incorporating cutting edge forensic accounting...

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2015 ANNUAL CONFERENCEI n d i a n a p o l i s

Presenter : Collin A. A. GreenlandExecutive Chairman

KAIZEN MANAGEMENT CONSULTANTS

Wednesday, 9/30/2015,1:10:00 PM‐2:50:00

INCORPORATING "CUTTING EDGE" FORENSIC ACCOUNTING TECHNIQUES /

METHODOLOGIES INTO COLLEGE / UNIVERSITY AUDITING.


To Sensitize / Review the essential aspects of Forensic Accounting, Definition, Nature, etc.

To Expose / Review the Need / Demand for Forensic Accounting Generally, and

Specifically for University Internal Auditors.

To Expose and Explain to Attendees the types of Forensic Assignments / Applications,

the Main Elements of a Forensic Audit, and How it is Conducted.

To Introduce “Cutting Edge” Forensic Accounting Methodologies, Techniques and

Technology into University Internal Auditing.

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WHAT IS FORENSIC ACCOUNTING ?

DEFINITION 1. :

The application of financial skills and an investigative mentality tounresolved issues, conducted within the context of the rules ofevidence. As a discipline, it encompasses financial expertise, fraudknowledge, and a strong knowledge and understanding of businessreality and the working of the legal system. (SOURCE : FraudAuditing and Forensic Accounting : New Tools and Techniques, byJack Bologna and Robert J. Lindquist, John Wiley & Sons, New York,1987.


WHAT IS FORENSIC ACCOUNTING (CONTD.)?

DEFINITION 2. :

Forensic accounting (or auditing) is the integration of accounting,auditing and investigative skills in order to provide an accountinganalysis suitable for the resolution of disputes (usually but notexclusively) in the courts.

(“Demystifying Forensic Accounting,” by Collin Greenland, The Weekend Observer, Pg. 5, December 7, 2001).

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THE NATURE OF FORENSIC ACOUNTING

Forensic accountants are required to be familiar with legal conceptsand procedures and must be able to identify substance over form whendealing with an issue. Forensic engagements usually require theanalysis, interpretation, summarization and presentation of complexfinancial and business-related issues in a manner which is bothunderstandable and properly supported.




Forensic accountants are required to be familiar with legal conceptsand procedures and must be able to identify substance over form whendealing with an issue. Forensic engagements usually require theanalysis, interpretation, summarization and presentation of complexfinancial and business-related issues in a manner which is bothunderstandable and properly supported.

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According to the American College of Forensic Examiners Institute, (ACFEI) a group oftheir educators have broken forensic accounting into 75 topics as Follows (inalphabetical order) :

1. Accounting systems and the detection of fraud2. Analytical procedures3. Analyzing financial statements4. Antitrust5. Bankruptcy6. Billing schemes7. Bribery and corruption investigation8. Business interruption


WHAT IS FORENSIC ACCOUNTING (CONTD.)?THE NATURE OF FORENSIC ACOUNTING

9. Business valuations and cost estimates10. Check tampering11. Civil and criminal fraud statutes and regulations12. Common fraud schemes13. Compliance with applicable laws and

regulations14. Computers and computer fraud15. Concealing fraud in accounting16. Concealment investigative methods17. Conflicts of interest investigative techniques18. Conversion investigative methods19. Corporate governance20. Criminology and white-collar and economic

crimes

21. Cyber fraud and computer topics22. Detecting management and employee fraud23. Document collection and analysis24. Elements of fraud, pressure, opportunity,

and rationalization25. Environmental and personal red flags26. Expert witness and expert testimony

techniques27 Financial statement fraud28. Financial reporting process29. Finding assets and people30. Forensic accounting practices31. Forensic and general accounting32.Forensic and general accounting32. Fraud auditing methodology

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33. Fraud perpetrators and their motivations34. Fraud prevention and fraud policies35. Fraud schemes / 36. Fraud statistics37. Fraud symptoms and computer-aided fraud

auditing techniques38. Fraud symptoms / 39. Fundamentals of fraud40. Hidden assets41. Internal control evaluation42. Interrogation43. Interview principles and methods to evaluate

deception44. Inventory and asset theft45. Investigation of financial crimes and legal

elements46. Kiting

47. Knowledge of the legal system48. Legal elements of fraud49. Litigation consulting techniques50. Loss prevention investigation51. Loss prevention programs52. Money laundering53 Occupational fraud54. Off-book accounting and financial

statement fraud56. Overview of ethics57. Overview of fraud auditing and fraud

investigation58. Overview of the legal elements of fraud59. Payroll and expense reimbursement60. Phases of forensic accounting



