Forensic Accounting

You probably know or have heard one the television show “CSI: Crime Scene Investigation”, wherein the actors play the role of a forensic crime scene investigators. The is exciting and interesting and has resulted in many other spinoff’s. Forensic accounting (FA) may not sound as exciting as “CSI”, but it can be every bit as important and exciting to your business. Generally, FA is the process of drawing reasonable conclusions from incomplete data. Most often persons think of fraud detection when they think of FA. It also includes issues like fire losses, business interruption claims, and other issues we will get to in a moment.

It is also impossible to talk about FA without talking about the concept of internal controls. Internal controls have been on the minds of many area business persons lately, because of wide spread counterfeit check scams. The definition of internal controls that I like best comes from an old auditing textbook, Principles of Auditing, tenth edition, Whittington, Pany, Meigs, and Meigs, 1992. The definition is “…But internal control extends beyond the accounting and financial functions; its scope is company-wide and touches all activities of the organization. It includes the methods by which top management delegates authority and assigns responsibility for such functions as selling, purchasing, accounting, and production. Internal control also includes the program for preparing, verifying, and distributing to various levels of management those current reports and analyses that enable executives to maintain control over the variety of activities and functions that constitute a large corporate enterprise. The use of budgetary techniques, production standards, inspection laboratories, time and motion studies, and employee training programs involve engineers and many other far removed from accounting and financial activities; yet all of these devices are part of the mechanism referred to as an internal control structure.” I know that is a mouthful, but read it again. I think it makes a lot of sense.

You might think that there are many people, especially accountants, who could analyze and help to assist in the enhancement of internal controls. Surprisingly, that is not the case. It can be a challenge to look at a system, decide if it is being adhered to, and determine how to enhance that adherence. Many accountants can do that. It is another matter to analyze a system, determine its inherent weaknesses, and/or recommend changes that will correct the short falls. Some folks say that you “need a bit of larceny running through your own veins” to be good at this. Maybe that is true. Some accountants’ skills in this area are recognized by the designations of CFA (certified fraud auditor), CFE (certified fraud examiner) and/or FCPA (forensic CPA).

But let’s get back to the notion of FA, drawing reasonable conclusions from incomplete data. In addition to fraud prevention and detection, you could be looking at claims for lost income due to a casualty. For example, how do you determine how much profit is lost by a company from a fire if the fire destroys much of the accounting records? How much money should an injured person receive today in order to fund their future personal and medical needs? If a self employed person suffers a casualty in bad economic times and goes out of business, what amount of profits are lost and how much of that, if any, is due to the casualty versus the bad economic times? Again, it is the art of drawing reasonable conclusions from incomplete data.

You may also have decided that internal controls have primarily to do with fraud. But I do not think that is the case. The more common problem is one of minimizing waste and inefficiency. For example: What are company policies? Are they good or not so good? If they are good, are they being followed? If they are not good, are they being followed? And what do we mean by “good”? No system will operate without errors. So what is the tolerable rate of error? Is the realized rate better or worse than that? Also, please keep in mind that this involves more than accounting and financial functions. Program goals that are not met because of non-compliance with policy, mean inefficiency and waste in terms of effort, energy, emotion, and utility as well as dollars and cents.