Importance of Forensic Accounting in Countries of Business Opacity: A Means to End Fraud15 min read
When hearing about Enron, Conrad Black, Kimberly Rogers or WorldCom, one will definitely think about theft, bribery and fraud. The key word here is “fraud”; where many studies have been conducted about this subject. What is fraud and how is it detected and dealt with, and how is it possible to be protected from it? Such questions and their answers are key terms in the domain of forensic accounting, since fraud has played a major role in the existence of accounting, hence forensic accounting. Understanding fraud is necessary for those who want to understand what Forensic Accounting is, how it has come into the system, how it exactly deals with the issues we face, and to what degree it has helped in certain issues of fraud, or even in strengthening the accounting system in general (Economist Intelligence Unit, 2007).
Research has been conducted on fraud and has been given different definitions, all which come in line with one another. Other researches were done to highlight the job of internal controls in minimizing the chance of theft or misappropriation. However, little research was done on forensic accounting diffusion and proper implementation.
Fraud activities have been manipulating, stealing, and destroying many businesses and industries. To face such harmful trends, fraud examination has been created; and great efforts have been exerted to detect, investigate, and prevent similar acts from encountering. These preventions have shed lights on a new concept and practice known as “Forensic Accounting (FA)”, which has become a common notion to fight against fraud and similar unethical acts. No matter how much fraud activities increase, there must always be an anti-fraud scheme to shield against it. To provide availability of balance and protection is the main reason why FA existed.
Nonetheless, the legal, supervisory, and regulatory systems of financially corrupted countries create significant opportunities and tools for the laundering and protection of the proceeds of crime, and allow criminals who make use of those systems to significantly increase their chances to evade effective investigation or punishment. A country’s commitment to bank secrecy and the absence of certain key supervisory and enforcement mechanisms aimed at preventing and detecting money-laundering increase the possibility that transactions involving the country’s entities and accounts will be used for illegal purposes.
Since one of the most powerful tools used today is forensic accounting, it is advantageous to study its possible implementation in countries with business opacity, and to probe the essential methods needed to establish the implementation of this procedure in different sectors and at many levels. Therefore, in order to achieve these objectives, there is a need to investigate the following research question: “What are the conditions of possibility for implementing FA in a country characterized by an opaque financial sector?” More specifically, this research has two objectives:
1. To identify the best way to highlight the importance of using forensic accounting activity in order to clear the roads of the future of business activities; by learning from past mistakes such as Enron and WorldCom and by using other cases of financial fraud similar to the international ones.
2. To identify the way to diffuse and implement forensic accounting as a vital tool that, when used professionally, can greatly help fight against fraud activity.
Moreover, the gap is that forensic accounting is not known in many countries. FA is not so much spread in the world, it is only known in USA and some developed nations. The study is contributed in finding the best way to implement FA especially with the existing gap, with the objective of covering it mainly because it is so hard to implement forensic accounting especially that it is not diffused worldwide. The objective is to arrive at an answer to the research question and to show how forensic accounting can be implemented in the countries characterized by an opaque financial sector; the overall aim is to achieve this goal.
Different research has been conducted to define fraud including the types of fraud such as that of Gilbert (1997, p. 124) who defined “fraud” as: “an act using deceit such as intentional distortion of the truth of misrepresentation or concealment of a material fact to gain an unfair advantage over another in order to secure something of value or deprive another of a right. Fraud is grounds for setting aside a transaction at the option of the party prejudiced by it or for recovery of damages.”
Farrell & Healy (2000) revealed about fraud that is increasing worldwide and is becoming more costly to businesses every year as fraudsters use intricate methods to commit and cover their criminal acts. Consequences of fraud can vary from public morality corrosion, weakened faith in the organization, to loss in market valuation and confidence of stakeholders.
With the various definitions attributed to fraud, other research done highlighted the importance of having internal control that would limit the continuous fraudulent behaviors. External audits are also undertaken to ensure that internally instituted fraud control mechanisms are adequate in scope, effective in application and complied with. However, it is quite unfortunate to note that the complexity of the human brain and its dynamic method of reasoning have tremendously diversified present-day scams away from the hitherto known modes of fraudulent activities that now render true corporate governance ideals almost unworkable.