61. Principles of ethics and corporate code

of conduct

62. Professional liability

63. Resolution of allegation of misconduct

64. Rules of evidence

65. Skills required of the forensic accountant

66. Statistical sampling

67. Tax consequences

68. Techniques in locating hidden assets

69. The civil justice system

70. The criminal justice system

71. Theft and skimming

72. Theft act investigative methods

73. Theory of fraud examination and

prevention

74. Trial and cross-examination

75. Who commits fraud

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THE NEED / DEMAND FOR

FORENSIC ACCOUNTING

• In 1999, Kessler International, who was named in 2011 as theForensic Accounting Firm of the Year by ACQ magazine, werequoting (US)$300 / hour for “forensic consultations.”

• In 2002 (February 18, 2002) a U.S. News and World Report coverstory ranked forensic accounting as the number one most securecareer track. The article was entitled “Sherlock Holmes, MeetEnron” and claimed nearly 40% of the top accounting firms wereexpanding their fraud and forensic services.



FORENSIC ACCOUNTING (CONTD.)

• In fact the journal, Accounting Today in their 2007 survey of the top100 accounting firms revealed between 77% and 78% citingforensic accounting growth on their radar.

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The demand for Forensic Accounting services was further confirmed when one examines theWorld Statistics of fees earned in 2010 (published by the IAB in January 2011):




In their “2011 Forensic and Valuation Services (FVS) Trend Survey, the American Institute ofCPAs (AICPA) predicted an increase in demand for their services in the next two to five years.These predictions were mirrored by the IBISWorld report, reported that Profits in theprofession total $669.8 million and wages total $1.6 billion - Seventy-nine percent of Forensic andValuation Services professionals participating in that survey predicted an increase in demand fortheir services in the next two to five years.

In 2012, both the Journal of Accountancy and CGMA Magazine senior predicted a strongdemand strong for forensic accountants in wake of financial crisis, and stated that Forensicaccounting revenue in the United States was expected to grow 6.8% annually over the next fiveyears.

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THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.)

In 2012, IBISWorld reported revenue in forensic accounting in the United States was expectedto grow 6.8% annually from $4.3 billion in 2012 to $6.0 billion in 2017, with a 7.0% increase inforensic accounting revenue expected for 2013 alone.

In 2014, IBISWorld confirmed that over the previous five years, demand for forensicaccounting services surged as financial regulation increased and the number ofbankruptcies and corporate restructures rose sharply. Businesses turned to theindustry for aid in assessing and correcting the damage inflicted during the recessionas well as for assistance with litigation. Though internal competition and competitionfrom other industries' in-house forensic accounting services were forecast to riseover the next five years, growth continue as opportunities arise in niche andemerging markets....




Today, forensic accounting is now regarded worldwide as one of the “20 hot job tracks of thefuture” and job opportunities abound in law firms, financial organizations, insurance companies,and Government agencies like the FBI, the Internal Revenue Service, and the Bureau of Alcohol,Tobacco and Firearms who constantly investigate everything from money laundering andidentity-theft- related fraud to arson and tax evasion;

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The consensus amongst both researchers and practitioners today, is that whilst board members,management and other stakeholders continue to expect assurances that an organization isadhering to industry best practices regarding governance and internal controls and that theorganization is on sound financial footing, increasingly in light of recent financial scandals,increasingly new and more stringent legal requirements, and the increasing complexity offinancial reporting places higher demands on internal audit, and all stakeholders’ awareness forrisk management is growing.




THE NEED / BENEFITS TO INTERNAL AUDITORS.

Deloitte Touche for example, in their 2012 survey reported that since their last Internal AuditFraud Survey in 2010, the mandate and role of Internal Audit functions have continued to evolve,in respect of both fraud risk management and investigation responsibility. Management are stilldependent on Internal Audit to provide them with assurance over the anti-fraud controls in placeacross their businesses, together with the ability to detect and investigate fraud, should it occu r.These are important pre-conditions and strong incentives for the inclusion of forensic accountingtechniques in internal audit functions.

