CHAPTER 2

Forensic Accounting Services and Skills

Executive Summary

Forensic accounting has advanced as an important and rewarding field of accounting to prevent, detect, and correct financial scandals and other types of fraud. In such an increasingly unstable economic and litigious environment, there has been significant growth in the demand for and interest in forensic accounting and investigative services. Forensic accountants provide litigation consulting, expert witnessing, valuation, and fraud investigation services. This chapter presents forensic accounting fraud and nonfraud services and skill sets required by forensic accountants to effectively conduct their services.

Introduction

The existence and persistence of high-profile alleged FSF (e.g., Enron, WorldCom, Parmalat, Satyam), as well as the investment Ponzi schemes and credit crunch scandals have negatively affected the safety and soundness of financial markets and investors’ confidence in public financial information. Forensic accountants perform a variety of fraud and nonfraud services, including expert witnessing, valuation, and litigation consulting. To effectively conduct their services, forensic accountants should have knowledge, education, and expertise in accounting, marketing, finance, management, psychology, criminology, and technology. This chapter presents fraud and nonfraud professional services commonly performed by forensic accountants as well as technical, analytical, and soft skill sets required for forensic accountants to effectively conduct their services.

Forensic Accounting Opportunities and Services

Forensic accounting is a field of accounting practice pertaining to fraud and nonfraud services. Forensic accounting is a practice of using accounting, marketing, finance, management, psychology, and criminology along with technology and science in performing fraud and nonfraud forensic accounting services. Exhibit 2.1 presents three general areas of forensic accounting—litigation consulting, expert witnessing, and fraud investigation.¹ Other specific areas of forensic accounting practices are typically classified into general categories of fraud and nonfraud forensic accounting practices and described in detail in this section.

Litigation and Expert Consulting

Litigation consultants assist lawyers in pretrial activities, disposition, and discovery. Forensic accountants apply their knowledge, skills, and experience in accounting, business and finance, and criminology to educate lawyers in the interpretation and understanding of financial and nonfinancial information. Litigation consulting services are in demand to determine liability and assess damages in business valuations, insurance claims, malpractice, divorce settlements, and embezzlements and thefts in the workplace. Litigation consultants assist attorneys in pretrial and trial activities, disposition and discovery, and legal deliberations. This type of forensic accountant applies skills, accounting, legal, auditing, and financial knowledge, experience, and training to educate lawyers in the interpretation and understanding of financial information and in auditing matters.

Litigation consultants are often hired by attorneys to assist them in evaluating cases and developing trial strategies. Litigation consultants achieve their success by conducting mock trials or focus groups. While performing this exercise, mock jurors are presented with evidence that will be seen during the actual trial. The mock jurors are then surveyed to see what items are the most impactful and what verdicts they are leaning toward. This results in knowing how jurors may react to the case and allows attorneys to know the best way to communicate their case in court.² Litigation consulting services are important and in demand to determine liability and assess damages in business valuations, malpractice, divorce settlements insurance claims, and embezzlements and thefts in the workplace. The AICPA released definitions and standards for consulting services in 2003. The nine-page document has five sections pertaining to relevant practices in consulting. The standards follow a code of ethics format and the scope of practitioners is clearly outlined in the definition section.³ The guidance is summarized is Exhibit 2.2.

Expert Testimony and Witnesses

Forensic accountants also serve as expert witnesses to educate jurors about the technical aspects of accounting and financial reporting. Although litigation consulting and expert witnessing services are similar in the sense of applying accounting education and practice to assist the characters of the court (lawyers, jurors, judges) to better understand, use, and interpret financial and nonfinancial information, the overriding difference is the way the forensic assignment is conducted. Forensic accountants serving as expert witnesses must keep professional skepticism and remain objective and neutral to establish credibility with the opposing cross-examiner. The primary objective of the cross-examiner throughout the court deliberation process is to deter credibility by proving that the forensic accountant has given contradictory statements. Litigation consultants, on the contrary, often work under the supervision of a lawyer and as such have special privileges in which specific details and evidence presented do not necessarily have to be revealed.