It is thus worth mentioning that in an attempt to prevent fraud, the Auditing Standard Board (ASB) in 2002 issued the Statements of Auditing Standard 99 (SAS 99) which introduced a “Fraud Triangle”. Fraud Triangle indicates that the probability of committing fraud is high in situations when managements or other employees have incentive or are under financial pressure, the conditions that provide opportunities for management or employees to commit fraud exists, or the ethical values or characteristics that cause management or employees to rationalize the fraudulent act exists (Maranjan, 2010).
Fraud can be detected and investigated to prevent the possible damages the activity can cause. So what advice would a forensic accountant give to a company suffering from fraud activity? A professional can list four things that can be done to mitigate the occurrence of fraud and they include fraud prevention, fraud detection, fraud investigation and follow-up legal action or resolution. The anti-fraud program of any company should focus on all four.
The past two decades have witnessed significant changes in the business environment including globalization, technological advances and now with reported high-profile financial scandals, ways to improve public trust and investor confidence in financial reports. Emerging regulatory, social, economic, ethical, and legal challenges facing the world of businesses contribute to an increasing demand for FA that encourages accounting.
A study done in October 2003 assures that the demand for an interest in FA will continue to increase in the future and more accounting programs are being planned to provide FA education, The business community and the accounting profession are deeply concerned with reported financial and accounting scandals. However, few to none research were conducted to study the proper diffusion and implementation of forensic accounting in the countries of opaque business practices.
Many factors in a country’s business mechanism contribute to the fraudulent behavior in the financial sectors. For instance, being considered as a tax haven country with banking secrecy regulations, money laundry activities and low corporate governance, fraudulent activities become easy to commit. All of this results in a national wide corruption triggering the need to introduce FA. However, due to the opaque financial nature of the country and prior to the introduction of FA, major changes has to be done to prepare the country for the diffusion and implementation of FA on both the macro and micro levels discussed earlier.
The causes for corruption of which several exist in most corrupted countries as it was previously noted, are attributed to the absence of dysfunctional key anti-corruption institutions, the lack of awareness on corruption, its causes, consequences and the weak legal framework and the absence of proper legal implementation mechanisms. Adding to these are the confessional and feudal mentalities, inefficiency of supervisory bodies, low salaries of public sector employees, political influences on the judiciary, the absence of civic education, foreign interference in domestic affairs, selective or lenient enforcement of the law, and the inefficient media. In other words, the factors contributing to the fraudulent business practices can be categorized under four notion; culture, education, management and government and legislation. Whether it is the lack of awareness regarding FA (culture and education) and the advantages it can bring, corrupt practices of management and the inefficiency of supervisory board or absence of a law that enforces FA (government and legislation), the four categories should be tackled to put an end to the continuous fraudulent acts.
For instance, the lack of whistle-blower protection laws prevented citizens from reporting on political corruption in the legislature or other sections of government. In the private and public sectors, the lack of an access to information law, a whistle-blowers’ protection law, conflict of interest law and other disclosure and transparency mechanisms is a major obstacle to integrity.
Results and Discussion
The literature review explained the different meaning of fraud, forensic accounting, and the characteristics of an opaque business country and how can FA help in limiting fraudulent behavior that is making it easy for money launderers to continue their illegitimate practices. Furthermore, FA can serve as a liberator for countries with opaque business practices such Luxembourg, Austria, Lebanon and many others, putting an end to all the business corruption taking place at the different sectors of the country, be it government or any other private or public sector. However, to reap the best results of FA, a proper diffusion and implementation process must take place that requires the work of the parties in a country, be it government itself, people’s view and awareness of FA on the cultural basis, the companies that must require from its employees to be aware of FA and to employ forensic accountants as well and universities and other academic institutions that bear on its ability to teach FA.
Countries with opaque business practices tend to share similar characteristics that justify the prevalence of fraudulent activities. As it was mentioned earlier, the factors that contribute to the fraudulent behavior in the financial sector can be categorized under four categories; culture, government and legislation (macro-level), management, and education (micro-level).
The importance of adopting forensic accounting is thus highlighted, however, the process of introduction is not an on the spot process. On the contrary, it requires time and effort in terms of shifting cultural awareness to realize the importance of FA. That being said, the government as a primary facilitator and the educational systems should take part in creating awareness and shifting cultural mentality towards FA. Managements must also educate employees on FA and to adopt it as part of its system.