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The Deloitte report pointed out that a robust anti-fraud culture is being promoted by seniormanagement with 98% of respondents stating senior management endorse and offer some,or extensive encouragement of a strong approach to fraud risk management. These areimportant pre-conditions and strong incentives for the inclusion of forensic accountingtechniques in internal audit functions.





The Deloitte report also predicted that over the next 12 months, the three key areas of focus inInternal Audit were to be firstly the inclusion (or continued inclusion) of fraud in the scope ofreviews undertaken (53%), secondly the increased coverage of fraud risk in the audit plan(40%), and thirdly performing fraud risk assessments (36%). Interestingly, 28% ofrespondents anticipate the implementation of fraud data mining tools, critical components inforensic accounting. Again, these are important pre-conditions and strong incentives for theinclusion of forensic accounting techniques in internal audit functions.

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In the matter of the initial detection of frauds, internal audit has consistently been exceeded bythe categories of “Tips,” and “Management Review” according to the most comprehensiveand widely accepted survey on occupational fraud known as “Report To The Nation OnOccupational Fraud and Abuse,” researched, compiled and presented by the Associationof Certified Fraud Examiners (ACFE) in 1996, 2002, 2004, 2006, 2008, 2010 , 2012 and2014. Below is an excerpt of the 2014 report - the inclusion of forensic accounting techniquesin internal audit functions will assist in improving its effectiveness in this area.


22

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THE NEED / BENEFITS TO INTERNAL AUDITORS.The need for the use of Forensic Accounting by internal auditors has been further enhanced bythe increased use of “Anti-Forensic” actions as the market has seen a flood of new Windows-based software offering to delete files securely and inhibit their recovery by digital forensicprograms. These frustrate forensic tools, investigations and investigators by erasing or alteringinformation; creating “chaff,” that waste time and hide information; implicate innocent parties

by planting fake evidence; exploiting implementation “bugs” in known tools; and leaving“tracer” data that cause computer forensic tools to inadvertently reveal their use to the

attacker.


TYPES OF FORENSIC ASSIGNMENTS / APPLICATIONS

The Forensic accountants are engaged in a wide range of investigations, spanning many differentindustries . The practical and in-depth analysis that a forensic accountant will bring to a case helps touncover trends that bring to light the relevant issues in various areas such as :

FORENSIC / CRIMINAL INVESTIGATIONS SHAREHOLDERS’AND PARTNERSHIP DISPUTES PERSONAL INJURY CLAIMS / MOTOR VEHICLE ACCIDENTS BUSINESS INTERRUPTION / OTHER TYPES OF INSURANCE CLAIMS BUSINESS / EMPLOYEE FRAUD INVESTIGATIONS MATRIMONIAL DISPUTES BUSINESS ECONOMIC LOSSES PROFESSIONAL NEGLIGENCE MEDIATION & ARBITRATION

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MAIN ELEMENTS OF A

FORENSIC AUDITEach forensic accounting assignment is unique and accordingly the actual approach adopted and

the procedures performed would be specific to it. However, in general, many forensic audits would

include the following steps :

MEET WITH THE CLIENT

PERFORM A “CONFLICT CHECK”

PERFORM AN INITIAL INVESTIGATION

DEVELOP AN ACTION PLAN

OBTAIN THE RELEVANT EVIDENCE

PERFORM THE ANALYSIS

PREPARE AND PRESENT THE REPORT


CONDUCTING FORENSIC AUDITS

AUDIT VS. INVESTIGATION

It is essential that internal auditors realize thaiont their “mind set” in an forensic audit should be onemore of an investigation, than that of an audit. Unlike a regular internal audit that focuses mainly oncompliance of auditees to established policies / procedures, a forensic audit is more investigativedesigned mainly to get the facts, find out what happened and gather sufficient evidence to allowmanagement / client to take corrective (or punitive) action.

Clearly this may be more adversarial than routine audits that depend most times on a consultativeapproach. This is not to say however, that experienced forensic auditors do not use consultative orcooperative approaches but the difference between their approach and that of routine auditors mustbe generally understood.

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CONDUCTING FORENSIC AUDITS (CONTD.)

THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION

In conducting forensic reviews, internal auditors are well advised to utilize the traditional Seven Steps

of Criminal Investigation, a process commonly taught and applied in the USA by federal, state, and

local law enforcement authorities.

Many variations of the “Seven-Step” method are used by law enforcement authorities, some agencies

employ a three, four, or five-step criminal investigation process. However, the Seven-Step method is

preferable due to its comprehensive detail. This customization capability enables forensic

practitioners to closely interface with respective law enforcement agencies, thus matching their

approach when applying forensic accounting.




The Methodology In Action — Process Map

The methodology is constructed as a process map that visually guides the practitioner through thelogical actions of a forensic accounting assignment. The methodology starts at the earliest stage of anassignment and progresses through the final stage, typically testimony delivery pursuant toprosecution. The process map flows left-to-right, top-to-bottom within the four phases and five stages,as shown in Exhibit 19 below (Source : The United States Attorneys’ Bulletin - May 2005, Volume 53,Number 3, Titled “Financial Forensics II).

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MAIN ELEMENTS OF A

FORENSIC AUDIT (CONTD.)




Due to the two-dimensional nature of the written word, the process map appears sequential.

However, the methodology is intended to be flexible, dynamic, integrated and simultaneous, and/or

iterative, thus mirroring how information and conclusions develop. For example, interviews and/or

interrogations might not be conducted until rather late in a forensic assignment.

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Methodology and Linkage to Criminal Investigation

The methodology was constructed using a forensic accounting/investigative linkage to the Seven-StepCriminal Investigation methodology.

The Seven-Step methodology is summarized as follows :


CONDUCTING FORENSIC AUDITS (CONTD.)THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION

1.Interviews and Interrogation Interviews and Interrogation (I&I) reflect the personal aspect of data-gathering, Obtained throughpersonal interviews and interrogation under law enforcement authority. It is generally considered asource of primary data.

KEY POINTS TO NOTE:

Interview vs. Interrogation (Know difference & when to use) Continuous process throughout an investigation Gain additional information with each interview Evidence from witnesses provides additional leads May identify additional witnesses Interview the target only after completing the interviews of the peripheral witnesses

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2.Background ResearchBackground Research (BR) is comprised of two broad categories: primary data andsecondary data. Primary data (see Interviews) is acquired by the practitioner's effortscollecting data otherwise unavailable through secondary sources. These may include:

Public Databases Secretary of State Websites County Seat Corporate Records Internet UYI



3.Electronic and Physical SurveillanceElectronic and Physical Surveillance (EP) is used to obtain evidentiary data throughObservation:

Physical Usually done by law enforcement or PI’s Surveillance cameras Can also be used to verify addresses for vendors, employees, etc.

Electronic Internet surveillance E-mail

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4.Confidential Informants Confidential Informants (CI) provide information that is considered primary data. This may includepaid or voluntary informants. These may include:

Hotlines E-mail Letters Current Employees Former Employees Vendors & former vendors Customers & former customers




5. Undercover Undercover (UC) is used to obtain first-hand subject data.

Usually a recommendation to use in special circumstances

Can be done if carefully planned

Best left to professionals

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6. Laboratory Analysis Laboratory Analysis (LA) should be done cognizant of jurisdictional rules, (eg. in the US – FederalRules of Evidence), plus chain of custody best practices. LA can include a wide range of investigatoryprocedures, including:

Physical examination of fictitious documents Fingerprint analysis Forgeries Ink sampling Document dating Computer Forensics (imaging, emails, digital analytics)



7. Analysis of TransactionsAnalysis of Transaction (AT) compares/contrasts transactional and pattern-sensitive data measures to provide a record for forensic analysis. Full and false inclusion tests, for example, are used to determine the appropriate "universe" of data under investigation. This ensures that no extraneous data is included and that no appropriate data is excluded. Analysis of financials may include:

Horizontal/vertical analysis Authorization of new vendors & employees Comparison of employee & vendor addresses Analysis of sales returns & allowance account Management override of controls Different reviews based on known industry fraud schemes

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“CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES

EARLY FORENSICS ANALYSES (PRE-COMPUTER)

Forensic Accountants utilized advanced forensic financial analyses even before the proliferation ofComputers. Admittedly, these techniques and methodologies were more time consuming, requiredmore “elbow Grease,” and in some instances less accurate especially where large scale sampling wasunavoidable.

