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Not Your Average Audit

Forensic accountants, after dissecting suspect claims or autopsying a deal gone bad, can tell you who did what, where and with what weapon.

For -most people, the word "forensic" may be more likely to conjure up scientists dissecting a body than an accountant picking apart a balance sheet.

But in the world of forensic accounting, it's often a certified public accountant who pieces together the cause of corporate death or disaster. When lawyers need to determine economic damages, put a price on a business, or unravel a complex financial tangle during an investigation, they turn to the forensic accountant.

Forensic accountants work in the broad field of accounting services known as litigation support, conducting fraud investigations and testifying as expert witnesses. Their work sometimes is referred to as conducting a financial autopsy.

The probe into Enron's collapse is a prime example. Of course, not every case forensic accountants investigate reaches that magnitude.

A more typical situation might arise when an attorney handling an arson claim needs to reconstruct the activities of a business before a fire destroyed its vast and expensive inventory.

In just such a case, forensic accountant James F. Hart found that a business's records showed a large increase in inventory supposedly in the store at the time of the fire. The business, however, lacked the cash to buy that inventory and had incurred no new debt. The owner had not borrowed the money, and suppliers didn't send the inventory on credit.

"We were able to establish that this large amount of inventory that supposedly burned, they couldn't account for," says Hart, who works with Taylor Consulting Group Inc., a financial consulting firm that provides investigations, business valuation, and bankruptcy and litigation services.

Forensic accountants also help determine damages, sometimes showing that a party's damage assumptions are inflated.

Hart's firm, for example, investigated one case for a former employer accused of wrongful termination. To bolster his claim for damages, the erstwhile employee had portrayed himself as a person rising through the ranks and on track to do well at the company over several years.

By investigating the typical turnover for people with that employee's job title, a far different picture of a short-term customer service job emerged- one that was not a stepping stone for advancement in the company. Additionally, Hares firm discovered the employee in question typically left jobs every two years, and was near the two-year mark when the disputed job ended. Facts like these color the assessment of the claim, says Hart.

A CPA, but 'Sexier'

Forensic accountants differ from traditional CPAs and auditors in a number of ways.

According to Paul Dopp, a principal at forensic accounting and litigation consulting for Kroll Linquist Avey, even the term "forensic accountant" has some mystique to it. "It sounds a bit sexier than 'auditor,' " he says.

A traditional CPA handles auditing, accounting and tax work. Usually, the work is not under scrutiny, evaluation and confrontation.

A forensic accountant, by contrast, might apply all the knowledge and experience of an accountant to investigate a dispute, and, his work is held up for challenge by another party, says Charles M Phillips, a forensic accountant with Acuitas Group Inc.

Where an auditor may rely on documents provided by a client, a forensic accountant may use third parties, search the Internet, and find and interview witnesses, says Taylor Consulting Groups' Hart. A CPA might ask a company's management to verify a certain matter, he adds, whereas a forensic accountant might go a stop further and also interview current and former employees and competitors.

What They Can Do for Lawyers

Typically, lawyers use forensic accountants in three situations- investigating fraud, developing economic damage estimates, and valuing business.

In fraud investigations, the forensic accountant is called to confirm or dispel a suspicions corporate client suspects internal fraud, a small-business client suspects the bookkeeper is embezzling, a growing company suspects its latest acquisition target misrepresented its revenue projections.

As expert witnesses, forensic accountants are hired primarily in deter- mining economic damages for clients involved in some proceeding, such as in a suit, arbitration or mediation.

Phillips says parties are hiring more forensic accountants as arbitrators because they understand accounting issues. In mediation, according to Dopp, parties have begun calling in forensic accountants earlier to deter- mine a range of damages that will help develop their settlement stance.

Forensic accountants also assist lawyers in preparing outlines for depositions and may educate lawyers on complex financial and investment matters, he says.

In business valuation, forensic accountants often are called in when a transaction fails. For example, Company A acquires Company B, which claimed 20 percent net income. Later, Company A discovers the true net income is only 5 percent.

