Forensic Accounting Explained for Dummies

What is forensic accounting?

Forensic accounting is a type of accounting used by forensic accountants to investigate, examine, and analyse the financial records of entities or individuals in order to detect evidence of crimes like fraud, suitable to be used in a court of law.

In addition, forensic accounting is used to obtain information to settle disputes regarding civil cases.

Merriam-Webster’s Dictionary defines ‘forensic’ as: ‘Belonging to, used in, or suitable to courts of judicature or to public discussion and debate.’ (Judicature refers to courts of justice.)

The Cambridge Dictionary describes a forensic accountant as ‘someone whose job is to examine financial records to find any illegal activity.’

Different types of financial investigations require different types of forensic accounting

There can be numerous reasons (criminal and civil) for individuals and companies to require a type of forensic accounting.

Broadly, the reasons to make use of forensic accountants for financial investigations can be categorised into two categories, civil cases, and financial crimes.

Civil cases

Civil cases comprise issues such as:

Civil disputes include, inter alia, the following types of disputes:

• Quantifying and calculating losses and economic damages, for example, losses or damages suffered through breach of contract.
• Disputes regarding company transactions such as acquisitions.
• Valuations of businesses.

Divorce proceedings.

Insolvency, referring to a state of financial distress when an organisation (or individual) is unable to cover its liabilities (debts) with its assets.

Bankruptcy is a legal process involving a debtor (individual, business, or organisation) that is unable to repay outstanding debts. The assets of the debtor are liquidated in order to pay a portion of the outstanding debt.

Defaulting on debt.

Claims for professional negligence take place when a claim is lodged against a professional, such as a lawyer, financial advisor, accountant, doctor, etc., for neglecting professional duties or obligations, resulting in losses and or damages for clients.

Financial crimes

Financial crimes comprise various types of crime. The following financial crimes are examples of such crimes:

Fraud includes:

• Bank fraud occurs when an individual, organisation, or business illegally attempts to obtain money from a bank or financial institution. Examples of bank fraud are credit card fraud and digital or internet fraud.
• Tax fraud happens when a person or business deliberately violates one or more tax laws of a country.
• Insurance fraud ‘is a deliberate deception perpetrated against or by an insurance company or agent for the purpose of financial gain.’ (Insurance Information Institute)
• Securities fraud, also referred to as stock fraud or investment fraud, takes place when investors are persuaded to buy or sell securities on the basis of false information.
• VAT fraud occurs when someone intentionally reports false information regarding input- or output tax.
• Mortgage fraud refers to the intentional deception or misrepresentation used by someone when applying for a mortgage loan to buy a property. Giving false information or omitting important information are examples of misrepresentation by a prospective buyer of the property.

Embezzlement – a type of fraud occurring when someone steals or misappropriates money or other assets from an employer, business, or a person who entrusted his or her money or assets to the fraudster.

Money laundering – ‘a process that criminals use in an attempt to hide the illegal source of their income. By passing money through complex transfers and transactions, or through a series of businesses, the money is “cleaned” of its illegitimate origin and made to appear as legitimate business profits.’ (Corporate Finance Institute)

Tax evasion occurs when a business or individual illegally and purposefully reduces the amount of tax payable.

Ponzi scheme, defined as a fraudulent investment plan in which investments received from new investors are paid as consistent high returns to earlier investors.[1]

Insider dealing, described by the Cambridge Dictionary as ‘the illegal buying and selling of shares of a company by people who have special information because they are involved with the company.’

Terrorist financing is defined by the Financial Intelligence Centre (FIC) in South Africa as follows: ‘Financing of terrorism is the collection or provision of funds for the purpose of enhancing the ability of an entity or anyone who is involved in terrorism or related activities to commit an act that is regarded as a terrorist act. Funds may be raised from legitimate sources, such as personal donations and profits from businesses and charitable organizations, as well as from criminal sources, such as the drug trade, the smuggling of weapons and other goods, fraud, kidnapping, and extortion.’ (Accentuations are by the article writer.)

The role of forensic accountants

Typically, forensic accountants are employed, inter alia, by law enforcement organisations, insurance companies, government agencies and investigative commissions (such as the Zondo Commission in South Africa), businesses, and banks.

The role of forensic accountants can be classified into two main areas:

• Forensic investigation

Forensic investigation is the process to determine whether criminal activities, as listed under ‘financial crime’ above, have occurred. In addition, the forensic investigation may also be required in civil cases, of which a list is provided above.

A forensic accountant uses his/her specialised investigative skills to analyse, interpret, and summarise intricate and complicated financial and business information in order to write an expert report to support a case in a litigation process.

• Litigation support

Litigation refers to the process of taking a dispute to and settling it in a court of law.

However, the report of a forensic accountant can be used by parties involved in a legal dispute to settle a dispute before they reach the courtroom.

If a dispute cannot be settled before going to court, the forensic accountant may be required to testify as an expert witness, presenting and defending his or her conclusions about the specific investigation.

[1] See the article, ’What is a Ponzi scheme?’ for a detailed explanation of this illegal investment scheme.