The analytical and investigative process usual utilized horizontal and vertical trending relationshipassessment of innumerable financial and Statistical variables. The most common of which included :


“CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.)

EARLY FORENSICS ANALYSES (PRE-COMPUTER):

Historical analyses of Balance Sheet and Income Statements Common sizing historical statistics by percentages Comparative analysis by Industry standards Cash flow trending analysis trending consistency of net sales, gross profit, operating income

and net income Benchmarking product pricing Inventory Valuation EBIT (Earnings before interest) Accounts receivable / payable turnover Net Worth changes Debt / equity Benford’s Law

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Modern day “CUTTING EDGE” Forensic Accounting however still use many of the traditionalmethods mentioned above but increasingly utilize a plethora of COMPUTER ASSISTED AUDITTECHNIQUES (CAATs) and / or other specific tools and techniques such as , e.g., Data Mining, Full-and-False Inclusion, Genogram, Entity(s) Charts, Timeline Analysis, Link Analysis, Item Listing,(Modified) Net Worth Method, Source and Use of Cash Method, Proof-of-Cash Method, and DigitalAnalysis - such as :– Duplicate Numbers Test– Rounded Numbers Test– Stratification Percentage Comparison– Benford’s Lawet al.



DATA MININGIn the world of forensic accounting, Data Mining provides a type of DNA assurance in evidencegathering as auditors / investigators search for exceptions, oddities, irregularities, patterns, andsuspicious transactions.

What is Data Mining?PricewaterhouseCoopers defines Data Mining as the “art of analyzing large amounts of data in aManner that detects obscure facts, trends, or inconsistencies in a complete and efficient manner utilizing"intelligent" computer applications.”

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DATA MINING (CONTD.)

A more comprehensive definition by professional journal “The Chartered Accountant” regards DataMining as “a technique with an objective to mine large amount of data to discover previously unknown,action oriented, hidden trends, patterns and complex relationships. The technique studies past data,operates on all the variables and entire population, extracts variables of importance and uncoverspatterns in the form of rules, and formulates models by using different techniques.”

Data Mining therefore can greatly assist internal auditors, investigators or analysts to discoverpreviously unknown and actionable trends, patterns and relationships in their company data duringroutine decision making, investigations or even modeling predictions.



ACCOUNTING RATIOS

Financial statement fraud causes the biggest losses and the inescapable logic of the accountingequation ensures that any major overstatement of assets or profits, will show up over time.Accordingly, the main Accounting Ratios used by early days analysts are still used today andanalysed mainly on the following criteria:

Income Profitability Liquidity Working Capital Bankruptcy

Long-Term Analysis Coverage Leverage

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ACCOUNTING RATIOS

These main Accounting Ratios are used even up to today and were utilised in analytical tasks to :

RETRIEVE VALUE.FILTERCOMPUTE DERIVED VALUEFIND EXTREMESSORTDETERMINE RANGECHARACTERIZE DISTRIBUTIONFIND ANOMALIESCLUSTERCORRELATE



ACCOUNTING RATIOS

HOWEVER, in addition to the having the benefit of computerization, modern day ForensicAccountants, after ascertaining these fundamentals, are able to apply more complexassessments by drawing from the over 250 or so ratios to delve more incisively into a widerscale of concerns. Internal auditors can emulate the use of these numerous ratios which Forexample, in alphabetical order, include:

Accounts Receivable Turnover,Advertising to Net Income,Advertising to Sales,Age of Inventory,Atman’s z-score (both Manufacturing and Non-

Manufacturing),

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Audit Ratio,Average Collection Period,AverageInventory Period,Average Obligation Period,Average Wage and Benefit Cost per Employee,Bad Debts Ratio,Breakeven Point,Capital Acquisition Ratio,Capital Employment Ratio,Capital Reinvestment Ratio,Capital Structure Ratio,Capital to Non-Current Assets



Cash and Marketable Securities to Current Liabilities (Acid Test),Cash and Marketable Securities to Working Capital,Cash Balance,Cash Breakeven,Point, Cash Debt Coverage,Cash Dividend Coverage,Cash Flow from Operations to Net Income,Cash Flows from Investing vs. Finance,Cash Flow from Sales to Total Sales,Cash Flow Ratio, Cash Flow to Debt,Cash Flow to Long Term Debt,Cash Flows from Investing vs. Finance,

