A Comprehensive Look into Forensic Accounting:

Empirical Evidence from a Big Four in Mexico City

Student: Carlos A. Rodriguez Ortiz

Student Number: 10825428

Word Count: 14,512

Program: MSc Accountancy and Control - Control Track

Supervisor: Professor Ron van Loon

Date: 22 June, 2015

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Statement of Originality

This document is written by student Carlos A. Rodriguez Ortiz who declares

to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original

and that no sources other than those mentioned in the text and its references

have been used in creating it.

The Faculty of Economics and Business is responsible solely for the

supervision of completion of the work, not for the contents.

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ABSTRACT

This study focuses on providing a comprehensive view of forensic accounting and

its contrast against the audit practice. Through the development of the main

elements of the practice with a literature review, a thorough understanding of the

history and underlying elements of forensic accounting is achieved. The

researcher conducted a qualitative empirical study in the form of interviews to

current practitioners of forensic accounting in a Big Four in Mexico setting, in

order to account for the differences between forensic accounting and the audit

practice. Findings suggest the differences lay on the scope, purpose and procedure

of the services. Other elements discussed in the findings include forensic

accounting litigation risk, necessary skills and abilities for forensic accountants

and the role of IT in forensic accounting as advised by current practitioners.

Keywords: forensic accounting, audit, fraud, anticorruption, forensic

investigations, fraud examination, forensic accounting education, computer

forensics, litigation risk

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TABLE OF CONTENTS

1. Introduction ................................................................................................... 4

1.1 Background and Overview ........................................................................ 4

1.2 Scope and Motivation ............................................................................... 7

2. Literature Review ........................................................................................... 9

2.1 Historical Perspective of Auditing and Forensic Accounting ...................... 9

2. 2 Fraud, Fraud Examination and Forensic Accounting ............................... 11

Figure 1. The Fraud Triangle ...................................................................... 12

2.3 Forensic Accounting Engagement Description ........................................ 14

2.4 Academic View of Forensic Accounting ................................................... 15

2.5 Forensic Accounting and Corporate Governance .................................... 16

2.6 Litigation Risk Literature as related to Audit Services ............................. 17

2.7 The Forensic Accountant Skill-set ............................................................ 20

2.8 Forensic Accounting and IT ..................................................................... 22

3. Research Methodology ................................................................................ 24

4. Case Context ................................................................................................ 26

5. Analysis and Results ..................................................................................... 27

5.1 Forensic Accounting and the Audit Practice ............................................ 27

5.1.1 Scope and Engagement Description of Forensic Accounting versus

Audit .......................................................................................................... 27

5.1.1 Provision of Forensic Accounting and Audit Services Simultaneously

to the Same Client ..................................................................................... 31

5.2 Skills and Education for Forensic Investigators ........................................ 33

5.3 Litigation Risk for Forensic Accounting Firms .......................................... 35

5.4 Role of IT in Forensic Accounting ............................................................ 37

6. Discussion and Conclusion ........................................................................... 38

References ....................................................................................................... 40

Appendix A. Interview Guide ........................................................................... 43

Appendix B. Interviewee Details ...................................................................... 44

Appendix C. Codes, Categories and Concepts .................................................. 45

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1. Introduction

Today´s business world is becoming more complex and dynamic than ever. New

technologies have had an enormous effect on how business is conducted and

managed, and more importantly, on how companies are controlled. Ineffective control

of an organization leads to internal and external operating issues, which may increase

the possibility of fraud being committed by internal and external parties.

A basic definition of fraud is ―to create a misjudgment or maintain an existing

misjudgment to induce somebody to make a contract‖ (Arzova, 2003), on an

organizational setting, a definition of fraud is to enrich oneself by intentionally

reducing the worth of an asset. In many cases, human error in the operation of

organizations may provoke unintentional losses, and thus fault is an important term

encountered when reviewing the concept of fraud. Fault refers to an unconscious

error and stems from the deficiencies originated from the person or the environment

in which he or she performs his/her duties, thus showing that intention is what

distinguishes fraud from fault (Ozkul & Pamukcu, 2012).

According to the Association of Certified Fraud Examiners‘ Report to the Nations

(2012), the cost of fraud to the US organizations is 5 percent of annual revenues,

despite increased emphasis on anti-fraud controls and recent legislation to combat

fraud. Black (2010) stated that financial statement fraud was a contributing factor to

the recent financial crisis and it threatened the efficiency, liquidity and safety of both

debt and capital markets. In addition, it has increased uncertainty and volatility in

financial markets, thus reducing the creditability of financial information that

investors use in their decisions (Rezaee & Kedia, 2012).

1.1 Background and Overview

In the early 2000s, the unveiling of huge fraud schemes such as Enron and

WorldCom provoked increased attention to the prevention of these types of schemes

due to their negative economic and social impact (Smith, 2012; Warshavsky et al.,

2013; Houck et al., 2006; Pearson et al., 2008). Fraudulent financial reporting can

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have harsh consequences for the organization and all its stakeholders. According to a

COSO Report (2010) periodic high-profile cases of fraudulent financial reporting

raise concerns about the credibility of the U.S. financial reporting process and thus

call into question the roles of management, auditors, regulators, and analysts.

Moreover, a world-wide study of organizations conducted by Murphy and Dacin

(2011) found that 30 percent of companies were victims of fraud in 2010 alone.

In general, schemes such as employee and management fraud, theft,

embezzlement, and other crimes were found to be augmenting and thus accounting

and auditing personnel must have training and skills to recognize the associated red

flags (Houck et al., 2006). An ACFE survey found that whistle-blowing is the single

most common method of fraud detection (Robinson & Robertson, 2012). In this

manner, if there are no whistleblowers within a company, the detection of fraud

and/or inappropriate proves to be a hard task even for the more experienced

employees of the firm and even more to internal or external auditors. As a means to

control wrongdoing in the corporate world, certain specialized professional services

have been developed in order to prevent and deter different kinds of fraud; these

services are most commonly known as forensic investigation services (Pearson et al.,

2008).

Forensic investigation have become more important and widely known since the

creation of the Sarbanes Oxley Act and are now offered as a professional service by

more and more accounting firms around the globe (Charles et al., 2010). The

increased regulation by governmental and private bodies posed as the main support

for the expansion of preventive and reactive investigation services. It is important to

assert that forensic investigations include a range of services that are complementary

in an investigation, such as forensic accounting (also known as forensic audits),

business intelligence and computer forensic services. Within the scope of forensic

investigations, Smith (2012) defines forensic accounting as a comprehensive view of

a fraud investigation, which encompasses the audit of accounting records to interpret

whether a fraud has occurred and who is involved. Smith (2012) asserted that in some

cases the forensic accountant is required to serve as an expert witness in court.

Forensic accounting knowledge thus affects the accounting profession on a daily

basis, since there is a continuous need to identify fraud schemes and illegal sources of

money at all levels within an organization (Houck et al., 2006).

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Forensic accounting in practice, unlike general audits, regardless of their type

(financial, compliance or internal control), takes a more focused standpoint into

analyzing day-to-day documentation and the gathering of qualitative and quantitative

data to provide an objective and unbiased opinion on specific (or even broader)

allegations (Warshavsky, 2013). Throughout the engagement, the forensic

accountants have access to confidential data and the final deliverables may or may

not be used in court depending on how the company chooses to proceed, internally or

legally (Warshavsky, 2013). These follow-up procedures may therefore cause

forensic audit engagements to be considerably high-risk from a litigious perspective

for the firms that provide the services, due to the intrinsic nature of the services and

the intended use of the deliverables. The litigious perspective on the provision of

forensic services will be a topic of importance during this study as no prior research

on litigation risk for forensic services was identified.

In general, the academic literature related to forensic accounting is limited and to

an extent repetitive. As such, the ambiguity and inexistence of prior literature that

encompasses a comprehensive overview of the forensic accounting field set the

motivation for this study. This study aims to provide a clear picture of the issues

faced by practitioners of forensic accounting and how they are addressed in order to

understand how the field practically works. On a more specific context, the purpose

of this empirical study is to provide an insightful view on the importance of forensic

investigations and its contrast against the audit practice. Special attention will be paid

to the identification of the skills, training and background education that are

perceived necessary to practice forensic investigations (forensic accounting included),

the litigation risk from the firm‘s perspective and the role that IT plays in these

services. Based on the previous statements, the main research question for this study

is as follows:

What are the most relevant elements of the Forensic Accounting practice and how

and to which extent does it differ from the Audit practice in a Big Four setting?

