The Role of Forensic Accounting in the Current Financial Crisis Situation - Essay Example

Forensic accounting has emerged as a respectful and highly responsible profession especially after successive accounting frauds erupted through the surface and jeopardizing the financial framework in the US. Forensic accounting includes accounting, auditing and other investigative services in order to assist legal matters pending in the courts. Companies have also employed forensic accountants for prevention of fraud and perform supervisory role in order to comply with regulations laid out by the SOX 2002. The current paper will examine the role of forensic accounting in the current financial crisis situation which has once again raised concerns amongst stakeholders as major US corporations are having financial difficulties and have already declared bankruptcies. The act of accounting manipulation in order to maintain interest of shareholders in companies is more likely to happen in addition to increase in other types of frauds. Therefore, forensic accountants are more than ever in the spot light for their role to tackle bigger challenges which lie ahead of the current recession. Forensic Accounting and its Importance in Current Financial Crisis Executive Summary In this research paper different aspects of forensic accounting will be discussed and its relevance as a determining factor to the outcome of accounting frauds and scandals that erupted in the previous recessions that left their trails on the US economy. This report is not limited to the US economy but it also relates to the role of forensic accounting and its due consideration provided by the regulatory frameworks of other countries by carrying out a thorough research and supplementing the report with inquisitive insight into the profession of forensic accounting and the challenges which are confronting this profession in the qualm of the current global recession and fears of yet again a stream of cases involving accounting manipulation emerging tearing down what is considered to be strictly regulated reporting framework. The reason for selecting this area of research is that cases of frauds and accounting manipulations are already on the rise as companies try to survive and retain shareholders interest in them. Emergence of Forensic Accounting The older version of forensic accounting could be traced back to 1817 when a case involving bankruptcy was being investigated in the US court and the formal use of term ‘ forensic accounting’ appeared in the article published by Maurice E. Peloubet (Crumbley, 2001). Today forensic accounting is considered to be one of the most important and highly valued branches of the accounting profession. There are a large number of both internal and external accountants who have cleared examination for forensic accounting and are working either as independent service providers or part of the internal audit teams of major corporations. Forensic Accounting has been defined in several ways however it is important for the purpose of this research paper to provide some which would help in better understanding of the reader. Forensic accounting has been defined as “a discipline that deals with the relationship and application of financial facts to business problems, conducted in a legal setting” (Bologna, Lindquist & Wells, 1993). Another definition by Manning (2002) suggests that forensic accounting is “the application of financial accounting and investigative skills to a standard acceptable by the courts to address issues in dispute in the context of civil and criminal litigation”. Zysman (2004) presented forensic accounting as a combination of accounting, auditing and investigative activities which are performed to assist in legal proceedings. It is therefore suggested that forensic accounting involves both legislative and investigative support and does include various activities ranging from physical evidence collection to performing tests and collaborating with other to form an opinion. In the UK courtrooms often engage forensic accountants for the recovery of criminal records which could be difficult to locate (Kennedy, 2007). Thus, it could be understood that the role of forensic accountants is not just limited to the irregularities in taxes and investigation of frauds but also extends to much wider range of activities including insurance claims, contract breaches, personal injury and warranty claims etc. This makes the field of forensic accounting to be much versatile and broader than it was expected in its earlier years. Also with the introduction of ISA240 there has been a shift in the role of internal auditors to provide their estimations and expectations of the risks of material misstatements in the financial statements and also to assess sufficiency and effectiveness of internal controls to prevent or detect fraud. This suggests increased deployment of forensic accountants by organizations (Enyi, 2008). Today, forensic accountants are well respected and engaged in different positions and responsibilities ensuring that the confidence