Forensic Accounting/Investigation Methodology - acfe

Report
ACCOUNTING TECHNIQUES USED
IN A FRAUD INVESTIGATION
Mary Anne Basilone, CPA, CFE, MMT, MA
Diane A. Matthews, PhD, CPA/CFF, CFE
Carlow University
Master of Science in Fraud & Forensics
Bachelor of Science in Forensic Accounting
Bachelor of Science in Accounting
1
TOPICS COVERED

INVESTIGATIVE METHODOLOGY

METHODS OF PROOF
DIRECT
 INDIRECT


DIGITAL ANALYSIS
TECHNIQUES
2
METHODOLOGY
OVERVIEW
STEPS IN CONDUCTING A
COMPREHENSIVE FRAUD
INVESTIGATION
3
PROCESS MAP
Dorrell, D., Gadawski, G. (2012). Financial forensics body of knowledge.
Hoboken, New Jersey: John Wiley & Sons.
4
INVESTIGATIVE METHODOLOGY
THE PROCESS MAP
5
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research


Identify parties to the case
Correlate the matters of law
Confirm technical capabilities







AICPA/BVFLS Practice Aids
Litigation Services Handbook,
4th & Cumulative Supplements
NACVA Resources
Laboratory
Analysis
Analysis of
Transactions

Clear conflict - firm-wide database
Insure matching of expectations between counsel
and facts and circumstances of matter
Determine whether engaged as consultant or expert
Prepare and secure engagement letter & retainer
Establish concrete timelines, e.g. discovery cutoff,
report submittal, etc.
Establish counsel communications protocol, e.g.
whether/how subject to discovery
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS




Identification of all parties
Specification of key timelines
Privilege determination
Agreement on standards
Deliverables



“Entity / Party Chart”
Signed engagement letter &
retainer
Retainer
6
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research
Continually define/refine
universes of data, primary and
secondary
Confidential
Informants
Trial
Preparation
Laboratory
Analysis
Analysis of
Transactions
Potential Issues
Tasks to be Performed



Initiate data collection processes
Prepare Document Request(s) as necessary
TASKS
 Genogram
 Entity(s)/party(s) chart
 Background investigation


References


Litigation Services Handbook,
4th, (matter-specific
references)
GenoPro Gold
PostAssignment
Testimony
&
Exhibits
Undercover
Purpose of Stage

TRIAL/REPORTS
Insure that all possible data
sources are defined
Establish protocol to manage
data requested and obtained
Deliverables




“Entity(s)/Party(s) Chart”
Genogram
Document Request
Timeline Analysis
7
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research

Gain confidence of parties
Obtain information from parties
Confidential
Informants
Trial
Preparation
Laboratory
Analysis
Analysis of
Transactions
Potential Issues
Tasks to be Performed



For Depositions:
Prepare Deposition Matrix
Attend depositions with counsel and advise






References




Kolb’s “Experiential Learning”
www.Reid.com ; w-z.com
Edwin T. Hall works
ACFE Fraud Examiner’s
Manual



For Interviews:
Background investigation on identified parties
Use interpersonal communication techniques to
analyze responses for further investigation
 Proxemic communication
 Kinetic communication
 Expectations-based analysis
Prepare interview matrix (next slide)
Establish preliminary hypothesis using Scientific
Method
PostAssignment
Testimony
&
Exhibits
Undercover
Purpose of Stage

TRIAL/REPORTS

Veracity of parties
“Hidden agendas” of parties
Blind leads
Additional/unrelated matters
Communication inhibitors
Deliverables






Deposition Matrix
Updated Genogram
Updated “Entity/Party Chart”
Interview Matrix
Video/audio recordings
Preliminary Hypothesis
8
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research

Obtain validating data
Obtain refuting data



 Internet
research, e.g. Best
Websites for Financial
Professionals, Business
Appraisers, and Accountants, 2nd
 TimelineXpress software InData
(Events Analysis)
Laboratory
Analysis
Analysis of
Transactions

Combine first-hand knowledge (e.g., Interviews and
Depositions) with second-hand knowledge (e.g.,
Background Research data
See “Online Databases – Sources of Information”
See “Government Sources of Information”
Identify disparities for additional investigation
TASKS
 Establish search protocol
 Collect data for validation/corroboration
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS



Veracity of parties
Currency of information
Admissibility of data
Deliverables




Search Log
Updated Genogram
“Events Analysis”
Output notebook
9
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research


