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Forensic Accounting and Digital Forensics

Explore the areas of specialty and methods of proof in forensic accounting. Learn about the process map and scoping of engagements for legal purposes, including fraud, money laundering, and financial reporting fraud. Discover the methods of direct and indirect proof with financial statement analysis and cash flow methods.

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Forensic Accounting and Digital Forensics

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  1. Forensic Accounting and Digital Forensics CA. Charanjot Singh Nanda Central Council Member, ICAI Chairman, Internal Audit Standards Board & Chairman, Committee for Members in IndustryThe Institute of Chartered Accountants of India

  2. FORENSIC ACCOUNTING • Use of accounting for legal purposes. • Use of intelligence-gathering techniques & accounting to develop information & opinion for use in civil litigation. • Identifying, recording, settling, extracting, sorting, reporting, and verifying past financial data or other accounting activities for settling prospective legal disputes or using such past financial data for projecting future financial data to settle legal disputes.

  3. AREAS OF SPECIALITY • Bribery and Corruption • Fraud and Misconduct • Breach of Company Procedures • Ponzi and other Investment Schemes • Conflict of Interest • Money Laundering • Embezzlement and Misappropriation • Financial Reporting Fraud • Procurement Fraud

  4. PROCESS MAP

  5. Assignment Development • Identify parties to the case, Co-relate matters of law, Confirm technical capabilities • Ensure matching of expectations • Prepare and secure engagement letter • Establish concrete timelines, e.g., discovery cut off, report submission, etc., • Establish communication protocol

  6. Scoping of Engagement • Continually define/ refine universe of data, primary and secondary • Initiate data collection processes • Prepare Document Request(s) as necessary • Establish protocol to manage data requested and obtained

  7. Interviews and Interrogations • Gain confidence of parties & obtain information from parties • Background investigation on identified parties • Use interpersonal communication techniques to analyse responses for further investigation • Prepare interview matrix • Check for • Hidden agenda of parties • Blind leads • Communication inhibitors

  8. Background Research • Combine first-hand knowledge (e.g., Interviews and Depositions) with second-hand knowledge (e.g., Background Research data) • See “Online Databases – Sources of Information” • See “Government Sources of Information” • Identify disparities for additional investigation

  9. Data Collection & Analysis • Missing information • Privacy laws • Unreliable informant / Inconclusive information • Entrapment • Engagement/personal risks

  10. Data Collection & Analysis • Perform any additional indirect or direct analytical forensic techniques as needed • Validate / correlate prior data obtained through alternate techniques • Genogram/Entity / Party Chart • Deposition Matrix/Interview Matrix • Search Log/Background Investigation • Lifestyles Analysis • Net Worth Method

  11. Analysis of Transactions • Summarize and analyze the findings of all deliverables and observations • Obtain sufficient relevant data to provide credible evidence • Identify any missing information or “gaps” • DRAFT the Forensic Accountant’s Report

  12. METHODS OF PROOF • DIRECT METHODS • SPECIFIC ITEM METHOD • FINANCIAL RELATIONSHIPS • FINANCIAL STATEMENT ANALYSIS • HORIZONTAL • VERTICAL • TREND • RATIO • CASH FLOW

  13. METHODS OF PROOF • INDIRECT METHODS • NET WORTH METHOD • (ASSET METHOD) • EXPENDITURES METHOD • (LIFESTYLES METHOD) • (SOURCES AND APPLICATION OF FUNDS METHOD) • BANK DEPOSIT METHOD

  14. METHODS OF PROOF • Information for specific industries • Learn distinct , detailed practices in a particular industry • Examination techniques • Common & unique industry issues • Business practices • Terminology • Example of market segments: • Construction or entertainment industry • Professions: lawyers or real estate agents

  15. METHODS OF PROOF Direct-Specific item method • Most common method • Relies on specific transactions • Uncovers specific financial transactions which relate to illegal activity, and to the suspect • Review books, records, bank accounts - directly traces a transaction • Direct (vs circumstantial) proof

  16. METHODS OF PROOF • Easiest to present @ trial • Most difficult for the suspect to refute • Example: Ghost employee on the payroll

  17. FINANCIAL RELATIONSHIPS • SALES VERSUS COST OF GOOD SOLD • SALES VERSUS ACCOUNTS RECEIVABLE • SALES VERSUS INVENTORY • ASSETS VERSUS LIABILITIES

