The Truth Behind the Numbers: Investigative Techniques Used in Forensic Accounting  

Summary: The digital era has given way to a rise in financial crime that threatens the economic security of both individuals and businesses. Learn about the investigative methods used by forensic accountants to identify and protect against fraudulent activity. 

Digital technology is evolving at a rapid pace — and with it the potential for financial crime. For every automated and AI-driven solution implemented to enhance efficiency and reduce costs, new opportunities arise for fraudulent activity that can threaten the economic security of both individuals and business entities.  

In response to the ever-growing threat of fraud and the highly sophisticated nature of financial crimes in the digital era, forensic accountants have developed more advanced methods to identify irregularities and uncover evidence of wrongdoing. This article will cover some of the most important tools and techniques used during a forensic accounting investigation.  

What is forensic accounting? 

With the global rise in digital data comes an unavoidable downside: the potential for that data to be exploited or misused, setting the stage for billions of dollars in financial losses. Firms providing forensic accounting services will play a critical role in safeguarding financial health now and in the future.  

Forensic accounting is a field of accounting that focuses on the investigation, identification, and prevention of financial misconduct. Forensic accounting professionals are certified public accountants (CPAs) with additional training and proficiency in areas such as fraud examinations, anti-money laundering investigations, financial forensics, and business valuations.  

When do you need a forensic accountant? 

Forensic accountants are often called upon to provide litigation support for attorneys and legal teams. They will examine financial records to uncover inconsistencies and locate hidden assets, provide damage calculations, and present a summary of their findings. They may also assist with depositions and provide expert witness testimony in court.  

In addition to litigation consulting, forensic accountants will work with business owners and CEOs in an advisory role to mitigate financial risk and ensure compliance with industry rules and regulations. This includes reviewing internal accounting controls to identify any weak points and make sure the appropriate checks and balances are in place. They will also work to educate employees on how to spot fraudulent activity and prevent crime before it happens.  

Finally, forensic accounting professionals play a pivotal role in carrying out fair and successful business transactions. Financial transparency is critical during mergers and acquisitions, new partnership negotiations, business dissolutions, and similar endeavors. A forensic accountant may assist with due diligence, perform an accurate business valuation, and provide negotiation and post-transition support.   

What investigative techniques do forensic accountants use? 

To examine the past and present financial activity of an individual or business entity, forensic accountants will apply a number of different investigative techniques. The following are some of the most common methods utilized to collect information, analyze data, and identify fraud.  

Information Gathering 

Forensic investigation begins with information gathering. This involves the collection and organization of past and current financial data (i.e., digital and hard copies) along with any relevant correspondence and business documents. During this stage, the forensic accounting team will also verify the authenticity and accuracy of all accounting records, contracts, invoices, and other documents.  

If and when fraudulent activity is suspected, surveillance is another investigative method forensic accountants will use to either confirm or contradict those suspicions. It includes monitoring the physical behavior of persons of interest, as well as tracking their electronic habits and digital communication.  

Conducting interviews is another strategy used to gather additional information and develop a more complete picture of the behavior of specific individuals connected to the investigation. In the case of corporate fraud examinations, for example, the forensic accounting team may ask to speak with business owners, employees, and other stakeholders to garner additional information. 

Data Analysis 

This involves analyzing and interpreting the data that has been collected to determine whether or not any wrongdoing occurred and who was responsible.  

Under the broader umbrella of data analysis is a technique called data mining, which incorporates trend analysis, financial ratio analysis, and forensic auditing to evaluate complex datasets and identify patterns, relationships, or irregularities that may indicate fraud or misconduct.  

Because the process of collecting, formatting, and interpreting large volumes of financial data can be time consuming, forensic accounting professionals will often make use of specialized software and predictive tools to help spot irregularities and identify trends. These include forensic accounting software such as FraudFindr and Valid8, statistical sampling, and Benford’s Law.  

Funds Tracing/Asset Tracing 

Funds tracing is another essential technique used by forensic accounting professionals during an investigation. It involves analyzing the flow of funds and/or the transmission of assets to identify evidence of unlawful activity and ultimately facilitate the recovery of financial assets that may have been misappropriated. 

Especially important in cases where fraud is suspected, asset tracing typically comprises one or more tracing methodologies to track the movement of funds and identify where fraudulent funds may have been commingled with legal funds. Examples include FIFO (first in, first out), LIFO (last in, first out), LIBR (lowest intermediate balance rule), and the pro rata method, which involves relative percentages of legal vs. illegal funds.  

Once their findings are complete and all funds have been quantified, forensic accountants will often work with legal teams and law enforcement officials to ensure any misappropriated assets are recovered and distributed fairly.   

Reporting and Recommendations 

A key element in every forensic investigation is the written report.  

While periodic updates may be provided throughout the course of the investigation, the end report will contain a detailed account of the steps taken by the forensic accounting team, their findings (i.e., visual data and exhibits as well as a timeline of events), and their recommendations going forward for mitigating risk as well as recovering assets. Whether used in support of litigation or as an advisory tool, the report will be written in such a way that non-financial persons can easily understand the findings.  

Forensic accountants may also be asked to provide expert witness testimony at trial. Utilizing their accounting, auditing, tax, and regulatory knowledge, they can provide a comprehensive overview of financial history and lend credibility to complex cases.  

Final thoughts: Safeguard your financial health 

Digital technology will continue to advance at the speed of light — putting your economic future at risk as financial crimes become even more insidious and increasingly difficult to detect. By sharpening the focus on your internal accounting controls and partnering with forensic services specialists at the top of their field, you can minimize the impact of a dispute on your business and rest easy knowing your assets are protected.