"The first thing they do is call their feel they've been defrauded," says Dopp. "Then the attorney would call (a forensic accounting firm) and look at investigative issues. Where were the misrepresentations? How did they happen? Why did they happen?"

Bankruptcy and insolvency investigations also are big areas for forensic accountants, according to Hart, who specializes in bankruptcy work. Sometimes forensic accountants get involved early enough in reorganization plans to point out what is not working, providing information that helps turn the company around. Often, however, the forensic accountant helps the trustee recover assets for creditors of liquidated companies.

In bankruptcy cases, Hart says, part of the forensic accountant's job is to figure out what went wrong, to help identify claims, and to identify property that belong to the bankruptcy estate.

Forensic accountants even follow the money in divorce cases, where one spouse suspects the other is hiding assets. Here too, the forensic accountant uses skills other than accounting.

In one divorce case, Dopp of Kroll Lindquist says, he dug up an article about a prized horse that won a race in Florida. The article quoted the horse's owner, who just happened to be the husband in the divorce case, declaring that the thoroughbred was the best of his five race horses-none of which was reported among his assets.

What Lawyers Can Do for Them

According to Phillips, attorneys get the best results from forensic accountants when they keep two things in mind: early involvement and frequent communication.

He admits that clients, holding the purse strings, don't always want forensic accountants brought in early, but says the sooner they can start work, the more value they add.

Forensic accountants are being called in earlier, as well as more often, says Dopp. Rather than waiting until a deal sours, lawyers are using forensic accountants while helping clients assess acquisitions. Having autopsied so many failed transactions, forensic accounts are in a good position to identify potential trouble. "They [lawyers] tell us, 'Take your knowledge and experience and, on the front end, tell us if there's anything wrong with this company before we part with our money, " says Dopp.

According to Dopp, his early investigation rarely has killed a deal. Rather, as a result of raising a red flag, the parties adjusted terms such as price or methods of financing.

Frequent communication-which includes providing information on schedules and when work is needed- adds value too, he says.

"That's a huge nemesis. ... We're way down on the list of the attorney in terms of communication," says Phillips. "They're very busy. They tend to forget about the [the forensic accountant] and what he is doing and when he needs to complete the work."

Still, the field is growing, according to Phillips, chair of the Georgia Society of CPA's business valuation and litigation services section.

It is hard to put a number on just how many people practice forensic accounting because there is no specific credential for the field, though many forensic accountants are CPAs or are certified fraud examiners, certified management consultants, or former Internal Revenue Service or FBI investigators.

According to Phillips, several factors are driving growth, including more complexity in the business and governmental world, more conflicts of interest and more interrelationships. Transactions now require more scrutiny because they have become more complex, increasing the chance of mistakes.

Finally, the high standards that forensic accountants as expert witnesses must meet under the Federal Rules of Evidence and the expanded requirement for written reports should thin out a lot of competitors serving as expert witnesses, says Phillips.

The Enron Effect

And then there's the Enron investigation.

All of the Big 5, not just Andersen, are responding to an erosion of confidence in auditing practices and corporate bookkeeping, and to claims that combining consulting and auditing under one roof creates a conflict. Among non-auditing practices, each of the Big 5 offers forensic accounting services, such as litigation support and fraud investigation.

Dopp says part of the fallout from Enron may be more demand for truly independent fraud investigators, such as the boutiques. Though his 23-person firm is a division of a larger, publicly traded risk consulting company, Kroll Inc., it does not handle audits or tax work. Rather, his firm concentrates strictly on litigation support.

Phillips, who worked for Coopers & Lybrand before it became PricewaterhouseCoopers, says the question of what the Big 5 will do with forensic accounting services is generating a lot of talk in CPA circles.

According to Phillips, though there's a possibility that large firms will cut their non-auditing practices, the likelihood is that forensic accounting will survive because it's profitable.

Still, says Dopp, "The word 'independence' has taken on a more important meaning. And the concern now with the Big 5 is how to provide services as auditors and also forensic accounting services."


 
 
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