  18. FINANCIAL STATEMENT FRAUD • FICTITIOUS REVENUES • TIMING DIFFERENCES • CONCEALED LIABILITIES AND EXPENSES • IMPROPER DISCLOSURES • IMPROPER ASSET VALUATION

  19. FINANCIAL STATEMENT ANALYSIS • PERCENTAGE ANALYSIS • HORTIZONAL • PERIOD TO PERIOD • INDUSTRY STANDARDS • COMPETITORS • VERTICAL • COMMON SIZE STATEMENTS • TREND ANALYSIS

  20. FINANCIAL STATEMENT ANALYSIS • RATIO ANALYSIS • LIQUIDITY • ASSET MANAGEMENT • DEBT MANAGEMENT • PROFITABILITY

  21. FINANCIAL STATEMENT ANALYSIS • CASH FLOW ANALYSIS • OPERATING • INVESTING • FINANCING

  22. INDIRECT METHODS OF PROOF • CIRCUMSTANTIAL PROOF • Inadequate books/records • Suspected: books do not reflect all income • Significant increase in net worth • Gross profit % changes significantly • Expenses exceed reported income without cause • Suspected income from unidentified sources is large

  23. INDIRECT METHODS OF PROOF SOURCES OF INFORMATION • Deeds of ownership, titles, liens, filings • The target • Informants/associates • Real estate records • Bankruptcy records • State motor vehicle records • Surveillance • Credit card applications/statements • Tax returns • Insurance records • Employment records • Cancelled checks • Deposit slips • Loan Applications

  24. INDIRECT METHODS OF PROOF • NET WORTH METHOD • Used to prove illicit income • Person’s assets or expenditures exceed known sources of income • 4 ways to dispose income: • Save it • Buy assets • Pay off debt • Spend it Used extensively in drug & money laundering cases

  25. INDIRECT METHODS OF PROOF • NET WORTH METHOD FORMULA Assets -Liabilities =Net worth -Prior year’s net worth =Increase in net worth +Living expenses =Income (or expenditures) -Funds from known sources =Funds from unknown sources

  26. INDIRECT METHODS OF PROOF • EXPENDITURE METHOD • CLUES • Lavish residence • Expensive cars/boats • Vacation home • Exotic vacations • WHEN TO USE...WHEN TARGET • Operates mostly on a cash basis • Little or no net worth but large expenditures • Little or no change in assets or liabilities

  27. INDIRECT METHODS OF PROOF • BANK DEPOSIT METHOD • WHEN TO USE • Assets & liabilities are fairly constant • No indications of extravagant lifestyle • Target’s known income is being deposited into financial institutions • HOW • Analyze bank deposits, cancelled checks, currency transactions

  28. INDIRECT METHODS OF PROOF • BANK DEPOSIT METHOD FORMULA Total deposits to all accounts -Transfer and redeposits =Net deposits to all accounts +Cash expenditures =Total receipts from all sources -Funds from known sources =Funds from unknown or illegal sources

  29. DIGITAL ANALYSIS TECHNIQUES • SOFTWARE PROGRAMS PERFORM • DATA MINING • Extracting information from databases • Comb DB for obscure patterns • Sort data to detect potential fraud • same address for two employees • DATA ANALYTICS • Statistical process used to analyze data • Identify red flags, transaction trends, patterns, anomalies

  30. DIGITAL ANALYSIS TECHNIQUES FUNCTIONS • Sorting • Record selection • Joining files • Multi-file processing • Correlation analysis • Date functions • Graphing • Verifying multiples of a number • Compliance verification • Duplicate searches • Vertical ratio analysis • Horizontal ratio analysis

  31. DIGITAL ANALYSIS TECHNIQUES FUNCTIONS • Data file inquiry • Random unit sampling • Calculate totals • Calculate averages • Specific criteria searches • Unusual item inquiries • Link analysis graphics • Identify gaps in sequence • Identify duplicates • Differentiate normal patterns from suspect patterns • Benford’s Law analysis • Stratification

  32. DIGITAL ANALYSIS TECHNIQUES EXAMPLES • Identify invoices w/o PO • Look for invoices from vendors not “approved” • Analyze claims paid by insurance providers • Look for high volume purchases from one vendor • Match names, addresses, phone numbers, numbers between employee and vendor files • Identify dormant accounts with activity • Search for large, rounded transaction values

  33. DIGITAL ANALYSIS TECHNIQUES COMMERCIAL SOFTWARE • Excel • ACL • IDEA • Active Data for Excel • Auto Audit • SNAP! Reporter • Data Watch’s Monarch for Windows • Oversight Systems

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