Several Supreme Court cases have set precedents regarding expert witnessing. Two of note are Daubert vs. Merrell Dow Pharmaceuticals, Inc. and The Kumho Tire Co. vs. Carmichael decision. Daubert vs. Merrell states that courts must determine whether the logic and methods presented by an expert are valid scientifically and if they can be applied to the case in question. The Kumho Tire Co. vs. Carmichael case extended Daubert vs. Merrell to all expert testimony. Testifying CPAs must detail their certification, qualifications, reasoning, and methods. Experts must also qualify their methodology’s reliability.⁴ Exhibit 2.3 presents two court cases relevant to expert witnessing forensic accounting services.

Fraud Investigation

Forensic accountants normally serve as fraud investigators to examine allegations of fraud. Fraud investigators examine financial and nonfinancial data and other evidence to discover and report fraudulent activities. Both financial statement auditing and fraud investigation are the process of gathering competent and sufficient evidence to substantiate the quality, reliability, completeness, transparency, and accuracy of financial reports. Financial auditors provide reasonable assurance that financial statements are free from material misstatements whether caused by errors of fraud, whereas fraud investigators examine allegations of fraud by searching for at least one event or transaction that could signal the possibility of fraud. Furthermore, financial auditors focus primarily on audit of financial statements and are more concerned with management fraud in manipulating financial statements, while fraud examiners can be hired to examine both fraud and nonfraud issues. Forensic accountants typically deal with the following: fraud prevention and detection (antifraud policies, procedures, and practices), family law (net worth valuation, divorce), fraudulent financial reporting (FSF) and white-collar crimes (larceny, defalcation, illegal acts, bribery, money laundering, corruption), economic damages (civil litigations), risk assessment (bankruptcy risk), asset valuations (bankruptcy, mergers, and acquisitions), and misappropriation of assets (thefts, embezzlements). In performing these services, forensic accountants should have technical skills including the ability to understand accounting, finance, and law and to think critically, analytical skills of using quantitative methods and conducting research and investigations, and soft skills of communicating effectively and conducting interviews.

Business Valuation

Business valuation is the assessing of the fair value of a business or company. To accomplish this task, valuation services are provided by people in the industry known as appraisers. The business valuation market has grown and will continue to grow because of mergers, acquisitions, employees stock ownership, stock options, preferred stock, debt, and start-up ventures, economic obsolescence and litigation, and better financing opportunities for businesses and individuals alike.⁵ Forensic accountants serving as appraisers should have the appraisal and industry aptitude to form credible valuation opinions.⁶ Forensic accountants are employed to perform business valuation when sales, mergers, partner ownership, or divorce rulings occur.

Forensic accountants in performing valuation services often use strategic valuation methods that consider asymmetric risks, management flexibility, real options, realistic estimations and related assumptions, and other factors relevant to the valuation services. Forensic accountants as valuation experts use a sophisticated, planned, properly executed, and well-documented methodology that investigates all relevant factors. Business valuation strategies and procedures go beyond just financial and market analyses that often focus on financial statement and cash flow analyses and take into consideration economic value-added, management, the market and economic conditions, and multiple regression analyses. The types of valuation services provided by forensic accountants are, but not limited to, the following:

• Value of a private company that is going public through the Initial Public Offering process
• Value of an investment opportunity to assess real options or asymmetric risks
• Value of an operating business and assessment of expansion or discontinuing products and services
• Value of a division or line of productions
• Value of assets and liabilities in the case of divorce disputes
• Value option decisions for buy or rent properties
• Value of investments in information technologies such as block chain risks
• Value investment portfolio
• Value of a franchise and franchisee
• Value of start-up and emerging growth companies

Other Nonfraud Forensic Accounting Services

Forensic accountants offer nonfraud services in addition to fraud investigations. Examples of these services include divorce litigation, economic damage quantification, and mergers and acquisitions. Divorce litigation is a big market and forensic accountants are on the forefront. During divorce litigation, forensic accountants use investigative skills to identify hidden assets or equity. These include personal assets, collectibles, collections, stock, and property. After the forensic accountant aids in locating these items, assessment of the long-term impact on divorce is also considered. This is often done by thorough review of tax returns, credit card statements, and other records. ⁷

