Vijay S. Sampath

Article / Updated 09-15-2022

Financial statement fraud, commonly referred to as "cooking the books," involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs that indicate suspect business accounting practices. These red flags include the following: Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered Unusually high revenues and low expenses at period end that can't be attributed to seasonality Growth in inventory that doesn't match growth in sales Improper capitalization of expenses in excess of industry norms Reported earnings that are positive and growing but operating cash flow that's declining Growth in revenues that's far greater than growth in other companies in the same industry or peer group Gross margin or operating margins out of line with peer companies Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages Unusual increases in the book value of assets, such as inventory and receivables Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction Invoices that go unrecorded in the company's financial books Loans to executives or other related parties that are written off A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.

Cheat Sheet / Updated 03-25-2022

Most of the time, forensic accounting is used when someone commits fraud. For this reason, forensic accountants are often referred to as fraud investigators or fraud examiners. Fraud takes many forms, but no matter how you look at it, fraud is theft; it is profiting by deceit or trickery and involves the theft of funds or information or the use of someone's assets without permission. Business practices are changing, leaving more room for fraudulent activity. Because of this, the new field of forensic accounting is filled with job growth and opportunity.

Article / Updated 06-01-2017

The Limited Liability Company or LLC is an alternative type of business entity. A Limited Liability Company or LLC is like a corporation regarding limited liability, and it’s like a partnership regarding the flexibility of dividing profit among the owners. An LLC can elect to be treated either as a partnership or as a corporation for federal income tax purposes. Consult a tax expert if you’re facing this choice. The key advantage of the Limited Liability Company (LLC) legal form is its flexibility, especially regarding how profit and management authority are determined. For example, an LLC permits the founders of the business to put up, say, only 10 or 20 percent of the money to start a business venture but to keep all management authority in their hands. The other investors share in profit but not necessarily in proportion to their invested capital. LLCs have a lot more flexibility than corporations, but this flexibility can have a downside. The owners must enter into a very detailed agreement that spells out the division of profit, the division of management authority and responsibility, their rights to withdraw capital, and their responsibilities to contribute new capital as needed. These schemes can get very complicated and difficult to understand, and they may end up requiring a lawyer to untangle them. If the legal structure of an LLC is too complicated and too far off the beaten path, the business may have difficulty explaining itself to a lender when applying for a loan, and it may have difficulty convincing new shareholders to put capital into the business.

Article / Updated 03-26-2016

Fraud can be a huge problem for a business or a government entity, and that problem is growing. Most frauds involve financial matters, so the most logical people to investigate them are accountants. Forensic accountants are specially trained to investigate and report fraud in relation to legal cases. If you want to tap into this growing career field, here are some courses to take and certifications to consider so you can be at the top of the forensic accounting pack. You want to first study accounting, of course. Taking a variety of courses in financial and advanced accounting, as well as one or two courses in auditing, is essential. Then, you want to supplement your accounting knowledge with other courses: Forensic accounting: If your school has a forensic accounting course, take it! You'll learn about forensic techniques, internal controls, and legal issues. Computers: You must be proficient in such common programs as Word, Excel, Access, and PowerPoint. When you investigate fraud, you use these programs to perform your analysis, write reports, and present your findings. Also, your targets (individuals and companies that you investigate) use these programs, and you must know how to navigate through complex files and find the frauds. You also need to know about accounting software (such as QuickBooks, Peachtree, SAP, and Oracle) because your targets will keep their accounting records using such software. Law: Knowing business law is invaluable for a forensic accountant so you can know if certain transactions are legal and be familiar with the Uniform Commercial Code (a federal act that governs sales and other commercial transactions throughout the United States). Knowing the basics of civil and criminal law is useful as well. Statistics: Knowing statistics and the principles of chance or odds will help you determine the true rate of errors and defalcations (the amount of money that has been misappropriated) in the transactions you examine. Economics: Understanding incentives that lead people to commit fraud requires knowing something about economics. Behavioral economics is a growing field today. Additionally, knowing economics helps in quantifying damages in civil litigation. Psychology: Accounting is as much about people as it is about numbers. Clients tell accountants about their problems with employees, customers, spouses . . . You need to learn how to handle being a confidant and advisor. Ethics: When you encounter situations where someone's actions are within the limits of the law but are still wrong, what do you do? A study of ethics can help. Languages: Never underestimate the value of speaking a second (or third or fourth) language. If a criminal speaks a language other than English, the investigator should as well. Criminology: Studying crime, criminals, and corrections will help you understand how the fraudsters you are up against work, why they do what they do, and how they interact with the people around them.

