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9/30/2015 INCORPORATING "CUTTING EDGE" FORENSIC ACCOUNTING TECHNIQUES / METHODOLOGIES INTO COLLEGE / UNIVERSITY AUDITING. Presenter : Collin A. A. Greenland Executive Chairman KAIZEN MANAGEMENT CONSULTANTS Wednesday, 9/30/2015, 1:10:00 PM‐2:50:00 2015 ANNUAL CONFERENCE Indianapolis To Sensitize / Review the essential aspects of Forensic Accounting, Definition, Nature, etc. To Expose / Review the Need / Demand for Forensic Accounting Generally, and Specifically for University Internal Auditors. To Expose and Explain to Attendees the types of Forensic Assignments / Applications, the Main Elements of a Forensic Audit, and How it is Conducted. To Introduce “Cutting Edge” Forensic Accounting Methodologies, Techniques and Technology into University Internal Auditing. 2015 ANNUAL CONFERENCE Indianapolis 1 9/30/2015 WHAT IS FORENSIC ACCOUNTING ? DEFINITION 1. : The application of financial skills and an investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As a discipline, it encompasses financial expertise, fraud knowledge, and a strong knowledge and understanding of business reality and the working of the legal system. (SOURCE : Fraud Auditing and Forensic Accounting : New Tools and Techniques, by Jack Bologna and Robert J. Lindquist, John Wiley & Sons, New York, 1987. 2015 ANNUAL CONFERENCE Indianapolis WHAT IS FORENSIC ACCOUNTING (CONTD.)? DEFINITION 2. : Forensic accounting (or auditing) is the integration of accounting, auditing and investigative skills in order to provide an accounting analysis suitable for the resolution of disputes (usually but not exclusively) in the courts. (“Demystifying Forensic Accounting,” by Collin Greenland, The Weekend Observer, Pg. 5, December 7, 2001). 2015 ANNUAL CONFERENCE Indianapolis 2 9/30/2015 WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING Forensic accountants are required to be familiar with legal concepts and procedures and must be able to identify substance over form when dealing with an issue. Forensic engagements usually require the analysis, interpretation, summarization and presentation of complex financial and business-related issues in a manner which is both understandable and properly supported. 2015 ANNUAL CONFERENCE Indianapolis WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING Forensic accountants are required to be familiar with legal concepts and procedures and must be able to identify substance over form when dealing with an issue. Forensic engagements usually require the analysis, interpretation, summarization and presentation of complex financial and business-related issues in a manner which is both understandable and properly supported. 2015 ANNUAL CONFERENCE Indianapolis 3 9/30/2015 WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING According to the American College of Forensic Examiners Institute, (ACFEI) a group of their educators have broken forensic accounting into 75 topics as Follows (in alphabetical order) : 1. Accounting systems and the detection of fraud 2. Analytical procedures 3. Analyzing financial statements 4. Antitrust 5. Bankruptcy 6. Billing schemes 7. Bribery and corruption investigation 8. Business interruption 2015 ANNUAL CONFERENCE Indianapolis WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING 9. Business valuations and cost estimates 10. Check tampering 11. Civil and criminal fraud statutes and regulations 12. Common fraud schemes 13. Compliance with applicable laws and regulations 14. Computers and computer fraud 15. Concealing fraud in accounting 16. Concealment investigative methods 17. Conflicts of interest investigative techniques 18. Conversion investigative methods 19. Corporate governance 20. Criminology and white-collar and economic crimes 21. Cyber fraud and computer topics 22. Detecting management and employee fraud 23. Document collection and analysis 24. Elements of fraud, pressure, opportunity, and rationalization 25. Environmental and personal red flags 26. Expert witness and expert testimony techniques 27 Financial statement fraud 28. Financial reporting process 29. Finding assets and people 30. Forensic accounting practices 31. Forensic and general accounting 32.Forensic and general accounting 32. Fraud auditing methodology 2015 ANNUAL CONFERENCE Indianapolis 4 9/30/2015 WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING 33. Fraud perpetrators and their motivations 34. Fraud prevention and fraud policies 35. Fraud schemes / 36. Fraud statistics 37. Fraud symptoms and computer-aided fraud auditing techniques 38. Fraud symptoms / 39. Fundamentals of fraud 40. Hidden assets 41. Internal control evaluation 42. Interrogation 43. Interview principles and methods to evaluate deception 44. Inventory and asset theft 45. Investigation of financial crimes and legal elements 46. Kiting 47. Knowledge of the legal system 48. Legal elements of fraud 49. Litigation consulting techniques 50. Loss prevention investigation 51. Loss prevention programs 52. Money laundering 53 Occupational fraud 54. Off-book accounting and financial statement fraud 56. Overview of ethics 57. Overview of fraud auditing and fraud investigation 58. Overview of the legal elements of fraud 59. Payroll and expense reimbursement 60. Phases of forensic accounting 2015 ANNUAL CONFERENCE Indianapolis WHAT IS FORENSIC ACCOUNTING (CONTD.)