Define data collection plan
Obtain data / information
Surface evidence
References



IRS’ MSSP (Market Segment
Specialization Program) for
selected industries
IRS Indirect Methods-Intro
IRS Indirect Methods-Example
Confidential
Informants
Trial
Preparation
Laboratory
Analysis
Analysis of
Transactions
Potential Issues
Tasks to be Performed




Identify remaining data needed to
substantiate/refute positions
Develop plan to obtain data using investigatory
steps

Surveillance (Electronic / Physical)

Confidential Informants

Undercover
NOTE: All preceding activities are dependent upon
evidence admissibility – counsel must advise
TASKS
 Records-based expectations
 Reasonableness testing
PostAssignment
Testimony
&
Exhibits
Undercover
Purpose of Stage

TRIAL/REPORTS


Non-existent data
Interpersonal data not
verifiable
Deliverables

Data collection plan
10
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research

Obtain data / information
Surface evidence






Investigator’s Little Black Book,
4th
“TimelineXpress” from inData
Corporation
Criminal Investigations
Laboratory
Analysis
Analysis of
Transactions



NOTE: All activities in this Stage are dependent
upon evidence admissibility – counsel must advise
Mobile v. fixed surveillance
Lead, participant and covert informants
Develop the assumed identity to gather data /
information
Document all data / information gathered
Develop “Lifestyle Analysis” (See document)
Validate / correlate prior data obtained through
alternate techniques
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS






Missing information
Privacy laws
Unreliable informant
Inconclusive information
Entrapment
Engagement/personal risks
Deliverables




Video/audio recordings
Root tracing results
Digital photographs
Validation /correlation of prior
data and deliverables
11
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research
Substantiate information by
using scientific methods


Background investigation
 Online sources
 Government sources
Software: Genogram/
Timeline/IDEA software
Laboratory
Analysis
Analysis of
Transactions

Perform any additional indirect or direct analytical
forensic techniques as needed
Validate / correlate prior data obtained through
alternate techniques
 Genogram/Entity / Party Chart
 Deposition Matrix/Interview Matrix
 Search Log/Background Investigation
 Lifestyles Analysis
 Net Worth Method
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS


Indirect analytical techniques
are inconclusive
Direct analytical techniques do
not support the indictment
Deliverables


Documented results
Validation /correlation of prior
data and deliverables
12
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research
Obtain sufficient relevant data
to provide credible evidence






Bragg, Steven M., Business
Ratios and Formulas (Wiley)
Benford’s – www.nigrini.com
IDEA software
Laboratory
Analysis
Analysis of
Transactions
Summarize and analyze the findings of all
deliverables and observations
Identify any missing information or “gaps”
DRAFT the Forensic Accountant’s Report
TASKS
 Common-sizing
 Horizontal analysis
 Vertical analysis
 Statement analysis (written)
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS


Forensic Accountant’s Report
does not support the indictment
Additional techniques do not
substantiate missing gaps
Deliverables



“Gap” Analysis
Indictment Matrix
WPN (words/pictures/numbers)
13
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research


Prepare for trial
Integrate parties & information
Ensure the completeness of all
testimony and exhibits






Writing and Defending Your
Expert Report (SEAK)
The Visual Display of
Quantitative Information (Tufte)
Laboratory
Analysis
Analysis of
Transactions

Obtain counsel’s and opposition’s DRAFT Trial
Brief
Identify the presentation sequence of evidence
Identify portions of report used as exhibits
Identify items used for expert testimony
Develop tactical trial plan
TASKS
 Reperform
 Reverse Proof
PostAssignment
Testimony
&
Exhibits
Potential Issues
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS


Meeting tight/changing
timelines
Presentation too complicated
Deliverables

Scripted Report
14
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research
Add credibility to the case by
providing expert information
Confidential
Informants
Trial
Preparation
Laboratory
Analysis
Analysis of
Transactions
Potential Issues
Tasks to be Performed




PRACTICE, PRACTICE, PRACTICE
Deliver expert witness testimony
Explain exhibits
TEACH the trier(s) of facts


References


Cross-Examination: T/he
Comprehensive Guide for
Experts (SEAK)
Kolb, Experiential Learning
PostAssignment
Testimony
&
Exhibits
Undercover
Purpose of Stage