The literature review will provide background on relevant aspects of forensic

accounting and how it is related to the audit practice in order to provide a better and

deeper understanding of the subject.

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This study aims to provide a more thorough understanding of the forensic

accounting subject in practice, as theory may differ substantially from practice in this

delicate field. In order to achieve this objective, this interpretive study was conducted

in a qualitative fashion. The information was obtained first-hand in a series of phone

interviews with forensic accounting practitioners in a Big Four located in Mexico

City. The academic background and position of the interviewees varies and provides

a rich perspective for the study, so as to take into account some positions have more

knowledge in the day-to-day operations and others have a higher knowledge in the

general strategy of the department.

The standpoint of this study is exploratory, and seeks to provide an easy-to-

understand and practical approach to the main elements of forensic investigations and

the field. This study thus intends to focus on the real life aspects of how the skills and

background education have an effect on actual forensic investigations, how litigation

risk is actually perceived and how IT affects this field in a corporate setting.

1.2 Scope and Motivation

Forensic accounting is gaining relevance in the business world, and as such it is

important to provide a comprehensive practical view of the different aspects of the

field. There is limited research on the relevant aspects of forensic accounting, more

specifically on the difference with the audit practice, the skills and education required

by forensic accounting practitioners, types of engagements, litigation risk perception

and role of IT in the field.

The academic research for forensic accounting at large is U.S. centric and is

largely focused on the skill-set required by forensic accountants and its relation to

previous education (Heitger & Heitger, 2008; Smith, 2012; Warshavsky; 2013;

Digabriele, 2008). No prior academic research was identified on litigation risk as

related to forensic accounting services, and no prior academic research was identified

in a Latin-American setting. This resulted interesting as it is widely known that Latin-

American countries have a higher corruption rate and thus are more prone to fraud in

private and public bodies. In addition, few articles on how IT has an effect on

forensic accounting investigations were identified (Garfinkel, 2013; Pearson &

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Singleton, 2008), which provide a very limited and theoretical scope of the usefulness

of IT.

The contribution of this study then lies in filling the gap of a comprehensive

empirical view of different relevant elements for the forensic accounting field in a

Big Four setting in Mexico, and its comparison to the audit practice in the same

setting. To the extent of my literature review, this is the first qualitative study of its

kind, and by interviewing current practitioners a clear and up-to-date set of

information can be retrieved. In addition to the empirical knowledge contribution of

the contrast with audit, the litigation risk perception and the usefulness of IT, the

contribution of the present study as related to the identification of relevant skills of

forensic accountants in a Big Four setting in Mexico provides useful insight on the

current topic researched by forensic accounting academics about the necessary

education courses and skills required to be a proficient forensic accountant. It will aid

to analyze if the correct skill-set results from a traditional accounting education or if

further specialization is needed in the accounting curricula. Thus, the identification of

specific relevant skills of forensic accountants in the results of this study contributes

forensic accounting education literature by identifying certain abilities that need to be

included with course content.

The remainder of the paper is structured as follows: first, literature review on

different identifiable elements of forensic accounting will be provided for the reader

to develop a basic yet important understanding of the subject. Second, the

methodology and assumptions will be presented. Lastly, the results and analysis will

be presented, followed by a conclusion.

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2. Literature Review

2.1 Historical Perspective of Auditing and Forensic Accounting

Gray and Mousalli (2006) point out forensic accounting has been defined

differently throughout the years, but in the end, different terms such as fraud auditing,

forensic accounting, litigation support, investigative accounting and even valuation

analysis are used interchangeably to refer to the same practice. Moreover, forensic

investigations may be grounded in different fields, such as accounting and

engineering. In this stuy forensic accounting will be addressed as related to forensic

investigations, which are performed to detect, measure and deter fraud.As for forensic

accounting, it focuses on an examination of evidence regarding an assertion to

determine its correspondence to established criteria suitable for a court. In relation to

this, Okoye and Akamobi (2009) stated that forensic accounting is the practice of

utilizing accounting, auditing and investigative skills to assist in legal matters. Thus,

forensic accounting is a special practice area of accounting that describes

engagements that result from actual or anticipated disputes or litigation (Enofe, 2013)

unlike general auditing, which is not historically defined as a service designed to be

utilized on legal disputes.

Forensic accounting, while apparently a new practice created to deter and identify

fraud at all levels within companies and institutions, has actually been around for

more than just a few years. Gray and Mousalli (2006) provide a very useful and

insightful historical perspective on forensic accounting where they identify the first

instances of the relation between auditors and fraud examination, and the stages that

the practice has evolved through in time. They further state that several years ago

auditors were responsible for detecting fraud at any given engagement. They quote

Robert Mongomery, one of the founders of the American accounting profession, who

stated that ―the detection of fraud is a most important portion of the auditor´s duties,

and there will be no disputing the contention that the auditor who is able to detect

fraud is – other things being equal – a better man than the auditor who cannot‖.

However, regardless of the original expectation that auditors were responsible for

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identifying fraud, audit firms denied primary responsibility over the detection of

fraud.

Gray and Mousalli (2006) pointed out that regardless of the auditors`stance, the

general public still expected them to be able to identify fraud schemes. Furthermore,

in most cases, it was identified that fraud was perpetrated by trusted people within the

companies, specially those in higher positions in the accounting, finance and IT

functions, which complicates the auditor´s job and the detection of fraud since

concealment is often easier to conduct when the employee has more power in the

organization (Pearson et al., 2008). The gap between expectations and actual

performance of auditors still exists, now more than ever auditors are expected to at

least conduct a fraud risk assessment under certain rules when the organizations are

governed by regulators and laws, i.e. Sarbanes-Oxley Act of 2002. Gray and Mousalli

(2006) advise that the accounting profession continued to teach auditors that

identifying fraud was an incidental part of the audit practice, not a responsibility. In

this manner, the fraud investigation field and more in-depth review of allegations was

relegated to forensic accountants, who are better suited and trained for the task.

Gray and Mousalli (2006) further state that in the past thirty years several efforts

were made to strengthen fraud awareness, i.e. the Treadway Commission was set to

study different accounting bodies (in the United States of America), where they

concluded that the ability of the independent public accountant to detect fraudulent

financial reporting is related directly to the quality of the audit, furthermore, the

Treadway Commission created audit standards related specifically to fraud detection.

But it was not until major scandals occurred (Enron, Tyco, Worldcom, HealthSouth)

that it was asserted that auditors were not focusing enough in identifying fraud, which

led to a reassessment of the audit profession, and the creation of the Sarbanes-Oxley

Act of 2002, an act that made fraud discovery a priority of auditors once again.

According to Albrecht et al. (2008), the Sarbanes-Oxley Act had broad

implications for both auditors and companies. In an effort to improve fraud detection

the Act established the Public Company Accounting Oversight Board in the U.S. The

public generally agrees that SOX has helped strenghten corporate governance and

decrease the incidence of fraud, however, the frequency of financial statement fraud

has not seemed to decline since the passage of the Sarbanes-Oxley Act (Bhasin,

2013).

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2. 2 Fraud, Fraud Examination and Forensic Accounting

The terminology in the forensic field can sometimes be used interchangeably but

on other occasions it may provoke confusion as similar terms are not necessarily the

same. In this section definitions, examples and relevant information on different

terms important to this paper will be provided, such as fraud, the different fraud

stages and the key difference between the concepts of fraud examination and forensic

accounting as identified in prior literature.

Fraud is a very broad term and is defined differently by different field researchers.

Houck et al. (2006) define fraud or fraudulent act as the means human ingenuity can

devise to get an advantage by false suggestions or suppression of the truth.

Furthermore, in relation to fraud terms, they define occupational fraud (more relevant

to this study) as the use of one's occupation for personal enrichment through the

deliberate misuse of the employing organization's resources or assets; and corruption

as the "paying off" of public or private in order to receive preferential treatment.