A. Forensic Accounting in Culture
Koh et al., (2009) conducted a study to examine the acceptance level of the public in Malaysia regarding forensic accounting. The study revealed that problems arise from the fact that FA service is still new to most of the businesses and even to the public in Malaysia. This leads to confusion among the public and some may even be unaware of the existence of the system. Therefore, the importance of the service is disregarded (goes unnoticed).
Two variables affect the acceptance levels of the public for the practice of forensic accounting as the main tool in investigating a company’s account to detect fraud. The variables include the public’s understanding level on forensic accounting functions and the perception regarding the implementation of forensic accounting in the investigation. The understanding level of the public and the functioning of forensic accounting will determine whether the public in Malaysia will accept it as the main tool in investigating a company’s account in case of fraud. The perception of the public on the implementation of forensic accounting in the investigation of a company’s financial statement also determines the acceptance level of forensic accounting in the country.
This study shows the importance of two basic components that should be available to create a ground for forensic accounting implementation; these elements are awareness and knowledge of forensic accounting as an anti-fraud tool and the perception of implementing forensic accounting, whereby these two elements are considered as major factors for the level of acceptance of such tool.
In other words, if a change is made in cultures of financially corrupted and opaque business practices, it will result in changes in the people’s practices, norms, and values, hence their behaviors; at the end, it will create an awareness and knowledge about fraud and how to fight it and the tools that could be used to inhibit it. In addition, this process similarly applies to forensic accounting.
B. Forensic Accounting in Education:
Although there is a growing demand for fraud and forensic accounting globally, much of its advancement and adoption in the accounting curriculum in the universities are taking place in the developed economies. The adoption of forensic accounting into the universities accounting curriculum has a huge potential to enhance students’ skills and competencies and could be used as a veritable resource from which fraud could be mitigated.
Many cases reveal that those who commit fraud are not necessarily geniuses or have a creative mind. They are typical accountants who copy fraud schemes from the past. Therefore, the importance of the programs for fraud prevention/detection education and training is emphasized, and the question is raised about whether the business school at universities offers enough programs to educate accounting and auditing professionals for fraud prevention/detection.
Forensic Accounting is not only restricted to university programs, there is also a specialized certificate that is concerned with forensic accounting, which is the Diploma in Investigative & Forensic Accounting (DIFA) program. DIFA is designed to provide a broad range of knowledge and skills to carry out financial investigations. This range includes accounting, audit, income tax knowledge, fraud knowledge, knowledge of law and rules of evidence, an investigative mentality and critical skepticism, understanding of psychology and motivation, and strong communication skills.
The DIFA program focuses on knowledge and skills that can be best taught and examined in person: such as handling a face-to-face meeting with a client, interviewing skills, and testifying in court as an expert witness.
In conclusion, the base of forensic accounting is a knowledge in accounting, auditing, internal controls, risk assessment and fraud detection, a basic understanding of the legal environment since the legal environment is essential in order to support the litigation, acknowledging their competence, obtaining a diploma specialized in forensic accounting which could be given by educational institutions that grant certifications such as DIFA. These formal certificates can deepen the students’ knowledge and sharpen their skills in forensic accounting.
C. Forensic Accounting in Management:
Poor corporate governance will lead a certain individual or a group of people with the same interest to act upon it to commit fraudulent activities in the company. This can be reinforced by the fact that top-level management should follow the policies of the firm, which will help the company to perform better.
Even if a company applies good internal control systems, the management will still be the major factor influencing the implementation. Companies should look towards new approaches rather than follow the traditional approach, as forensic accounting may be the next best alternative in resolving problems.
Loebbecke and Willingham (1998) conclude that the probability of material financial misstatements due to fraud is a function of three factors. The factors include the degree to which those in authority in an entity have reason to commit management fraud, the degree to which conditions allow managerial fraud to be committed, and the extent to which those in authority have comply to ethical values that would facilitate fraud commitment. These three factors show that the management could simply commit fraudulent activities since the public including shareholders are unaware of the countermeasure to be taken to prevent financial crimes. It argues that there should be a set of guidelines created for the public and management to ensure that actions should be taken when financial fraudulent activities occur.
