New York's Cooperative and Condominium Community

Habitat Magazine Insider Guide



The Facts About Forensics

There is a demand for a new breed of accounting specialist. The reasons are clear: there is an increase in business fraud incidents estimated to cost billions each year and the belief that our law enforcement agencies do not have the expertise needed or time required to uncover fraud.

Forensic accounting is the application of accounting skills and an investigative mindset to incidents of fraud and other financial improprieties perpetrated largely by white-collar criminals. The list of wrongdoing is as broad as it is long and includes employee, management, and supplier frauds, involving bribery, kickbacks, and secret commissions.

Within this new area of accounting, there are two broad classifications of accountant or areas of practice: litigation support specialists and investigative or fraud accountants. Within the litigation support specialist practice, there are the categories of business valuation, revenue analysis, expert witness testimony, and future earnings' evaluation. The American Institute of Certified Public Accountants (AICPA) describes litigation services as "any professional assistance non-lawyers provide to lawyers in the litigation process." The job of the expert witness is to present and clarify the facts in a court battle. Forensic scientists examine and interpret evidence and facts in legal cases and offer expert opinions regarding their findings in courts of law.

The investigative or fraud accountant has two areas of emphasis - seeking out evidence of criminal conduct and dispelling or supporting damages. The investigative accountant searches for evidence of criminal conduct or assists in the determination of, or rebuttal of, claimed damages. Detecting fraud, or white-collar crime, is often thought of as part of the accounting or auditing function. After all, isn't fraud something internal or external auditors are supposed to guard against by their periodic audits?

Fraud is a broad legal concept and auditors do not make legal determinations of whether fraud has occurred. Rather, the auditor's interest specifically relates to acts that result in a material misstatement of the financial statements. An auditor's role is to check for the compliance of a company's books to generally accepted accounting principles and company policy.

The primary factor that distinguishes fraud from error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional. Unlike error, fraud is intentional and usually involves deliberate concealment of the facts. Usually, management and employees engaged in fraud will take steps to conceal the crime from the auditors and others within and outside the organization. Thus, a new category of accounting has developed. This is known as forensic accounting.


The term forensic accountant refers to a certified public accountant who performs an orderly analysis, investigation, inquiry, test, inspection, or examination in an attempt to obtain the truth and form an expert opinion. Forensic accountants are specialists who are trained to look beyond numbers and identify illegal or improper conduct. They are trained to analyze, interpret, summarize, and present complex financial and business-related issues in a manner that are both understandable and properly supported. They are familiar with legal concepts and procedures and can identify substance over form. Normal financial statement audit procedures cannot be relied upon to detect fraud and auditors are not trained fraud investigators.

Recently, the Auditing Standards Board of the AICPA has approved release of a new statement on auditing standards (SAS No. 99) to provide additional guidance to financial statement auditors in obtaining the information needed to identify the risks of material misstatement caused by fraud. It includes the need to "brainstorm the risks of fraud while emphasizing increased professional skepticism; discussions with management and others as to whether they are aware of fraud."

In order to accomplish this, auditors will need enhanced auditing skills, specifically interviewing skills, together with increased professional skepticism. Practitioners will have to make inquiries to management and others within the entity about the risk of fraud and whether they are aware of any frauds within the organization. Still, the scope of a financial statement audit does not come within the realm of forensic accounting or fraud examination.


Fraud examination consists of specialized knowledge from four fields: accounting and auditing, investigation, law, and criminology. The professional interested in uncovering or documenting fraud must not only know how to discover it in the books and records. He/she must know how to recognize fraud symptoms; how to obtain evidence, take statements, and write reports; how to testify to findings; and how to assist in the prevention and detection of fraud. The actual scope and procedures of a fraud investigation depend on such factors as the type of fraud committed, the objectives of the investigation, and the type and amount of available evidence.

A fraud investigation generally arises from the board of directors' or management's suspicion of fraud. Suspicions may develop as a result of:

Customer (in a cooperative or condominium, the customer would be the shareholder or unit-owner) or vendor complaints. Such complaints may disclose payments not being credited to the customer's accounts or payments not received by the contractor.

Problems detected by internal controls, such as frequent overpayment on invoices.

Accidental discovery of an issue that warrants follow-up, such as two expense reports that contain receipts for the same expenditures.

Changes in an employee's lifestyle not consistent with his/her wages and other known sources of income.

Unusual or unexplained financial statement trends.

