Digging Into Forensic Accounting

By Greg Regan, CPA/CFF
Forensic accounting services generally involve applying the specialized knowledge and investigative skills possessed by CPAs to collect, analyze and evaluate evidential matter, as well as possibly interpreting and communicating these findings in the courtroom, boardroom or other legal or administrative venue. 

CalCPA’s Forensic Services Section (FSS) is the largest and one of the most active state societies for forensic accountants. The group has a deep history of contributions to the body of forensic accounting knowledge on a national level, as well as boasts authors of standards and practice aids; speakers at local and national conferences; and involvement with the academic community.

While forensic accounting has grown in popularity in recent years, many people are unfamiliar with what CalCPA has to offer in the forensice accounting arena in terms of education and networking. Four subsections addressing the major types of engagements forensic accountants are called upon to perform comprise FSS: 

1. Fraud & Financial Investigations
2. Family Law
3. Business Valuation
4. Economic Damages

Often, skillsets for these engagement types are interrelated. For example, a family law matter may require a business to be valued; or, an alleged fraud may result in economic damages. Highlighted below are examples of recent cases in each of these sections.

Fraud & Financial Investigations (FFI)
Forensic accountants in this area investigate a variety of matters, including financial statement fraud, employee theft, money laundering, hidden assets in a marital dispute, violations of the Foreign Corrupt Practice Act, contract compliance and vendor fraud. 

Although the needs of any particular investigation vary, there are skills necessary in any investigation: being detail oriented, possessing professional skepticism and being able to simplify often complex and circuitous information. Creativity is key when it comes to illustrating the what, how and when questions that come with nearly every engagement.

FFI Section Chair Tim Sherman (FTI Consulting in Los Angeles) recounted a financial statement investigation where a team of forensic accountants was asked to look into the timing of a consumer product company’s write-down of its inventory of a new product that did not sell above the cost to manufacture. 

After an unsuccessful launch, the inventory was written down in Q1, instead of Q4 of the prior year. The team was asked to determine whether contemporaneous facts warranted an earlier write-down. They studied relevant GAAP, reviewed sales records and documentation of the inventory valuation, reviewed materials provided to financial statement auditors, interviewed company management and reviewed email. For the email review, the team identified relevant individuals or custodians and crafted dozens of targeted search terms (e.g., “inventory” within five words of “write-down,” “writedown,” “write-off,” “writeoff” or “loss”). Based in large part upon the emails of relevant custodians, the team recommended that restatement was appropriate.

Family Law
Forensic accountants often are retained in family law matters to assist attorneys and clients sorting the division of marital assets and debts, and to help with analyses of funds available for support. For example, if one party has assets that they bring into the marriage or inherit during the marriage, they might hire a CPA to “trace” their separate assets. Many people have a misunderstanding that if separate funds are deposited into a joint bank account that the funds are co-mingled and cannot be traced. In fact, if the documents are available, almost anything can be traced.

Family Law Section Chair Darlene Elmore (sole proprietor, Santa Rosa) was recently retained to trace one spouse’s separate funds brought into the marriage. The tracing involved several different bank and brokerage accounts throughout the 25-year marriage. At the outset of the case, the client was surprised to learn that he had the ability to recover the separate funds.

“I was able to work with the client to identify his separate assets and to prepare the analysis which ultimately proved that the funds held in the bank accounts at the date of separation were his separate property,” says Elmore. “In the end, this analysis helped resolve his case.”

Business Valuation
Many of us are familiar with CPAs who perform business valuation services. The valuation of a business, or perhaps the lost value of a business pursuant to an alleged harm, is often the subject of a forensic CPA’s analyses. As an example, California Corporate Code Sec. 2000 cases involve the valuation of a minority corporate interest for purposes of a buyout.

Business Valuation Section Chair Tom Collins (partner, Collins Forensic and Valuation Services in Sacramento) recently worked on a team of CPAs to value a law practice pursuant to the aforementioned California Corporations Sec. 2000. According to Collins, this matter was challenging because each shareholder had competing views of the company’s value.

To resolve this conflict, the team gathered and analyzed numerous documents—tax returns, accounts receivables, work in progress and lease contracts. Ultimately, the CPAs wrote a joint business valuation report that was provided to the judge, who accepted the finding. The finding was then used to establish the fair value of the company’s shares used as the purchase price for the minority interest.

Economic Damages
CPAs also are frequently retained to perform economic damage calculations. Lost profits are a common type of damages claimed by plaintiffs. For example, a plaintiff may claim that a defendant breached a contract to pay royalties for sales of software containing the plaintiff’s technology. In such matters, CPA experts may be retained by either party to determine whether the defendant appropriately reported sales and, if not, the related profits the plaintiff may have obtained.

I’m a partner at Hemming Morse, a firm of 40 professionals, and chair of CalCPA’s FSS. Recently I was retained by Amazon, which was litigating a dispute with a company named Fuse Chicken. Fuse Chicken alleged it had sustained lost profits stemming from the sale of counterfeit products on Amazon and related negative product reviews. 

For this case, I analyzed the plaintiff’s lost sales projections—including which products had allegedly been counterfeited, how sales before and after the alleged counterfeiting varied, if sales trends varied by customer and possible differences in sales by geography or sales channels. My work culminated in an expert report. Ultimately, both the opposing expert and I were subject to depositions where attorneys cross-examined us on the opinions we each expressed in our expert reports.

Putting the Pieces Together
Perhaps “putting the pieces together” is the common thread across forensic accounting engagements. It’s safe to say that forensic accountants must be skilled in acquiring and objectively analyzing data. Performing forensic analyses often requires an ability to interview clients and perform market research. Frequently the CPA must be able to communicate the results of the analysis in an expert report and/or expert testimony. 
To be successful, the CPA’s analysis must be able to withstand rigorous scrutiny whether from the client, the opposing party’s counsel, regulators, judges and juries.

For more information, join us us Oct. 22-23 for the annual Family Law Conference is scheduled for Oct. 22-23. And if you’re already performing forensic accounting, consider applying for our Forensic Expert Leadership Program.
Greg Regan is a partner at Hemming Morse.