Arzova (2003) defines fraud as the creation of a misjudgment or maintaining an

existing misjudgment. Ozkul & Pamukcu (2012) suggest fraud refers to enriching

oneself by intentionally reducing the value of an asset. They also state fault is an

important term related to fraud, as there may be misstatements or misjudgments that

arise from wrong actions but unintentionally due to deficiencies from the persons and

the systems overseeing them. Thus, the most important differences between fault and

fraud are the intention of the person and the objective of material gain. In general, it is

claimed that accounting fraud occurs due to different integrated factors, such as lack

of auditor independence, weak law enforcement, dishonest management, poor internal

controls and weak corporate governance (Bhasin, 2013).

There are two general types of fraud identified by Ozkul & Pamukcu (2012): the

personal use of business resources (money embezzlement, tampering bank records,

document forgery, fake payments) and drawing false financial statements (largely

corporate fraud to mislead investors, debt issuers, and the market).

Ozkul & Pamukcu (2012) further discuss that fraud detection has increased in the

past years due to the increasing number of fraud events. They advise that fraud

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detection begins with the identification of red flags in the business´ operations, so that

employees and managers concern about losses in assets. In general, the ways in which

fraud can be detected vary and in general include detection by chance,

whistleblowing by an employee or detection by conducting a preventive review.

Ozkul & Pamukcu (2012) assert that people who are exposed to fraud in the

organization usually are aware that some kind of fraud is being committed, but could

not bring it to light either because they are unwilling to blame someone directly or are

unsure of how to go about reporting the inappropriate actions, in addition, employees

may also be afraid of being labeled as a whistleblower. It is important to point out

that whistleblowing is the most important and effective way of detecting fraud. Ozkul

& Pamukcu (2012) describe that the most successful effort to identify fraud is to set

anonymous hotlines within the organization or outsource them to independent

organizations. Although this is a very effective approach, there is always a risk

involved of receiving false reports by unhappy employees and thus the company must

evaluate which reports should and should not be investigated.

Fraud identification and detection is of utmost importance for organizations, but

they must be aware of why fraud is committed in the first place in order to avoid it.

According to Albrecht et al (2008), fraud researchers identified three elements

common to all frauds. These three elements together are known to create the concept

of the fraud triangle, and these elements are: perceived pressure, perceived

opportunity, and some way to rationalize the fraud as ethically acceptable. The

following figure summarizes the fraud triangle concept:

Figure 1. The Fraud Triangle

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Source: Albrecht et al., 2008

After a fraud scheme is identified, a fraud examination is usually the best next

step to follow. Smith (2012) states that the fraud general theory consists of four

elements: facts, assumptions, rationale, and conclusion. He also describes fraud

examination as the process of identifying and determining whether fraud has

occurred. This process usually includes collecting and analyzing documentary

evidence, interviewing key personnel within an organization and suspects of fraud,

reporting on observations, and testifying on conclusions. Smith (2012) further advises

that in a fraud examination the client and fraud examiner initially discuss the reasons

why a fraud may have occurred, conduct an analysis of relevant documents, direct

inquiries are made in the form of interviews and collection of transactional records

and document support. A similar approach is suggested by Ozkul & Pamukcu (2012),

who states the first stage raises fraud consciousness and fraud risk assessment (in a

risky environment, fraudulent events are doomed to occur). The second stage is the

investigation stage, where all security procedures and internal control are included.

The larger part of the investigation is conducted by interviewing and examining

documents and it is important to point out that the investigation may not lead to a

final decision but is usually costly and time-consuming. Ozkul & Pamukcu (2012)

assert that there are four possible decision actions at this time: do nothing, fire the

fraudster, transfer the fraudster to another department, or fire the fraudster and start

legal proceeding. The third stage then proceeds in implementing the chosen course of

action, and in the final stage the file is closed and new controls are applied.

Smith (2012) and Ozkul & Pamukcu (2012) advise that forensic accounting and

fraud examination are related terms, but differ based on the underlying reason of each

service. For instance, forensic accounting work is done by accountants in anticipation

of litigation and can involve different fields such as fraud and valuation. Fraud

examinations refer to either preventively or reactively treating fraud and can be

conducted by either accountants or non-accountants. A fraud examination refers

solely to antifraud matters. Forensic accounting uses accounting, auditing, and

investigative skills to conduct investigations into theft and fraud. Different types of

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schemes and situations provide for different assignments required by clients, forensic

assignments include corporate investigations, litigation support, criminal matters,

insurance claims and governmental issues, and thus forensic accounting is considered

the intersection between accounting, investigation and the law (Houck et al., 2006). In

addition, forensic accountants are of assistance in legal disputes such as

shareholder/partner disputes, matrimonial dissolutions, breach of contract, white-

collar criminal investigations and bankruptcy (Warshavsky, 2013).

2.3 Forensic Accounting Engagement Description

According to Renick (2007) and Warshavsky (2013) a forensic accounting

engagement may contain different phases depending on its core purpose, such as

providing the service solely for a corporation´s internal review or providing the

service to use the deliverables for litigation purposes. Renick (2007) advises that in

general, all engagements are divided in an exploration and evaluation phase and then,

if a cause of action is determined and supportable a scope expansion phase is

followed. During the exploration and evaluation phase the forensic accountants define

the issues involved and the scope of the engagement, the interviews and document

review is limited to readily accessible information, and the conclusion is a report of

preliminary findings. A determination is made at this point of whether the

investigation should be expanded if there is enough evidence that a fraud is being

committed and that further findings will strengthen the case. Warshavsky (2013)

advises a similar approach, describing the following steps: foundational, in this stage

the forensic accountants provide assistance in the case´s initial development and in

the identification of relevant courses of action and the financial framework;

interpersonal, during this phase forensic accountants plan and conduct interviews to

collect case data and find new lines of investigation; data collection and analysis,

where document and interview data is combined and analyzed in different ways to

evaluate if the fraud allegation/theory is true from an objective standpoint; and expert

report, all conclusions from the analysis are aggregated into a summarized expert

report which may or may not be used in trial depending on the agreed scope of the

investigation.

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2.4 Academic View of Forensic Accounting

First of all, it is important to point out that the literature identified for the

academic view and academic support of forensic accounting is limited and U.S.

centric. Forensic accounting has been analyzed from an academic formation

standpoint more thoroughly since the major scandals in the beginning of the century,

given that historically, the accounting academic curricula does not usually include

forensic accounting courses (Heitger, 2008). Forensic accounting is academically

defined in a study as ―the practice of rigorous data collection and analysis in the areas

of litigation support, consulting, expert witnessing, and fraud examination‖ (Rezaee

et al., 2004). By comparing the forensic accounting practice to the accounting

profession curricula a clear gap was identified, since forensic accountancy is currently

considered a secure career track for accountants, but only a limited number of

accounting programs (in the U.S.) offer forensic-related courses. The study conducted

by Rezaee et al. (2004), in which they surveyed academicians and practitioners in the

U.S. to determine the importance and relevance of forensic accounting education,

reveals that the demand for and interest in forensic accounting is expected to increase,

that more universities plan to provide forensic accounting education, that respondents

viewed forensic accounting education as relevant and beneficial to accounting

students and the business community, and that there is a general consesus that

forensic accounting topics are important in the academic accounting curricula.

In addition to the previous study, Peterson (2013) identified two possible main

reasons for the limited inclusion of fraud topics in the accounting curricula. First, a

reason why fraud education is not included is that educators are not aware of the

magnitude of the fraud issues in the business environment. In the past years, several

researchers have performed surveys of different sizes to monitor fraud and its main

effects on business and society, these findings are alarming, especially considering

that fraud statistics are estimates, since not all frauds are discovered and not all frauds

are reported to an external entity. Two examples of these surveys include the ACFE

(Association of Certified Fraud Examiners), that reviewed 662 fraud cases that were

investigated in 2002 and aggregated seven billion USD in losses. The second

example is the survey conducted by Ernst&Young, one of the leading consultancy

firms worldwide, which identified that more than two thirds of the respondents

suffered some type of fraud in the past year, and hat 82% of frauds were committed

by employees. The second reason for the limited amount of fraud education is that

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there is little room for an additional course in the accounting curriculum, taking into

account that some accounting courses are more important to the base curriculum than

more specialized courses, such as a forensic accounting course. It is expected that

courses in accounting principles, intermediate accounting, advanced accounting,

accounting information systems, auditing, tax, cost accounting, and governmental

accounting are of utmost importance and necessary, and cannot be eliminated from

the accounting base curriculum.

