prevention and Deterrence —Understanding of why people commit fraud and ways to prevent it, including crime causation, white-collar crime, occupational fraud, fraud prevention, fraud risk assessment, and the ACFE Code of Professional Ethics.

Nontraditional Services Provided by Audit Firms

Many CPA Firms have Certified Fraud Examiners in house.

Why? If fraud noted at a client, ability to keep work in house and provide the best service

possible to clients.

CFE’s are internal experts and are a resource for audit teams if fraud is detected and a response is required.

Audit firms can provide: Internal control consulting.

Internal control or other audits.

Agreed upon procedures.

Other fraud consulting.

In many cases, a CFE employed by the audit firm assists with the design and execution of these nontraditional services.

Should I Involve Legal Counsel?

Short Answer: Yes

Why?

If you believe that you may be taking legal action in response to your concerns of fraud it is important that legal counsel work with the forensic investigator.

While the forensic investigator is the expert who should be the one designing and executing the investigation, legal counsel should evaluate results and provide guidance throughout the process for legal purposes.

If investigator is expected to act in role of expert witness in court, legal counsel should assist with preparing expert for court.

Conclusion

Ultimate goal is that this session provides you a roadmap to determine what services you need and who you need to involve in this process.

The hope is that you never have to use it!

Learn from others’ experiences. Keep your eye on news about frauds at entities similar to you and learn how fraud occurred at those entities, what you need to look for, how you can react to fraud, and who to call.

Chris Banta, CPA, CFE Partner

Brown, Edwards & Company, LLP

(540) 345-0936

cbanta@becpas.com