Another area where forensic accountants work in is economic damage. Economic damage can be defined as the loss of income and earning capacity. To figure out the amount of loss or reduction in capacity, economic damage quantification must be done. This is a process in which lawyers, agents, and forensic accountants corroborate in the areas of fraud, dispute, and injury to reach quantitative results. The methods used to find results include the benchmark approach, the contract method, and the profit method. Each revolves around the examination of performance metrics and correlate the results with the degree of harm. This allows forensic accountants to show proof of wrongdoing during litigation. ⁸

Mergers and acquisitions (M&A) are common in the business world and forensic accountants can be called upon to evaluate M&A transactions. When mergers and acquisitions occur, practitioners often determine the effect of professional skill sets on the process. The professionals involved in the transaction should be skilled in completeness of exhibits and disclosure and accuracy of the entire business deal. To evaluate the aforementioned correctly, forensic accountants are knowledgeable in virtual data storage, visualization software and material, and the Confidential Information Memorandum (CIM), which is a marketing technique used to attract buyers.⁹

Forensic Risk Assessment and Management

Risk has different notions and is defined in different ways and contexts. Global business is constantly changing and becoming more unpredictable, complex, and volatile. In this challenging business environment, forensic accountants can be hired to identify risks, assess their determinants and consequences, and minimize their detrimental effects. Organizations incur different types of risks to attain their mission, including capital structure risk, credit risk, liquidity risk, interest rate risk, strategy risk, and financial and exchange risk. Forensic accountants are well trained to assist organizations in assessing and managing risks and maximize their rewards and minimize their detrimental effects. Forensic accountants can use the Enterprise Risk Management (ERM) in assessing risks and in turning challenges into opportunities. ERM is a continuous process of identifying, assessing, and disclosing risks that challenge the company, their potential losses, and possible rewards. The Committee of Sponsoring Organizations (COSO) in 2004 defined ERM as “. . . a process, effected by an entity’s board of directors, management and other personnel . . . designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite . . .”¹⁰

Dispute Resolution

Dispute resolution is the process of ending grievances between parties. In forensic accounting, a range of acceptable methods are used by practitioners to resolve a dispute, conflict or claim. During the dispute resolution process, forensic accountants often investigate commercial damages and valuations by reviewing financial transactions, reporting on interviews, and debating expert reports. Dispute resolutions are generally a tedious process requiring forensic accountants to act as mediators between parties. A mediator is an individual or party who aids opposing parties in reaching an agreement. In addition to the above-mentioned traditional investigation methods, technology has brought upon new ways to examine litigation. New methodology resulting from the advancement of technology includes retrieval of deleted information, review of electronic data transmissions (calls and e-mails), verification of metadata, and examination of the electronic audit trail.¹¹ The Circle of Conflict, developed by Christopher W. Moore, details a process for mediators.¹² The process contains four quadrants, each representing primary, secondary, and third parties, respectively. The inner circle of the quadrants represents issues and options that are viable to each quadrant. This diagram is intentioned to depict opportunities that arise from disputes. ¹³

Skill Sets of Forensic Accountants

A survey study sponsored by the Forensic Valuations Services Section of the American Institute of Certified Public Accountants (AICPA) in 2009 reveals characteristics and skills of forensic accountants described in this section.¹⁴ Successful forensic accountants need to have three sets of technical, analytical, and soft skills as explained in the following subsections.

Technical Skill Sets

Forensic accountants need to be familiar with broad accounting knowledge, the law, and investigative techniques within specialized areas of forensic accounting. Forensic accountants performing financial and investigative fraud services should understand accounting standards, policies, and practices, accounting information systems, auditing standards, procedures and practices, use of research methodology, computer technology and digital forensics, fair value estimation, business valuation, and economic damages. The various legal tasks a forensic accountant undergoes include testifying as witness in trial, understanding the legal system, whether in a specific area of expertise such as credit card fraud, or its entirety. The FBI has a large presence in investigating white-collar crime and fraud schemes, and forensic accountants are recruited by the FBI for their familiarity with the legal, investigative process.