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Cash Flows from Operations to Current Portion of Long Term Debt,Cash Flows from Operations to Total Debt and Equity,Cash Maturity Coverage,Cash Return on Assets (Including and Excluding Interest),Cash Return to Shareholders, Cash Turnover,Collection Period, Collection Period to Payment Period,Contribution Margin, Contribution Margin Ratio,Current Ratio, Current Liabilities to Sales,Current Return on Training and Development,Daily Savings in Delayed Cash Payments,Days of Liquidity,Debt to Assets,



Debt to Equity Ratio,Defensive Interval Period,Discretionary Costs as a Percent of Sales,Dividend Yield,EBIT to Sales,Employment Change,Equipment Replacement Ratio,Equipment Upkeep Ratio,Equity Multiplier,Expenses to Current Assets,

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ANALYSING BALANCE SHEETS / INCOME STATEMENTS, ETC.

Internal auditors should for example become familiar with some of the most established use ofanalytical tools and techniques such as Benford’s Law, Altman Z-Score, Piotroski F-Score andBeneish’s M-Score.



BENFORD’S LAW

Benford’s Law, also called the first-digit law or leading-digit phenomenon, enables you to quicklyascertain the accuracy of the data, and can help alert auditors / investigators to possible errors,potential fraud, manipulative biases, costly processing inefficiencies or other irregularities. It isparticularly helpful for detecting fraud in various business data such as check payment amounts andfraudulent tax returns.

Referred to as the “DNA-equivalent technique for financial analysis,” by authoritative sources such asthe Journal of Accountancy (May 1990); accepted legally in major jurisdictions such as the UnitedStates, where evidence based on Benford's Law has been admitted in criminal cases at the federal,state, and local levels; and empirically tested / verified scientifically / statistically further validated byChi Squared, Kolmogorov–Smirnov and Kuiper tests (depending on sample size)

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BENFORD’S LAW

Mathematically speaking, Benford's law states that the leading digit d (d ∈ {1, …, b − 1} ) in base b (b ≥ 2) occurswith the following probability: This quantity is exactly thespace between d and d + 1 in a log scale. In Base 10, theleading digits have the distribution shown on the right Where d is the leading digit and p the Probability.



BENFORD’S LAW

Graphically illustrated, the law appears as follows:

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ALTMAN Z-SCORE

In testing for example, the probability that a firm will experience bankruptcy within two years, aformula developed by NYU Professor Edward Altman, called a “Z-Score” could be used. This “Z-Score” was established to measure financial distress along a number of objective metrics whichincludes five easily derived business ratios, weighted by coefficients.

The original formula, widely applicable, is as follows :



ALTMAN Z-SCORE

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 +0.99X5.Where;

X1 = Working Capital / Total Assets (Measure the liquidity of thecompany’s asset base);

X2 = Retained Earnings / Total Assets (Measure cumulative profitabilityrelative to firm size)

X3 = EBIT / Total Assets (Measure how efficiently the company uses itsassets to generate earnings from its operations.

X4 = Market Value of Equity / Book Value of Total Liabilities (Consideration ofthe market’s view of the company relative to its liabilities).

X5 = Sales / Total Assets (Measures asset turnover).

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ALTMAN Z-SCORE

To interpret the resultant Z-Score, a company would be placed in one of three categories:

1.SAFE – If with a Z-Score greater than 2.99 and thus have a relatively remote risk of bankruptcy;

2.LESS CLEAR - With a Z-Score between 1.81 and 2.99, and existing in a greyarea where a clear statement cannot be made.

3.IN DISTRESS - With a Z-Score less than 1.81 and thus at A high risk of bankruptcy.



ALTMAN'S Z-SCORE

Sceptics or detractors who find limitations in Altman's Z-score, may prefer to find comfort in acompanys “F-Score” developed by Joseph Piotorski in 2000 while at the University of Chicago.Compared to Altman's Z-score which test 5 inputs, the F-score tests nine, but does not weight them.Accordingly, Piotorski's F-Score is calculated as follows :

The F-score is the sum the scores for each of nine tests. Each test scores one for a pass and zero for afail.

