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This article was first published in the March 2012 UK edition of Accounting and Business magazine.
When the going gets tough, the tough get going! Unfortunately, this is also true when it comes to corporate fraud. Read any fraud survey or report and you are likely to come across a disturbing common finding - that fraud is on the rise.
EY's Asia-Pacific Fraud Survey 2013 reported that: 'Across the Asia-Pacific area - comprising Australia, China, Indonesia, Malaysia, New Zealand, South Korea, Singapore and Vietnam - fraudulent practices are on the rise, and there is a disconnect between the policies that are in place and how they are applied in practice.
'Overall, one in five respondents considers bribery and corruption to be widespread in their home countries. In the rapid-growth markets where growth is relatively high but systems and procedures are typically less developed - such as China, Indonesia, Malaysia and Vietnam - the figure is close to one in two.'
The recently released KPMG Malaysia Fraud, Bribery and Corruption Survey 2013 found that 89 percentage of its survey respondents felt that the extent of fraud had increased over the past three years, while 94 percentage said they believed that frauds had become more sophisticated and 85 percentage agreed that frauds are increasingly becoming aligned to industry and more targeted to certain business processes.
With fraud on the rise, the need and demand for the specialist skills and services of forensic accounting professionals has also been growing in recent years. A 2011 Forensic and Valuation Services Trend Survey conducted by the American Institute of CPAs found that 79 percentage of respondents expected to see a greater demand for such services in the next two to five years.
Not surprisingly, all sizes of organisations and industries said that they expected to see more litigation and regulatory enforcement within the next two to five years, and 80 percentage of respondents saw this as a future trend. A resounding 83 percentage said they used internal resources to support their forensic practice while 24 percentage had taken on more internal forensic professionals in their practices.
The definition of forensic accounting
Forensic accounting is a science that deals with the application of accounting facts and theories gathered through auditing methods and procedures to resolve legal problems.
Forensic accounting professionals' analyses of corporate accounts have a primary objective of resolving a dispute and, given that 'forensic' means 'suitable for use in a court of law', it is to that standard and potential outcome that they generally work.
Forensic accounting is very different from conventional auditing: the specialisation integrates investigative, accounting and auditing skills. Forensic accounting professionals look at documents, and financial and other data in a critical manner in order to draw conclusions and calculate values or indicators to identify irregular patterns and/or suspicious transactions. They do not merely look at the numbers, but rather behind and in between them, and they try to assess what the patterns and trends suggest. This analysis is then used to gather qualified evidence.
The forensic accounting process
Forensic accounting and fraud investigation entails a methodological process of collecting and compiling financial data that can be used in the court of law or internally within an organisation.
An investigation is usually triggered by a suspicion or indications of irregularity (also known as 'red flags') such as unusual increases in purchases, major fluctuations in operating expenses, unexplained claims, increasing complaints from customers on quality of goods/services, and so on.
It is uncommon for forensic accounting to be carried out as a routine procedure or endeavour in an organisation, but having some form of forensic accounting/investigative approach (or anti-fraud programme) as part of an organisation's risk management programme is gaining a following.
The initial step that a forensic accountant takes is reconstructing a probable method, or trail, with supporting evidence of how the suspicious event took place. This is sometimes referred to as the 'dead body theory' approach.
At this juncture, it is imperative that forensic accountants consider the fraud triangle when devising theories of how (and even why) the potential fraudulent event/transaction transpired.
Once a number of possible theories are on the table, they have to be validated somehow. One way is to conduct interviews with potential suspects, witnesses and other informants. It is crucial that the forensic accounting professional is methodical in order to garner as much information as possible.
The primary purpose of most interviews is to gather evidence through facts and other information supplied by witnesses. Interviewers should obtain background information about the witnesses, the subject matter of the investigation, and the potential suspects.
Efforts should be made during the interviews to identify new records or evidence, and additional witnesses.
Interviews should strive to obtain answers to the basic questions: who, what, where, when, how and why. The key ground rules in performing an effective interview include:
- exercise courtesy and respect with interviewees
- if documents or exhibits are to be used, they must be carefully collated before the interview, preferably using copies of documents as opposed to originals
- when arranging an interview, choose a location to ensure privacy and to minimise interruptions, and note that it is recommended that only one person be interviewed at a time
- ensure your interviewee has access to an exit that is not blocked by the interviewers. This is a safety consideration, but may also subtly highlight the voluntary nature of statements given
- as preparation, interviewers should thoroughly review the appropriate data, documents and information relating to the subject matter of the interview
- all relevant parties, including the interviewee, should consent to any audio or video recording of the interview
- take notes during the interview, and dictate and clean them up within a day or two while it is fresh in your mind.
