Fraud happens more often than you may think. In fact, over $7 billion of total losses has occurred due to fraud within the workplace alone.
The aftermath of fraud can leave an organization reeling, regardless of size. The extent of the damages can have a lasting impact on an organization and recovery can be difficult. That’s where forensic accounting and forensic audit come in to play.
Employee fraud and embezzlement cost American companies $50 billion annually, much of that coming out of the pockets of small business owners. It’s often an employee who you trust the most who turns out to be the most untrustworthy. Listen to Monday Morning Radio podcast to hear three experts on employee theft – an investigator (from Eide Bailly), a litigation attorney, and a prosecutor -- for a panel discussion on how to prevent, detect, and respond to dishonest employees.
What is fraud?
Fraud is defined as any intentional or deliberate act that deprives another of something, typically property or money, through deception.
Fraud does not distinguish between for-profit or non-profit organizations. It can happen at any level of an organization and to any size organization. In fact, small businesses are often harder hit by fraud, losing almost twice as much per fraud scheme.
Why wasn’t the fraud caught?
On average, a fraud scheme can go undetected for 16 months. If you’re an organization that requires a financial audit, a key question on your mind is: why didn’t your auditors catch the fraud?
When organizations hire an auditor, they are asking them to validate their bookkeeping as it relates to their financial statements. Your auditor is utilizing their expertise to verify that your organization’s financial statements are not materially misstated. The amount considered material is determined by your auditor and can depend on several factors.
Your auditor will maintain professional skepticism and objectivity throughout the audit and will perform procedures in response to identified fraud risks. However, their primary concern is making sure your financial statements are presented fairly to stakeholders. In fact, in a large portion of fraud cases we examine, the fraud is reflected in the financial statements. In these instances, they are typically concealed within the organization’s expenses by the fraudster. It is the hidden nature of fraud that makes it so difficult to identify.
Even though financial statement audits are not designed to identify immaterial employee theft, they still can and sometimes do. In fact, having a financial statement audit is always a better option for fraud prevention than not having a financial statement audit.
While preventing a fraud from occurring provides a greater return on investment, the likelihood is high that most organizations will face a fraud situation at some point. When that happens, it’s important to know the impact of a forensic audit and forensic accounting.
When fraud happens, there’s much to uncover.
When do I need forensic accounting?
To locate or identify potential fraud, organizations can hire forensic accountants to assist with forensic audit, forensic examinations, fraud risk assessments or due diligence fraud exams. Forensic accountants can determine fraud has been committed, what pressures led to the crime and what assets need to be recovered.
A certified forensic accountant is a trained professional to help clients navigate the court system, whether it be civil or criminal. An experienced forensics accountant utilizes financial records in order to help uncover illegal financial activity, as well as serve as a witness should a court case arise.
Forensic accountants will conduct a forensic audit, or an “examination of financial records to find any illegal activity.” In other words, forensic audits are conducted with the assumption that matters will appear in court, or in some form of mediation.
Believe it or not, many forensic accountants are never called to testify; the work they conduct for their client provides leverage in negotiations, and many times an agreement is reached before the inside of the courtroom is ever seen.
Want to know where the money went?
Who can benefit from forensic accounting or a forensic audit?
Forensic accounting goes beyond just the numbers in a case and instead seeks to uncover the truth behind fraud and schemes.
Here are a few examples of how an organization can benefit from a forensic accountant’s help.
Financial Institutions & Auto Dealerships
The bank president was concerned about an auto dealership. The bank had a significant amount of depositor’s money invested as a line of credit to the local car dealer. Periodic visits to the dealer to validate cars associated with the loans could not be personally inventoried. The dealer would profess that the vehicles in question were always “at the car wash” or “out for a test drive” or some similar excuse. Monthly reports to the bank were also creating suspicion that the dealership was paying too much money for vehicles in the inventory.
The dealership was a family owned staple in the community. More recently, the reins had been handed down from retiring parents to a child to operate the business.
It became apparent to the bank president that perhaps there was out of trust selling and other issues that needed investigation. He called Eide Bailly’s Forensic Accounting & Valuation unit to help.
The investigation revealed that the bank had been defrauded of more than $1.5 million by various means. False monthly records to the bank were documented. Several employees were identified as being part of the scheme. They were duped into helping the fraud by the owner.
Computer forensics investigations helped to identify the pressure points that resulted in the fraud:
All these things created pressure on the dealership owner. Purchases on eBay, Amazon, and other online retailers could easily be documented from computer data through forensic tools, as could emails between those involved in the fraud. The dealer eventually was charged and convicted of bank fraud in federal court.
The construction business was going well. However, total receipts were down. The owner could not figure out why the large amount of red ink was on his ledger. A review by Eide Bailly forensic accountants quickly identified the company accountant as the reason. Using one of several company checking accounts, he was embezzling more than $160,000 a year. To complete the case, computer forensics was needed to identify pressure for the theft and to try and determine if assets were recoverable.
The search began on the internet for digital information. Using the personal email of the accountant, public social media posts were found indicating that the accountant’s leisure time involved significant visits to “gentleman’s” clubs and visits to hotel rooms with the dancers for prostitution purposes. In one post, he acknowledged that he supplied one performer with $3,000 in one month for her various personal needs. Bank records showed the company checks being deposited and money withdrawn from the ATM machines at the club he preferred to visit.
The digital forensics investigation revealed that the accountant had numerous 401K loans outstanding. This information provided to the forensic accountant discovered that he was using company checks to repay the loans. Local hotel reservation for his trysts with the dancers were documented, as were other details on the company losses. In short, there were no recoverable assets to be pursued.
How do I work with a forensic accountant?
Forensic accountants can deal with any number of allegations of misconduct or fraud, including embezzlement, employee theft, false vendors, ghost employees, improper payroll, exaggerated overtime or expenses and more.
Many times, a forensic audit or accounting engagement will begin with a simple question: what happened to all the money? The scope of the work can then change directions due to new information or detection of other potential fraudulent schemes. This flexibility allows forensic accountants to change focus quickly to resolve concerns and figuring out what happened to their resources.
The cost of fraud is so much more than meets the eye.