Forensic Accounting - Jan 2021

"When you have eliminated the Impossible, Whatever remains however improbable must be the truth."

Hola Readers!!!

Fascinated by Sherlock? Ever thought of a detective job in the Accounting Industry too? Well, if yes, we are here to tell you more about it!! Happy reading! FORENSIC ACCOUNTING

One winter evening, two friends were catching up over a cup of Joe. One of them, a forensic accountant said:

“Accounting is possibly the most boring subject and very confusing too, but if you want to be rich, it could be the most important subject.” The other one agreed and said that he had been quite fascinated by forensic accounting and its evolution for some time now and wanted to know more about it. Suddenly, the news broke out citing accounting embezzlement of Rs. 7,926 crores from multiple banks by a firm named Transstroy Ltd. Overhearing the news, the Forensic accountant chuckled, “It’s time for me to have some fun now!” The other one retorted “Then who do you suppose will explain to me what all this is about?". The accountant replied, “Come with me, it’s time to do some practical work. And don’t worry, I’ll explain to you what all this is about on the way there.” Then he went on to explain what Forensic accounting was all about.

What is Forensic Accounting?

Forensic Accounting is a combination of accounting and investigative techniques that plays an imperative role in performing timely detection, prevention, and regulation of corporate fraud. It involves detailed research and analysis of financial information to detect fraud and embezzlement cases so as to help explain the nature of financial crimes in the courts. The role of a forensic accountant is to assist the courts, clients, and solicitors understand complex financial and accounting issues. Forensic Accounting has evolved and grown by leaps and bounds in recent history. Although the profession has been around since the early 1900s, the term “Forensic Accounting” gained prominence only after the capture of the infamous Al Capone in 1931. He attracted the attention of authorities by repeatedly failing to satisfactorily declare all of his “earnings” for tax purposes. It was later discovered that his “income” came from embezzlement, gambling, and other illegal activities thus making it difficult for authorities to tax his income. This was the inception of forensic accounting which over the years has evolved significantly with the various advancements in technology. However, with great power, comes great responsibility and the opportunity to abuse it. Technology has given people plenty of opportunities to exploit it. Financial misinterpretation can be brought about by something as simple as creating fake invoices or changing a transaction entry in the general ledger. This has once again increased the demand for forensic accounting. Forensic Accounting can be broadly classified into 3 categories – Criminal Investigation, Litigation & Insurance Claim Review. It is used in criminal investigations to uncover crimes like employee theft, securities fraud, or identity theft and to assess the likelihood of criminal intent. In litigation services, this is implemented to assess and quantify the damages being claimed. Forensic accounting is also extensively used in Insurance Claims to assist in tangled cases where multi-facets of accounting overlay multiple areas of insurance coverage. With all the detailed explanations, it is quite easy to confuse forensic accounting with auditing. They are, however, quite disparate. While Forensic accounting focuses on the restructuring of past transactions and analyzing a specific set of transactions or searching for misappropriated assets, auditing focuses on compliance and performance of the organization to ensure that financial statements are reasonable. Auditors use materiality threshold i.e., a benchmark used to obtain reasonable assurance, and hence many a time they fail to detect frauds and this is where Forensic Accountants come in. According to the Association of Certified Fraud Examiners 2020 “Report to the Nations”, external audit accounts for just 4% of fraud detection while 43% are through tips.

Fig 1: Detection of Occupational Fraud

(Source: ACFE, 2020 Report)


Investigation of financial crimes has grown since the conviction of Al Capone in 1931, with the industry growing at a CAGR of 7.8% from $10.9 billion in 2012 to $16.3 billion in 2018. According to the IBIS World report, the number of businesses providing forensic accounting services in the US has grown by 1% in the last 5 years with employment generation of approximately 3%. Practitioners believe that the demand for the services of forensic accountants is growing because of tightening economic conditions and the increasing scrutiny of how companies are governed. Approximately 5% of the revenues earned are lost in fraud and 10% of the frauds are related to financial statements with a median loss of nearly $1 million. 95% of the cases which are discovered by forensic accountants involve a perpetrator trying to conceal their actions. Some glimpses of the frauds and industry trends are:

Fig 2: Change in the level of Fraud

(Source: ACFE, 2020 Report)

