What is Forensic Accounting? An Introduction
Forensic Accounting is the process of using one’s Accounting acumen to investigate possible fraud or other such criminal activity and preparing the findings in a simple format (supported by relevant data) which is then used in legal proceedings to help assist in concluding an ongoing dispute. The Forensic Accountants by virtue must have excellent analytical, perceptive and deductive skills in order to extrapolate information from complicated financial and business data and put it into a concise, well-documented presentation.
The accountant should also be well-versed in Legal terminologies and procedures such as:
- Financial evidence examination
- Performing forensic research to trace funds and identify assets for recovery.
- Using customized Software to extract and format the software’s findings.
- Prepare forensic final reports from the data they would have collected
- Be familiar with accounting and auditing standards and protocols
- Offer litigation support in the form of acting as an expert witness, (as and when required) backing their statements with graphical representations to support their evidence.
It should be noted that some Forensic Accountants are assigned to tasks such as Civil disputes while others handle Government entities, Banks and so forth usual consisting of two slightly different skill sets and approaches being required.
Now that we have introduced the concept, let us now look at two key methods normally used.
1) The Direct Method (Transaction Method)
This area of Forensic Accounting deals with investing of cancelled cheques, invoices, breach of contract, agreements, investigations into public records, conducting interviews with company employees, creating a cash flow statement over a given period, notices by an accountant and more.
2) The Indirect Method
This method of Forensic accounting can be broken down into three main categories, namely the Cash T Method (also called the Source and Application of Funds Method,) The Net Worth Method and the Bank Deposit Method. We will now give a brief overview of each:
i) The Cash T Method (The Source and Application of Funds Method)
The Cash T method is usually utilized when an individual or company’s books and records do not clearly show their income leading to a suspicion that they may have omitted some of their earnings for a particular period of time.
The Source and Application method measures money spent on lifestyle against money spent on assets and investments to check if any noticeable discrepancies exist.
It is the aspect of measuring incoming vs expenditures that make these two methods often comparable.
ii) Net Worth Method
Under this method, the total net worth of a person is calculated at the beginning and the end of a stipulated time period. To net worth is added nondeductible living expenses which increase the net worth. If there is a difference between what they have reported against the net worth calculated a Forensic accountant can begin an investigation to try and ascertain the reason for this discrepancy.
iii) Bank Deposit Method
Bank deposits are checked against total expenses during a given year. They calculate the net deposits utilizing a specific formula and the difference between accounts, transfers and redeposited cheques are subtracted from total deposits. To calculate Total receipts, the total cash expenditures are added to these net deposits and to reach what the total funds from ‘unknown sources’ figure the number of receipts are compared to the funds from known sources. If these figures end up having a significant discrepancy a Forensic Accountant may then delve into the origins of the unknown sources and can call anyone of relevance to the investigation to be interviewed. They will also trace and track information to help find out what the exact “unknown” amounts are.