40 Current Issues: Forensic Accounting, Money Laundering & Financial Intelligence

Ms. Deepika Gautam

LEARNING OBJECTIVES

This module aims to provide basic knowledge of Forensic Accounting, it’s worth and limitations and the role played by forensic accountant. At the end of the module, the students should be able to discuss the basic concept of Money Laundering and its various processes and may be able to identify the economic impacts of money laundering and different Stages of Money Laundering as a attempt has been made to give a holistic overview of money laundering standards and issues. Students may also learn that how in the era of competition managers are expected to use financial data to make decisions, allocate resources, and budget for profit with a method called Financial Intelligence, it is the intellectual use of managing key elements of business.

A. Forensic Accounting: Introduction:

The term “Forensic” means suitable for use in a court of law and was first used in 1946 by Maurice E. Peloubet, a partner in a New York accounting firm and it is unique in that it combines accounting with investigation. It is the practice of utilizing accounting, auditing, and investigative skills to assist in legal matters. It is one of the specialty practice area of accountancy that describes engagements that result from actual or anticipated disputes or litigation. Forensic accounting is the application of accounting principles, theories, and disciplines to facts or hypotheses at issue in a legal dispute, and encompasses every branch of accounting knowledge. Forensic accounting can be considered as the third eye of the corporate culture.

Forensic Accounting involves application of special skills like: Accounting, Auditing, Finance, Quantitative methods Forensic Accounting involves investigative skills: To collect, Analyze, Evaluate, Interpret and Communicate Findings.

In simple words Forensic accounting refers to the use of accounting, auditing and investigative knowledge to form a suitable analysis of a business. A Forensic Investigation may be grounded in accounting, medicine, engineering or some other discipline.

Definitions:

“Belonging to, used in or suitable to courts of judicature or to public discussion and debate.” Webster’s Dictionary.

“Forensic Accounting provides an accounting analysis that is suitable to the court which will form the basis for discussion, debate and ultimately dispute resolution”

Alan Zysman.

UNIQUENESS OF FORENSIC ACCOUNTING:

I.  Reviewing all financial transactions for compliance with standard accounting procedures and approvals.

II. Completing analysis of financial disbursement transactions in the accounting system to determine if they are normal or outside company policy and, thus, possibly fraudulent.

III.Reviewing Journal Ledger and Financial Reporting System transactions for possible improper

IV.classification or manipulation of data or accounts and its impact on the balance sheets.Examining warranty claims or returns for patterns of fraud or abuse.

V.Helping estimate the economic damages and the resulting insurance claims which may arise due to natural calamities such as fires or other natural disasters.

VI.Evaluating or confirming business valuation in Amalgamation, Internal Reconstruction and External Reconstruction.

Forensic Accountants: The Bloodhounds of Book-keeping

Comparing with a normal accountant who acts like a watchdog, a forensic accountant acts like a bloodhound. They look behind the facade and do not accept financial records at their face value. These bloodhounds inhale fraud and criminal transactions which may occurred in bank, corporate entity or from any other organization’s financial records. They hound for the conclusive evidences and find out the misstatements calculatingly. Forensic accountants make use of business information and financial reporting systems, accounting and auditing standards and procedures, evidence gathering and investigative techniques, and litigation processes and procedures to perform their work. Now-a day’s Forensic accountants are playing key role by designing and performing extended procedures as part of the statutory audit, acting as advisers to audit committees, fraud deterrence engagements, and assisting in investment analyst research. Forensic accountant takes a more proactive, skeptical approach in examining the company’s books of Accounting and is often asked to serve as an expert witness for a lawsuit or criminal case in a court. A Forensic Accountant must be open to consider all alternatives, scrutinize the fine details and at the same time see the big picture. In addition, a Forensic Accountant must be a good listener and have effective communication skills.

WORTH OF FORENSIC ACCOUNTING

Forensic accounting refers to the use of accounting, auditing and investigative knowledge to form a suitable analysis of a business. It involves a thorough analysis of accounting data to arrive at the reality of the issue being investigated and to ascertain whether all the principles have been followed or not. Forensic accounting helps investors in making portfolio decisions i.e., whether to invest in a particular business or not and various other decisions related to projects.