The tests are profitability related and are as follows:

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ALTMAN'S Z-SCORE1.Net profit is positive;2.Operating cash flow is positive;3. Net profit ÷ total assets at beginning of year, minus the same number for the

previous year is positive;4. Operating cash flow is greater than net profit, capital structure and debt

service;5. Long term debt ÷ by average assets has not increased;6. The Current ratio has increased (the change is more then zero, so even a

negligible increase asses the test!);7. No raising of ordinary (common) equity over the previous year: this test is

passed if the company did not issues any ordinary shares;8. Gross margin has improved over the previous year;9. Asset turnover has increased.



BENEISH M-SCORE

The more skeptics amongst us who feel that a company’s earnings may be manipulated so the aboveanalyses may not be valid, should also know that any possible manipulations can be tested byapplying the “Beneish Model,” a mathematical model that uses financial ratios and eight variables toidentify whether a company has manipulated its earnings.

The variables are constructed from the data in the company's financial statements and, oncecalculated, create an “M-Score” to describe the degree to which the earnings have been manipulated.The original M-Score formula is as follows:

M-Score = -4.84 + 0.92*DSRI + 0.528*GMI + 0.404*AQI + 0.892*SGI + 0.115*DEPI – 0.172*SGAI +4.679*TATA – 0.327*LVGI

Where :

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BENEISH M-SCORE

Where :1. DSRI - Days' sales in receivable index2. GMI - Gross margin index3. AQI - Asset quality index4. SGI - Sales growth index5. DEPI - Depreciation index6. SGAI - Sales and general and administrative expenses index7. LVGI - Leverage index8. TATA - Total accruals to total assets

Once calculated, the eight variables are combined together to achieve an M-Score for acompany and one less than -2.22 would suggests that it will not be a manipulator, whereas anM-Score of greater than -2.22 would signal the possibility that it is likely to be a manipulator.



BENEISH M-SCORE

Once calculated, the eight variables are combined together to achieve an M-Score for acompany and one less than -2.22 would suggests that it will not be a manipulator, whereas anM-Score of greater than -2.22 would signal the possibility that it is likely to be a manipulator.

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CATEGORIES OF FRAUD

The ACFE’s classifications of fraud has evolved as the most accepted and respected classifications offraud, i.e. Corruption, Asset Misappropriation and Fraudulent Statements.

Internal Auditors investigating fraud should become very familiar with these categories and theACFE’s procedures / techniques in deterring, preventing, detecting and reporting these categories.

The categories are as follows:


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COMPUTER FORENSICS

As mentioned previously, modern day analysts still use many of the traditional methods mentionedabove, but presently they are now utilizing a plethora of COMPUTER ASSISTED AUDITTECHNIQUES (CAATs) pursued mainly through COMPUTER FORENSICS defined below by theNational Institute of Standards and Technology as follows :

. . . the application of science to the identification, collection, examination, and analysis of datawhile preserving the of the information and maintaining a strict chain of custody for the data. Datarefers to distinct pieces of digital information that have been formatted in a specific way. . .



COMPUTER FORENSICS

COMPUTER FORENSICS is regarded as a branch of Digital Forensic Science, pertaining to legalevidence found in computers and digital storage media. The goal of computer forensics is to examinedigital media in a forensically sound manner with the aim of identifying, preserving, recovering,analysing and presenting facts and opinions about the digital information.

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COMPUTER FORENSICS

Forensic investigators typically follow a standard set of procedures. After physically isolating thecomputer in question to make sure it cannot be accidentally contaminated, investigators make adigital copy of the hard drive. Once the original hard drive has been copied, it is locked in a safe orother secure storage facility to maintain its pristine condition. All investigation is done on the digitalcopy. The renowned “Forensic Magazine." delineate an eight step forensics process:1.Search authority2.Chain of custody3.Imaging/hashing function4.Validated tools5.Analysis6.Repeatability (Quality Assurance)7.Reporting8.Possible expert presentation



DIGITAL EVIDENCE

What is Digital Evidence?

“Digital evidence is information of probative value that is stored or transmitted in a binary form”.This field includes not only computers in the traditional sense but also includes digital audio andvideo. It includes all facets of crime where evidence may be found in a digital or binary form.

Any information can be stored electronically, and almost all new information is being created andstored exclusively in electronic format. Background information called Metadata (inherent withelectronic data) can turn up skeletons you had no idea existed. Knowledge of the location of data,storage methods and document types is critical.