Article / Updated 03-26-2016

Businesses lose huge sums of money each year to fraud committed by their employees. Small businesses and large businesses alike must establish strong internal controls to prevent employee fraud, whether it involves employees stealing company inventory, embezzling cash, or fudging expense reports. Here are some crucial steps a business can take to deter employee fraud: Set the right tone from the top of the company. Make sure company managers and board members act honestly and (as much as possible) transparently. If employees suspect shady dealings at the top of the company, they're more likely to justify committing fraud themselves. Establish a segregation of duties policy. Keep accounting tasks and the handling of cash or business assets completely separate. Someone who works a cash register or books checks received in the mail should not also be tallying accounts receivable in the company's financial reports. Establish strict policies for accessing company assets, such as business inventory. That way, if inventory starts disappearing, you have a clear list of candidates for the theft. Require more than one signature on transactions of a significant amount. Depending on the size and structure of your business, that may mean that checks over $100 or over $1,000 require two signatures from company managers and/or board members. Decrease opportunities for employee theft. If you discover a case of theft, put new controls in place to prevent it from recurring. Respond quickly and justly to an incidence of employee fraud. You want other employees to see that theft and other fraud will be punished. Try to gauge employee satisfaction regularly. Keep your eyes and ears open, and employ formal survey tools if necessary to get a sense of how your employees feel about working for the company. Conduct background checks on employees before they join the company. You can likely identify some bad apples even before they join your organization. Rotate duties of employees and make sure that they take vacations. Frauds committed by employees are usually detected when they are on vacation.

Article / Updated 03-26-2016

To become a forensic accountant, no government-issued license is required. However, certifications related to forensic accounting and fraud investigation are issued by several professional associations. Here are some of the certifications you may wish to pursue en route to becoming a forensic accountant: Certified Public Accountant (CPA): You don't have to be a CPA to be a forensic accountant, but this certification is very valuable. These three letters say that you are an accountant who has had a rigorous education and passed one of the toughest licensing examinations in the United States. Also, the Association of Certified Public Accountants issues a Certified in Financial Forensics (CFF) credential for forensic accountants. Certified Forensic Examiner (CFE): The CFE is arguably the most recognized credential related to forensic accounting. The Association of Certified Fraud Examiners (ACFE) issues the CFE designation; visit www.acfe.com. Certified Forensic Financial Analyst (CFFA): The CFFA designation is sponsored by the National Association of Certified Valuation Analysts (NACVA), which is best known for its Certified Valuation Analyst (CVA) certification: a certification in the valuation of businesses. Business valuations are often performed for forensic purposes: matrimonial disputes, torts, and litigation with the IRS related to estate and gift taxes. See www.nacva.org.

Article / Updated 03-26-2016

Making profit generates cash flow — any business owner knows that. What may not be known, however, is that the actual increase in cash during a given period is invariably lower or higher than the profit number. Understanding how cash flow relates to profit is critical for business owners and accountants. The following points illustrate how cash flow relates to profit: The amounts of cash flows during the period rarely are equal to the revenue and expense numbers in the P&L (profit and loss) report for the period. Actions that lower cash flow: Increasing accounts receivable and inventory; decreasing accounts payable and accrued expenses payable. Actions that raise cash flow: Decreasing accounts receivable and inventory; increasing accounts payable and accrued expenses payable. Depreciation expense isn't a cash outlay; neither is amortization expense. Unusual losses recorded in the period may not involve cash outlay but rather be write-downs of assets or write-ups of liabilities.

Article / Updated 03-26-2016

The nature of audit evidence refers to the form of the evidence you're looking at during the audit. It should include all accounting documents and may include other available information, such as the minutes of the board of directors meetings. Accounting documents Accounting documents come in two forms: books and records. Here are some examples of books: General ledger: A file of all financial accounts, usually by account number, that shows all events that affected each account during the month. Subsidiary ledger: A file that shows more detailed information than is shown on the general ledger. For example, the accounts receivable subsidiary ledger shows all customers who owe the business money and the amount each owes. Journals: Day-by-day records of transactions. Examples of journals are the cash receipts, cash disbursement, and general journals: All transactions involving cash coming into the business go in the cash receipts journal. This includes cash sales, interest, dividend income, and money the company receives if it sells an asset. Cash disbursement journals show all money paid out in the form of cash, checks or automated debit for accounts payable, merchandise purchases, and operating expenses. The general journal is a catchall journal. Any transactions that don't logically belong anywhere else go here. This includes any accounting adjustments you give the business during the audit. Here are some examples of records (also known as source documents): Invoices from suppliers that show what the business ordered and how much it cost. Z-tapes from cash registers that show daily sales in a retail shop. The Z-tape is the company's version of the cash register tape you receive with your purchase, but the company's Z-tape lists all sales made during the day. Customer invoices that show what customers purchased from the company and how much it cost. Time cards that show how many hours an employee worked during a pay period. Non-accounting evidence In addition to meeting minutes from the board of directors, other non-accounting evidence you look at during the audit includes confirmations from third parties, internal control manuals, and comparable industry standards. (An example of a confirmation from a third party would be sending a letter to a customer verifying the amount it owes your client at year-end.)