? THE NATURE OF FORENSIC ACOUNTING 61. Principles of ethics and corporate code of conduct 62. Professional liability 63. Resolution of allegation of misconduct 64. Rules of evidence 65. Skills required of the forensic accountant 66. Statistical sampling 67. Tax consequences 68. Techniques in locating hidden assets 69. The civil justice system 70. The criminal justice system 71. Theft and skimming 72. Theft act investigative methods 73. Theory of fraud examination and prevention 74. Trial and cross-examination 75. Who commits fraud 2015 ANNUAL CONFERENCE Indianapolis 5 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING • In 1999, Kessler International, who was named in 2011 as the Forensic Accounting Firm of the Year by ACQ magazine, were quoting (US)$300 / hour for “forensic consultations.” • In 2002 (February 18, 2002) a U.S. News and World Report cover story ranked forensic accounting as the number one most secure career track. The article was entitled “Sherlock Holmes, Meet Enron” and claimed nearly 40% of the top accounting firms were expanding their fraud and forensic services. 2015 ANNUAL CONFERENCE Indianapolis THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) • In fact the journal, Accounting Today in their 2007 survey of the top 100 accounting firms revealed between 77% and 78% citing forensic accounting growth on their radar. 2015 ANNUAL CONFERENCE Indianapolis 6 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) The demand for Forensic Accounting services was further confirmed when one examines the World Statistics of fees earned in 2010 (published by the IAB in January 2011): 2015 ANNUAL CONFERENCE Indianapolis THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) In their “2011 Forensic and Valuation Services (FVS) Trend Survey, the American Institute of CPAs (AICPA) predicted an increase in demand for their services in the next two to five years. These predictions were mirrored by the IBISWorld report, reported that Profits in the profession total $669.8 million and wages total $1.6 billion - Seventy-nine percent of Forensic and Valuation Services professionals participating in that survey predicted an increase in demand for their services in the next two to five years. In 2012, both the Journal of Accountancy and CGMA Magazine senior predicted a strong demand strong for forensic accountants in wake of financial crisis, and stated that Forensic accounting revenue in the United States was expected to grow 6.8% annually over the next five years. 2015 ANNUAL CONFERENCE Indianapolis 7 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) In 2012, IBISWorld reported revenue in forensic accounting in the United States was expected to grow 6.8% annually from $4.3 billion in 2012 to $6.0 billion in 2017, with a 7.0% increase in forensic accounting revenue expected for 2013 alone. In 2014, IBISWorld confirmed that over the previous five years, demand for forensic accounting services surged as financial regulation increased and the number of bankruptcies and corporate restructures rose sharply. Businesses turned to the industry for aid in assessing and correcting the damage inflicted during the recession as well as for assistance with litigation. Though internal competition and competition from other industries' in-house forensic accounting services were forecast to rise over the next five years, growth continue as opportunities arise in niche and emerging markets.... 2015 ANNUAL CONFERENCE Indianapolis THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) Today, forensic accounting is now regarded worldwide as one of the “20 hot job tracks of the future” and job opportunities abound in law firms, financial organizations, insurance companies, and Government agencies like the FBI, the Internal Revenue Service, and the Bureau of Alcohol, Tobacco and Firearms who constantly investigate everything from money laundering and identity-theft- related fraud to arson and tax evasion; 2015 ANNUAL CONFERENCE Indianapolis 8 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) The consensus amongst both researchers and practitioners today, is that whilst board members, management and other stakeholders continue to expect assurances that an organization is adhering to industry best practices regarding governance and internal controls and that the organization is on sound financial footing, increasingly in light of recent financial scandals, increasingly new and more stringent legal requirements, and the increasing complexity of financial reporting places higher demands on internal audit, and all stakeholders’ awareness for risk management is growing. 2015 ANNUAL CONFERENCE Indianapolis THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) THE NEED / BENEFITS TO INTERNAL AUDITORS. Deloitte Touche for example, in their 2012 survey reported that since their last Internal Audit Fraud Survey in 2010, the mandate and role of Internal Audit functions have continued to evolve, in respect of both fraud risk management and investigation responsibility. Management are still dependent on Internal Audit to provide them with assurance over the anti-fraud controls in place across their businesses, together with the ability to detect and investigate fraud, should it occu r. These are important pre-conditions and strong incentives for the inclusion of forensic accounting techniques in internal audit functions. 