2.5 Forensic Accounting and Corporate Governance

Corporate governance is one of the most important elements of an organization

and thus it is interesting to discourse the importance of forensic accounting as related

to corporate governance. Bhasin (2013) addressed that the effectiveness of corporate

governance mechanisms will deter fraud at all levels, especially higher levels (most

common for fraudulent financial reporting) which can have significant consequences

for an organization, but also to its stakeholders and the public at large.

Bhasin (2013) further discusses that the interests of investors and stakeholders are

usually protected by its corporate governance system, which is specifically directed

toward enforcing company policies, achieving company objectives, monitoring

company performance, and ensuring adequate disclosure of the company‗s activities.

The main issues of a corporate governance code that could lead to fraud are: lack of a

well-developed corporate governance policy, lack of honesty in reporting and

inefficient and ineffective internal control system. According to Bhasin (2013), the

forensic accountant should be skilled in financial accounting, internal control

systems, law, investigative proficiency, and interpersonal skills, so organizations can

rely on these skills for developing a consistent corporate governance system. The

main features the forensic accounting field can develop and strengthen in a corporate

governance system include designing the correct channels to transfer information

within and outside the company, ensuring that governance policies and objectives are

considered into the internal control system, setting up fraud prevention systems, and

investigating any allegations of fraud at any level.

In addition, Bhasin (2013) advised that as part of the corporate governance

committee, forensic accountants can make a significant contribution in areas such as:

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comprehensive corporate governance policy that include dependent and independent

directors and management, the prevention of fraud by establishing an ethical

reporting code and ensuring a revision of relevant transactions and procedural control,

creating a positive work environment, establishing effective lines of communication,

conducting constant monitoring at all levels, establishing clear consequences for

incorrect behavior and deterring fraud by proactively conducting fraud examinations.

2.6 Litigation Risk Literature as related to Audit Services

One of the main risks that consultants face when providing professional services

is the risk of litigation from existing or prior clients. As mentioned in the beginning of

this study, no prior literature on forensic accounting litigation risk was identified and

this study attempts to fill the gap in that regard. In order to obtain a comparable base

of litigation risk history, the most relevant litigation risk academic research articles in

the audit literature were reviewed. The audit business environment is close in nature

to the environment of forensic accounting, which was my main reasoning for

reviewing audit literature to present a general overview of the litigation risk topic.

Mong & Roebuck (2005) recognize that auditor litigation risk is a principal

concern to auditors and that it is difficult to ascertain with any degree of certainty

before the engagement. It is also recognized that the issue has been ongoing for many

years and is one of the main concern0073 for the audit profession. According to

Krishnan (1997), the incidence of litigation against audit firms has increased

dramatically in the past years. Other researchers also measured litigation incidence;

Free (1999) found that litigation costs in the U.S. accounted for 14 per cent of gross

fees in 1992, while Pratt and Stice (1994) found that the level of litigation against

auditors increased 300 per cent approximately between 1985 and 1994. Palmrose

(1988) states that litigation against auditors typically involves a process, from initial

discovery of potentially false or misleading statements, to filing of lawsuits, and

eventual resolution of such suits. Throughout the years there have been a variety of

studies that look into different aspects of litigation risk.

The main issues involved in previous litigation risk literature in the audit field

include auditor independence, audit fees and the issuance of specific opinions

depending on the clients. Schmidt (2012) states that ―there is a longstanding view that

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auditor independence is threatened by the economic dependence of an auditor on

client fees and that ―additional fees obtained through the provision of nonaudit

services (NAS) increase an auditor‘s economic dependence on a client, and thus have

been perceived by regulators to threaten auditor independence‖. Blay (2005)

conducted a study to investigate whether litigation risk and auditor independence

threats influence auditor´s evaluation of information. Blay (2005) results suggest that

the greater the independence threat, the less auditors decreased their predictions that

the firm would survive; as for litigation risk, the greater it is, the more auditors

decreased final survival probability assesment. Prior research also provides evidence

that client fees impair perceived auditor independence but it is unclear whether

particular types of fees result in impairment (Schmidt, 2012). Most prior studies

measure perceived auditor independence by examining the costs to clients instead

than to auditors. For instance, the study conducted by Schmidt (2012) examines the

initiation and resolution of audit restatement-related litigation to provide evidence on

whether fee dependence impairs perceived auditor independence. This study

ultimately concludes that more severe restatements, as well as those that involve

revenue-recognition failures are more likely to end in audit litigation. Another

interesting factor involving litigation risk is how audit firms price different

engagements based on a number of characteristics. Audit fees play an important role

in the litigation risk setting. Simunic (1980) defined the audit process as the

calculation of the cost of the accounting system, the cost of the external audit, and

expected losses from litigation. Litigation costs for auditors include delisting,

bankruptcy and lawsuits (Beaty,1993). There have been numerous studies that focus

on how audit fees are affected by litigation risk. For example, Taylor and Simon

(1999) analyzed the extent to which fees are determined by micro and macro-

economic and other environmental factors across countries. In this study, it is pointed

out how the effect of excessive litigation and regulation increases the price of

accounting services. Another recent study conducted by Elliot et al. (2013) found that

succesor auditors charge higher fees to their clients that previously reported

disagreements and other reportable events, which lead to higher litigation risk.

Minutti-Meza (2014) provides rich and insightful information on the review of

Badertscher et al. (2014), where it is stated that litigation risk is expected to be a

strong incentive for auditors to deliver high-quality audits and an important

determinant of audit fees, although determining the impact of litigation risk is hard to

measure since it is complicated to examine variation in litigation risk for different

19

scensarios. Prior studies reach conclusions similar to the one stated previously. For

instance, Simunic and Stein (1996) examined audit fees for a sample of public and

private U.S. firms in a litigation risk setting, where they found that public clients pay

higher fees than private clients do, and that the auditors appear to respond to higher

client-specific litigation risk by putting more effort into the audit rather than charging

a higher premium. Venkataraman et al. (2008) stated that audit fees are usually

related to auditor exposure to losses from legal liability; moreover, they state that the

expectation that audit fees should reflect differences across litigation regimes

(different countries) has an effect on audit quality. A study conducted by Dye (1993)

confirms the relation between audit fees, audit quality and litigation risk exposure.

Another study by Choi et al. (2009) concludes that auditors charge comparatively

higher fees for firms that are cross-listed in countries with strong legal regimes. As

for the issuance of specific audit opinions, the study performed by Mong & Roebuck

(2005) examined whether the issuance of an audit opinion with a going concern

paragraph disclosure has any effect on higher or lower litigation risk for the auditor.

The study concludes that the issuance of a modified opinion can significantly reduce

the likelihood of auditors facing legal action from its clients, although the effect of

work practices disclosure was not deemed significant. Kaplan et al. (2013) conducted

another study in similar grounds, their motivation states that auditors ―may be able to

reduce their exposure to litigation when auditing a financially stressed client by

issuing a going concern report.‖ Other studies that consider litigation risk relation to

going concern decisions include Blay (2005), Krishnan and Krishnan (1996) and Kida

(1980).

In addition to litigation risk derived from a failed financial audit, auditors are

required to design audit procedures to identify fraud risks as part of the audit in some

regimes, such as defined by the AICPA in the U.S. Litigation exposure is an

important and delicate topic, in fact, according to Reffett (2010) there is a practice

aide that advises auditors against documenting the specific fraud risks identified

during the required fraud-related brainstorming sessions since doing it may cause

litigation exposure. Moreover, Reffett (2010) also states that a forensic accounting

guide published by a Big Four partner suggests that enhancing audit procedures to

improve fraud detection may raise the risk of litigation. In the same study, he cites

Coffee (2004) who stated that auditor´s best defense in cases of undetected fraud is

ignorance, so that in this case there is an incentive to not conduct a thorough audit.

