What Is Forensic Accounting? Definition, Examples, and Resources
April 15, 2020
Forensic accounting professionals analyze an individual’s or organization’s financial activity, looking for discrepancies, unusual patterns, or potential criminal or illicit activity.
Insurance companies use forensic accounting to analyze a policyholder’s finances and determine if potential fraud has been committed. Government agencies, such as the FBI and the IRS, turn to forensic accounting to help uncover potential money laundering and other crimes. Businesses also use forensic accounting for internal reviews.
Forensic accounting is a fundamental skill for accountants and other financial professionals. The LSU Online Bachelor of Science in Accounting (BSA) provides graduates with a deep understanding of how to conduct effective forensic accounting and prepare reports and insights based on their findings.
What Is Forensic Accounting?
Forensic accountants use accounting, auditing, and investigative techniques to examine an individual’s or organization’s finances. Then they analyze and organize these findings for legal cases involving crimes like fraud and embezzlement. “Forensic accountants are trained to look beyond the numbers and deal with the business reality of a situation,” according to Investopedia.
For example, a professional may use forensic accounting to help determine if a business shared false information on its yearly tax filing. That professional may audit the organization’s bank records, analyze past deposits and transactions, and discover that the business actually earned more than it claimed on its tax filings. The professional can then organize that information for use in legal proceedings. A forensic accountant will often explain the findings in court.
Accountants who perform forensic accounting must possess strong math skills and an investigative mindset. Forensic accountants must know not only how to analyze complex financial statements, but also how to spot signs of illicit or negligent activity.
Crimes Forensic Accounting Can Uncover
Forensic accounting can reveal extensive information about a party’s financial background. It can help uncover common types of crimes or illicit activity, including the following:
- Fraud -- The Association of Certified Fraud Examiners (ACFE) says that “in the broadest sense, fraud can encompass any crime for gain that uses deception as its principal modus operandus.” Within forensic accounting, fraud primarily includes one individual or organization attempting to deceive another regarding financial activity. That can include a business not being open with the IRS regarding how much it truly earned or a hedge fund not revealing to investors the true value of its investment or the fund itself.
- Money laundering -- A person or business may earn money from participating in or committing certain illegal or prohibited acts. “Money laundering is the processing of these criminal proceeds to disguise their illegal origin,” according to the Financial Action Task Force. Examples of money laundering may include a drug trafficker transferring illegally obtained money into a nonprofit organization to make it appear more legitimate or criminals who just committed a robbery taking their money to a casino to make it look as if they had won it from gambling.
- Embezzlement -- The U.S. Department of Justice states that “embezzlement is the fraudulent appropriation of property by a person to whom such property has been entrusted, or into whose hands it has lawfully come.” Embezzlement may include an employee transferring funds from the company payroll to a personal account or a lawmaker or politician purchasing personal luxury items with money designated for a government initiative.
Where Is Forensic Accounting Used?
Many types of organizations and scenarios benefit from forensic accounting.
- Government agencies -- Professionals in government agencies (FBI, IRS, CIA) use forensic accounting procedures to help determine whether bad actors commit certain financial crimes, like fraud or embezzlement. They can also perform forensic accounting procedures to see if an individual’s financial activity may be related to another crime.
- Insurance companies --
- -- Forensic accountants in the insurance field analyze the true economic damage that a policyholder sustained, like from a car wreck or a home destroyed in a fire. Additionally, claimants can use forensic accounting when trying to prove loss sustained, such as a store proving it had a certain amount of inventory on hand when a robbery was committed.
- Construction projects -- Often construction projects don’t meet their deadlines, resulting in additional fees. Professionals can use forensic accounting in this situation to determine if fraud or other illicit activity is potentially behind these delays.
- Civil and business disputes -- Forensic accounting can also be used in noncriminal legal disputes. In a divorce proceeding, one party could use the services of a forensic accountant to support a claim that a partner was owed a certain amount. If a large business were considering purchasing a smaller one, they could use forensic accounting to paint an accurate portrait of how much that smaller business was worth.
- Nonprofit organizations -- Both nonprofit organizations and parties they may work with can use forensic accounting. For example, leaders within a nonprofit can turn to a forensic accounting professional to prove that their organization received a certain amount in donations over the past year. Other organizations, such as the IRS, also use forensic accounting to see if a nonprofit failed to fully disclose the amount of donations received.
Ultimately, forensic accounting can be used in a variety of legal, business, and interpersonal procedures and disputes to find out more about the financial background and behavior of a person or organization.
Key Forensic Accounting Tools and Resources
Professionals can use several accounting and investigative tools and resources during the forensic accounting process. The ACFE provides a list of useful skills and knowledge for forensic accountants. According to the ACFE, these skills include the following:
- Regression analysis -- Regression analysis is a statistical analysis process in which forensic accountants chart the relationships between two different sets of data. A forensic accountant might use regression analysis to determine if the data from a nonprofit’s donations and the data from its director’s bank statements reveal any interesting patterns and potential signs of fraud.
- Present value and discount rates -- Knowledge of present value and discount rates help forensic accountants accurately determine how much a person’s or an organization’s assets may be worth and whether any discrepancies arise between their actual worth and claimed worth. If an individual claims to have lost a $5,000 TV in a home fire, a forensic account could use this information to determine that TV’s actual value.
- Professional skepticism and judgment -- Forensic accountants need to know how to find discrepancies or red flags in an individual’s or organization’s financial reports, which requires skepticism. But they also need to carry themselves in a professional manner. For example, a forensic accountant should exercise caution with a person claiming to make a small annual salary that contradicts their annual purchases. Alternatively, forensic accountants should reserve judgment on a tax return if, for example, the filer has never filed taxes before.
- Accounting knowledge and expertise -- Investigations and analysis are major components of forensic accounting, as are conventional accounting practices and procedures. Forensic accountants need an understanding of bookkeeping, accounts receivable and payable, balance sheets, cost and full disclosure principles, and more.
Make an Impact in Forensic Accounting
What is the need for forensic accounting? Different types of fraud—including fraud that involves elders, mortgages, and credit cards—continue to rise. This suggests that the need for talented, conscientious forensic accounting professionals will only increase in the future.
Forensic accounting can be a rewarding field for accounting professionals with analytical and investigative skills. Those who want to make a positive impact and help bring justice should consider pursuing the LSU Online Bachelor of Science in Accounting Covering key accounting principles and tools, the program prepares graduates to make their mark as forensic accountants.