Forensic accountants must go through extensive schooling to understand these processes. An example curriculum for a student aspiring to become such an accountant includes courses such as Forensic Accounting: Litigation Support and Expert Witnessing. Other courses offered by many universities include Fraud Examination and Computer Forensics and IT Auditing.¹⁵ All of these courses teach students about investigative techniques, the legal process, accounting knowledge, and criminology that forensic accountants partake in daily. Some of these technical skills are anti-fraud education and practice, careers in forensic accounting, compliance with applicable laws and regulations, corporate governance, expert testimony and expert witness techniques, FSF, legal elements of fraud, principles of ethics and corporate code of conduct, professional standards pertaining to forensic accounting, and types of fraud (e.g., employees, management).

Analytical Skill Sets

Analytical skill sets are often referred to as digital forensics, information technology (IT), Big Data, data analytics, and the ability of forensic accountants to effectively perform their services. Forensic accountants should possess analytical skills of using research methodology and data analytics in gathering and evaluating evidence. The 2009 AICPA survey suggests that the majority (more than 60%) of surveyed attorneys, CPAs, and accounting professors rank being analytical, ethical, and detailed-oriented as essential characteristics and traits of forensic accountants.¹⁶ The use of IT, Big Data, data analytics, and time series analyses is very important in digital forensics. There has been an increase in the use of data analytics in the twenty-first century. With the rise of Big Data, forensic accountants are having to become increasingly adaptable for future challenges. According to the 2014 Survey on International Trends in Forensic and Valuations Services, conducted by the AICPA, the biggest challenge in the field of forensic accounting today is electronic data analytics; 85 percent of survey responses indicated as much. The evolution of Big Data requires forensic accountants to not only accumulate a lot of data but also be able to decipher and understand it.¹⁷

IT skill sets including Big Data and data analytics skills, experience, and knowledge have become increasingly important for forensic accountants. IT advances (e.g., block chain, cloud computing, electronic social media, analytics) provide forensic accountants with an unprecedented amount of data and information availability. Big Data is typically viewed as high-volume, high-velocity, and high-variety information that is typically processed electronically to improve decision-making.¹⁸ Forensic accountants typically have access to the huge amount of both structured (e.g., financial information general ledger or transaction data) and unstructured data (e.g., financial disputes, valuation information, e-mail, voice or free-text fields in a database) and semi-structured data (e.g., nontraditional data sources such as third-party watch lists, news media, free-text payment descriptions) to effectively perform their forensic and investigative services.

Ernst & Young (EY) reports two factors relating to cyberattacks and digital fraud have increased the use of Big Data and data analytic tools by forensic accountants.¹⁹ First, the existence and persistence of cyberattacks in recent years have caused significant disruption of critical operations, transfer of funds, and misappropriation of intellectual property/confidential personal data and other critical digital assets. Second, ever-increasing fraud risks because of insider threats triggered by unauthorized trading, espionage, or IT sabotage cause malicious insiders to manipulate or destroy data and perpetrate fraud. Big Data enables forensic accountants to perform technological, cultural, analysis and use methodology opportunities in capturing and analyzing both structured financial information and unstructured nonfinancial information. The use of Big Data and data analytics enables forensic accountants to integrate nontraditional sources of financial information and nonfinancial information into audit processes.

Forensic accountants use Big Data and data analytics to improve the quality of their investigation, reduce the costs, and enhance profitability. For example, forensic accountants can utilize database-to-database verification with independent trading partners. Forensic accountants can use automatic data collection and rule-based analysis techniques to identify errors, irregularities, and fraud. Big Data can change forensic accounting in the following areas: First, population-level investigations are possible and feasible over traditional sampling tests because of the digitization of transaction data and reduced costs of data analysis. Second, the role of forensic accountants with the emergence of Big Data will move from statement-level investigation and opinion to data-level investigation and report. Third, forensic accountants are able to use text analytics to manage unstructured or semi-structured data, such as text in the management discussion and analysis sections of financial reports. Finally, forensic accountants face a less challenging task in asserting the existence of tangible assets where records are complemented with pertinent audio, video, and textual information.