20

Reffett (2010) conducted a study based on counterfactual theory to empirically test if

investigating fraud risks increase auditors´liability when fraud goes undetected. The

study concludes that ―evaluators in a between participants environment experience

more intense thoughts of what the auditors could have done differently to detect the

fraud and are more likely to hold auditors liable for plaintiff losses when the auditors

performed audit procedures to investigate for the fraud, relative to when the auditors

did not investigate for the fraud.‖ This conclusion suggests that evaluators lack an

understanding of what auditors should be held responsible and thus makes increasing

the quality of the audit a counterproductive measure.

It is the purpose of this exploratory study to identify if some of the litigation risk

elements presented are to an extent transferable to forensic accounting services, and if

it represents such an important hindrance in forensic accounting as it does in the audit

environment.

2.7 The Forensic Accountant Skill-set

Ozkul & Pamukcu (2012) defined that forensic accountants, also referred to as

forensic or investigative auditors, have different duties and responsibilities throughout

their engagements, and thus their skill set is quite dynamic. Forensic accountants

must have a very broad skill set as the nature of their job requires flexibility and sly

thinking. In general, forensic accountants utilize an understanding of holistic business

information and financial reporting systems, accounting and auditing standards and

procedures, a thorough understanding of fraud schemes, the ability to comprehend the

internal control systems of corporations and to set-up control systems, proficiency in

computer and network systems‘ knowledge, command of basic criminal and civil law,

evidence gathering and investigative techniques, and litigation processes and

procedures (Ozkul & Pamukcu, 2012; Bhasin, 2013). Furthermore, they also state that

forensic accountants may be required to give expert evidence at a trial, playing a

proactive role in risk reduction by designing extended procedures as part of statutory

audit, acting as advisers to audit committees and fraud deterrence services. In

addition, forensic accountants must have a skeptical mindset. In contrast with a

financial auditor, what turns a well-trained and experienced accounting professional

into a good forensic investigator is the knowledge of human behavior and the ability

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to detect red flags intuitively and then being able to find evidence that proves this

theory (Ozkul & Pamukcu, 2012; Bhasin, 2013). Ozkul & Pamukcu (2012) also assert

that the skeptical mindset of the forensic accountant should raise questions about the

reasonableness of all transactions and the underlying evidence.

On the academic side of the skill set of forensic accountants, Digabriele (2008)

conducted a very interesting study in which he surveyed a large sample of

practitioners and academics in the accounting field (U.S. centric) to analyze what the

necessary skill set of the forensic accountant is. The results indicate that practitioners

and academics agree on the importance of forensic accountants´ holistic technique to

an investigation, where the forensic accountant has to maintain an open-mind in the

different people involved in the investigation and the related accounting transactions.

Moreover, practitioners and academics also agree that being able to solve a financial

puzzle with an incomplete set of pieces is an extremely important characteristic for

forensic accountants. Other abilities that are also important and were strongly agreed

by the participants were: oral communication to participate in expert testimony,

effective communication in writing to clearly communicate the findings of an

examination, general although working knowledge of the legal process and the

evidence rules used in court when required by the engagement and maintaining

composure during an engagement, more specifically during expert witnessing. In

summary, Digabriele‘s (2008) findings pose that practitioners and academics agree

that critical thinking, unstructured problem solving, investigative flexibility,

analytical proficiency, and legal knowledge are important skills of forensic

accountants.

Certification-wise, Ozkul & Pamukcu (2012) advise that the ACFE (Association

of Certified Fraud Examiners) provides an antifraud international certification called

the CFE (Certified Fraud Examiner), to professionals with at least 2 years of

professional experience in a field either directly or indirectly related to the detection

or deterrence of fraud. The areas that the ACFE recognizes as important for qualified

antifraud professional experience are: accounting, auditing, criminology, fraud

investigation, law as related to fraud.

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2.8 Forensic Accounting and IT

The role of IT has grown exponentially in organizations of all industries and sizes.

The shift from physical information to digital information has had an effect on how

fraud is committed, detected and investigated in a corporate setting. Pearson and

Singleton (2008) advise that an understanding of digital tools and techniques is

necessary to deter fraudulent acts. Furthermore, they state that the role of

technologies and digital data is growing significantly in fraud detection and thus IT

and forensic accounting are interrelated in various ways. Pearson & Singleton (2008)

also state that knowledge and application of technology has become essential and

effective in forensic accounting and anti-fraud programs. Businesses now, regardless

of their size or industry, use computers and networks where all transactions are

recorded and thus leave a trace. From an audit perspective, such as internal or

external audit, several firms purchase analytic software to conduct analysis of huge

amounts of data to search for red flags, this process is called data analytics and data

mining. In general, according to Pearson & Singleton (2008), IT has influenced

forensic accounting in the following ways: increased usage of IT in fraud detection,

since auditors now have the tools to play a proactive role on the detection of fraud

and protection of privileged information; increased usage of IT by those who commit

frauds, since the growth and accessibility of the Internet and digital technologies

offers more opportunities to the criminal mind; prevention and deterrence, since IT

systems can be breached and circumvented; digital evidence, since special knowledge

and skills are necessary to present and preserve digital evidence; detection and

investigation, since data extraction and analysis can be performed in a variety of ways

and some are more effective than others under specific circumstances.

Furthermore, Pearson and Singleton (2008) state that the current importance of IT

is derived from the fact that for crimes committed in the past years only digital

evidence exists. For instance, cyber-crime is only traceable through digital sources, so

that wrongdoers are able to conceal their acts and misappropriate assets without

auditors and law enforcements being able to persecute them. According to Garfinkel

(2013), these issues gave rise to digital forensics, which encompass different actions

such as the uncovering and examination of evidence located on all devices with

electronical storage, such as computers, cell-phones and even networks. Garfinkel

(2013) further discuss that digital forensics researchers and practitioners continually

face challenges in their work environment such as analyzing huge amounts of data,

23

language processing, data visualization and cyber-security. Moreover, Garfinkel

(2013) states that ―digital forensics is powerful because computer systems are

windows into the past. Many retain vast quantities of information—either

intentionally, in the form of log files or archives, or inadvertently, as a result of

software that does not cleanly erase memory and files.‖ Due to this fact, investigators

can recover old emails messages, chat logs and other kinds of data that were created

weeks, months or even years before, and thus can provide missing pieces of

information during an investigation.

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3. Research Methodology

Due to the nature of the study and in order to obtain a practical in-depth

understanding of the topic at hand a interpretive qualitative approach will be utilized

to conduct the research case. According to Bryman (2008) interpretive research

stresses on the understanding of the social world through the interpretation of the

world by its participants. Moreover, a case study provides the opportunity to better

answer the how and why of the research question in more detail (Yin, 2009).

The main objective of this case study will be to provide a comprehensive picture

of the most relevant elements and issues of the forensic accounting practice. There are

a number of subtopics that will also be specifically regarded during the case study,

such as is to investigate the extent to which forensic accounting differs with the audit

practice, if forensic accounting services can be provided simultaneously with audit

services by the same firm to the same client, the litigation risk perceived on the field,

the education and skills necessary for proficient forensic accountants and the role of

IT in the forensic accounting field.

The study will be exploratory as there is limited related prior research and the

intention of this study is to provide a base for the forensic accounting field literature.

The instrument used in this study was the qualitative interview. Theoretically

speaking, the qualitative research interview seeks to describe and the meanings of

central themes in the life world of the subjects and the main task in interviewing is to

understand the meaning of what the interviewees say (Kvale,1996). A qualitative

research interview seeks to cover both the facts and meanings (Kvale, 1996); which is

useful in this type of study due to its exploratory nature. Interviews are particularly

useful for getting the story behind a participant‘s experiences. Moreover, the

interviewer can pursue in-depth information around the topic by asking follow up

questions.

