Forensic accounting is defined as the application of financial expertise to legal issues, encompassing two primary functions: litigation advisory services and investigative services. It involves analyzing financial and nonfinancial data to address disputes, such as determining liability or calculating damages in cases like insurance claims or employment disputes.
The chapter illustrates forensic accounting through scenarios, including:
Insurance Claim Dispute: A contractor’s alleged negligence in placing a water pipe in an unheated attic led to significant water damage. Forensic accountants must assess liability, contractual obligations, and damages, including lost profits for a retail business impacted during peak season.
Employment Damages: In cases of workplace injuries or accidents, forensic accountants use financial records (e.g., W-2s, tax returns) and nonfinancial data (e.g., life expectancy) to quantify damages.
David Williams Fraud Case: A Texas fitness trainer was arrested in 2017 for submitting over $25 million in fraudulent medical claims, highlighting the role of forensic accounting in investigating billing fraud.
Fraud is defined as intentional deception causing economic loss to victims or gain to perpetrators. The legal elements include:
A material false statement.
Knowledge of the statement’s falsity.
Victim reliance on the false statement.
Resulting damages.
The chapter categorizes fraud into three types, supported by ACFE’s 2016 Report to the Nations:
Asset Misappropriation: The most common (85% of cases), with a median loss of $130,000. Examples include cash skimming and inventory theft.
Corruption: Occurs in 37% of cases, with a median loss of $200,000, involving schemes like bribery and conflicts of interest.
Financial Statement Fraud: The least frequent (9%) but most costly, with a median loss of $1 million, often involving revenue overstatement or liability concealment.
Table 1-1 outlines schemes such as billing fraud, payroll manipulation, and expense reimbursement fraud. The ACFE’s Fraud Tree classifies these into subcategories, aiding detection and investigation.
The chapter organizes content into seven modules:
Module 1: Defines fraud, its legal elements, and common schemes.
Module 2: Explores forensic accounting’s role versus fraud examination.
Module 3: Details technical, investigative, and communication skills for professionals.
Module 4: Compares auditing, fraud examination, and forensic accounting.
Module 5: Analyzes fraud’s societal costs and ACFE statistics.
Module 6: Introduces forensic investigation techniques.
Module 7: Covers fraud examination processes, including prevention and detection.
Forensic accountants and fraud examiners require:
Technical Competence: Knowledge of accounting, auditing, and finance.
Investigative Skills: Evidence collection and critical thinking.
Communication: Clear reporting and courtroom testimony.
The Crazy Eddie case, led by Eddie Antar, is a seminal example of retail fraud in the 1980s electronics industry. Eddie Antar revolutionized consumer electronics by breaking price-fixing norms, offering discounted merchandise, and building customer loyalty. However, the company’s culture fostered widespread fraud, driven by greed and a disregard for legal and ethical standards.
The fraud unfolded over nearly two decades, as detailed by Sam E. Antar, the former CFO and a CPA:
1969–1979 (Skimming Phase): The Antar family skimmed profits to evade taxes, underreporting cash sales and pocketing sales tax. Employees, often family members, were paid off the books, reinforcing a culture of loyalty and secrecy.
1979–1983 (Pre-IPO Phase): Skimming was gradually reduced to inflate reported income, preparing Crazy Eddie for its initial public offering (IPO) on September 13, 1984.
1985–1986 (Stock Inflation Phase): Post-IPO, the company falsified financials to boost stock prices, allowing insiders to sell shares at inflated values. Tactics included fictitious revenue and fraudulent asset valuations.
1987 (Cover-Up Phase): As losses mounted, fraud focused on concealing prior schemes, using tactics like money laundering and concealed liabilities.
Crazy Eddie’s fraud was enabled by:
Distraction Tactics: Employees wined and dined auditors to disrupt audit procedures, creating “controlled chaos” to rush audits and limit scrutiny.
Exploiting Auditor Weaknesses: Auditors failed to verify sales transactions or check deposits, missing that funds came from skimmed money rather than legitimate sales.
Cultural Loyalty: The Antar family’s tight-knit group fostered loyalty, making fraud harder to detect compared to economically motivated frauds like Enron.
The fraud cost investors and creditors hundreds of millions, leading to bankruptcies and job losses. Sam Antar emphasized greed as the primary motive, rejecting the fraud triangle’s rationalization component. He advocated for rigorous verification over trust, criticizing generic audit programs and urging auditors to use public records and media to identify inconsistencies. The case highlighted the need for robust internal controls and proactive fraud detection, influencing modern auditing standards like Sarbanes-Oxley.
The ACFE estimates global fraud costs at $3.7 trillion annually. Key findings include:
Detection Methods: Tips (e.g., whistleblowing) detect 39.1% of frauds, followed by internal audits (16.5%).
Perpetrator Profiles: Higher authority correlates with larger losses (e.g., executives cause $703,000 median losses). Males cause higher median losses ($187,000) than females ($100,000).
Concealment: Document-based methods (e.g., falsified records) remain prevalent.
Enron (2001): Executives like Ken Lay and Jeff Skilling manipulated financials, leading to a $60 billion collapse, $2 billion in pension losses, and thousands of job losses. Whistleblower Sherron Watkins exposed the fraud.
Wal-Mart’s Thomas Coughlin: A senior executive falsified invoices for personal expenses, highlighting fraud even among high earners.
Effective corporate governance, including boards of directors and audit committees, is critical for fraud prevention. The Sarbanes-Oxley Act (2002) strengthened oversight, mandating internal control assessments and whistleblower protections.
The IIA, AICPA, and ACFE recommend:
Written fraud risk policies.
Targeted risk assessments.
Prevention and detection techniques.
Robust reporting processes.
Forensic accounting draws on disciplines like criminology, cyberforensics, and psychology, creating diverse career paths (e.g., FBI agent, internal auditor).
Certified Fraud Examiner (CFE): Administered by ACFE, recognized by the FBI and DoD.
Certified in Financial Forensics (CFF): An AICPA credential for forensic accounting expertise.
Certified Anti-Money Laundering Specialist (CAMS): Focuses on preventing money laundering.