FORENSIC ACCOUNTING AND DIGITAL FORENSICS CA. Charanjot Singh Nanda Central Council Member, ICAI Chairman, Internal Audit Standards Board & Chairman, Committee for Members in Industry The Institute of Chartered Accountants of India 1 FORENSIC ACCOUNTING Use of accounting for legal purposes. Use of intelligence-gathering techniques & accounting to develop information & opinion for use in civil litigation. Identifying, recording, settling, extracting, sorting, reporting, and verifying past financial data or other accounting activities for settling prospective legal disputes or using such past financial data for projecting future financial data to settle legal disputes. AREAS OF SPECIALITY Bribery and Corruption Fraud and Misconduct Breach of Company Procedures Ponzi and other Investment Schemes Conflict of Interest Money Laundering Embezzlement and Misappropriation Financial Reporting Fraud Procurement Fraud PROCESS MAP Assignment Development 6 Identify parties to the case, Co-relate matters of law, Confirm technical capabilities Ensure matching of expectations Prepare and secure engagement letter Establish concrete timelines, e.g., discovery cut off, report submission, etc., Establish communication protocol Scoping of Engagement Continually define/ refine universe of data, primary and secondary Initiate data collection processes Prepare Document Request(s) as necessary Establish protocol to manage data requested and obtained Interviews and Interrogations 8 Gain confidence of parties & obtain information from parties Background investigation on identified parties Use interpersonal communication techniques to analyse responses for further investigation Prepare interview matrix Check for Hidden agenda of parties Blind leads Communication inhibitors Background Research Combine first-hand knowledge (e.g., Interviews and Depositions) with second-hand knowledge (e.g., Background Research data) See Online Databases Sources of Information See Government Sources of Information Identify disparities for additional investigation Data Collection & Analysis Missing information Privacy laws Unreliable informant / Inconclusive information Entrapment Engagement/personal risks Data Collection & Analysis Perform any additional indirect or direct analytical forensic techniques as needed Validate / correlate prior data obtained through alternate techniques Genogram/Entity / Party Chart Deposition Matrix/Interview Matrix Search Log/Background Investigation Lifestyles Analysis Net Worth Method Analysis of Transactions Summarize and analyze the findings of all deliverables and observations Obtain sufficient relevant data to provide credible evidence Identify any missing information or gaps DRAFT the Forensic Accountants Report METHODS OF PROOF 13 DIRECT METHODS SPECIFIC ITEM METHOD FINANCIAL RELATIONSHIPS FINANCIAL STATEMENT ANALYSIS HORIZONTAL VERTICAL TREND RATIO CASH FLOW METHODS OF PROOF 14 INDIRECT METHODS NET WORTH METHOD (ASSET METHOD) EXPENDITURES METHOD (LIFESTYLES METHOD) (SOURCES AND APPLICATION OF FUNDS METHOD) BANK DEPOSIT METHOD METHODS OF PROOF 15 Information for specific industries Learn distinct, detailed practices in a particular industry Examination techniques Common & unique industry issues Business practices Terminology Example of market segments: Construction or entertainment industry Professions: lawyers or real estate agents METHODS OF PROOF 16 Direct-Specific item method Most common method Relies on specific transactions Uncovers specific financial transactions which relate to illegal activity, and to the suspect Review books, records, bank accounts - directly traces a transaction Direct (vs circumstantial) proof Easiest to trial Most difficult for the suspect to refute Example: Ghost employee on the payroll METHODS OF PROOF FINANCIAL RELATIONSHIPS SALES VERSUS COST OF GOOD SOLD SALES VERSUS ACCOUNTS RECEIVABLE