The interviews were semi-structured, leaving room for the practitioners to

elaborate on broader topics regarding forensic accounting. According to Bernard

(1988), semi-structured interviews should be used when there are few chances to

interview people and thus the best information possible has to be obtained in one

interview. Semi-structured interviews are usually preceded by observation and prior

review of the topic in order to develop a keen understanding before conducting the

25

interview. The semi-structured interview guide provides a clear set of questions for

interviewers, which creates more reliable and comparable data, but each respondent

was able to elaborate on different topics based on their knowledge and experience.

The case study was performed at a Big Four firm located in Mexico. Access was

granted by the partners as the researcher had a prior working relationship with one of

the main partners of the practice. In total, eight current practitioners were interviewed

as it was complicated to interview more since employees in this field are constantly

traveling or are located at the client´s office and unavailable to contact. Appendix A

provides a summary of the interview guide. Appendix B provides a summary of the

interviewee records, including their gender and position. These employees had a

minimum of three years of experience in the field and up to 26 years for the main

partner. Different positions and experience provide for a rich background of

information as different level employees have different activities and thus different

working knowledge.

An initial interview guide was developed to cover the main topics described in

previous sections, but as the interviews progressed other topics of interest were

covered. Interview duration averaged 24 minutes and interviews were conducted in an

anonymous manner. Although all respondents were bilingual, all interviews were

conducted in Spanish to better capture the essence of their knowledge and experience.

All interviews were conducted via conference call, they were recorded digitally and

are stored in an electronic file, all interviews were transcribed into Word Documents

totaling 41 pages of transcribed interviews. Respondent validation was obtained from

all interviewees except the two partners whom were unavailable due to high

workload.

Data analysis was conducted utilizing the software ―Atlas TI‖ for qualitative

analysis. The initial coding of the final transcripts was performed and then a second-

cycle coding was conducted, in which several codes were merged and others erased to

provide a clearer picture of the analysis. Several quotes were selected during the first

coding analysis but the second cycle provided a better approach to deciding which

quotes to utilize for the final results. Appendix C shows the final codes, categories

and concepts that resulted from the final analysis, and which were used to develop the

analysis and results of the study.

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4. Case Context

As previously stated, the case study was conducted on a Big Four context located

in Mexico City. The department within the Big Four is called Forensic and Dispute

Services and encompasses a variety of services that are complementary during an

investigation project. The different service lines are: forensic accounting, which

serves the review of transactional records and direct inquiries to an organization‘s

employees, the review and investigation of fraud allegations and the creation of

expert reports to assist litigation related to fraud and anticorruption matters; business

intelligence, which serves the investigation of individuals and/or organizations in the

form of background checks, these checks include the review of legal private and

public databases for criminal records, lawsuit records, private property ownership,

participation in public or governmental positions, investment trading and ownership

of businesses i.e. public incorporation acts; antimoney laundering, which serves the

niche of antimoney laundering preventive and reactive services for private and public

financial institutions; and computer forensics, which includes the data copying, data

mining and eDiscovery services, these services provide organizations the availability

to make an exact copy of a digital storage device (PC hard drive, cellphone, USB

flashdrive) in order to analyze it thoroughly and find information that could aid an

investigation. These four service lines may or may not be used in a complementary

manner, but according to most of the interviewees it is common for clients to utilize

forensic accounting, business intelligence and computer forensics simultaneously.

Another important issue for the context of the case is that several of the higher

level employees have a wider view of the forensic investigation services as opposed

to a narrow forensic accounting view. This is reflected in how they answered some of

the questions during the interview; whenever possible it was requested from them to

provide more detail for the forensic accounting section in order to obtain a better

understanding of the subject.

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5. Analysis and Results

The analysis and results will be subdivided in four different sections to provide a

clear-cut set of information.

5.1 Forensic Accounting and the Audit Practice

The focus of the comparison between forensic accounting and auditing lies on the

scope of the service and the procedures performed during an engagement. These were

the major topics discussed during the interviews, but a third topic arose related to the

possibility of providing both forensic accounting services and auditing services

simultaneously by the same firm (different lines of service) to the same client. The

results in this section will then be organized in two major subtopics: scope and

engagement description of forensic accounting versus audit and provision of forensic

accounting and audit services simultaneously.

5.1.1 Scope and Engagement Description of Forensic Accounting versus Audit

First of all, it is important to point out that the interviewees have a broader view

of forensic accounting that includes the interrelation of different services provided by

the department. These services include forensic accounting, background checks,

computer forensics and antimoney laundering and all are provided individually or in a

complementary manner and thus the interviewees sometimes took a step back to

clarify that forensic accounting was not the same as forensic investigations, as has

been identified in some academic literature. According to the partners:

The department in which we work is generally known as forensic investigations, within

an investigation there can be different components depending on the size of the engagement

and the procedures that must be performed. Forensic accounting refers to a section where you

are focused on the analysis of accounting information or historical records. In a broader

context, an investigation can include computer forensics, background checks and if necessary

antimoney laundering services, these elements are utilized together depending on the

requirements (I1, partner).

In our case (the department), the projects related to fraud investigation, anticorruption

and largely all projects that derive from the investigation of conducts that lead to a violation

28

of internal and external laws, preventive assessments for fraud and compliance. For (forensic)

accounting, to serve the requirements of organizations that have suffered damage in their

assets derived from a financial crime performed by their employees or a third-party (I2,

partner).

As a starting point, it is important to provide the description of forensic

accounting and its scope as narrowed down by the coding procedures performed to

the different interviewees. Main descriptions are:

The focus of forensic accounting is performing an in-depth analysis of specific

transactions or historical records that permit a better understanding and clarity about the

reasonableness of certain operations that may have arisen doubts or inconsistencies. Forensic

accounting is commonly used to investigate an allegation of possible deviation of funds,

conflict of interests or other related topics (I1, partner).

The forensic accounting service focuses on specific topics, normally there is a preexisting

allegation of bad practices within an organization that could be related to fraud or corruption.

The services provided are to review the statements and accounting information, uniquely

related to the original allegation, this allegation is usually made by an employee (I5,

manager).

In the case of forensic accounting normally they are projects that derive from an

anonymous allegation of inappropriate conducts, or suspicion of the latter, it is a reactive

service usually and it is usually provided when there is an existing situation that the

organizations are concerned about and wish to take action (I2, partner).

The main focus of forensic accounting is to detect/measure fraud or possible violations to

anticorruption laws and antimoney laundering (I8, senior associate).

From the previous quotes, it is noticeable that in practice in the Mexico setting the

scope of forensic accounting is similar to the one presented on the literature review,

in which it is explained that the scope of a forensic accounting engagement is specific

and narrow, but a major difference with the literature is that it can be inferred that not

all forensic accounting engagements are started in anticipation of litigation (Enofe,

2013). Some engagements of forensic accounting may only provide information that

will be used internally by the client, without necessarily engaging in legal action.

Four interviewees stated this fact as part of their description of usual activities.

According to a senior associate:

29

Forensic accounting is a specialized practice focusing in fraud and corruption topics, and

this may or may not end in a legal dispute or litigation (I7, senior associate).

Another finding is that most common way of starting a forensic accounting

engagement is by an anonymous allegation made by an employee of the firm, whom

notices misbehavior and reports it through the available communication channels. All

interviewees agreed on this and this finding is in line with the literature review.

As for the focus between forensic accounting and audit services, the qualitative

analysis‘ main finding is that the differences between these services are their core

purposes and procedures, they are fundamentally different and thus auditors cannot

provide forensic accounting services since it falls out of the scope of their expertise,

which is of performing an overview and measure of the reasonableness of financial

statements, internal controls or other topics depending on the focus of the audit, but

ultimately does not follow the detailed review that has to be performed in a forensic

accounting engagement. All interviewees have at least two years of audit experience

and all agreed on the main differences between forensic accounting and audit

services. Extracts from the interviews follow:

The purposes and procedures performed of each service are different, while in an audit of

financial statements (or other type) the purpose is to verify that the financial statements meet

certain regulations and criteria, such as completeness, the forensic audit focuses on a

particular situation, in other words, to validate or reject any evidence that an allegation is

true. This allegation could be fraud, or any other related topic, but it is narrowed down and

goes beyond the review of an accounting record, it implicated the in-depth understanding of

the transaction or group of transactions and the process it followed, the systems used,

descriptive methodologies, how operations were conducted and how communication flowed

as they occurred (I1, partner).