2015 ANNUAL CONFERENCE Indianapolis 9 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) THE NEED / BENEFITS TO INTERNAL AUDITORS. The Deloitte report pointed out that a robust anti-fraud culture is being promoted by senior management with 98% of respondents stating senior management endorse and offer some, or extensive encouragement of a strong approach to fraud risk management. These are important pre-conditions and strong incentives for the inclusion of forensic accounting techniques in internal audit functions. 2015 ANNUAL CONFERENCE Indianapolis THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) THE NEED / BENEFITS TO INTERNAL AUDITORS. The Deloitte report also predicted that over the next 12 months, the three key areas of focus in Internal Audit were to be firstly the inclusion (or continued inclusion) of fraud in the scope of reviews undertaken (53%), secondly the increased coverage of fraud risk in the audit plan (40%), and thirdly performing fraud risk assessments (36%). Interestingly, 28% of respondents anticipate the implementation of fraud data mining tools, critical components in forensic accounting. Again, these are important pre-conditions and strong incentives for the inclusion of forensic accounting techniques in internal audit functions. 2015 ANNUAL CONFERENCE Indianapolis 10 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) THE NEED / BENEFITS TO INTERNAL AUDITORS. In the matter of the initial detection of frauds, internal audit has consistently been exceeded by the categories of “Tips,” and “Management Review” according to the most comprehensive and widely accepted survey on occupational fraud known as “Report To The Nation On Occupational Fraud and Abuse,” researched, compiled and presented by the Association of Certified Fraud Examiners (ACFE) in 1996, 2002, 2004, 2006, 2008, 2010 , 2012 and 2014. Below is an excerpt of the 2014 report - the inclusion of forensic accounting techniques in internal audit functions will assist in improving its effectiveness in this area. 2015 ANNUAL CONFERENCE Indianapolis 2015 ANNUAL CONFERENCE Indianapolis 22 11 9/30/2015 THE NEED / DEMAND FOR FORENSIC ACCOUNTING (CONTD.) THE NEED / BENEFITS TO INTERNAL AUDITORS. The need for the use of Forensic Accounting by internal auditors has been further enhanced by the increased use of “Anti-Forensic” actions as the market has seen a flood of new Windowsbased software offering to delete files securely and inhibit their recovery by digital forensic programs. These frustrate forensic tools, investigations and investigators by erasing or altering information; creating “chaff,” that waste time and hide information; implicate innocent parties by planting fake evidence; exploiting implementation “bugs” in known tools; and leaving “tracer” data that cause computer forensic tools to inadvertently reveal their use to the attacker. 2015 ANNUAL CONFERENCE Indianapolis TYPES OF FORENSIC ASSIGNMENTS / APPLICATIONS The Forensic accountants are engaged in a wide range of investigations, spanning many different industries . The practical and in-depth analysis that a forensic accountant will bring to a case helps to uncover trends that bring to light the relevant issues in various areas such as : FORENSIC / CRIMINAL INVESTIGATIONS SHAREHOLDERS’ AND PARTNERSHIP DISPUTES PERSONAL INJURY CLAIMS / MOTOR VEHICLE ACCIDENTS BUSINESS INTERRUPTION / OTHER TYPES OF INSURANCE CLAIMS BUSINESS / EMPLOYEE FRAUD INVESTIGATIONS MATRIMONIAL DISPUTES BUSINESS ECONOMIC LOSSES PROFESSIONAL NEGLIGENCE MEDIATION & ARBITRATION 2015 ANNUAL CONFERENCE Indianapolis 12 9/30/2015 MAIN ELEMENTS OF A FORENSIC AUDIT Each forensic accounting assignment is unique and accordingly the actual approach adopted and the procedures performed would be specific to it. However, in general, many forensic audits would include the following steps : MEET WITH THE CLIENT PERFORM A “CONFLICT CHECK” PERFORM AN INITIAL INVESTIGATION DEVELOP AN ACTION PLAN OBTAIN THE RELEVANT EVIDENCE PERFORM THE ANALYSIS PREPARE AND PRESENT THE REPORT 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS AUDIT VS. INVESTIGATION It is essential that internal auditors realize thaiont their “mind set” in an forensic audit should be one more of an investigation, than that of an audit. Unlike a regular internal audit that focuses mainly on compliance of auditees to established policies / procedures, a forensic audit is more investigative designed mainly to get the facts, find out what happened and gather sufficient evidence to allow management / client to take corrective (or punitive) action. Clearly this may be more adversarial than routine audits that depend most times on a consultative approach. This is not to say however, that experienced forensic auditors do not use consultative or cooperative approaches but the difference between their approach and that of routine auditors must be generally understood. 2015 ANNUAL CONFERENCE Indianapolis 13 9/30/2015 CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION In conducting forensic reviews, internal auditors are well advised to utilize the traditional Seven Steps of Criminal Investigation, a process commonly taught and applied in the USA by federal, state, and local law enforcement authorities. Many variations of the “Seven-Step” method are used by law enforcement authorities, some agencies employ a three, four, or five-step criminal investigation process. However, the Seven-Step method is preferable due to its comprehensive detail. This customization capability enables forensic practitioners to closely interface with respective law enforcement agencies, thus matching their approach when applying forensic accounting. 