Business Financial Crime: Introduction to Forensic Accounting

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Business Financial Crime Introduction to
Forensic Accounting
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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

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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)

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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

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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

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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

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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.

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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.

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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

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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

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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.

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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

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FLOW CHART

• Summary of transactions
• Source and destination of funds
• Conversion of assets

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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

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TIME LINE

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

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Techniques in Financial Statement Fraud Cases

• Analytical procedures
• Horizontal analysis
• Vertical analysis

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Analytics Inc.
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Analytics Inc.

• GP Margin increase 87.5 - valid pricing or
  fictitious sales
• Other expenses increase 63.64 - check

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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

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Benford Analysis

• Another technique for analysis based on Benfords
  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.

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Benford Analysis

• Applies to such data as invoice numbers as well
  as monetary figures

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Symptoms of Fraud

• Record related symptoms unusual source
  documents or relationship among financial data
• Person related symptoms based on human behaviour

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Indicators of Fraud in Documents
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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

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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

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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

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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

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Sources of Evidence

• Public records eg
• Land registry
• Court records
• Business names
• Credit status
• Voter registrations
• Business licences
• Bankruptcy and divorce filings

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Sources of Evidence

• Restricted sources
• DVLA
• Local authority council tax records
• Vehicle dealers records
• Credit card records
• HM Customs and Revenue
• Banks records

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Link Analysis

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

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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.

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Surveillance

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

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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.

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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

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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

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Interview and Interrogation

• Assess fraud triangle perspective ie suspects
  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.

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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

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Interview and Interrogation

• May be an attempt to reduce severity of
  punishment
• A subjects 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

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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

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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

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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

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Interview and Interrogation

• Other qualifiers are thats 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 suspects method
  of speaking

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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
  suspects behaviour

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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

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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

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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.

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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)

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Body Language

• Subjects 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 subjects responses.
• For example significant pauses before answering
• Reaching for nearby objects, scratching,
  adjusting clothing or picking lint can also
  indicate deception

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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 subjects
  receptiveness

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Body Language

• Mirroring is a process by which the interviewer
  can attempt to establish rapport by mimicking the
  subjects 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

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Question Types

• Closed end forced choice open ended
  connecting positive reaction clarifying
  confrontational secondary
• Closed end yes or no answers
• Forced choice similar but give limited 2 or 3
  choices eg when you took the money was it
  because of something your employer did?

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Question Types

• Open-ended encourages the subject to respond with
  more detail
• Connecting questions connect detail and events
  eg you mentioned you were in the office on
  Monday. Was that the day you overheard the
  conversation?
• Positive reaction questions are used to elicit an
  agreement eg you saw the person who took the
  money didnt you

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Question Types

• Clarifying questions used to clear a particular
  point. you said you had difficulties what type
  of problems were they?
• Confrontational questions or statements are used
  to highlight contradictory evidence eg you said
  you were at work from 900 am. Is that correct?
  if confirmed the interviewer continues A witness
  saw you come in at 1030 am
• This confrontation is to study speech and
  behaviour changes

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Question Types

• Secondary questions obtain an expanded
  response. Typically repeat of subjects sentence
  to encourage elaboration
• Subject the accounts receivable were not
  correct
• Interviewer the accounts receivable were not
  correct
• Interviewer should avoid questions that allow the
  subject to respond with vague answers. One
  example would be a compound question bringing
  several issues into one question
• Leading questions designed to elicit a
  predetermined response should not be used
• Negatively phrased questions should also not be
  used as the responses may not be clear

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Interviewing Plan

• Interviewers should prepare a plan for the
  interview to use their knowledge of verbal/no
  verbal cues and types of questions
• First five minutes are most critical
• Must assess subjects willingness to co-operate,
  personality and mood.
• If willing then can use inductive approach by
  asking question about details and then
  generalising.
• If unwilling use a deductive approach working
  from general questions to put the subject at ease
  before moving on to detail.

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Persuasive Approaches