1 FORENSIC ACCOUNTING AND DIGITAL FORENSICS CA Charanjot

1 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

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 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 6

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 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 8

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 Ø Deposition Matrix/Interview Matrix Ø Search Log/Background Investigation Ø Lifestyles Analysis Ø Net Worth Method Ø

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 Accountant’s Report

METHODS OF PROOF DIRECT METHODS SPECIFIC ITEM METHOD FINANCIAL RELATIONSHIPS FINANCIAL STATEMENT ANALYSIS HORIZONTAL VERTICAL TREND RATIO CASH FLOW 13

METHODS OF PROOF INDIRECT METHODS NET WORTH METHOD EXPENDITURES METHOD (ASSET METHOD) (LIFESTYLES METHOD) (SOURCES AND APPLICATION OF FUNDS METHOD) BANK DEPOSIT METHOD 14

METHODS OF PROOF 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 15

METHODS OF PROOF 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 16

METHODS OF PROOF Easiest to present @ trial Most difficult for the suspect to refute Example: Ghost employee on the payroll

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 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 23

INDIRECT METHODS OF PROOF SOURCES OF INFORMATION 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

INDIRECT METHODS OF PROOF NET WORTH METHOD Used to prove illicit income Person’s assets or expenditures exceed known sources of income 4 ways to dispose income: & Save it rug d y in ses l Buy assets sive g ca n exte nderin d Pay off debt Use ey lau mon Spend it 25

INDIRECT METHODS OF PROOF NET WORTH METHOD FORMULA Assets -Liabilities =Net worth -Prior year’s net worth =Increase in net worth +Living expenses =Income (or expenditures) -Funds from known sources =Funds from unknown sources 26

INDIRECT METHODS OF PROOF 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 27

INDIRECT METHODS OF PROOF BANK DEPOSIT METHOD WHEN TO USE Assets & liabilities are fairly constant No indications of extravagant lifestyle Target’s known income is being deposited into financial institutions HOW Analyze bank deposits, cancelled checks, currency transactions 28

INDIRECT METHODS OF PROOF 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 29

DIGITAL ANALYSIS TECHNIQUES 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 30

DIGITAL ANALYSIS TECHNIQUES FUNCTIONS 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

DIGITAL ANALYSIS TECHNIQUES FUNCTIONS 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 Benford’s Law analysis Stratification

DIGITAL ANALYSIS TECHNIQUES EXAMPLES 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

DIGITAL ANALYSIS TECHNIQUES COMMERCIAL SOFTWARE Excel ACL IDEA Active Data for Excel Auto Audit SNAP! Reporter Data Watch’s Monarch for Windows Oversight Systems