How Forensic Accounting Works

The types of crimes forensic accountants investigate are "crimes against property." They investigate crimes such as financial fraud and serve as expert witnesses in court trials. They also perform work related to civil disputes. Forensic accountants are also known as fraud investigators, investigative accountants, forensic auditors or fraud auditors.

­Although forensic accounting may not sound as glamorous as its other investigative counterparts, forensic accountants are instrumental to high-profile, financial white-collar crimes involving large corporations, such as the Enron an­d Adelphia Communications scandals of 2001 and 2002.

The federal government employs impartial forensic accountants to uncover the extent of the fraud and other accounting irregularities practiced by executives and the associated accounting firms.

Forensic accountants are more than just number crunchers who happen to work on criminal or civil disputes. They must conduct investigations, know how to use various computer programs and communicate well.

Some forensic accountants specialize in specific industries susceptible to fraud, such as insurance or banking, and learn the business practices associated with those fields.

Because the reputations of individuals and companies are at stake, forensic accountants must be very discreet when conducting their investigations. They must be independent and impartial, considering both the financial records and the conduct of employees.

Unlike other accountants, forensic accountants actively look for signs of fraud when they conduct audits. In addition to examining financial statements to determine whether they are accurate and complete, they may seek internal databases and court records. Because people committing fraud have hidden the evidence of their crimes, forensic accountants must look beyond the numbers and anticipate criminal actions.

Whether their assignments are criminal or civil, these accountants follow the same forensic accounting basics when conducting their investigations.

Financial Investigations

First, they meet with a government representative, attorney or other client to learn the specifics of the alleged fraud. Then, they begin their initial research and plan the logistics of the investigation. The next step is to search the records — bank statements, credit statements, journals, ledgers, databases, e-mails and memos — anything that will offer a bigger picture of the financial situation.

After gathering the records, forensic accountants often interview the accused and other involved parties to get individual stories about the irregularities.

Forensic accountants must possess observational skills to identify subtle hints or suspicious clues that may eventually lead them to the perpetrator. Clues may include new cars, numerous vacations and starting additional businesses without other visible sources of capital.

How far will forensic accountants go to obtain information? It all depends on the nature of the case. In criminal cases, they usually work with law enforcement and the district attorney's office. Just as with other types of evidence, the prosecution must obtain search warrants and subpoenas to locate financial information and compel knowledgeable people to give interviews about the situation in question.

If the case is civil, they're empowered by the client, who is usually a part of the company being investigated or holds agreements that permit accounting investigations.

After gathering all of the information, a forensic accountant begins the analysis. They may trace the assets of the company, calculate the total loss and exactly how it occurred, and summarize various transactions.

The final step (unless the accountant is also testifying in court) is to prepare a report detailing the plan of action and what the investigation uncovered. This may include graphs, charts, spreadsheets and other methods of explaining the case.

Litigation Support

In addition to investigating, forensic accountants may provide litigation support. Attorneys engage the services of forensic accountants to review existing documentation and testimony and explain their financial significance.

A forensic accountant can tell the attorney what additional information may be needed to prove the case and what questions to ask of witnesses. The forensic accountant may also review damage reports and state whether the report was put together accurately and supports the case.

Although the basic strategy is the same, the types of assignments that require the services of a forensic accountant vary.

An independent consultant may assist the owner of a small company who suspects their bookkeeper of embezzling funds; or an accountant working for a government agency may attempt to prove that a corporation has been laundering profits. Financial institutions and insurance companies may hire forensic accountants to perform fraud investigations.

It can be difficult to find case studies of forensic accounting at work because most companies don't publicize details of financial misconduct. Still, there are some notable examples of forensic accounting in action.

The Orinda-Moraga Disposal Services Case

In 1996, a city manager in California's Contra Costa County became suspicious when a local disposal service company asked for help keeping itself afloat. Orinda-Moraga Disposal Services wanted to raise rates on its customers and needed the Contra Costa Sanitation District's approval. However, the company had recently stated its desire to lower rates. The wary city manager hired forensic accountant Dan Ray to uncover the truth.

After examining Orinda-Moraga's records, Ray discovered that the company sent checks to nonexistent people at several companies with fake addresses. The disposal company's owner deposited the checks into an account. He had created these companies to siphon money from Orinda-Moraga illegally and inflated its business costs to justify the rate increase.

Ultimately, Orinda-Moraga's owner and his partner were found guilty in civil and criminal suits.

The Sunbeam Case

In 1997, Sunbeam, a company that manufactures small appliances, followed a practice called bill and hold. Bill and hold is when a company records sales of its products as profits for the current quarter while waiting to deliver the product (typically, they would only be recorded as sales once they were actually shipped).

Sunbeam sold huge amounts of its products to other companies at a discount but kept the items in warehouses. On paper, the company appeared to have had high sales; however, Sunbeam's warehouses were full of unsold product. This practice was uncovered by a financial analyst at investment firm Paine Webber, who downgraded the value of Sunbeam's stock.

Bill and hold isn't illegal, but Sunbeam's shareholders felt deceived and filed lawsuits. Sunbeam's accounting firm, Arthur Andersen (later ruined by its involvement with Enron), performed an audit and reported that Sunbeam's books were accurate and in accordance with federal guidelines.

However, the board was unsatisfied and hired Deloitte & Touche to review Arthur Andersen's audit. This follow-up uncovered proof that the numbers had been manipulated.

The Securities and Exchange Commission investigated Sunbeam, and its CEO, Albert Dunlap, was fired and forced to pay millions of dollars to settle investment lawsuits. He paid $500,000 in fines and was banned from serving as an officer in a public company.

Forensic accounting can be a very lucrative and enjoyable career path with a wide variety of potential employers from law enforcement agencies to financial institutions. Like all accountants, forensic accountants must have a thorough knowledge of Generally Accepted Accounting Principles (GAAP), business practices and applicable laws.

In the United States, most forensic accountants have at least a bachelor's degree in accounting and a few years of experience in that field.

The next step in becoming a forensic accountant is passing the Uniform Certified Public Accountant Examination to become a Certified Public Accountant (CPA). This exam was created by the American Institute of Certified Public Accountants and is a condition of employment by many firms, in addition to meeting other state and federal eligibility requirements.

Continuing education is a requirement for maintaining the CPA certification, and many aspiring forensic accountants attend graduate school to fulfill this requirement, as well as gain more knowledge in the field and become more marketable. Many universities offer master's degree programs in forensic accounting or business administration with a concentration in forensic accounting.

Some forensic accountants take courses in:

Several organizations provide training and additional certification for forensic accountants. The American College of Forensic Examiners International (ACFEI) began offering the Certified Forensic Accountant (Cr.FA) designation in 2001.

There is also the Association of Certified Fraud Examiners (ACFE), which offers the designation of Certified Fraud Examiner (CFE), and the Association of Certified Fraud Specialists (ACFS), which has the title of Certified Fraud Specialist (CFS).

These professional organizations require that their members possess varying degrees of education and experience and must sit for additional exams. These certifications show that a forensic accountant has specialized knowledge, training and professional experience beyond that of a standard accountant.

The term "forensic accounting" was first used in 1946 by Maurice E. Peloubet, a partner in a New York accounting firm. He wrote about the use of accounting in courtroom proceedings as part of testimony, but acknowledged that investigation was becoming more prevalent for accountants due to the increase in government agencies that regulated financial practices.

Journals began to publish articles about the connections between law and accounting. In 1953, a New York lawyer named Max Lourie claimed that he invented the phrase "forensic accounting," although Peloubet wrote about it first. Lourie stressed the need for forensic accounting literature and training.