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION The Methodology In Action — Process Map The methodology is constructed as a process map that visually guides the practitioner through the logical actions of a forensic accounting assignment. The methodology starts at the earliest stage of an assignment and progresses through the final stage, typically testimony delivery pursuant to prosecution. The process map flows left-to-right, top-to-bottom within the four phases and five stages, as shown in Exhibit 19 below (Source : The United States Attorneys’ Bulletin - May 2005, Volume 53, Number 3, Titled “Financial Forensics II). 2015 ANNUAL CONFERENCE Indianapolis 14 9/30/2015 MAIN ELEMENTS OF A FORENSIC AUDIT (CONTD.) 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION Due to the two-dimensional nature of the written word, the process map appears sequential. However, the methodology is intended to be flexible, dynamic, integrated and simultaneous, and/or iterative, thus mirroring how information and conclusions develop. For example, interviews and/or interrogations might not be conducted until rather late in a forensic assignment. 2015 ANNUAL CONFERENCE Indianapolis 15 9/30/2015 CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION Methodology and Linkage to Criminal Investigation The methodology was constructed using a forensic accounting/investigative linkage to the Seven-Step Criminal Investigation methodology. The Seven-Step methodology is summarized as follows : 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 1.Interviews and Interrogation Interviews and Interrogation (I&I) reflect the personal aspect of data-gathering, Obtained through personal interviews and interrogation under law enforcement authority. It is generally considered a source of primary data. KEY POINTS TO NOTE: Interview vs. Interrogation (Know difference & when to use) Continuous process throughout an investigation Gain additional information with each interview Evidence from witnesses provides additional leads May identify additional witnesses Interview the target only after completing the interviews of the peripheral witnesses 2015 ANNUAL CONFERENCE Indianapolis 16 9/30/2015 CONDUCTING FORENSIC AUDITS (CONTD.) 2.Background Research Background Research (BR) is comprised of two broad categories: primary data and secondary data. Primary data (see Interviews) is acquired by the practitioner's efforts collecting data otherwise unavailable through secondary sources. These may include: Public Databases Secretary of State Websites County Seat Corporate Records Internet UYI 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 3.Electronic and Physical Surveillance Electronic and Physical Surveillance (EP) is used to obtain evidentiary data through Observation: Physical Usually done by law enforcement or PI’s Surveillance cameras Can also be used to verify addresses for vendors, employees, etc. Electronic Internet surveillance E-mail 2015 ANNUAL CONFERENCE Indianapolis 17 9/30/2015 CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 4.Confidential Informants Confidential Informants (CI) provide information that is considered primary data. This may include paid or voluntary informants. These may include: Hotlines E-mail Letters Current Employees Former Employees Vendors & former vendors Customers & former customers 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 5. Undercover Undercover (UC) is used to obtain first-hand subject data. Usually a recommendation to use in special circumstances Can be done if carefully planned Best left to professionals 2015 ANNUAL CONFERENCE Indianapolis 18 9/30/2015 CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 6. Laboratory Analysis Laboratory Analysis (LA) should be done cognizant of jurisdictional rules, (eg. in the US – Federal Rules of Evidence), plus chain of custody best practices. LA can include a wide range of investigatory procedures, including: Physical examination of fictitious documents Fingerprint analysis Forgeries Ink sampling Document dating Computer Forensics (imaging, emails, digital analytics) 2015 ANNUAL CONFERENCE Indianapolis CONDUCTING FORENSIC AUDITS (CONTD.) THE TRADITIONAL SEVEN STEPS OF CRIMINAL INVESTIGATION 7. Analysis of Transactions Analysis of Transaction (AT) compares/contrasts transactional and pattern-sensitive data measures to provide a record for forensic analysis. Full and false inclusion tests, for example, are used to determine the appropriate "universe" of data under investigation. This ensures that no extraneous data is included and that no appropriate data is excluded. Analysis of financials may include: Horizontal/vertical analysis Authorization of new vendors & employees Comparison of employee & vendor addresses Analysis of sales returns & allowance account Management override of controls Different reviews based on known industry fraud schemes 2015 ANNUAL CONFERENCE Indianapolis 19 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES EARLY FORENSICS ANALYSES (PRE-COMPUTER) Forensic Accountants utilized advanced forensic financial analyses even before the proliferation of Computers. Admittedly, these techniques and methodologies were more time consuming, required more “elbow Grease,” and in