of shareholders does not falter further which is much likely to happen in the current situation of economic slowdown and increased complexities of the ways in which businesses are operated. It would not be wrong to suggest that forensic accounting has evolved in an interesting profession which requires high level of capability and knowledge and is in fact highly rewarding (Enyi, 2008). It is further commented that forensic accounting should not always be considered for its application to the negative cases of both personal and business dealings such as bankruptcy, fraud, business disputes, or matrimonial divorce. It also play important role in providing positive assurances and services in respect of creating sound due diligence practices, performing business valuations, offering advisory services and implementing risk management at all levels of corporations. In commercial disputes forensic accountants could be seen as contributors to the resolving of the issues as expert witnesses, consultants or arbitrators (Golden, Skalak & Clayton, 2006) Importance of Forensic Accounting in Present Scenario The current financial crisis situation prevailing in the global economy has raised brows of regulators, investors, creditors and other stakeholders over the sustainability of businesses and continuance of their operations. It has been observed in the US that the current financial crisis did not just restrict itself to the housing industry and financial sector but also its affects have spilled over and affected businesses across different industries. With this came the obvious huge job losses and plunging financial health of businesses. In these weak economic conditions stakeholders are likely to lose their confidence in the companies and withdraw their investments from companies with poor financial results. This negative perception lead to tremendous capital outflows from all major stock markets of the world including NYSE, LSE, DAX and even Asian financial markets are experiencing volatile shocks in stock values causing a panic situation. To control this situation it is felt that major initiatives are required by all levels of the economies to avoid disperses, incontrollable and far damaging effects of financial crisis. In the course of this financial turmoil governments of different countries have played a big brother role by taking control of ailing industries and putting its stake high to inject liquidity and avoid a major catastrophic credit crunch which had already weakened the financial sector of the US and other countries. However, this approach does not guarantee for small businesses and even those businesses which the government may not have its own interest. In such situations owners of companies are more likely to manipulate their accounts in order to keep their businesses attractive to stakeholders. This could cause an eruption of accounting scandals and frauds that would resemble to situation in early 2000 as discussed in previous sections. A risk consulting firm Kroll investigated the possibilities of accounting fraud in the wake of the current global recession. It is predicted in the report published by the company that white collar crimes will rise in 2009 as whistle-blowing is becoming common. These frauds are expected to be carried out with a different approach which could surely makes both realization and investigation of such manipulations a difficult task for regulators, investigators and prosecutors to establish causes and supporting evidence for reported frauds (Kroll, 2009). For example, in a fraud case involving Madoff Investment Securities LLC. that is considered to be one of the largest financial frauds on the Wall Street involving US$50 billion (Glovin & Scheer, 2008) in which prosecutors had issues gathering evidence regarding a fraud involving payment to clients from money which never existed and had to reconstruct customer records which were destroyed by the company’s management (WebCPA Staff, 2009). As the alleged committed to the crime and insolvency the money lost by investors went into fumes and billions of dollars were wiped off the stock market. This raised concerns of shareholders regarding corporate governance and transparency. It is further concluded that in tougher economic conditions there are lesser opportunities for businesses to avail and as completion heats up companies are induced to get involved in accounting malpractice to report misleading figures of revenue. This has been a common phenomenon in previous recessional years of 1987, 1991 and 2002 in the US economy and regulators and accountant need to adopt a tougher stance to ensure due diligence and internal controls (Kroll, 2009). Another perspective that requires discussion to the possibilities of frauds under the current global crisis situation and investigations by forensic accountants is that the fraudulent activities will not only involve the higher management of companies but will also surely increase participation of employees working in these companies. This has been suggested by a group of independent accountant