Article / Updated 03-26-2016

Transactions are day-to-day accounting events that happen within a company. For example, the company receives a bill from the telephone company and posts it to accounts payable — that's a transaction. When the company pays the bill, that's another transaction. The term classes of transactions refers to the fact that the company's various transactions are divided into categories in its financial statements; like transactions are grouped together. Six management assertions are related to classes of transactions. Four of them closely mirror the assertions represented in the financial statement presentation and disclosure (in the prior section). However, the way the assertions relate to transactions differs slightly from the way they relate to presentations and disclosure, as delineated in the following list: Occurrence: This means that all the transactions in the accounting records actually took place. No transactions are made up or are duplicates. For example, if the client records its telephone bill on the day it's received and then records it again a few days later, that's a mistake: The duplication overstates accounts payable and the telephone expense. Completeness: All transactions needing entry into the books are recorded. The business excludes nothing. For example, the accounts payable clerk's desk drawer doesn't have a pile of unpaid bills waiting for entry into the accounting system. This situation would understate accounts payable and any expenses that relate to the unpaid bills. Authorization: All transactions have been approved by the appropriate member of company management. For example, many companies have restrictions on check-signing authority, stipulating that any check written in excess of a certain dollar amount requires two signatures. Accuracy: The transactions are entered precisely. The right financial statement accounts reflect the correct dollar amounts. The telephone bill is for $125, and the clerk enters it for $125. If the clerk inadvertently transposes the numbers and enters the invoice as $215, that's a failure of the accuracy assertion. Cutoff: You need to keep a close eye on the cutoff assertion. Some clients just love to move revenue from one period to another and shift expenses from one period to another. Make sure all transactions go into the correct year. If the company has a year-end date of December 31 and receives a bill on that date, it can't move the expense into the subsequent year to increase income. A good way to catch problems with the cutoff assertion is to use the subsequent payment test. To do so, select payments made within a month to six weeks after the end of the financial period. Pull the supporting invoices, and check to see whether the expenses are recorded in the appropriate year. Classification: The company records all transactions in the right financial statement account. Say the client has a high-dollar equipment asset purchase. If the clerk assigns that transaction to repairs and maintenance expense on the income statement instead of the balance sheet asset account, that action definitely affects the correctness of both the income statement and balance sheet and misleads users of the financial statements.

Article / Updated 03-26-2016

To judge the reliability of a client's internal control procedures, you first have to be aware of the five components that make up internal controls. For each client, you need to understand each component in order to effectively plan your audit. Your understanding of these components lets you grasp the design of internal controls relevant to the preparation of financial statements. That understanding also enables you to verify whether each internal control is actually in operation. Many models have been established to help your clients identify and offset control risk. The Sarbanes-Oxley Act of 2002 recommends the Committee of Sponsoring Organizations (COSO) model as a means for companies to identify and mitigate risk that can lead to financial misstatement. The COSO model is just one representation that can be used, and at its heart it guides management through the implementation of a control framework that's measurable and targeted at reducing risk. Here are the five components of internal controls: Control environment: This term refers to the attitude of the company, management, and staff regarding internal controls. Do they take internal controls seriously, or do they ignore them? Your client's environment isn't very good if, during your interviews with management and staff, you see a lack of effective controls or notice that previous audits show many errors. Risk assessment: In a nutshell, you should evaluate whether management has identified its riskiest areas and implemented controls to prevent or detect errors or fraud that could result in material misstatements (errors that cause net income to change significantly). For example, has management considered the risk of unrecorded revenue or expense transactions? Control activities: These are the policies and procedures that help ensure management's directives are carried out. One example is a policy that all company checks for amounts more than $5,000 require two signatures. Information and communication: You have to understand management's information technology, accounting, and communication systems and processes. This includes internal controls to safeguard assets, maintain accounting records, and back up data. For example, to safeguard assets, does the client tag all computers with identifying stickers and periodically take a count to make sure all computers are present? Regarding the accounting system, is it computerized or manual? If it's computerized, are authorization levels set for employees so they can access only their piece of the accounting puzzle? For data, are backups done frequently and kept offsite in case of fire or theft? Monitoring: This component involves understanding how management monitors its controls and how effectively. The best internal controls are worthless if the company doesn't monitor them and make changes when they aren't working. For example, if management discovers that tagged computers are missing, it has to put better controls in place. The client may need to establish a policy that no computer gear leaves the facility without managerial approval.