some instances less accurate especially where large scale sampling was unavoidable. The analytical and investigative process usual utilized horizontal and vertical trending relationship assessment of innumerable financial and Statistical variables. The most common of which included : 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) EARLY FORENSICS ANALYSES (PRE-COMPUTER): Historical analyses of Balance Sheet and Income Statements Common sizing historical statistics by percentages Comparative analysis by Industry standards Cash flow trending analysis trending consistency of net sales, gross profit, operating income and net income Benchmarking product pricing Inventory Valuation EBIT (Earnings before interest) Accounts receivable / payable turnover Net Worth changes Debt / equity Benford’s Law 2015 ANNUAL CONFERENCE Indianapolis 20 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) Modern day “CUTTING EDGE” Forensic Accounting however still use many of the traditional methods mentioned above but increasingly utilize a plethora of COMPUTER ASSISTED AUDIT TECHNIQUES (CAATs) and / or other specific tools and techniques such as , e.g., Data Mining, Fulland-False Inclusion, Genogram, Entity(s) Charts, Timeline Analysis, Link Analysis, Item Listing, (Modified) Net Worth Method, Source and Use of Cash Method, Proof-of-Cash Method, and Digital Analysis - such as : – Duplicate Numbers Test – Rounded Numbers Test – Stratification Percentage Comparison – Benford’s Law et al. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) DATA MINING In the world of forensic accounting, Data Mining provides a type of DNA assurance in evidence gathering as auditors / investigators search for exceptions, oddities, irregularities, patterns, and suspicious transactions. What is Data Mining? PricewaterhouseCoopers defines Data Mining as the “art of analyzing large amounts of data in a Manner that detects obscure facts, trends, or inconsistencies in a complete and efficient manner utilizing "intelligent" computer applications.” 2015 ANNUAL CONFERENCE Indianapolis 21 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) DATA MINING (CONTD.) A more comprehensive definition by professional journal “The Chartered Accountant” regards Data Mining as “a technique with an objective to mine large amount of data to discover previously unknown, action oriented, hidden trends, patterns and complex relationships. The technique studies past data, operates on all the variables and entire population, extracts variables of importance and uncovers patterns in the form of rules, and formulates models by using different techniques.” Data Mining therefore can greatly assist internal auditors, investigators or analysts to discover previously unknown and actionable trends, patterns and relationships in their company data during routine decision making, investigations or even modeling predictions. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ACCOUNTING RATIOS Financial statement fraud causes the biggest losses and the inescapable logic of the accounting equation ensures that any major overstatement of assets or profits, will show up over time. Accordingly, the main Accounting Ratios used by early days analysts are still used today and analysed mainly on the following criteria: Income Profitability Liquidity Working Capital Bankruptcy Long-Term Analysis Coverage Leverage 2015 ANNUAL CONFERENCE Indianapolis 22 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ACCOUNTING RATIOS These main Accounting Ratios are used even up to today and were utilised in analytical tasks to : RETRIEVE VALUE. FILTER COMPUTE DERIVED VALUE FIND EXTREMES SORT DETERMINE RANGE CHARACTERIZE DISTRIBUTION FIND ANOMALIES CLUSTER CORRELATE 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ACCOUNTING RATIOS HOWEVER, in addition to the having the benefit of computerization, modern day Forensic Accountants, after ascertaining these fundamentals, are able to apply more complex assessments by drawing from the over 250 or so ratios to delve more incisively into a wider scale of concerns. Internal auditors can emulate the use of these numerous ratios which For example, in alphabetical order, include: Accounts Receivable Turnover, Advertising to Net Income, Advertising to Sales, Age of Inventory, Atman’s z-score (both Manufacturing and NonManufacturing), 2015 ANNUAL CONFERENCE Indianapolis 23 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) Audit Ratio, Average Collection Period, AverageInventory Period, Average Obligation Period, Average Wage and Benefit Cost per Employee, Bad Debts Ratio, Breakeven Point, Capital Acquisition Ratio, Capital Employment Ratio, Capital Reinvestment Ratio, Capital Structure Ratio, Capital to Non-Current Assets 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) Cash and Marketable Securities to Current Liabilities (Acid Test), Cash and Marketable Securities to Working Capital, Cash Balance, Cash Breakeven, Point, Cash Debt Coverage, Cash Dividend Coverage, Cash Flow from Operations to Net Income, Cash Flows from Investing vs. Finance, Cash Flow from Sales to Total Sales, Cash Flow Ratio, Cash Flow to Debt, Cash Flow to Long Term Debt, Cash Flows from Investing vs. Finance, 2015 ANNUAL CONFERENCE Indianapolis 24 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) Cash Flows from Operations to Current Portion of Long Term Debt, Cash Flows from Operations to Total Debt