firms PKF and a senior partner and forensic accountant working at PKF LLC, UK remarked that "history tells us that, as corporate growth and output falls in a downturn, fraud inevitably rises. In any event, there has been a 240% increase in nine years, so the trend is already quite clear. The recipe for employee fraud has three key ingredients; personal or organizational pressures, opportunities and the belief the crime will go undetected" (Fairhurst, 2009). In addition to corporate frauds involving higher management of companies there has been increasingly reported crimes involving fraudsters who are involved in different types of crimes. In the UK, a fraud preventive service company CIFAS has reported a sharp increase of 16% in frauds throughout the UK in 2008. The most common frauds included facility takeover fraud which involves loss of personal information and control over accounts allowing forged withdrawals from individuals’ accounts. In addition to this misuse of facility and application frauds e.g. those submitted individuals for credit approval covering personal loans, credit cards and other types of loan facilities are commonly reported and investigated by forensic accountants (CIFAS, 2009). The recession and fraudulent activities are considered to go alongside each other and it is commonly held by analysts that in times of recession frauds begin to surface and their growth is significant as the Chief Executive of CIFAS commented that “there has been much attention given to the financial impact of the current economic turmoil on society. Fraud is yet another aspect and one that should not be overlooked” (Hurst, 2009). According to Jonathan Lovell of KPMG one of the top four big accounting firms in times of recession the extent and volume of commercial disputes are likely to increase which has already taken some form of pattern in the current financial crisis especially in the financial sector. These claims are mainly due to negligence by the financial institutions and increased insolvency to back their warranties and fall in the value of their assets. In such situations disputes and litigation are on the rise which may involve forensic accountants to perform extensive field work and evidence collection (Lovell, 2009). The increasing trend in fraudulent activities and commercial disputes has put further pressure on the forensic accounting profession and requires accountants to adopt newer strategies and procedures to determine and collect evidence for satisfying reasonably the requirements of cases pending in the courts for punishing those involved. This thus raised expectation of general public from forensic accountants to bring those to justice who have committed crimes and have caused losses to them but it is not an easy as it seems to be on the paper because of the challenges facing forensic accountants discussed in the next section of this report. Experiences from Previous Recessions and Forensic Accounting In the early 2001 the US economy had been in shackles of accounting fraud cases which did not only badly hit the corporate sector of the US but also affected the consumer sector. The owners of companies were induced by the lust of sudden phenomenological increases in the values of their stocks which was fueled by the advancements in the energy and telecommunication sector in the late 1990s. This led many to consider this as only for short term and they attempted to make most of it by playing with their figures and bending accounting rules and regulations to present to stakeholders something which never existed. All responsible elements including the top management, internal audit, audit committees, investors, lawyers and even external auditors were found involved in the heinous misrepresentation and misreporting of financial information. Amongst these cases Enron, WorldCom, Adelphia, Tyco Arthur Andersen and Parmalat etc. which all suggested the enormity of weaknesses and deepening failures of accounting profession. As these cases proceeded to their respective courts the regulators and prosecutors were no different on suggesting that these accounting frauds would not be easy to be solved as weaknesses were not just in the reporting procedure but also the corporate governance, internal controls, role of external accountants, supervisors & regulators and in fact the overall sentiment regarding the role of accountancy was somewhat wrong which allowed fraudsters to mislead investors (Ramaswamy, 2005). Forensic accounting has been at the forefront of gathering evidence for prosecutors in order to defend their claims against the management of major corporations such as Enron, Worldcom etc. In particular Enron case had put forensic accountants high on the demand as prosecutors searched for evidence in bringing culpurits to justice. During proceedings of Enron case FBI and CIA hired forensic accountants to carry out investigations into examining financial records which were either deliverately destroyed or lost by the company’s management and external auditors. However it is also suggested that in cases such as Enron placing forensic accountants within organizations to prevent tax frauds may not always yield in the best results (Sherwood, 2009). Challenges facing Forensic Accounting In the present economic recession forensic accountants are faced with issues which need careful understanding and planning to assure continuance of stakeholders’ interest in the profession of forensic accountant and the information which it provides for investigating and resolving cases involving accounting and reporting frauds. 