(i) Detection and Prevention of Fraud:

Fraud is quite common in large size organizations where the number of daily financial transactions is huge. In such an environment, an employee can easily be involved in counterfeit without being caught. Forensic accounting helps in analyzing whether the company’s accounting principles are followed or not, and whether all the transactions are clearly stated in the books of accounts. Any deviation observed in the books of accounts can help in detecting scam, and necessary measures can be taken so that it may not repeat in future.

(ii) Helpful in Making effective Investment Decisions

As forensic accounting helps in SWOT (Strength, Weakness, Opportunity and Weakness) analyzing of a business, it provides a path for interested people to make thoughtful investment decisions. A company dealing with fraud or scam is definitely not a good option for investment. Therefore, the reports of forensic accountants act as a guide for potential investors of a company. Many organizations also apply for loans from various financial institutions. By performing an analysis, such institutions can come to a decision on whether they should fund a company or not.

(iii) Framing effective Economic Policies

Forensic analysis acts as a reference for the government to formulate effective economic policies that would be able to curb various fraudulent activities in the future. With the help of forensic analysis, the government can strengthen the economy and prevent such illegal activities in the country.

(iv) Creating Job Opportunities

Forensic accounting acts as a bridge between unemployment and employment, as it not only involves regular accounting activities, but also involves identification, analysis, and reporting of the findings during an audit. The acceptance of reports generated by a forensic accountant by the court of law, gives them an upper hand as compared to normal accountants. Good forensic accountants are in high demand and can easily draw a good starting salary.

(v) Other Worth of Forensic accounting

a) It involves a thorough analysis of accounting data to arrive at the reality of the issue being investigated.

b) The information is used for legal reviews or public debates with the aim of resolving disputes.

c) Unlike accounting, which is quite monotonous, forensic accounting is an interesting career path and it is considered as employment generator.

LIMITATIONS OF FORENSIC ACCOUNTING

(i) Privacy:

The privacy of confidential matters as well as financial statements cannot be maintained since the scrutiny of a company’s financial records is done by an external forensic accountant. It is true that their code of ethics clearly mentions that forensic accountants and other members involved in the scrutiny must not engage in disclosing confidential data to outsiders, but the possibility of disclosure cannot be stopped.

(ii) Coercion and Negative Publicity:

If the analysis of a company’s financial statements points out the involvement of a particular person in fraudulent activities, there is a significant chance that the person will try to threaten the company to safeguard himself from the trial. Also, any trial that confirms a fraud happening in the company comes under public eye then it may have direct effect on the goodwill of the company and if the goodwill is effected then nobody will be interested to invest in such company’s which ultimately led to decrease in the value of share.

(iii) Very Expensive:

Forensic accounting can be an expensive affair as it involves analyzing of accounts through high-end accounting software. Moreover the fees of the forensic accountants are usually very high. So this can be adopted by only large size organizations and can be a matter for concern for small size organizations.

(iv) Losing Employee’s faith:

Employees are considered to be assets of any organization because it is the only alive factor among all 5M’s (Men , Material, Machine, Method and Money) and they feel offended when they come to know that their job is under scrutiny by a third person. Feeling may arise in the minds of employees that their employer does not have faith in them and lost trust can be difficult to regain.

(v) Possibility of Risk:

Forensic accounting involves detection of fraudulent activities and their representation in a court of law. It exposes the forensic accountant to criminal acts like blackmail and threats from the individuals. There are also risks of adverse publicity to the company which restricted the future investments.

But despite of all the disadvantages as stated above forensic accounting, will continue to be an important part in the era of competitive business. This is because it helps organizations and individuals to figure out whether their financial accounts are accurate or fabricated to hide illegal activities going on within the organization.