TRIAL/REPORTS
“Surprises”
Extraordinary personal stress
Deliverables


Expert Witness Testimony
Transcript
15
Forensic Accounting/Investigation Methodology (FA/IM)©
FOUNDATIONAL
INTERPERSONAL
DATA COLLECTION AND ANALYSIS
Surveillance
-Electronic,
Physical
Interviews
&
Interrogation
Assignment
Development
Data
Collection
Scoping
Background
Research

Obtain the results of the case
Benefit from the experience
Laboratory
Analysis
Analysis of
Transactions


Learn from the experience
Assess firm’s performance
TASKS
 Evaluate performance of each party
 Update CV
 Extract “show and tell” as feasible
 Follow-up with counsel; grading form
Potential Issues

Your previous results
Continuous professional
development
Deliverables


PostAssignment
Testimony
&
Exhibits
Tasks to be Performed

References
Confidential
Informants
Trial
Preparation
Undercover
Purpose of Stage

TRIAL/REPORTS



Verdict
Judge’s Ruling
“Lessons Learned”
Updated CV
16
METHODS OF PROOF (OF FRAUD)
FOR FINANCIAL INVESTIGATORS

DIRECT METHODS
SPECIFIC ITEM METHOD
 FINANCIAL RELATIONSHIPS
 FINANCIAL STATEMENT ANALYSIS

HORIZONTAL
 VERTICAL
 TREND
 RATIO
 CASH FLOW

17
METHODS OF PROOF (OF FRAUD)
FOR FINANCIAL INVESTIGATORS

INDIRECT METHODS

NET WORTH METHOD
(AKA ASSET METHOD)

EXPENDITURES METHOD
(AKA LIFESTYLES METHOD)
(AKA SOURCES AND APPLICATION OF FUNDS METHOD)

BANK DEPOSIT METHOD
18
METHODS OF PROOF (OF FRAUD)
FOR FINANCIAL INVESTIGATORS
Information for specific industries

IRS’s Market Segment Specialization Program
(MSSP) Audit Techniques Guides (ATGs)






Learn distinct , detailed practices in a particular industry
Examination techniques
Common & unique industry issues
Business practices
Terminology
Example of market segments:


Construction or entertainment industry
Professions: lawyers or real estate agents
19
METHODS OF PROOF (OF FRAUD)
FOR FINANCIAL INVESTIGATORS
Direct-Specific item method



Most common method
Relies on specific transactions
Uncovers specific financial transactions which
relate to illegal activity, and to the suspect





Review books, records, bank accounts… directly traces a
transaction
Direct (vs circumstantial) proof
Easiest to present @ trial
Most difficult for the suspect to refute
Example: Ghost employee on the payroll
20
FINANCIAL STATEMENT ANALYSIS

NEED FOR FINANCIAL STATEMENT
ANALYSIS
COSO
 REPORT TO THE NATIONS


POWER OF FINANCIAL STATEMENT
ANALYSIS
FINANCIAL RELATIONSHIPS

SALES VERSUS COST OF GOOD
SOLD

SALES VERSUS ACCOUNTS
RECEIVABLE

SALES VERSUS INVENTORY

ASSETS VERSUS LIABILITIES
FINANCIAL STATEMENT FRAUD

FICTITIOUS REVENUES

TIMING DIFFERENCES

CONCEALED LIABILITIES AND
EXPENSES

IMPROPER DISCLOSURES

IMPROPER ASSET VALUATION
FINANCIAL STATEMENT ANALYSIS

PERCENTAGE ANALYSIS:

HORTIZONAL
PERIOD TO PERIOD
 INDUSTRY STANDARDS
 COMPETITORS


VERTICAL


COMMON SIZE STATEMENTS
TREND ANALYSIS
FINANCIAL STATEMENT
ANALYSIS CON’T

RATIO ANALYSIS
LIQUIDITY
 ASSET MANAGEMENT
 DEBT MANAGEMENT
 PROFITABILITY


CASH FLOW ANALYSIS
OPERATING
 INVESTING
 FINANCING

INDIRECT METHODS OF PROOF
CIRCUMSTANTIAL PROOF
 ADMISSIBLE IN COURT(1954 Supreme Court Holland v. U.S.)
 WHEN TO USE?