1. As the current financial crisis in the US and other major economies of the world continue to slow down businesses and as bankruptcies are common in all major sectors there has been a growing trend of businesses shifting their focus to emerging markets which are still considered to be less prone to shocks in the US economy. Companies are mitigating their risks by operating in different markets and financial institutions are involved in developing tools which could help businesses in achieving their targets. However, with this the complexity of assets and instruments being used makes the job of forensic accountants more difficult as they have to be well versed to understand the processes and issues at the back hand of these new products and services. 2. Also the diversity of business activities across borders requires the scope of forensic accounting and accessibility to documents may become extremely difficult. Also due to high fees charged by forensic accountants for their services small companies may not be willing to use their services which may create a expectation gap from the reporting published by small businesses. 3. The role of forensic accountants is emphasized for fraud prevention and protection of the interests of shareholders who are increasingly placing their trust over forensic accountants to prevent huge losses as incurred by shareholders in previous recessions or economic downslides (Herrera, 2009). This situation puts extra burden on them to keep them updated with new ways of carrying out fraud by companies and the accounting areas which are likely to be targeted for accounting manipulation. 4. The introduction of SOX 2002 and later its implementation and regulatory role of PCAOB has set out the important of corporation governance and role of audit committees to provide information regarding the efficiency, effectiveness and sufficiency of the internal controls placed within in the organizations to prevent frauds and deter individuals at all levels from indulging into any criminal act. This has led to the increased demand for forensic accountants who are now hired by organizations in order to meet the requirements of the SOX and with it comes a higher level of commitment and responsibility required of forensic accountants. The level of transparency and inquisition should remain high and integrity of the profession should remain intact so that shareholders can finally have some confidence back in the corporate sector which is under present conditions finding it difficult. 5. In the current financial crisis the types of frauds have evolved and have become relatively new and complex which puts pressure on forensic accountants to gain more understanding and develop tools to investigate these crimes and provide sufficient evidence in order to bring these criminals to justice. The definitions of fraud incorporated by ACFE are becoming increasingly versatile in their coverage of crimes which requires immediate response by forensic accountants (Houck, 2006). 6. Also events leading to terrorist attacks in the US the need to track the movement of funds and misuse of banking framework to transfer illegal money and hide terrorism finances have raised concerns for the forensic accountants. These false activities have increased over the period and regulator and accountants felt greater need to find ways of stopping such transactions. Therefore, forensic accountants need to be more vigilant and reactive to point out any such suspicious transactions to the concerned authorities (Pacini, 2002). 7. Increasing use of internet technology and sharing of information on the web makes the job of forensic accountants more difficult. Businesses invest heavily in the security of their mailing and communication systems however it has been observed that internet crimes have increased drastically with identify thefts and misuse of information for criminal purposes. In addition to these corporate sector have also experienced criminals breaking into their systems and either placing incorrect information, retrieving secret information or even causing their systems to malfunction. In such crimes it is extremely difficult to track back to the source where the crime actually took place. Therefore, forensic accountants could have major difficulties in tracing supporting evidence against criminals (Smith, 2001). Conclusions & Recommendations From the above presentation of facts and useful information regarding the emergence of forensic accounting and its role as an investigative and probing tool it could be concluded that