Fig 3: Financial Statement Fraud

(Source: ACFE, 2020 Report)


1. Enron Accounting Scandal, 2001 This scandal of $70 billion is not only the biggest accounting scandal but also probably the most complex one. Enron, an energy company, wanted to gain quick success and after the appointment of Jeffery Skilling as COO entered into deals that were quite risky in nature. This led to the firm incurring huge losses. To protect their image, they cooked their books by manipulating their accounts. At first, they changed the accounting method from historical cost to mark to market in 1992 in order to inflate the value of their assets. Moreover, they even showed their deferred revenue as current profit leading to a rather inflated Profit & Loss statement while in reality, the company was actually facing huge losses. They used “Special Purpose Vehicles” to get capital (loans from the bank) and the assets transferred were shown as sales. After the dot com bubble burst, the company’s stock plummeted from $90 to $1 prompting the SEC’s forensic accountants to review their financial statements. It was only when the accountants looked beyond the inflated figures, that they understood the true nature of the crime that Enron had perpetrated (not like auditors going through all financial statements). Enron was finally charged with hiding debt partnerships, inflating stock prices and debt rating, and misrepresentation of accounts. 2. Satyam Scam, 2009 This Rs. 14000 crore scam not only shook the entire nation but also put increased pressure on forensic auditors to tackle bookkeeping frauds. In the words of Mayur Joshi, a leading Indian forensic accountant, “Forensic auditing work has seen a growth of at least 100% in the post-Satyam era”. Mr. Raju, The owner of Satyam Computers, was fascinated by the boom of the real estate market and invested in the sector by opening 365 smaller companies in the names of his friends and relatives and also financed loans on their behalf. He also inflated the financials and created approximately 7500 fake sales invoices and backed them with bank statements to showcase excess reserves. After the 2008 financial crisis, Satyam Computers lost a lot of money due to a fall in real estate prices. To cover up the fake profit, Satyam decided to purchase Maytas (which was owned by relatives of Raju) which was a totally loss-making firm. Investors were unhappy with this decision and share prices started to fall. When SEBI started investigating the various business decisions of Satyam Computers, they caught a lot of unaccounted transactions while many had discrepancies. Raju later confessed to SEBI about the inflated prices, but the question arose as to why PWC being the auditor of the company was not aware of the same. PWC being the auditor was only able to give an assurance based on a benchmark, and it was only when forensic accountants undertook a detailed analysis of Satyam’s financials that the fraud was revealed. Let us give you a recent example. 3. Wirecard (payment processing company), 2020 In 2018, E&Y (auditor of Wirecard) stated that they were not able to find $2 billion worth of money from the company’s financials, and with no cash flows in hand, the company went bankrupt. The share price fell from $180 to $6. So, let us know what went wrong? The company continuously inflated the values to get licensing from different countries. They also engaged in “Round Tripping” wherein they would transfer some amount to their subsidiaries to showcase it as revenue. This would however make a roundtrip and eventually come back to the company. From 2018 to 2020, the Financial Times consistently targeted Wirecard in their articles to grab the attention of financial authorities in Germany. Finally, in April 2020, when the company went for an independent forensic investigation conducted by KPMG, the consultants stated that the company did not provide them with adequate documents and that they even found some discrepancies in the transactions. But Wirecard fraudulently published the KPMG report stating that KPMG could not prove anything. Then in June 2020, when E&Y announced that they found the $2 billion missing from books, the company stated that those were the reserves they had kept in a Philippines Bank. Based on further suspicion, German authorities hired forensic accountants and found that the money stated in accounts as reserves in various banks were never there and the company had actually committed accounting fraud. This begs the question, why E&Y being the auditor of the company was unable to detect the accounting misrepresentation?


Considering a career in Forensic accounting? Well, as per a report by Deloitte, there is a huge scope and with the industry, into the boom phase, the demand is also high. Even the Big 4 now have a separate department of forensic accountants. Various graduates are pursuing this course and with technology and data analytics coming into the picture, the career prospects are immense. This would require skill sets from pure critical analysis to working knowledge of technical aspects such as data set management, normalization techniques, visualization, and delivery of analysis that goes beyond the plain numbers. The forensic accounting industry is spending more time analyzing information that can lead to more money being saved in future years.

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