After building up the case (or validating the developed theories) through information obtained from the interviews, a forensic accounting professional will be able to narrow down the search/scope for the 'hard' evidence by performing analytical procedures such as financial, ratio, operating cashflow and trend analyses to look for irregular patterns and abnormalities, as well as transactions outside the ordinary course of business.
This approach enables the forensic accountant to zero in on specific transactions, timelines or areas (such as type of activity, department or persons) where the potential incriminating evidence can be found.
A common analytical tool that has been incorporated into many forensic software tools is Benford's Law. It looks at an entire account to determine if the numbers fall into the expected distribution. Most accounting-related data can be expected to conform to a Benford distribution because typical accounts comprise transactions that result from combining numbers.
For example, accounts receivable is the number of items sold multiplied by the price per item. Benford's Law will apply to almost any natural data set (e.g. payment amounts), but not to a limited-by-definition category (e.g. payment amounts between $50 and $100) or to predetermined data sets (e.g. customer or social security numbers).
Once the suspected transactions or evidence that substantiates the potential fraud have been isolated, the evidence has to be retrieved and evaluated to ensure that it qualifies for use in further action, be it disciplinary or prosecutable in nature. A high standard is usually applied for this, whereby it must be able to stand the scrutiny of law.
Therefore it is crucial that the evidence gathered satisfies:
- intent - to show motive for the act committed
- method - how and what was done in committing the fraudulent act
- persons - who committed the act (including any accomplices)
- quantified - the impact of the act to the organisation/victim.
The nature of evidence may include documents detailing or depicting the act (such as forgery), oral testimony (confessions from suspects, witnesses/experts), audio/video recordings, electronic data capture and so on.
There are many occasions where the incriminating evidence may be electronic or digital in nature, such as emails, electronically transmitted transactions or correspondences, or even files and information that have been deliberately deleted with a view to disguising a fraudulent act.
In such instances, it often becomes necessary to employ computer forensic tools, as the evidence is lying within computer hard drives, and on networks or other electronic equipment. Such investigations are often described as the autopsy of a computer hard disk drive because specialised software tools and techniques are required to analyse the various levels at which data is stored after the fact/transaction.
The objective of computer forensics is to provide digital evidence of a specific or general activity. It is important to note that when it comes to using computer forensic tools, it is not a good idea to use freeware as its integrity is questionable in a court of law and could even corrupt data.
Following the gathering of qualified evidence, it is crucial that it is properly preserved and safe custody is ensured, as illustrated in the diagram below.
A matter of law
Whether an act of fraud has been committed is ultimately determined by law. This is why forensic accounting (including evidence-gathering) must be conducted in a manner suitable for a court of law. Given the requirement for this 'high standard', the entire forensic process must be completed in a proper manner and not 'tainted', as this can lead the facts and evidence presented to become inadmissible. These standards include:
- it must be performed by qualified, competent, independent and experienced personnel or experts
- the entire process - from the red flags, interviews and analysis to qualified evidence - must be properly documented
- due care must be exercised during the investigation, such as obtaining the necessary consents and approvals, with no coercion, threats or force in obtaining information, testimonies or confessions; and obtaining warrants, subpoenas or court orders, where relevant, to proceed with a search, interview or interrogation
- compliance with relevant laws, especially those relating to privacy
- maintenance of a strong chain of custody over evidence gathered.
Forensic accounting professionals need to keep up to date with laws relating to evidence in their respective jurisdictions, such as the Evidence Act 1950 in Malaysia and the Evidence Act (Chapter 97) 1997 in Singapore, so as to be aware of what is expected when it comes to 'accepted' evidence in a court of law. This avoids the possibility of being 'disqualified' on a technicality.
There are clear indications that fraud is not fizzling out any time soon, and it is undeniable that the need for forensic accounting will be greater in the future.
Factors such as uncertainties in the marketplace, technological advancements in business, increasing concerns and regulations by regulators, enhanced scrutiny over experts, changes in legislation relating to evidence as well as emerging new tactics in committing fraud by 'new-age' fraudsters mean that the scope of the forensic accounting professional's role is broadening, and the challenges that they face will be greater.
Forensic accounting needs to evolve and be a step ahead of the game.
Ramesh Ruben Louis is a professional trainer and consultant in audit & assurance, risk management & corporate governance, corporate finance and public practice advisory