The main problem or issue is the constant misunderstanding of the role and responsibility of the auditor as the public expects auditors to detect financial asset misstatement or even fraudulent activities from the financial statements. This has been the long perception of what an auditor’s responsibilities are. Therefore, this perception should be regenerated and corrected. Auditors with forensic accounting background would be allotted as forensic accountants specifically to investigate the company’s financial statement. These people would be responsible for detecting financial misstatements. With the proper education given to the public, this perception of auditors could be enhanced.
D. Forensic Accounting in Government and Legislation:
Forensic accounting has played a major role in the improvement of detection, investigation, and representation of all cases at hand in law courts in judicial formalities.If companies wish to utilize information regarding a fraudulent activity in a court law, they may acquire the skills of forensic accountant because they can handle investigations in a way that is completely acceptable in a court of law.
Forensic accounting is the specialty practice area of accountancy that describes engagements resulting from actual or anticipated disputes or litigation. “Forensic” means “suitable for use in a court of law,” and it is to that standard and potential outcome that forensic accountants generally have to work. Forensic accountants often have to give expert evidence at the eventual trial.
Forensic accounting should be part of criminal investigation, for the matters relating to financial implications where the report of forensic accountants must be considered as evidence and proof to be presented in court trials.
Countries that established forensic accounting in their legal system, have forensic accountants who work with law enforcement and the district attorney’s office. Just as with other types of evidence, the prosecution obtains search warrants to locate financial information and compel knowledgeable people to conduct or hold interviews about the situation in question.
Forensic accountants can also provide litigation support. Attorneys engage the services of forensic accountants to review existing documentation and testimony and explain their financial significance. A forensic accountant can tell the attorney about the additional information needed to prove the case and questions to ask the witnesses. The forensic accountant may also review damaged reports and state whether the report was put together accurately and supports the case.
Government agencies like the FBI, the Internal Revenue Service, and the Bureau of Alcohol, Tobacco and Firearms have forensic accountants to investigate everything from money laundering and identity-theft-related fraud to arson for profit and tax evasion. Law firms often use forensic accountants to help divorcees uncover their exes’ hidden assets.
This article deals with the importance of having an investigative system that would limit the frequent financial frauds and business opacity taking place worldwide. In this context, forensic accounting has been presented as a tool to inhibit the prevailing frauds, money laundry and theft. However, to the reap better results forensic accounting must be properly diffused and implemented with a great emphasis on enhancing public (cultural) awareness, attributing a major role to managements, education and governments/legislation.
For instance, the public may be unaware of the significance of forensic accounting and may lack the needed knowledge for implementing it in investigative matters. Thus, the need to incorporate forensic accounting in the culture of financially corrupted countries in order to create awareness of forensic accounting as an anti-fraud tool and the means of implementing it in the investigation of financial statements. This step can be handled by government and legislation as primary facilitators.
Furthermore, the importance of adopting forensic accounting in the universities’ accounting curriculum is highlighted especially that the demand for it is increasing gradually. Such adoption has a huge potential to enhance students’ skills and competencies and could be used as a veritable resource from which fraud could be mitigated. Fresh graduates can as well attain a diploma in Investigative & Forensic Accounting (DIFA) program that provides a broad range of knowledge and skills to carry out financial investigations.
As for managements, there is a need to develop a proper corporate governance and internal control systems in which those of high authority are held liable and responsible for any fraudulent and unethical misbehavior.
In sum, it is somehow a long process to start incorporating forensic accounting in academic curricula. A first step that needs to be established is creating awareness on ethical issues. As it was discussed, cultural shifts towards the importance of FA is must be maintained, governments, legislation, educational systems as well as managements should share their part in the diffusion and implementation of forensic accounting.
Farrell, B. R., & Healy, P. (2000). White Collar Crime: A Profile of the Perpetrator and an Evaluation of the Responsibilities for its Prevention and Detection.
Gilbert (1997), Law Dictionary, Harcourt Brace Legal and Professional Publications.
Kohl A. N., Arokiasamy L., Ah Suat C.L. (2009). Forensic Accounting: Public Acceptance towards Occurrence of Fraud Detection
Loebbecke, J.K, Eining, M.M. Willingham, J.J. (1989). Auditor’s experience with material Irregularities.
Maranjan, S. (2010). The surprising plaque killing retailer profits.