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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

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 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

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

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 METHODS OF PROOF

 INDIRECT METHODS
 NET WORTH METHOD
 (ASSET METHOD)

 EXPENDITURES METHOD
 (LIFESTYLES METHOD)
 (SOURCES AND APPLICATION OF FUNDS METHOD)

 BANK DEPOSIT METHOD

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 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

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 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

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 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
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INDIRECT METHODS OF PROOF

SOURCES OF INFORMATION

 Deeds of ownership,  Surveillance

titles, liens, filings  Credit card
applications/statements
 The target
 Tax returns
 Informants/associates  Insurance records
 Real estate records  Employment records
 Bankruptcy records  Cancelled checks
 State motor vehicle  Deposit slips
records  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

 Buy assets

 Pay off debt

 Spend it

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 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

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 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

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 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
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 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

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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
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DIGITAL ANALYSIS TECHNIQUES

FUNCTIONS
 Sorting  Verifying multiples of a
 Record selection number
 Joining files  Compliance verification
 Multi-file processing  Duplicate searches
 Correlation analysis  Vertical ratio analysis
 Date functions  Horizontal ratio analysis
 Graphing
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
 Match names, addresses,
 Identify invoices w/o phone numbers, numbers
PO between employee and
 Look for invoices from vendor files
vendors not “approved”
 Identify dormant accounts
 Analyze claims paid by with activity
insurance providers
 Search for large,
 Look for high volume rounded transaction
purchases from one values
vendor
 DIGITAL ANALYSIS TECHNIQUES

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