Problems encountered in the course of an external financial statement audit. External financial statement auditors may report suspicions of fraud arising from a financial statement audit to management and may be requested by management to investigate further. Such conditions and evidence may arise when there are discrepancies in accounting records; conflicting or missing evidence such as missing documents, significant unexplained items or reconciliations; inconsistent, vague, or implausible responses from management or employees to inquiries; significant discrepancies between the organization's records and replies to auditor confirmations; denial of access to records, facilities, certain employees, vendors or others from whom audit evidence might be sought.

As a result of any of these conditions, the auditor may need to modify the audit approach because of fraud concerns with respect to the auditor's assessment of the risk of material misstatement because of fraud or because the auditor finds fraud or possible fraud involving management that could be material.



In those situations, a financial statement audit can lead to a fraud investigation. The auditor may be able to address the fraud concerns by applying traditional audit procedures. But since the audit focuses on the financial statement effect of fraud, it may not provide enough information to meet other client objectives.

For example, if an auditor finds evidence of potential fraud in payroll transactions and applies additional audit procedures, the auditor may determine that the fraud is immaterial on a financial statement level. The fraud will be reported to management and no further procedures are required by generally accepted auditing procedures. In this situation, the audit procedures may not provide enough evidence to permit legal action against those who are committing the fraud.

The client should ask the auditor to perform a fraud investigation to obtain more evidence. Using the company's independent auditor will be more cost-effective, since he/she is already knowledgeable about the company's operations. But if the suspected or alleged fraud is complex or pervasive, the auditor and/or client may decide that a forensic investigation conducted by a specialist is the most effective way to obtain evidence.

A manager or attorney, who has strong suspicions or evidence of fraud, may engage an outside investigator. The investigator may hold the designation of CPA or Certified Fraud Examiner (CFE) or both. The fraud investigator may be engaged to serve as an expert consultant or an expert witness. (The expert consultant may ultimately become an expert witness.) As a consultant, the investigator is engaged to develop evidence used by an attorney as a basis for taking various actions including firing the perpetrator, attempting to recover stolen assets, making an insurance claim for losses, instituting civil litigation against the perpetrator, reporting the suspect to appropriate law enforcement authorities and taking measures to prevent future fraud.

An investigator may approach a fraud investigation in a variety of ways depending on the circumstances. It may begin with a general concern about fraud rather than a specific suspicion. If there is no specific allegation of fraud, one could investigate all aspects of the organization. This approach would be costly and impractical. Rather, the process should focus on areas where fraud is more likely to occur. Generally, the fraud investigator will follow basic steps such as identifying fraud exposures, looking for symptoms in the exposure areas, and considering pressures and motivations to commit fraud.

There are two broad areas of fraud exposure: assets susceptible to theft and financial statement items susceptible to misstatement. It should be noted that assets can be stolen in many ways besides merely removing them from the premises. For example, cash can be stolen by writing checks to fictitious employees or vendors and cashing them for personal use. The presence of one or more fraud symptoms does not necessarily mean that a fraud has occurred or is occurring. Research focusing on fraud has identified three key factors that determine whether a person will commit fraud. The three factors, often defined as the "fraud triangle," are:

(1) perceived pressure facing the person,

(2) perceived opportunity to commit fraud, and

(3) the person's rationalization or integrity.

All three factors are usually necessary for a fraud to occur. Understanding the fraud triangle will provide the avenues an investigator may seek to explore.


The opportunity to commit and conceal fraud exists only where there are assets susceptible to misappropriation and a lack of internal control to prevent or detect fraud. Investigators should be selected for their understanding of the nature of the client's business in order for them to identify areas where assets are susceptible to fraud.

Some fraud exposures are common to many organizations and others are specific to certain businesses. Therefore, when the fraud examiner is considering fraud exposures, he/she will consider which assets are vulnerable. After identifying fraud exposures, the investigator will look for symptoms suggesting that fraud is occurring or has occurred in those areas.

There are several accounting symptoms that involve unusual or suspicious items in the organization's accounting records or related documents. These so-called "source documents" are the basis for making entries in the accounting records. Concerns will be raised if there are significant missing documents or excessive voids of checks and/or other documents or excessive credits issued to customers or vendors.

The forensic investigator will be looking for evidence of fictitious suppliers, vendors, or other payees. There may be alterations of source documents, unusual or unknown signatures in the approval process, or handwritten changes. One fraud scheme is to write duplicate payments to a vendor and cash the second check. Stale items on a bank reconciliation may result from thefts of cash or cash receipts.

