What Is Forensic Accounting – Its Working, Types, Services And Advantages
Financial discrepancies in a company’s balance sheet can occur more often than you think. If this happens intentionally, it is a fraud. The impact of a public fraud investigation can damage a company’s reputation beyond the point of recovery. This is where the discipline of forensic accounting can prove its worth.
A forensic accountant can investigate and close loopholes enabling illegal activity. By appointing a forensic accountant, businesses can save their finances as well as their reputation.
What is Forensic Accounting?
Forensic accounting is a system put in place to check the finances of an individual, firm or company. This procedure includes an in-depth analysis of financial data and documenting the entire investigation.
Forensic accountants are required to solve financial conspiracies like securities fraud, embezzlement, money laundering, tax evasion, etc. They can also be hired for civil proceedings like divorce settlements and family disputes or for internal investigations by a company.
How Does Forensic Accounting Work?
The process of forensic accounting begins with learning the specifics from an attorney, a government representative or a client before commencing the initial research.
The next step is planning the investigation based on details provided by the person or a firm. After this, all the bank statements, ledgers, credit statements, e-mails, journals, memos and databases are checked thoroughly, which helps to understand the overall financial situation.
The accountant must conduct interviews with the accused and anyone involved in the case. However, such decisions rest solely on the person dealing with the case at hand. Forensic accountants are responsible for drawing upon the hints or clues presented by the people they interview, which might help them to get hold of the perpetrator.
Finally, the accountant must use all the gathered information to calculate losses, trace the movement of funds and summarise transactions. If the accountant needs to testify in court, he/she must provide litigation support to the concerned attorneys.
Also Read: What is Branch Accounting? How Does it Work and Why is it Important?
Objectives of Forensic Accounting
The primary purpose of forensic accounting is to gather evidence of a crime and present it in a court of law. To conduct the process, a forensic accountant is hired who examines the financial records of an individual, a firm or an entire corporation.
Forensic accounting also ensures that your company’s financial documents are in accordance with laws and regulations. This entire checking is done via investigating the records.
In short, the major objectives of forensic accounting are-
- To prove financial crimes that have taken place
- Prevent financial crimes from taking place
- Predicting financial crimes that might take place
Types of Forensic Accounting
Below are several kinds of forensic accounting that are clubbed together based on the legal proceedings they fall under:
- Professional negligence claims
- Bankruptcy
- Privacy information
- Money laundering
- Financial theft (customers, employees, or outsiders)
- Tax evasion or fraud
- Securities fraud
- Defaulting on debt
- Corporate valuation disputes
- Economic damages (various types of lawsuits to recover damages)
- Divorce proceedings
- Mergers & Acquisitions related lawsuits
Forensic Accounting Services
Businesses can use forensic accounting for the following services:
1. Litigation Support Services
In this situation, a forensic accountant examines the damages reported by both parties involved in a legal dispute. This helps to settle the ongoing conflict before it escalates. The forensic accountant can serve as a witness to provide evidence in case the issue reaches the courtroom.
2. Investigative/Fact-finding Services
For this particular service, the job of a forensic accountant is to provide solid evidence on whether any illegal activity such as insurance racket, securities embezzlement, identity theft or employee felony has occurred.
Advantages of Forensic Accounting
Financial accounting helps to understand the financial situation of any company or business by studying the available data. Any firm or business planning to cut down on losses can benefit from the services of forensic accounting and fraud detection.
A few advantages of forensic accounting are as follows-
1. Minimising Losses
Forensic accounting primarily helps to reduce financial losses. A forensic accountant restricts fraudulent activity and prevents financial discrepancies from taking place, which often leads to huge monetary losses for businesses daily.
2. Enhancing Efficiency
The forensic accountant performs a thorough study of the current system and offers solutions or suggestions to successfully deal with any inspection of the ongoing financial strategies and processes, which help them formulate better solutions for improving the standard of businesses.
3. Lowers Risk of Exploitation
A forensic accountant also has the skill to patch up any ‘gaps’ within the current financial processes, reducing the scope of any financial exploitation in the future. This protects the business in advance from any illegal activities that can take place.
4. Steer Clear of Legal Issues
The cost of recovering from a case of internal or external fraud can be quite high. Here, the skill of a forensic accountant can come in handy to prevent any such occurrence by detecting and nipping the issue in the bud.
5. Improves Brand Recognition and Authority
Any brand or organisation that has had to deal with any cases of fraud and manipulation has a hard time gaining back the trust of its customers. The reputational damage can even be irreparable, so people must be appointed to detect and prevent such activities.
Disadvantages of Forensic Accounting
Although the importance of forensic accounting is unmatched, below are a few disadvantages to such a process.
