Business Financial Crime: Introduction to Forensic Accounting

1. Business Financial Crime: Introduction to Forensic Accounting

2. Definition • The word forensic means used in or pertaining to law • Accounting is the recording, classifying and summarising economic events in a logical manner for the purpose of providing financial information for decision making

3. Definition • Forensic accounting is the application of investigative and analytical skills for the purpose of resolving financial issues in a manner that meets standards required by courts of law. Hopwood, Leiner and Young (2007) • Forensic accounting is the application of accounting principles, theories and disciplines to facts or hypotheses at issue in a legal dispute… Technical Working Group for Education in Fraud and Forensic Accounting USA (2007)

4. Broad Base Forensic accounting is broader than fraud examination. It also includes services that could involve investigation related to the purchase of businesses, valuation of divorce assets, determination of damages and calculation of lost profits

5. Forensic Accountant Role A mix of accountant and private investigator With a strong financial intuition and an ability to think laterally Strong knowledge of professional accounting standards

6. Knowledge and skills Auditing skills – information collection and verification nature of role. Produce evidence. Investigative knowledge and skills, such as surveillance tactics and interviewing and interrogation skills. Criminology particularly the study of the psychology of criminals ie. Motives and rationalisation

7. Knowledge and skills Accounting knowledge helps the forensic accountant analyse and interpret the financial information necessary to build a case. Knowledge of internal controls related to corporate governance. Legal knowledge and understanding of court procedures to be able to identify type and quality of evidence necessary to meet legal standards A good appreciation of IT skills. Communication skills to convey the results.

8. Audit vs. Forensic engagement Audit: Event transpires PRIOR to issue of FS No assumption that fraud has taken place. Purpose is to assist the reader in reaching a financial decision. Forensic: Event transpires FOLLOWING issue Assumption that fraud has taken place Purpose is to assist the reader in reaching a legal decision.

9. Auditing Procedures Confirmation – external source Observation – examine activities Physical examination – examine assets Re-performance – perform a task to test how well completed Analytical procedures Inquiry of client – reasonableness of answers Documentation – examine source documents

10. Forensic Engagement - Investigation Plan An investigation plan should be drawn up. This is to ensure you have a structure to your investigation. The plan could include the following: • what are the facts to date; • what is the best strategy to investigate this matter; • what is the contravention/internal concern; • who are the targets; • who are the witnesses; • what documents should be obtained; • who should be interviewed; • who will be of assistance; • who will not be of assistance; • where to keep documents/control procedures; • relevant bank accounts;

11. Forensic Engagement - Investigation Plan • paper trail; • phone records; • computer records; • need for outside expertise – forensic accountant/computer analysis; • can documents be destroyed; • how to secure documents; • need for surveillance; • need to tape interviews; and • what questions need to be asked.

12. Understanding the environment: Identify the personnel and their roles; Develop a general understanding of the business and a specific understanding of the accounting cycle; Access industry expertise: competitors or regulatory agencies

13. FLOW CHART Summary of transactions Source and destination of funds Conversion of assets

14. NET WORTH Basic Balance Sheet composition: Assets, Liabilities against known income Acquisition of assets requires explanation through liabilities or legitimate income source; Unexplained income is assumed to be proceeds of crime

15. TIME LINE Organizes data in chronological fashion for better understanding of how events unfolded Provides corroboration between financial and non-financial evidence.

16. Techniques in Financial Statement Fraud Cases • Analytical procedures • Horizontal analysis • Vertical analysis

17. Analytics Inc.

18. Analytics Inc. GP Margin increase 87.5% - valid pricing or fictitious sales Other expenses increase 63.64% - check

19. Skimming The act of taking cash receipts before being deposited or reflected in the financial records. Difficult to detect by horizontal analysis if has been a long term practise Could be revealed by vertical analysis if compare margins across the industry

20. Benford Analysis Another technique for analysis based on Benford’s law Based on the statistical probability that the sequence of numbers 1,2,3,4,5,6,7,8,9 will appear as the first digit in a number. The number 1 is more likely than the number 2 and so on. Benford analysis can be used to test a sample of invoices for risk of fraud.

21. Benford Analysis Applies to such data as invoice numbers as well as monetary figures 21

22. Symptoms of Fraud Record related symptoms – unusual source documents or relationship among financial data Person related symptoms – based on human behaviour

23. Indicators of Fraud in Documents

24. Document investigation: Consider the following: The “source” of the document (who created it); The “context” of the document (what is the purpose of the document); The “reliability” of the document (can the information be corroborated elsewhere). Secure records

25. Symptoms of Fraud Record related: Unusual relationships among financial data include unreasonable amounts of revenue or expenses Unexpected levels of inventory on the balance sheet Large purchases that seem unreasonable given normal levels and frequent late charges

26. Symptoms of Fraud Person related Changes in behaviour can signal underlying problems – weight loss, dependency of drugs or alcohol, fidgeting, aggressiveness to the point of arguing, inability to look others in the eyes. Key whether this behaviour differs from actions in the past

27. Symptoms of Fraud Person related Levels of spending that exceed apparent level of income These symptoms could indicate that fraud could have occurred Forensic accountant will ascertain the reasons for the behaviour to determine outcome

28. Sources of Evidence • Public records eg • Land registry • Court records • Business names • Credit status • Voter registrations • Business licences • Bankruptcy and divorce filings

29. Sources of Evidence • Restricted sources • DVLA • Local authority council tax records • Vehicle dealers records • Credit card records • HM Customs and Revenue • Banks records

30. Link Analysis Process that allows information in a variety of databases to be evaluated and integrated to test for associations Produces an association matrix

31. Invigilation Used for testing existence of skimming or theft. The presence and purpose of the forensic accounting is announced to employees. After some time an announcement is made that the investigation has ended Forensic accountant then compares the data from the three periods – pre, during and post adjusting for any seasonal impact. Assessment of theft can then be made.