SALES VERSUS INVENTORY ASSETS VERSUS LIABILITIES FINANCIAL STATEMENT FRAUD FICTITIOUS REVENUES TIMING DIFFERENCES CONCEALED LIABILITIES AND EXPENSES IMPROPER DISCLOSURES IMPROPER ASSET VALUATION FINANCIAL STATEMENT ANALYSIS PERCENTAGE ANALYSIS HORTIZONAL PERIOD TO PERIOD INDUSTRY STANDARDS COMPETITORS VERTICAL COMMON SIZE STATEMENTS TREND ANALYSIS FINANCIAL STATEMENT ANALYSIS RATIO ANALYSIS LIQUIDITY ASSET MANAGEMENT DEBT MANAGEMENT PROFITABILITY FINANCIAL STATEMENT ANALYSIS CASH FLOW ANALYSIS OPERATING INVESTING FINANCING INDIRECT METHODS OF PROOF 23 CIRCUMSTANTIAL PROOF Inadequate books/records Suspected: books do not reflect all income Significant increase in net worth Gross profit % changes significantly Expenses exceed reported income without cause Suspected income from unidentified sources is large INDIRECT METHODS OF PROOF Deeds of ownership, titles, liens, filings The target Informants/associates Real estate records Bankruptcy records State motor vehicle records Surveillance Credit card applications/statements Tax returns Insurance records Employment records Cancelled checks Deposit slips Loan Applications SOURCES OF INFORMATION INDIRECT METHODS OF PROOF 25 NET WORTH METHOD Used to prove illicit income Persons assets or expenditures exceed known sources of income 4 ways to dispose income: Save it Buy assets Pay off debt Spend it Used extensively in drug & money laundering cases INDIRECT METHODS OF PROOF 26 NET WORTH METHOD FORMULA Assets -Liabilities =Net worth -Prior years net worth =Increase in net worth +Living expenses =Income (or expenditures) -Funds from known sources =Funds from unknown sources INDIRECT METHODS OF PROOF 27 EXPENDITURE METHOD CLUES Lavish residence Expensive cars/boats Vacation home Exotic vacations WHEN TO USE...WHEN TARGET Operates mostly on a cash basis Little or no net worth but large expenditures Little or no change in assets or liabilities INDIRECT METHODS OF PROOF 28 BANK DEPOSIT METHOD WHEN TO USE Assets & liabilities are fairly constant No indications of extravagant lifestyle Targets known income is being deposited into financial institutions HOW Analyze bank deposits, cancelled checks, currency transactions INDIRECT METHODS OF PROOF 29 BANK DEPOSIT METHOD FORMULA Total deposits to all accounts -Transfer and redeposits =Net deposits to all accounts +Cash expenditures =Total receipts from all sources -Funds from known sources =Funds from unknown or illegal sources DIGITAL ANALYSIS TECHNIQUES 30 SOFTWARE PROGRAMS PERFORM DATA MINING Extracting information from databases Comb DB for obscure patterns Sort data to detect potential fraud same address for two employees DATA ANALYTICS Statistical process used to analyze data Identify red flags, transaction trends, patterns, anomalies DIGITAL ANALYSIS TECHNIQUES Sorting Record selection Joining files Multi-file processing Correlation analysis Date functions Graphing Verifying multiples of a number Compliance verification Duplicate searches Vertical ratio analysis Horizontal ratio analysis FUNCTIONS DIGITAL ANALYSIS TECHNIQUES Data file inquiry Random unit sampling Calculate totals Calculate averages Specific criteria searches Unusual item inquiries Link analysis graphics Identify gaps in sequence Identify duplicates Differentiate normal patterns from suspect patterns Benfords Law analysis Stratification FUNCTIONS DIGITAL ANALYSIS TECHNIQUES Identify invoices w/o PO Look for invoices from vendors not approved Analyze claims paid by insurance providers Look for high volume purchases from one vendor Match names, addresses, phone numbers, numbers between employee and vendor files Identify dormant accounts with activity Search for large, rounded transaction values EXAMPLES DIGITAL ANALYSIS TECHNIQUES Excel ACL IDEA Active Data for Excel Auto Audit SNAP! Reporter Data Watchs Monarch for Windows Oversight Systems COMMERCIAL SOFTWARE