Soft Skill Sets

Soft skills are very important to forensic accountants to communicate their findings effectively and in interviewing suspected fraudsters and in testifying in court. Soft skill sets include communication, psychology, interviewing, testifying, and problem-solving ability of forensic accountants to effectively perform their services. Soft skills including communication and interview skills are essential for forensic accountants. Forensic accountants serving as expert witnesses often testify before the courts and write their expert reports that are subject to intensive scrutiny by cross-sectional trials and in depositions. Litigation consultants need to write reports that can effectively stand cross-examinations in trials. Because of the nature of the job, forensic accountants must be well organized and be able to communicate their findings in an efficient and effective manner. Accountants must develop a way to communicate with other experts outside of the accounting and finance fields of study. Commonly, being too technical with others can lead to a lack of understanding and can produce undesired results, especially for technical legal matters. Interviews are a procedure in investigations that requires information to be extracted in an objective and through manner by not accusing the suspect. When suspects feel accused, they may decide not to divulge critical information, and thus, it is important to make sure the suspect is comfortable with talking.²⁰

Forensic accounting services often require dealing with nerves of people under pressure. Thus, forensic accountants need to remain calm, relaxed, and approachable to soothe those nerves and foster cooperation. During investigations and disputes, integrations and interviewees, individuals may feel accused when they have done nothing wrong, and therefore, forensic accountants should have the necessary soft skills to create a cordial and congenial environment of calmness, cooperation, and respect. Forensic accountants can effectively perform their services and accomplish effective interviews by being objective, organized, and being candid and transparent by discussing the investigation process upfront. Forensic accountants should develop effective listening skills to give opportunity to interviewees to talk freely and listen and observe their body language. Creative thinking, problem solving, and critical thinking are important skills for forensic accounting. Forensic accountants should be able to think quickly, recognize the changes, and adapt to the changes during an investigation. Understanding fraudsters and suspects, their ways of thinking, intent, and motivations is important in investigating fraud. Forensic accountants in investigating fraud may need to obtain a confession that requires collecting documentary evidence and conducting interviews. The process of obtaining confession requires the ability to assess deception from honesty and truthfulness and the knowledge and skills to analyze eye movements and body language rooted in psychology.

The AICPA 2009 survey regarding essential characteristics and traits of forensic accountants state the following skills as important in the order of raking by surveyed attorneys, academics, and practicing accountants (CPAs): being analytical, detail-oriented, ethical, responsive, insightful, inquisitive, intuitive, persistent, skeptical, evaluative, confident, as well as functioning well under pressure, generating new ideas and scenarios, making people feel at ease, team playing, and being adaptive.²¹ In summary, the required skill sets for successful forensic accountants are as follows: accounting, auditing, knowledge of the legal system, criminology, investigative techniques, data analytics, detail-oriented, organized, focused, critical thinking, effective commutation, and creative thinking. Relevant to technical, analytical, and soft skill sets, Exhibit 2.4 summarizes and contrasts the American Accounting Association operating manual for forensic accounting, auditing, and financial reporting sections. Information presented in this exhibit contrasts the education knowledge, along with the teaching and research objectives of auditors, financial accountants, and forensic accountants.

Conclusion

Forensic accounting is a rewarding, demanding, and challenging field of accounting. Forensic accountants perform both fraud and nonfraud services presented in this chapter. Fraud services consist of FSF examination, employee fraud, embezzlement, and theft and misappropriation of assets investigation. Nonfraud forensic accounting services consist of litigation consulting, expert witnessing, valuation, and dispute resolution. To effectively fulfill their responsibilities and thoroughly conduct their services, forensic accountants should obtain technical, analytical, and soft skill sets discussed in this chapter.

Action Items

1. Forensic accounting is a rewarding and demanding career.
2. Forensic accounting services are fraud investigation, litigation consulting, expert witnessing, valuations, risk assessment, economic damages among others.
3. Forensic accounting is a process of gathering, analyzing, and evaluating evidence, making decisions and conclusions, and effectively communicating the results of forensic accounting services.
4. Forensic accountants should possess technical, analytical, and soft skill sets to effectively perform their professional services.