If an exposure exists in the payroll area such as the setting up of fictitious employees, overstating of hours worked, working unauthorized overtime, and/or maintaining terminated employees on the payroll and taking their checks, the forensic investigator will apply investigative procedures to determine whether fraud is occurring.

Payables and disbursements exposure exists if there are higher than usual costs, lower quality goods or services, excess goods or services, vendor complaints, increase in purchases from favored vendors, and/or unusual payees.

We should understand that there are "off-the-books" versus "on the books" types of fraud. Some fraud, such as bribery, kickback, and conflict of interest against a company, involves "off-the-books" schemes that do not create a documentary trail of transactions or manipulation of the company's books and records or other documents. When investigating suspected "off-the-books" crime, evidence has to be obtained in ways other than examining company documents and generally will require a forensic specialist and private detective or law enforcement authorities.

When identifying fraud exposures related to misappropriation of assets, the focus is on susceptibility to theft and weaknesses in internal controls. If you are pursuing fraudulent financial reporting, the focus is on the susceptibility to financial statement accounts to manipulation and control weaknesses related to financial reporting.

Fraudulent financial reporting is the intentional misstatement or omission of financial statement amounts or disclosures to deceive users of the financial statements. Co-op and condo owners are more concerned with misappropriation of assets than with fraudulent financial reporting.

Investigations of misappropriations of assets can vary widely depending on the circumstances. However, they will generally include procedures such as conducting initial interviews and document inspections; obtaining an understanding of the organization's systems and procedures; identifying and evaluating fraud symptoms; searching for evidence about the suspected fraud and finally reporting on the investigation. Initial interviews will be conducted with management members who might be aware of the fraud or those officers or employees who solicited the engagement. Document inspections may take place at the same time to refresh an interviewee's recollections.

The investigator will obtain an understanding of the organization's procedures relating to those areas where fraud is suspected. It will be imperative for the investigator to determine how a system actually works rather than how it is supposed to work in accordance with an entity's designed system of internal controls. After the identification of fraud exposures and fraud symptoms, part of the investigation phase will include evaluation of the evidence obtained to date and determination of whether additional evidence is necessary to meet investigation objectives.


If it has been determined that a fraud is occurring, procedures will be followed to determine who is suspected of committing the fraud; how, when, where, and why the fraud was committed; and the extent or monetary damages of the crime.

There are a variety of techniques employed to gather the different types of proof necessary. Generally, these include documentary evidence obtained by searches of public records and computer databases; examination of documents; confirmation of numbers with independent third parties; and inspection of contracts, leases, loan agreements, bank records, etc.

The investigator will obtain testimonial evidence from interviews, interrogations, and polygraph tests. Evidence will also include physical examinations, such as counts, inspections, and covert operations, and investigations of a suspect's financial status and lifestyle to obtain proof of unexplained income.

Evidence can be obtained from interrogation of suspects and interviewing of witnesses and others not suspected at being involved in the fraud. Investigators may attempt to observe a scene where the fraudulent activity is expected to occur and record observations on paper or film.

There are many legal considerations when attempting to accumulate evidence. Certain of the aforementioned procedures should be performed only by trained professional private investigators who may be retained by the forensic investigator.

As a result of the expertise required and the time needed to identify the fraud symptoms, document and obtain evidence, and provide expert testimony, such an investigation will be very costly. Typically, such an investigation will be charged at an hourly rate and most fraud investigators will require a significant percentage of the total estimated fee as an advance retainer. Depending on the availability of documents, evidence, and the period of time the suspected fraud took place, an investigation could take several weeks to several months.

Consequently, careful consideration should first be given to whether the initial suspicions warrant further action and then to the element of cost versus benefit. A board of directors should communicate their concerns as early as possible to their independent auditors. Those auditors will be prepared to expand their procedures to assist in determining whether a full forensic investigation is warranted.

Finally, it is important for the board and management to resolve any findings of fraudulent activities immediately so as not to put themselves at risk. Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the company. They are also responsible for safeguarding the assets of the company and therefore for taking reasonable steps for the prevention and detection of fraud and other irregularities.


Subscriber Login

Ask the Experts

learn more

Learn all the basics of NYC co-op and condo management, with straight talk from heavy hitters in the field of co-op or condo apartments

Professionals in some of the key fields of co-op and condo board governance and building management answer common questions in their areas of expertise

Source Guide

see the guide

Looking for a vendor?