Difference Between Auditing and Forensic Accounting:

Auditing	Forensic Accounting
Auditing is specifically checking to see if the accounts are maintained as per the stated policies or not.	Forensic Accounting is analytical.
Auditing is designed to provide an overall opinion on final accounts.	Forensic accounting is much more detailed and focused.
Auditing has a limited review for particular issues, particularly “negative” issues.	Forensic accounting understands a specific issue.
Auditing do not involve in resolving litigation.	Forensic accounting often used in resolving disputes, including litigation support.
Auditing simply means the opinion of Independent auditors on preparation of financial statements by the management of the company in context of statutory audit.	Forensic accounting simply effective evidences gather by auditors which “suitable for use in a court of law” and mostly used by govt. agencies.

B.  MONEY LAUNDERING:

Money laundering is the common word used to describe the process by which criminals disguise the original ownership and control of the proceeds of criminal conduct. It is an act of laundering in circumstances where a person is engaged in an arrangement (i.e. by providing a service or product) and that arrangement involves the proceeds of crime. These arrangements include a wide variety of business relationships e.g. banking, fiduciary and investment management. The objective of the money laundering is to take the profit out of crime. The rationale for the creation of the offence is that it is wrong for individuals and organizations to make possible the commission of such crimes by providing financial services to them. Such activity damages the financial-sector institutions that are critical to economic growth, reduces productivity in the economy’s real sector by diverting resources and encouraging crime and corruption, which slow economic growth.

There are two key elements to a money laundering offence:

1. The necessary act of laundering itself i.e. the provision of financial services; and

2. A requisite degree of knowledge or suspicion (either subjective or objective) relating to the source of the funds or the conduct of a client.

Different Stages of Money Laundering:

There are three stages involved in money laundering which are described as follows:

(i) Placement: This is the movement of cash from its original source. Occasionally the source can be easily disguised or misrepresented. This is followed by placing it into circulation through financial institutions, casinos, shops and other businesses, both national and international. The process of placement can be carried out through many processes including:

a. Currency Smuggling: The physical illegal movement of currency and monetary instruments from one country to another country.

b. Bank involvement: When a financial institution are owned or controlled by unscrupulous individuals or organized crime groups.

c. Securities Brokers: Through structuring large deposits of cash in a way that disguises the original source of the funds.

d.Asset Purchase: It is a classic money laundering method.

(ii)  Layering: The purpose of layering is to make it more difficult to detect and uncover a money laundering activity. It is meant to make the trailing of illegal proceeds difficult for the law enforcement agencies. This may involves:

a. Cash conversion: This involves the use of banker’s drafts and money orders into monetary instruments

b. Material Assets: Purchasing through illicit funds can be resold locally or abroad.

(iii) Integration: This is the movement of previously laundered money into the economy mainly through the banking system and these earnings appear to be normal business earnings. This is dissimilar to layering, for in the integration process detection and identification of laundered funds is provided through informants. This may include:

a. Property Dealing: The sale of property to integrate laundered money back into the economy.

b.Front Companies and False Loans: Criminals lend themselves their own laundered proceeds in an apparently legitimate transaction.

c.Foreign Bank Complicity: It represents a higher order of complexity and presents a very difficult target for law enforcement.

 C.FINANCIAL INTELLIGENCE

Since the mid-1980s, the need for a modern anti-money-laundering strategy has become widely accepted globally. The negotiations of the 1988 United Nations Convention against Illicit Traffic in Narcotic Drugs and Psy-chotropic substances can be seen as the starting point of financial intelligence. It is the process of receiving data, converting it, and disseminating it, for the purpose of enhancing key decision making Depriving criminal elements of the proceeds of their crimes has increasingly been seen as an important tool to fight against drug trafficking and all serious crimes. Progress in this area is becoming a critical element in fighting organized crime, corruption, and the financing of terrorism, and maintaining the integrity of financial markets. As countries developed their anti-money-laundering strategies and found that law-enforcement agencies had limited access to relevant financial information, it became clear that the strategy required them to “engage the financial system in the effort to combat laundering while, at the same time, seeking to ensure the retention of the conditions necessary for its efficient operation.” Organizations also found that implementation of a system requiring disclosures of suspicious transactions on the part of financial institutions created the need for assessing and processing these disclosures.