the need for forensic accounting is recognized as undeniable and unchallenging in the present situation of financial crisis which has gripped the US economy once again. The current recession is not just limited to the US but has a spillover effect that could be experienced in major financial centers around the world. The role of forensic accounting has heightened as it has been suggested that more frauds and accounting foul play is likely to happen in the periods of recession where companies are facing difficulty in keeping their operations profitable and perhaps attractable to the shareholders. Shareholders in such situation become less confident and seek out other avenues of investment by pulling their funds from their existing positions. This could be drastic for businesses who are not able to pay off their liabilities and it is imperative that management of such companies would get involve in accounting manipulation to avoid investment pull outs. In addition to this trading disputes are also common as businesses fail to meet their delivery commitments. Hence, upon examining the overall situation the role of forensic accountants is becoming somewhat relentlessly challenging and the pressure on the forensic accounting profession is mounting. As shareholders seek save investments opportunities in the shrinking capital market forensic accountants may feel that ethical and professional responsibility place upon them is far too much and it should be clear that their role within organization does not necessarily provide complete assurance that frauds will not take place. Their role within organizations is to allow some assurance that the internal controls have certain levels of sufficiency to prevent frauds from taking place but it all depends upon the accessibility and commitment by audit committees within organizations. The current recessionary period has caused forensic accountants to be more cautious, responsible for updating themselves to newer ways of frauds and preventing them. They feel that all eyes are upon accountants who have been criticized on several occasions for not doing what was expected from them. It is therefore suggested through this report that forensic accountants need to learn from past experiences of major corporate corruption cases and should also prepare for the challenges which lie ahead of the current recession and changes in the socio-political set up of the world surrounding businesses. References List Bologna, G. J., Lindquist, R. I. & Wells, J. T. (1993). The Accountants Handbook on Fraud and Commercial Crime. New York: John Wiley & Sons. CIFAS. (2009). 2008 Fraud Trends. London: CIFAS. Crumbley, D. L. (2001). Forensic Accounting: Older Than You Think. Journal of Forensic Accounting , 181-202. Enyi, P. E. (2008). Detecting Causes of Variances In Operational Outputs of Manufacturing Organizations: A Forensic Accounting Investigation Approach. Ogun State: Covenant University. Fairhurst, M. (2009). Fraud fuelled by the recession . Retrieved September 4, 2009, from PKF LLC.: http://www.pkf.com/site/international/home/cache/offonce/pid/164%3Bjsessionid=A0D3C17E4C6E91C90FC6A38DDD8B1805 Glovin, D. & Scheer, D. (2008, December 11). Madoff Charged in $50 Billion Fraud at Advisory Firm . Retrieved September 4, 2009, from Bloomberg: http://www.bloomberg.com/apps/news?pid=20601087&sid=anWXzISP4XCg Golden, T. W., Skalak, S. L. & Clayton, M. M. (2006). A guide to forensic accounting investigation. New York: John Wiley Publishing. Herrera, C. (2009). Forensic Accounting is Challenging. Retrieved September 5, 2009, from BellaOnline: http://www.bellaonline.com/articles/art37535.asp Houck, M. M. (2006, August 1). Forensic Accounting as an Investigative Tool. Retrieved September 6, 2009, from AllBusiness: http://www.allbusiness.com/accounting/fraud/4074089-1.html Hurst, P. (2009). Fraud trends and recession go hand in hand. Retrieved September 4, 2009, from CIFAS: http://www.cifas.org.uk/default.asp?edit_id=899-57 Kennedy, A. (2007). An evaluation of the recovery of criminal proceeds in the United Kingdom. Journal of Money Laundering Control , 33-46. Kroll. (2009). Kroll Global Fraud Report. New York: Kroll . Lovell, J. (2009). Forensic Accountant. Forensic Accountant , pp. 4-27. Pacini, C. (2002). The Forensic Accountant’s Role in Fighting Terrorist Financing. Journal of Forensic Accounting , 289-300. Ramaswamy, V. (2005). Corporate Governance and the Forensic Accountant. CPA Journal , [online]. Sherwood, C. (2009). About Enron & Forensic Accounting. Retrieved September 7, 2009, from eHow: http://www.ehow.com/about_4614281_enron-forensic-accounting.html Smith, G. S. (2001). New age technology threats and vulnerabilities. Journal of Forensic Accounting , 125-130. WebCPA Staff. (2009, May 15). Forensic Accountants Reconstruct Madoff Books. Retrieved September 4, 2009, from WebCPA: http://www.webcpa.com/news/Forensic-Accountants-Reconstruct-Madoff-Books-50484-1.html Zysman, A. (2004). Forensic Accounting Demystified world investigators network. Toronto: Canadian Institute of Chartered Accountant. Read More