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DIGITAL EVIDENCE

Internal auditors should be aware that the inventory should include the location and storage formatsof all electronic data and any information stored and or used by computer technology is considered tobe electronic evidence discoverable in litigation. Relevant information may exist in a variety oflocations and various forms and basic categories should not be overlooked.

Digital Evidence comes in numerous form factors, and can include the following:


“CUTTING EDGE” FORENSIC ACCOUNTING

METHODOLOGIES (CONTD.)

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“CUTTING EDGE” FORENSIC ACCOUNTING

METHODOLOGIES (CONTD.)

FORENSIC PROCESS

COMPUTER FORENSIC INVESTIGATIONS usually follow the standard digital forensic process orphases: acquisition, examination, analysis and reporting. Investigations are performed on staticdata (i.e. acquired images) rather than "live" systems. This is a change from early forensic practiceswhere a lack of specialist tools led to investigators commonly working on live data.



FORENSIC PROCESS

TECHNIQUESThe techniques are used during computer forensics investigations include the following:

Cross-drive analysis forensic technique that correlates information found on multiple harddrives. The process, still being researched, can be used to identify social networks and toperform anomaly detection.

Live analysis - Examination of computers from within the operating system using customforensics or existing sysadmin tools to extract evidence. (A system administrator, or sysadmin, isa person who is responsible for the upkeep, configuration, and reliable operation of computersystems; especially multi-user computers, such as servers). The practice is useful when dealingwith Encryption Fie Systems, for example, where the encryption keys may be collected and, insome instances, the logical hard drive volume may be imaged (known as a live acquisition)before the computer is shut down.

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FORENSIC PROCESS

TECHNIQUES (Contd.)

Deleted files - A common technique used in computer forensics is the recovery of deleted filesused by modern forensic software which have their own tools for recovering or carving outdeleted data. File carving, for example, involves searching for known file headers within thedisk image and reconstructing deleted materials.

Stochasted forensics – a method which uses stochastic properties of the computer system toinvestigate activities lacking digital artifacts. (Physical systems in which we are uncertain aboutthe values of parameters, measurements, expected input and disturbances are termedStochastic Systems. In probability theory, a purely stochastic system is one whose state israndomly determined, having a random probability distribution or pattern that may beanalyzed statistically but may not be predicted precisely. In this regard, its chief use is toinvestigate data theft.



FORENSIC PROCESS

WHICH ARE THE “BEST” TOOLS?

In many instances, companies, indeed internal auditors operate on limited budgets, so it isunlikely that one company will invest in multiple forensic softwares.

If a “best tool” is sought however, a disk editor might be a worthwhile investment.Understandably also, it is not feasible for forensic auditors to procure every possible data base,spreadsheet, word processing, flow chart, or other software application on a suspect’s harddrive or other media under investigation.

Instead, a file viewer can be obtained and products such as Jax Software’s Quick View, FileStream Inc’s Turbo Browser 2000, and Clear and Simple Inc.’s Disk Jockey 2000 enables usersto view hundreds of file types using one tool.

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FORENSIC PROCESS

WHICH ARE THE “BEST” TOOLS?

THE FOLLOWING TABLE DISPLAYS SOME OF THE BEST AVAILABLEFORENSIC TOOLS RESEARCHED BY THIS PRESENTER:


EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS

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EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS (Contd.)


EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS (Contd.)

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WHICH ARE THE “BEST” TOOLS? (Contd.)

My experience and research of the software brands engaged in forensic accounting work revealthat EnCase is one of the most multifaceted, popular, effective, reputedly used by over 75% ofthe world’s forensic and amongst my personal favorite.



WHICH ARE THE “BEST” TOOLS? (Contd.)

ACL is very popular software used by internal auditors and they have developed forensic toolsand with innovative and creative manipulations, which have allowed internal auditors to doimpressive forensic work.

The key point to note is that using the right investigative tools can help to maximize theeffectiveness of computer forensic work, and equip internal auditors to incorporate “CuttingEdge” Forensic Accounting Methodologies into their day to day tool kit.

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CONTACT INFORMATION:

COLLIN GREENLAND,EMAIL : [email protected]

incorporating cutting edge forensic accounting...

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