32. Surveillance • Covert activity • Stationary • Active – following • Electronic • Rubbish can be scrutinised if not within curtilage of property.

33. Statement types and analysis: Free form: Allows the witness to recount events without interruption. Suspect/witness will often “avoid” detail surrounding sensitive topics. Q & A: Question and Answer format which allows investigator to direct course of the interview. Greater detail will be obtained but interviewer may miss what is motivating the suspect/witness to talk.

34. Interview and Interrogation Interview is usually non-confrontational information seeking technique of a person who is not believed to have committed a crime Interrogation is an information seeking technique involving people in custody. More likely to be confrontational

35. Interview and Interrogation • Interviewing skills are of paramount importance to the forensic accountant. • Prepare and build profiles of individuals • Position in firm • Job functions • Length of service • Salary and benefits • Any promotions expected not received • Relationships with co-workers • Age and marital status • Interest and hobbies • Credit status including recent purchases of cars etc

36. Interview and Interrogation Assess fraud triangle perspective ie suspect’s pressures, opportunities and rationalisation. Formulate a strategy for the interview Maintain active scepticism During initial interview subject should be asked – if he knows the purpose of the interview – who he believes committed the fraud and why . Interviewer should endeavour to establish a rapport with the subject.

37. Interview and Interrogation • Subject responses • People who are not trying to hide anything usually provide direct answers to questions without hesitation • They do not seem distracted and may even appear interested in helping • Exceptions to this do occur – eg if the subject knows that the fraud is being carried out by their supervisor – may even give deceptive answers • Might attempt to treat the crime as unimportant

38. Interview and Interrogation • May be an attempt to reduce severity of punishment • A subject’s verbal attack on the interviewer may be caused by fear • ie fight or flight response – when cornered • Interviewer should respond calmly re-establishing rapport • If not possible could terminate interview until another time • Interviewer should not become angry as this transfers control to the subject

39. Interview and Interrogation Verbal cues – conscious and sub-conscious Use of words such as you, your and they rather than I and my to describe their own behaviour can be a attempt to shift responsibility to others

40. Interview and Interrogation • Also by this approach the subject could be trying to engender sympathy • Suspects can attempt to deceive by responding to questions with their own questions • eg “did you take the money?” • “why would I do something as foolish as that?” • This attitude implies they did not take the money • But did not answer the question • May follow up with “I am a well respected member of the management team” to provide a reason to drop the question

41. Interview and Interrogation Qualifiers • Words that modify the meaning of a sentence • Eg if a suspect has not followed the internal control procedures • “we prepare a listing of the checks almost all the time” • Note the word almost which qualifies the response and avoids making an untrue statement • Care needed as if innocent may use the qualifier to be more precise • Other times the suspect may use phrases like “to the best of my knowledge” which allows them to later improve their memory

42. Interview and Interrogation Other qualifiers are that’s about it, sometimes, often, maybe, possibly, typically and normally They all represent ways of hedging enabling the suspect to avoid making definite statements that could be shown to be untrue. At time s the suspect may use qualifiers to enhance their credibility the truth is, to be perfectly honest, as God is my witness – may be truthful in the midst of falsehoods Sounds such as “ah” or “um” can provide extra time to think of plausible responses – signpost here is change or lack of it in suspect’s method of speaking

43. Interview and Interrogation • Another indication of deception is a response that is overly specific. • Response may be after the suspect has had time to consider their story • Non verbal clues • Can include failure to deny an allegation as well as failure to answer questions. • Two major areas here eye movements and body language • Major point here is looking for changes in suspect’s behaviour

44. Eye Movements • Can be clues to truthfulness • If a suspect has made direct eye contact up until the point the interviewer brought the crime up. The lack of eye contact may be an important indicator of guilt • When asked a question that requires a memory response a subject who is primarily sight oriented will usually look up and to the left, straight ahead or both when truthful

45. Eye Movements • A subject must visually construct an image that has not occurred to avid the truth • Eg “at the time of the theft where were you” • A sight dominated person will look up and then to the right • Prior to this interviewer should ask questions which she knows the answer of to test typical behaviour

46. Eye Movements A subject who is auditory dominated ,exhibits truthful memory recall by either looking down and to the left or horizontally and to the left. Change of behaviour, say looking horizontally to the right can indicate an untruth.

47. Eye Movements A subject who is dominated by feeling or touch will normally either look downward and to the right, look downward, blink rapidly or close the eyes when being truthful (or a combination)

48. Body Language • Subject’s body language can communicate non verbal signals • Shifting or making almost any discernable change, particularly when the topic is crime, can signal subtle yet revealing clues to the truthfulness of the subject’s responses. • For example significant pauses before answering • Reaching for nearby objects, scratching, adjusting clothing or picking lint can also indicate deception

49. Body Language • Swallowing, biting lips and perspiring can also indicate untruthful responses • A person who usually experiences the world through feelings exhibits certain characteristics when she is receptive to questions • For example deep breathing accompanied by relaxation of the major muscle groups (arms legs, abdomen and chest) • A change in behaviour whether from or to a more relaxed position indicates the subject’s receptiveness

50. Body Language Mirroring is a process by which the interviewer can attempt to establish rapport by mimicking the subject’s body language – appear similar and identify with subject If subject crosses left leg over right – interviewer crosses right over left In short friends confide in friends Mimicking is used to produce the emotional feeling of closeness