Well, firstly, lets clarify that a ―normal‖ audit is focused on compliance with existing

legislation, either national or international which is a very different line of service (from

forensic audit). A forensic audit is (in simple words) a supporting service provided to a client

to prove or disprove an issue, in a forensic audit no opinions are provided to the client as it is

done in a traditional audit by the auditors, since the opinion provided will be used by third

parties (I8, senior associate).

In general, the audit is designed to provide an opinion on the financial information (of a

company), but a detailed analysis of all transactions or operations on the focus of the audit is

not performed, only a determined group of transactions or a percentage of them is used as a

30

sample. In a forensic audit there is more attention to detail on specific details and in some

situations there may be a legal dispute or litigation (I7, senior associate).

As stated by Gray and Mousalli (2006) in the historical perspective of audit and

fraud investigation, the audit practice has largely maintained itself separated from

fraud identification responsibilities and focused more on the overall review of

controls and financial information. The qualitative results confirm this statement to an

extent, as forensic accounting practitioners recognize the difference in scope of the

audit procedures versus the forensic accounting procedure. This in turn reflects that

auditors are not practically obligated to detect and investigate fraud issues during

their engagements, thus leaving this more specific and detailed reviews to the forensic

accounting line of service. A director added:

Normally, we are contacted (by potential clients) when there are already existing (fraud)

issues (within the company), most likely a lawyer has been hired already and there are

suspicions of fraud, of any kind really, embezzlement, asset misappropriations, collusion with

clients, etc. We start with forensic accounting procedures to identify how thing happened,

what impact they have on the accounting system (reporting) and determine the material

monetary amount that was lost by the company, in this manner we are able to correct controls

and have a clear idea of the economic loss (I3, director).

While audits usually follow a sampling procedure to ensure that protocols are

being followed, and conduct a review of current policies and procedures to ensure

there are no deviations in the day-to-day operations, forensic accounting conducts a

more detailed set of steps into specific allegations. All of the interviewees have

previous working knowledge in the audit practice and thus are able to put in context

the differences between the procedures followed in one service as opposed to the

other. According to a partner:

The starting point is to understand the situation of the client very well, taking into

account all the problems and requirements, the next step is to design a work plan that will

provide a solution to the issues that were discussed. Normally there is an agreement with the

client on what the scope of our services will be, this scope may be very limited and only

focuses on the specific issues that were discussed, but it is very common that after we

identified fraud and reviewed all the damage clients request an additional review with a larger

scope to find out if other deviations could have occurred. So, the first stage is understanding

31

the client´s situation, the second stage is finding a possible solution, the creation of a work

plan and its execution, an analysis stage to develop theories and find evidence to prove them

or reject them and the development of conclusions and recommendations. The final stage

refers to when you create a deliverable, it could be a series of recommendations or just a

report that describes in an organized and clear manner what happened, how it happened, who

and how they participated, the benefits they obtained and what damaged they caused to the

organization. This report may unleash legal action by the client and this legal action must be

supported with an accounting expert report (I2, partner).

5.1.1 Provision of Forensic Accounting and Audit Services Simultaneously to the Same

Client

The topic of providing forensic accounting and audit services by the same firm to the

same clients arose from the description of the services of the interviewees. The

practitioners´ perspective varied but a general consensus was reached by all of them

regarding the different courses of action. It was primarily identified that the forensic

accounting department and the audit department are fundamentally different lines of

services and thus are not interrelated when providing services, even when it is the same

client.

The first view of the practitioners (five interviewees) poses that forensic accounting

services and audit services can be provided to the same client under certain

circumstances. Some issues have to be addressed, such as independency between the lines

of services and what kind of revision is performed by the forensic investigation

department (preventive or reactive). It was also stated very clearly by a partner that a

revision cannot be performed by the forensic investigation department when the audit

department overlooked sensitive elements that could be related to fraud, as independence

issues are doomed to exist if an actual fraud is discovered. A senior associate stated that

the services may be provided simultaneously as long as a conflict of interests waiver is

signed by all parties to agree on keeping the confidentiality and independence. According

to the interviews:

In my experience, each case has to be evaluated in an independent manner (simultaneous

services), there is no absolute yes or absolute no answers. When these activities are

performed in a preventive manner then a forensic audit is of great help and it complements

32

the financial statement audit. Both departments work together and the forensic investigation

part focuses on reviewing fraud by reviewing high-risk areas or transactions. On the other

hand, when a sensitive issue happened (in the company) and was overlooked by the auditors,

then the forensic accounting services cannot be provided since there could be independence

issues that would hinder objectivity. In short, it depends on a case-to-case basis by making

sure independence is not hindered (I1, partner).

Yes, definitively. Certain criteria has to be met but the same firm is able to provide both

lines of service, sometimes the audit department requires forensic accounting services to

review the client´s controls, also to review topics associated to anticorruption, antimoney

laundering, fraud and even to provide ethics training to the client´s personnel. Generally, both

lines of service must sign a nondisclosure agreement and a conflict of interests waiver to

maintain objectivity (I7, senior associate).

Yes, it is possible. In our firm the financial audit line of service is separate from internal

audit services and of course from the forensic investigations specialized department. The

forensic accounting department is formed by professionals with a specialized focus on fraud

investigation, anticorruption and inappropriate conducts. So it can be used to support the

audit practice with the greater degree of skill on these topics (I2, partner).

An important finding extracted from these quotes is that each department develops its

own proposal independently although complementary services may be provided between

the two lines of service, especially when forensic accounting can provide a preventive

opinion on fraud risk assessment.

The second view on the provision of forensic accounting and audit services by the

same firm to the same client was negative by the remaining three interviewees. This

contrasting finding, as compared with the view previously described, may derive from

different working experience by the interviewees as the partners may have a broader view

of the firm´s operation and how clients and independence conflicts are reviewed. Previous

experience in this issues may also explain the reason why these interviewees provided a

negative answer. The stance of the interviewees with this point of view is that regardless

of the situation with the client, a conflict of interests (and thus independence hindrance)

exists and therefore the analysis and results may suffer from manipulation and lack of

objectivity. According to the interviews:

In my experience in the forensic investigation department the answer is no, the reason why is

the conflict of interests that arises within the firm. If the audit practice was responsible for

reviewing the accounting records in the first place, and then the forensic investigations

33

department has to perform an assessment then some employees would see the conflict that arises

from reviewing to an extent your ―colleagues‘‖ work, the best step would be that a third-party

conducts the forensic investigation (I5, manager).

The services cannot be provided due to a conflict of interests, i.e. it is ethical that a firm that

provides traditional audit services to a company cannot provide forensic investigation reviews to

the same client since it would be to an extent reviewing its own firm´s work. As external auditor

you have the obligation to report the results to third-parties such as government bodies. If the

same firm, regardless of different department, identifies a possible fraud issue or risks, it is

obligated to report it so that the third-parties are informed, but they can decide not to because it is

not good for the firm (I8, senior associate).

5.2 Skills and Education for Forensic Investigators

First of all, it is of utmost importance to remark the difference between forensic

investigations and forensic accounting one more time as previously explained in the

study. Forensic accounting refers to the review of accounting information to detect

and measure fraud, and it may provide information for litigation purposes, while

forensic investigation refers in this study‘s context to the department that provides

investigation services that include forensic accounting, business intelligence,

computer forensics and antimoney laundering. This explanation is made for clarity‘s

sake in this section, as some of the background education identified in the qualitative

analysis differs widely from a traditional accounting background, which in common

sense would be the career that best fits this topic.

Throughout the first and second cycle coding analysis there were a variety of

different education backgrounds mentioned by the interviewees. These were

summarized for clarity purposes as the analysis advanced and in the end a clearer set

of previous education was identified for the forensic accounting field. The general

consensus among all interviewees regarding educational backgrounds that have been

effective in a practical setting in Mexico include public accounting, finance,

economics, actuarial studies, lawyers, and international relations. According to

interviewees:

For the forensic accounting field the employees have to be accountants, financial or

economics studies as well, in general people with a focus on number crunching and analysis,

at large they must be people with experience in the field and could go from accountants to

34

lawyers, communication studies, actuarial studies and even international relations (I3,

director).