From the above image it can be concluded that Financial Intelligence involves different stages which are described as follows:

Stage1 Review the past: The past performance of the company helps the manager to decide what went well, what went wrong and what can be improve.

Stage 2 Forecast The Future: Forecasts are vital to planning, so for the smooth planning it is important to forecast the future so that various policies can be framed.

Stage 3 Set Strategies and Plans: Strategic planning is critical to business success and it sits above and informs all other plans in the organization. Strategic planning can provide an overall strategic direction to the management of the organization.

Stage 4 Set Annual Budgets: Budgets usually represent a detailed analysis of how a company expects to spend money in future time periods. Using an annual budget process restrict the amount of time companies spend creating and managing capital resources.

Characteristics:

1. Financial intelligence is only one part of the organizational which may include its employees, systems, physical and intellectual property, and customer and supplier relationships.

2. It will provide the organization with a competitive advantage on adding worth to customers (who are considered to be a king of the market) by either using less or providing more.

3. Financial intelligence is able to reduce uncertainty as well as speed up the feed-back loops to enable better understanding of cause and effect relationships.

4. Financial intelligence processes should be considered a key part of the governance framework.

5. Sufficient management time and resource should be allocated to planning, establishing, monitoring and interpreting various financial intelligence processes.

6. The financial intelligence is an aid to the top management in an organization in understanding tactics in framing strategies.

FUNCTIONS:

a.To ensure that professionals fulfilling obligations in respect of double checking, customer identification, book-keeping and reporting obligations.

b.To establish and maintain an effective policy and strategies to oversee compliance and to provide high quality, financial intelligence for use in the fight against crime, money laundering and terror finance.

c.To protect the integrity and stability of the company’s financial systems.

d.It strives to develop a strong legal basis to combat money laundering, financing of terrorism activities and other financial crimes to protect the stability of the financial system, by monitoring and supervising the anti-money laundering and anti-financing of terrorism controls.

e.To produce intelligence products that incorporates the analysis of relevant classified information.

f.Financial intelligence units are agencies that receive reports of suspicious transactions from financial institutions and other persons and entities, analyze them, and disseminate the resulting intelligence to local law-enforcement agencies to combat money laundering.

g. It will be only one part of overall organization knowledge and provide the organization with competitive advantage to be associated with overall organization strategy.

SUMMARY:

Forensic accounting refers to the use of accounting, auditing and investigative knowledge to form a suitable analysis of a business. It can be consider as the private eyes of the corporate culture as it involves the application of special skills in accounting. As forensic accounting helps in SWOT (Strength, Weakness, Opportunity and Weakness) analyzing of a business, it provides a path for interested people to make thoughtful investment decisions. Comparing with a normal accountant who acts like a watchdog, a forensic accountant acts like a bloodhound. They look behind the facade and do not accept financial records at their face value. Money laundering is the common word used to describe the process by which criminals disguise the original ownership and control of the proceeds of criminal conduct. It is an act of laundering in circumstances where a person is engaged in an arrangement (i.e. by providing a service or product) and that arrangement involves the proceeds of crime. Financial intelligence is an important part of overall organization knowledge and one that can provide strong benefits to the bottom line if gathered and used effectively. Financial intelligence must however be treated as a strategic resource, must give the organization a competitive advantage, and needs to be developed in a systematic way to ensure the best use of resources. Financial intelligence has uses in both tactical and strategy areas but organizations need to ensure its use is appropriate for each purpose.

SUGGESTED READINGS:

• Singleton .W Tommie & Singleton Aaronj “Fraud Auditing and Forensic Accounting”
• Howard Schilit and Jeremy Perler, Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd Edition Hardcover – May 5, 2010.
• Thomas R. Ittelson, Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports Paperback – August 15, 2009.
• John Madinger, Money Laundering: A Guide for Criminal Investigators, Third Edition 3rd Edition ISBN-13: 978-1439869123