Endnotes

  1. Z. Rezaee, L. Crumbley, and R. Elmore. 2004. “Forensic Accounting Education: A Survey of Academics and Practitioners.” Advances in Accounting Education Teaching and Curriculum Innovations 6, pp. 193–232.

  2. American Psychological Association. 2016. How Did You Get that Job? http://www.apa.org/monitor/2016/06/job-studebaker.aspx, (accessed February 8, 2018).

  3. The AICPA. 2003. Statement of Standards for Consulting Services. https://www.aicpa.org/interestareas/forensicandvaluation/resources/standards/downloadabledocuments/sscs.pdf

  4. D.L. Crumbley, and K.A. Russell. 2004. “So You Want to Be an Expert Witness,” Journal of Accountancy. https://www.journalofaccountancy.com/issues/2004/oct/soyouwanttobeanexpertwitness.html, (accessed: February 16, 2018).

  5. Investopedia. 2018. Business Valuation. https://www.investopedia.com/terms/b/business-valuation.asp, (accessed February 23, 2018).

  6. Z. Rezaee. 2001. Financial Institutions, Valuations, Mergers, and Acquisitions (2nd ed., Hoboken, NJ: John Wiley & Sons, Inc.).

  7. McKinley Irvin. October 16, 2017. How Might a Forensic Accountant Benefit My Divorce Case? https://www.mckinleyirvin.com/family-law-blog/2017/october/how-might-a-forensic-accountant-benefit-my-divor/, (accessed October 2, 2018).

  8. MMD Forensic Accountants. n.d. What Is Economic Damage Quantification? https://mdd.com/what-is-economic-damage-quantification/, (accessed October 2, 2018).

  9. McGovern & Greene LLP. n.d. Mergers & Acquisitions. https://www.mcgoverngreene.com/forensic-accounting/mergers-acquisitions.html, (accessed October 2, 2018).

10. Committee of Sponsoring Organizations of the Treadway Commission (COSO). September, 2004. Enterprise Risk Management—Integrated Framework (New York, NY: COSO).

11. Kroll. June 1, 2013. Dispute Resolution: The Role of Forensic Accountants and Computer Forensics. https://www.kroll.com/media/pdf/articles/AsianMena_Counsel_v11.pdf, (accessed August 30, 2018).

12. Deloitte. 2017. The Role of the Forensic Accountant in Mediation. https://www2.deloitte.com/ie/en/pages/finance/articles/role-of-forensic-accountant-in-mediation.html, (accessed September 4, 2018).

13. Ibid.

14. American Institute of Certified Public Accountants (AICPA). 2009. Characteristics and Skills of the forensic accountant. https://www.aicpa.org/InterestAreas/ForensicAndValuation/Resources/PractAids/Guidance/DownloadableDocuments/ForensicAccountingResearchWhitePaper.pdf

15. Missouri State University. n.d. Accountancy Courses. https://www.missouristate.edu/registrar/catalog/courses_ac.htm, (accessed November 5, 2017).

16. AICPA. 2009. Characteristics and Skills.

17. AICPA. 2014. The 2014 AICPA Survey on International Trends in Forensic and Valuation Services. Available at https://rodburkert.com/wp-content/uploads/2015/08/FVS-International-Trends-2014.pdf

18. M. Vasarhelyi, A. Kogan, and B.M. Tuttle. 2015. “Big Data in Accounting: An Overview,” Accounting Horizons 29, no. 2, pp. 381–396.

19. Ernst and Young (EY). 2016. Global Forensic Data Analytics Survey 2016. Shifting into Higher Gear: Mitigating Risks and Demonstrating Returns. http://www.ey.com/gl/en/services/assurance/fraud-investigation---dispute-services/ey-shifting-into-high-gear-mitigating-risks-and-demonstrating-returns, (accessed January 4, 2017).

20. M.L. Murphy. December 3, 2014. “Top Soft Skills for Forensic Accountants,” AICPA. https://www.aicpastore.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2014/FVSNews/skillsforforensicaccountants.jsp, (accessed November 7, 2017).

21. AICPA. 2009. Characteristics and Skills.

22. FARS. Financial Accounting and Reporting Section. http://aaahq.org/fars, (accessed June 25, 2018).