and Equity, Cash Maturity Coverage, Cash Return on Assets (Including and Excluding Interest), Cash Return to Shareholders, Cash Turnover, Collection Period, Collection Period to Payment Period, Contribution Margin, Contribution Margin Ratio, Current Ratio, Current Liabilities to Sales, Current Return on Training and Development, Daily Savings in Delayed Cash Payments, Days of Liquidity, Debt to Assets, 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) Debt to Equity Ratio, Defensive Interval Period, Discretionary Costs as a Percent of Sales, Dividend Yield, EBIT to Sales, Employment Change, Equipment Replacement Ratio, Equipment Upkeep Ratio, Equity Multiplier, Expenses to Current Assets, 2015 ANNUAL CONFERENCE Indianapolis 25 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ANALYSING BALANCE SHEETS / INCOME STATEMENTS, ETC. Internal auditors should for example become familiar with some of the most established use of analytical tools and techniques such as Benford’s Law, Altman Z-Score, Piotroski F-Score and Beneish’s M-Score. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENFORD’S LAW Benford’s Law, also called the first-digit law or leading-digit phenomenon, enables you to quickly ascertain the accuracy of the data, and can help alert auditors / investigators to possible errors, potential fraud, manipulative biases, costly processing inefficiencies or other irregularities. It is particularly helpful for detecting fraud in various business data such as check payment amounts and fraudulent tax returns. Referred to as the “DNA-equivalent technique for financial analysis,” by authoritative sources such as the Journal of Accountancy (May 1990); accepted legally in major jurisdictions such as the United States, where evidence based on Benford's Law has been admitted in criminal cases at the federal, state, and local levels; and empirically tested / verified scientifically / statistically further validated by Chi Squared, Kolmogorov–Smirnov and Kuiper tests (depending on sample size) 2015 ANNUAL CONFERENCE Indianapolis 26 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENFORD’S LAW Mathematically speaking, Benford's law states that the leading digit d (d ∈ {1, …, b − 1} ) in base b (b ≥ 2) occurs with the following probability: This quantity is exactly the space between d and d + 1 in a log scale. In Base 10, the leading digits have the distribution shown on the right Where d is the leading digit and p the Probability. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENFORD’S LAW Graphically illustrated, the law appears as follows: 2015 ANNUAL CONFERENCE Indianapolis 27 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ALTMAN Z-SCORE In testing for example, the probability that a firm will experience bankruptcy within two years, a formula developed by NYU Professor Edward Altman, called a “Z-Score” could be used. This “ZScore” was established to measure financial distress along a number of objective metrics which includes five easily derived business ratios, weighted by coefficients. The original formula, widely applicable, is as follows : 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ALTMAN Z-SCORE Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 +0.99X5. Where; X1 = Working Capital / Total Assets (Measure the liquidity of the company’s asset base); X2 = Retained Earnings / Total Assets (Measure cumulative profitability relative to firm size) X3 = EBIT / Total Assets (Measure how efficiently the company uses its assets to generate earnings from its operations. X4 = Market Value of Equity / Book Value of Total Liabilities (Consideration of the market’s view of the company relative to its liabilities). X5 = Sales / Total Assets (Measures asset turnover). 2015 ANNUAL CONFERENCE Indianapolis 28 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ALTMAN Z-SCORE To interpret the resultant Z-Score, a company would be placed in one of three categories: 1.SAFE – If with a Z-Score greater than 2.99 and thus have a relatively remote risk of bankruptcy; 2.LESS CLEAR - With a Z-Score between 1.81 and 2.99, and existing in a grey area where a clear statement cannot be made. 3.IN DISTRESS - With a Z-Score less than 1.81 and thus at A high risk of bankruptcy. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ALTMAN'S Z-SCORE Sceptics or detractors who find limitations in Altman's Z-score, may prefer to find comfort in a companys “F-Score” developed by Joseph Piotorski in 2000 while at the University of Chicago. Compared to Altman's Z-score which test 5 inputs, the F-score tests nine, but does not weight them. Accordingly, Piotorski's F-Score is calculated as follows : The F-score is the sum the scores for each of nine tests. Each test scores one for a pass and zero for a fail. The tests are profitability related and are as follows: 2015 ANNUAL CONFERENCE Indianapolis 29 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) ALTMAN'S Z-SCORE 1.Net profit is positive; 2.Operating cash flow is positive; 3. Net profit ÷ total assets at beginning of year, minus the same number for the previous year is positive; 4. Operating cash flow is greater than net profit, capital structure and debt service; 5. Long term debt ÷ by average assets has not increased; 6. The Current ratio has increased (the change is more then zero, so even a negligible increase asses the test!); 7. No raising of ordinary (common) equity over the previous year: this test is passed if the company did not issues any ordinary shares; 8. Gross margin has improved over the previous year; 9. Asset turnover has increased. