Fraud And Forensics- Two New F-Bombs And What They Mean To You

Preface: If you are embarking on a career in public accounting it is imperative to stay current with the latest accounting pronouncements. This is something that you will hear me say again and again. The importance of this cannot be understated. The industry is changing at a pace never before seen. In these pages I will summarize mission-critical accounting developments in hopes of presenting them in a manner that is effective for the new accounting elite.

Fraud (n): An intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right. A false representation of a matter of fact, whether by words or by conduct, by false or misleading allegations, or by concealment of that which should have been disclosed.

Fraud. It happens. In fact, not only does fraud occur in limited circumstances, but rather it has been recently revealed that fraud is occurring pervasively. A February 2008 article in the CPA journal recently sited statistics that are jaw-dropping:

- The Association of Certified Fraud Examiners' (ACFE) 2006 "Report to the Nation on Occupational Fraud and Abuse" estimated that a typical organization loses 5% percent of its annual revenues to fraud, or about $4,500 per employee each year

- Restatement of financial statements almost doubled from 2004 (616) to 2005 (1,195), representing almost 8.5% of U.S. publicly traded companies

The causes of fraud are many. The CPA Journal cites the most common sources as a lack of internal control, the need to maintain an expensive lifestyle and pressure to meet internal or external demands and expectations. These actions are blamed on ignorance, rationalized away in the perpetrators minds and even resulting from just plain stupidity. Whatever the cause, auditors must be on notice.

What does this mean to the aspiring auditor? In a word: everything. If you are in auditor, fraud will become your responsibility. According to the standards adopted by the Public Company Accounting Oversight Board (PCAOB), AU section 110.02, (Responsibilities and Functions of the Independent Auditor) "The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud."

Audits are performed on a risk assessment and cost-benefit analysis. Due to the crushing time and budget constraints, many audit firms rely on standard check-lists of audit procedures with little or no objective evaluation of a specific client's fraud risk. The CPA Journal sites one hilarious anecdote that lends itself extremely well to this problem:

an external auditor giving the walk through checklist to an employee of the company and asking the employee to fill it out!

Forensic Accounting (n): Application of accounting methods to the tracking and collection of forensic evidence, usually for investigation and prosecution of criminal acts such as embezzlement or fraud. (business dictionary.com).

While much more expensive than a traditional audit, a forensic accounting just may be the key to cracking the fraud code. Unlike a traditional audit, forensic accounting focuses on a specific aspect of the books and may examine each item in a series, whereas a financial audit uses sampling to gain an adequate level of comfort. There is no checklist to tick off and move on. Forensic accounting requires an extreme attention to detail and investigative and intuitive skills not often called upon in a traditional financial audit.

In 2006, the Global Capital Markets and the Global Economy: A Vision From the CEOs of the International Audit Networks was published. Containing commentary from all of the Big 4, this report contained insider insights into what is required to combat the recent ramp-up in fraud. It was suggested that public companies be subjected to a forensic audit on a regular or random basis. While this has not yet come to pass, one thing is clear: forensic accounting is booming field.

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