1. Time-consuming Process
The process is never simple or easy. The task of the hired forensic accountant is to go through all the financial documents to complete their investigation. Factors like (i) severity of the case, (ii) the number of documents to be checked, and (iii) the size of the organisation affects the overall time consumption that is required to reach any conclusion.
2. Expensive
The factor of cost majorly creates issues for smaller companies. As the process of forensic accounting is quite intense and time-consuming, expenditure is equally high. However, bigger companies might not have trouble with financing such needs.
3. Can cause Distraction
As the process of forensic accounting can be quite rigorous, it can also be disruptive. There may be involvement of people from outside the organisation, hampering the efficiency and productivity of the staff present.
4. Can affect Employees’ Morale
Introducing forensic accounting in existing business operations might make the employees feel that their integrity towards the company is being questioned. Hence, the managers and owners need to take the extra step of ensuring that their workers are well informed regarding the process. They should know that it is not a sign of distrust towards them.
Difference between Forensic Accounting and Audit
| Factors | Auditing | Forensic Accounting |
|---|---|---|
| Objective | Identifies errors and prevents them from occurring further | Detects felonies and frauds |
| Skill Set Required | Knowledge of accounting | Must have knowledge regarding advanced data analytics, criminalistics, law and information technology other than accounting |
| Purpose | Compares books of accounts with Generally Accepted Accounting Principles (GAAP) | Analyses financial records to identify fraudulent and illegal activity within an organisation |
| Investigation | This process involves going through the financial transaction samples | Every detail involving finances is checked thoroughly |
| Process | Accounts are reviewed according to GAAP | Forensic accountants search for specific patterns or outliers during the course of an investigation |
| Litigation Perspective | No | The entire process of investigation is recorded and presented in front of the court of law |
| Appointed By | Shareholders of the company | Owners, counsels, third parties and directors |
| Frequency | Companies must appoint an auditor | Generally appointed when any fraud is suspected |
| Carried Out By | Certified Public Accountant (CPA) | A team of professionals, including CPAs |
Important Points to Know about Forensic Accounting
To become a forensic accountant, one must have the following set of skills-
1. Analytical Skills
A forensic accountant must have sufficient analytical skills to review the available information. Without adequate skill, it will be difficult for them to figure out the specification of a financial crime.
2. Critical Thinking Skills
The task of detecting fraud or the root cause of the financial discrepancies can be tricky to determine. Hence, there is a need to be critical while reviewing the documents.
3. Interviewing Skills
Sometimes, a forensic accountant might feel a need to interview people to gain better clarity regarding the situation at hand. They might talk to people from the respective organisation or people involved in crime. Good interviewing skills will make them more vigilant in assessing their replies.
4. Communication Skills
Communication skill is another important skill required for this field. A forensic accountant must write thorough investigation reports and convey the same orally. There can be a situation where a forensic accountant is asked to narrate the entire investigation in front of a jury. Here, having good communication skills can pay off.
5. Problem-solving Skills
With the discovery of new information, any ongoing investigation can take new turns, challenging the initial course of action. Here, someone with good problem-solving skills can intently shift their process of finding a solution.
6. Attention to Detail
Possessing this skill can prove to be beneficial for a forensic accountant. It can help to point out minute financial discrepancies or irregularities in any system. Attention to detail can also assist them in carefully documenting the investigation process.
Also Read: Accounting Cycle – Benefits, Limitations, Working with 5 Important Steps
Final Word
Forensic accounting is a field where accountants probe financial information to find out if there is any discrepancy. With a rise in corporate scams and frauds, such accountants are needed by various organisations, law enforcement agencies and legal cases.
Forensic accounting and fraud examination can also control money flow, which can be beneficial for a company in the long run.
FAQs
Ans. As a forensic accountant’s job includes investigating and accounting, the applicable tools are accounting software, bookkeeping and computer forensic tools like data-mining applications and statistical principles like Benford’s Law.
Ans. To become a certified public accountant (CPA), one must clear the CPA Exam and gain work experience. Forensic accountants need to acquire additional training and experience in the specified field of financial investigation and forensics. Generally, in case of embezzlement or other white-collar crimes, forensic accountants are appointed.
Ans. An unusual situation showcasing a pattern of peculiarities that can be a warning sign of someone’s misconduct is considered a red flag. In such circumstances, further inquiry and a thorough investigation must be conducted.
Ans. There are multiple records that a forensic accountant goes through, like tax returns, real estate records, court filings, bank records and insurance policies. Also, documents of credit reports, employment applications and loan applications are valuable when it comes to assessing someone’s wealth.
Ans. The job of a forensic accountant entails multiple facets, including investigating fraud, examining financial data and assisting in criminal and civil financial investigations. They also work toward curbing the financial risks of companies by implementing changes in policies and procedures to make them more efficient.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