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENEISH M-SCORE The more skeptics amongst us who feel that a company’s earnings may be manipulated so the above analyses may not be valid, should also know that any possible manipulations can be tested by applying the “Beneish Model,” a mathematical model that uses financial ratios and eight variables to identify whether a company has manipulated its earnings. The variables are constructed from the data in the company's financial statements and, once calculated, create an “M-Score” to describe the degree to which the earnings have been manipulated. The original M-Score formula is as follows: M-Score = -4.84 + 0.92*DSRI + 0.528*GMI + 0.404*AQI + 0.892*SGI + 0.115*DEPI – 0.172*SGAI + 4.679*TATA – 0.327*LVGI Where : 2015 ANNUAL CONFERENCE Indianapolis 30 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENEISH M-SCORE Where : 1. DSRI - Days' sales in receivable index 2. GMI - Gross margin index 3. AQI - Asset quality index 4. SGI - Sales growth index 5. DEPI - Depreciation index 6. SGAI - Sales and general and administrative expenses index 7. LVGI - Leverage index 8. TATA - Total accruals to total assets Once calculated, the eight variables are combined together to achieve an M-Score for a company and one less than -2.22 would suggests that it will not be a manipulator, whereas an M-Score of greater than -2.22 would signal the possibility that it is likely to be a manipulator. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) BENEISH M-SCORE Once calculated, the eight variables are combined together to achieve an M-Score for a company and one less than -2.22 would suggests that it will not be a manipulator, whereas an M-Score of greater than -2.22 would signal the possibility that it is likely to be a manipulator. 2015 ANNUAL CONFERENCE Indianapolis 31 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) CATEGORIES OF FRAUD The ACFE’s classifications of fraud has evolved as the most accepted and respected classifications of fraud, i.e. Corruption, Asset Misappropriation and Fraudulent Statements. Internal Auditors investigating fraud should become very familiar with these categories and the ACFE’s procedures / techniques in deterring, preventing, detecting and reporting these categories. The categories are as follows: 2015 ANNUAL CONFERENCE Indianapolis 2015 ANNUAL CONFERENCE Indianapolis 32 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) COMPUTER FORENSICS As mentioned previously, modern day analysts still use many of the traditional methods mentioned above, but presently they are now utilizing a plethora of COMPUTER ASSISTED AUDIT TECHNIQUES (CAATs) pursued mainly through COMPUTER FORENSICS defined below by the National Institute of Standards and Technology as follows : . . . the application of science to the identification, collection, examination, and analysis of data while preserving the of the information and maintaining a strict chain of custody for the data. Data refers to distinct pieces of digital information that have been formatted in a specific way. . . 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) COMPUTER FORENSICS COMPUTER FORENSICS is regarded as a branch of Digital Forensic Science, pertaining to legal evidence found in computers and digital storage media. The goal of computer forensics is to examine digital media in a forensically sound manner with the aim of identifying, preserving, recovering, analysing and presenting facts and opinions about the digital information. 2015 ANNUAL CONFERENCE Indianapolis 33 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) COMPUTER FORENSICS Forensic investigators typically follow a standard set of procedures. After physically isolating the computer in question to make sure it cannot be accidentally contaminated, investigators make a digital copy of the hard drive. Once the original hard drive has been copied, it is locked in a safe or other secure storage facility to maintain its pristine condition. All investigation is done on the digital copy. The renowned “Forensic Magazine." delineate an eight step forensics process: 1.Search authority 2.Chain of custody 3.Imaging/hashing function 4.Validated tools 5.Analysis 6.Repeatability (Quality Assurance) 7.Reporting 8.Possible expert presentation 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) DIGITAL EVIDENCE What is Digital Evidence? “Digital evidence is information of probative value that is stored or transmitted in a binary form”. This field includes not only computers in the traditional sense but also includes digital audio and video. It includes all facets of crime where evidence may be found in a digital or binary form. Any information can be stored electronically, and almost all new information is being created and stored exclusively in electronic format. Background information called Metadata (inherent with electronic data) can turn up skeletons you had no idea existed. Knowledge of the location of data, storage methods and document types is critical. 