Inadequate books/records
Suspected: books do not reflect all income
Significant increase in net worth
Gross profit % changes significantly
Expenses exceed reported income without cause
Suspected income from unidentified sources is large
26
INDIRECT METHODS OF PROOF
SOURCES OF INFORMATION







County courthouse: deeds
of ownership, titles, liens,
UCC filings
The target
Informants/associates
Real estate records
Bankruptcy records
State motor vehicle records
Loan applications








Surveillance
Credit card
applications/statements
Tax returns
Insurance records
Child support/divorce records
Employment: salary, W-2s
Cancelled checks
Deposit slips
27
INDIRECT METHODS OF PROOF (O
NET WORTH METHOD
 Used to prove illicit income


Person’s assets or expenditures exceed known
sources of income
4 ways to dispose income:
1.
2.
3.
4.
Save it
Buy assets
Pay off debt
Spend it
28
INDIRECT METHODS OF PROOF (O
NET WORTH METHOD FORMULA
Assets
-Liabilities
=Net worth
-Prior year’s net worth
=Increase in net worth
+Living expenses
=Income (or expenditures)
-Funds from known sources
=Funds from unknown sources
29
INDIRECT METHODS OF PROOF (O
EXPENDITURES METHOD
Sources & Application of Funds; Lifestyles Method

CLUES






Lavish residence
Expensive cars/boats
Vacation home
Private schools for children
Exotic vacations
WHEN TO USE?...WHEN TARGET



Operates mostly on a cash basis
Little or no net worth but large expenditures
Little or no change in assets or liabilities
30
INDIRECT METHODS OF PROOF (O
EXPENDITURES METHOD FORMULA
Total expenditures
(i.e., Application of funds)
-Known sources of funds
=Funds from unknown sources
31
INDIRECT METHODS OF PROOF (O
BANK DEPOSIT METHOD

WHEN TO USE?




Assets & liabilities are fairly constant
No indications of extravagant lifestyle
Target’s known income is being deposited into financial
institutions
HOW?

Analyze bank deposits, cancelled checks, currency
transactions
32
INDIRECT METHODS OF PROOF (O
BANK DEPOSIT METHOD FORMULA
Total deposits to all accounts
-Transfer and redeposits
=Net deposits to all accounts
+Cash expenditures
=Total receipts from all sources
-Funds from known sources
=Funds from unknown or illegal sources
33
DIGITAL ANALYSIS TECHNIQUES

SOFTWARE PROGRAMS PERFORM

DATA MINING




Extracting information from databases
Comb DB for obscure patterns
Sort data to detect potential fraud
 same address for two employees
DATA ANALYTICS


Statistical process used to analyze data
Identify red flags, transaction trends, patterns,
anomalies
34
DIGITAL ANALYSIS TECHNIQUES
FUNCTIONS

Sorting
 Record selection
 Joining files
 Multi-file processing
 Correlation analysis
 Date functions
 Graphing

Verifying multiples of a
number
 Compliance verification
 Duplicate searches
 Vertical ratio analysis
 Horizontal ratio analysis
35
DIGITAL ANALYSIS TECHNIQUES
FUNCTIONS

Data file inquiry
 Random unit sampling
 Calculate totals
 Calculate averages
 Specific criteria searches
 Unusual item inquiries
 Link analysis graphics

Identify gaps in sequence
 Identify duplicates
 Differentiate normal
patterns from suspect
patterns
 Benford’s Law analysis
 Stratification
36
DIGITAL ANALYSIS TECHNIQUES
EXAMPLES

Identify invoices w/o PO
 Look for invoices from
vendors not “approved”
 Analyze claims paid by
insurance providers
 Look for high volume
purchases from one
vendor



Match names, addresses,
phone numbers, SS
numbers between
employee and vendor
files
Identify dormant accounts
with activity
Search for large, rounded
transaction values
37
DIGITAL ANALYSIS TECHNIQUES
COMMERCIAL SOFTWARE

Excel
 ACL
 IDEA
 ActiveData for Excel
 AutoAudit
 SNAP! Reporter
 DataWatch’s Monarch for
Windows
 Oversight Systems

Case Management
Software—Analyst’s
Notebook i2; LexisNexis
CaseMap



Organize, evaluate, explore
evidence
Timeline Software—
TimelineXpress (inData
Corp)
Genogram--GenoPro
38
ACCOUNTING TECHNIQUES USED
IN A FRAUD INVESTIGATION
Mary Anne Basilone, CPA, CFE, MMT, MA
Chair, Accounting & Forensic Accounting Programs
[email protected]
Diane A. Matthews, PhD, CPA/CFF, CFE
Associate Dean, School of Management
[email protected]
39

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