2015 ANNUAL CONFERENCE Indianapolis 34 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) DIGITAL EVIDENCE Internal auditors should be aware that the inventory should include the location and storage formats of all electronic data and any information stored and or used by computer technology is considered to be electronic evidence discoverable in litigation. Relevant information may exist in a variety of locations and various forms and basic categories should not be overlooked. Digital Evidence comes in numerous form factors, and can include the following: 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) 2015 ANNUAL CONFERENCE Indianapolis 35 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) FORENSIC PROCESS COMPUTER FORENSIC INVESTIGATIONS usually follow the standard digital forensic process or phases: acquisition, examination, analysis and reporting. Investigations are performed on static data (i.e. acquired images) rather than "live" systems. This is a change from early forensic practices where a lack of specialist tools led to investigators commonly working on live data. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) FORENSIC PROCESS TECHNIQUES The techniques are used during computer forensics investigations include the following: Cross-drive analysis forensic technique that correlates information found on multiple hard drives. The process, still being researched, can be used to identify social networks and to perform anomaly detection. Live analysis - Examination of computers from within the operating system using custom forensics or existing sysadmin tools to extract evidence. (A system administrator, or sysadmin, is a person who is responsible for the upkeep, configuration, and reliable operation of computer systems; especially multi-user computers, such as servers). The practice is useful when dealing with Encryption Fie Systems, for example, where the encryption keys may be collected and, in some instances, the logical hard drive volume may be imaged (known as a live acquisition) before the computer is shut down. 2015 ANNUAL CONFERENCE Indianapolis 36 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) FORENSIC PROCESS TECHNIQUES (Contd.) Deleted files - A common technique used in computer forensics is the recovery of deleted files used by modern forensic software which have their own tools for recovering or carving out deleted data. File carving, for example, involves searching for known file headers within the disk image and reconstructing deleted materials. Stochasted forensics – a method which uses stochastic properties of the computer system to investigate activities lacking digital artifacts. (Physical systems in which we are uncertain about the values of parameters, measurements, expected input and disturbances are termed Stochastic Systems. In probability theory, a purely stochastic system is one whose state is randomly determined, having a random probability distribution or pattern that may be analyzed statistically but may not be predicted precisely. In this regard, its chief use is to investigate data theft. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) FORENSIC PROCESS WHICH ARE THE “BEST” TOOLS? In many instances, companies, indeed internal auditors operate on limited budgets, so it is unlikely that one company will invest in multiple forensic softwares. If a “best tool” is sought however, a disk editor might be a worthwhile investment. Understandably also, it is not feasible for forensic auditors to procure every possible data base, spreadsheet, word processing, flow chart, or other software application on a suspect’s hard drive or other media under investigation. Instead, a file viewer can be obtained and products such as Jax Software’s Quick View, File Stream Inc’s Turbo Browser 2000, and Clear and Simple Inc.’s Disk Jockey 2000 enables users to view hundreds of file types using one tool. 2015 ANNUAL CONFERENCE Indianapolis 37 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) FORENSIC PROCESS WHICH ARE THE “BEST” TOOLS? THE FOLLOWING TABLE DISPLAYS SOME OF THE BEST AVAILABLE FORENSIC TOOLS RESEARCHED BY THIS PRESENTER: 2015 ANNUAL CONFERENCE Indianapolis EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS 2015 ANNUAL CONFERENCE Indianapolis 38 9/30/2015 EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS (Contd.) 2015 ANNUAL CONFERENCE Indianapolis EVIDENCE RECOGNITION, COLLECTION, AND ANALYSIS TOOLS (Contd.) 2015 ANNUAL CONFERENCE Indianapolis 39 9/30/2015 “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) WHICH ARE THE “BEST” TOOLS? (Contd.) My experience and research of the software brands engaged in forensic accounting work reveal that EnCase is one of the most multifaceted, popular, effective, reputedly used by over 75% of the world’s forensic and amongst my personal favorite. 2015 ANNUAL CONFERENCE Indianapolis “CUTTING EDGE” FORENSIC ACCOUNTING METHODOLOGIES (CONTD.) WHICH ARE THE “BEST” TOOLS? (Contd.) ACL is very popular software used by internal auditors and they have developed forensic tools and with innovative and creative manipulations, which have allowed internal auditors to do impressive forensic work. The key point to note is that using the right investigative tools can help to maximize the effectiveness of computer forensic work, and equip internal auditors to incorporate “Cutting Edge” Forensic Accounting Methodologies into their day to day tool kit. 2015 ANNUAL CONFERENCE Indianapolis 40 9/30/2015 2015 ANNUAL CONFERENCE Indianapolis 2015 ANNUAL CONFERENCE Indianapolis 41 9/30/2015 CONTACT INFORMATION: COLLIN GREENLAND, EMAIL : [email protected] 2015 ANNUAL CONFERENCE Indianapolis 42