Forensic accountants must have knowledge in the legal and finance field. To my

knowledge a good forensic accountant should have an accounting background with a

specialization in legal studies (I6, manager).

Several backgrounds have worked properly, it depends on what kind of activities the

forensic investigator is hired to perform, generally employees with background in accounting,

law, audit, internal audit, finance and even business administration are hired (I7, senior

associate).

This is an important finding for the forensic accounting literature as no prior

literature (to the extent of my knowledge) has identified that different educational

backgrounds (other than public accountant) are useful for the forensic accounting

practice. The flexibility of prior education thus provides for a broad range of

knowledge that is exchanged in the forensic accounting setting, leaving the actual

―accounting‖ knowledge as not absolutely necessary to provide these services.

According to a director:

Some of the basic investigative skills (for forensic accountants) cannot be learned

sometimes, even within our practice we discuss that the number-crunching abilities and

number-analysis can be learned and improved through practice and experience, but the

general mind set of an (fraud) investigator is key to be successful, and this is harder to

develop than other theoretical knowledge (I3, director).

This statement is in line with prior literature by Ozkul & Pamukcu (2012)

regarding the required skeptical (investigative) mind-set by forensic accountants.

Moreover, this statement also directs us to the skills that are deemed necessary for the

forensic accounting practice. Prior literature suggests a certain set of skills as

necessary for forensic accountants, i.e. Bhasin (2013) and Ozkul & Pamukcu (2012)

state that skills such as flexibility, sly thinking, proficiency in computer knowledge,

command of basic law and investigative techniques are of utmost importance to

forensic accountants; Digabriele (2008) summarized that skills such as critical

thinking, unstructured problem solving, flexibility, analytical proficiency and legal

knowledge are important and necessary skills. This study‘s findings are in-line with

prior literature and provide that in practice all the previously mentioned skills are of

utmost importance to provide high-quality forensic accounting services. Other skills

35

identified by this study include paying attention to the minimum details, sensitivity to

understand underlying processes and reasons, ability to interview people and identify

false statements, team work and emotional intelligence to maintain objectivity.

According to the interviewees:

The main skills are orientation to detail, this is very important and related to the

sensitivity of the information that you are analyzing and how well you can understand the

policies and procedures and their relation with the scope (of the investigation), skills are also

needed to interview people correctly in order to extract all the relevant information they can

provide (I7, senior associate).

I would say a person that has the (investigative) mind-set would be an uneasy person, one

that always wants to understand all the reasons for certain actions completely and inquire

about other courses of action, a person that understands and follows the rules and makes sure

they are not violated, a person that conducts work professionally and is good working in a

team (I3, director).

A high level of sensitivity to the information, trust and autonomy while conducting the

investigation, being discrete, high analytic skills for financial statements and accounting

records, emotional intelligence to avoid taking a stance (bias) during the investigation,

confidentiality and objectivity to provide evidence (I6, manager).

The main skills are objectivity, analytical, attention to detail is crucial, being organized

(methodological) and also creative. Paying attention to small details is what make a forensic

accountant successful, precisely due to the nature of fraud, wince fraudsters devise a way to

hide irregular activities so that they can occur and not be noticed by their colleagues, in fact

some fraud schemes can be ongoing from two to five years without being discovered, this

means that if a scheme happens for this long there are very small details that vary in contrast

with regular transactions so that draws the importance for an investigator to focus on small

details (I1, partner).

5.3 Litigation Risk for Forensic Accounting Firms

The findings in litigation risk are interesting and the analysis provided diverse

reasoning regarding litigation risk. This may have happened due to the different

knowledge of the practitioners as some had significantly more experience in

management issues of the forensic investigations department and others were more

36

knowledgeable of the day-to-day operations but not the larger picture of the practice.

In general, all interviewees posed that litigation risk is not as present in the forensic

accounting practice as it is in the audit practice.

According to the litigation risk relevant literature for the audit practice that was

provided in the literature review, litigation risk has been present for virtually as long

as the audit practice existed (Mong & Roebuck, 2005) and as such it was expected

that this would hold true (to an extent) for the forensic accounting practice. In

addition, the relation of audit fees, audit risk and in general the existent relationship

with the client and the expected outcome of the service was expected to play an

important role in the litigation risk topic. According to two partners and one director

who have experience in both the audit practice and the forensic investigations

practice:

In my point of view (the litigation risk) is controlled because we are not responsible for

any reporting (to third parties) in any ways, we sign an engagement letter with the

characteristics (scope) prior to providing the services and we work with the information

provided by the company, we are limited by the information they provide and we limit the

deliverable to present objective information, so third-parties cannot take decisions on our

deliverable unless specifically stated beforehand. We provide deliverables based on objective

evidence of what happened and what can be proved, if there is no evidence then that is our

deliverable (no opinions). So far, I am not aware of any legal disputes we have faced due to

our forensic accounting services (I1, partner).

We do not see it as a risk (litigation risk) since the services requested by our client

typically involve litigation support, in other words, someone already caused them economic

damage and they want to start a legal dispute and they need an expert to understand what

happened, how and who participated and how to document it. It differs from the audit

practice litigation risk, in this case when in the review of financial statements or other related

subjects they overlook certain issues or misstate certain procedures on purpose, or even as

accidental negligence of not identifying issues or follow the set rules then there is always a

higher risk present, either from a regulation body or an unhappy client (I2, partner).

In my point of view the litigation risk issue is mild since we usually provide internal

reports, so that they cannot be utilized formally by a third-party such as the authorities, this

issue is part of the scope during the engagement. The litigation risk could be derived from

revealing confidential information or violating the procedures of a company or to obtain

information for the investigation in an illegal way. This differs from the external auditors of a

37

traditional audit, this service complies with external reporting to third parties such as

investors, etc. and this in turn brings a higher risk to the firm (I3, director).

The most important finding extracted from the analysis for the litigation risk topic

is that due to the difference of scope and purpose between the audit and forensic

accounting services, as explained in section 5.1.1 of the analysis and results, conveys

a different way to perceive litigation risk. For instance, forensic accounting services

are provided when a specific issue or suspicion exists, that is usually derived from an

anonymous tip, and thus the services encompass a specific review of certain clients,

transactions, and even departments. Thus, the final deliverable will be limited by the

information that was on the scope of the project and was ultimately reviewed by the

forensic accountants, and excludes anything else that did not fall within the scope of

the engagement. In this manner, the forensic accountants are not deemed responsible

for any other issues that may arise later or that were not taken into account at the time

of the engagement. Furthermore, forensic accounting deliverables are not utilized by

third-parties unless specifically indicated in the scope of the service and certain

conditions are agreed with the client in this regard, i.e. the use of deliverables by

lawyers or the requirement of a law-abiding accounting expert report to support a

legal dispute.

5.4 Role of IT in Forensic Accounting

The findings for the role of IT in forensic accounting are more of a descriptive

nature and do not provide contrasting opinions, on the contrary, all interviewees

agreed that IT plays a very important role in investigations and that it has become the

most important element in a forensic accounting engagement, as all organizations

have shifted to digital information rather than physical information. This is in line

with Pearson and Singleton (2008) and Garfinkel (2013). According to a manager:

The role of IT is huge, I can even say that as technology advances it has become vital.

Often when we start an investigation a lot of information is missing, we start with a broad

allegation to pursue and this allegation may be missing many pieces of information. In my

experience, what we can do with IT is access devices such as hard drives and mobiles to

review information of the employees that manage an organization´s operations. We make a

forensic copy of the information and then review this to have access to original documents

and information, such as email communications, conversations, text messages, etc. All this

information can provide important insight of the day-to-day operations and thus give a broad

38

view of what we are looking for (the allegation), or it can help to limit the search into a

specific context. These are the main reasons why in my experience IT are vital in a forensic

accounting setting (I5, manager).

6. Discussion and Conclusion

The findings suggest a clear difference between the forensic accounting practice

and the audit practice. The different scopes of the aforementioned services and more

specifically the different target of the final deliverables provide a strong base to

differentiate these services. It is possible to mention that to an extent, the forensic

accounting practice is a specialization of the audit practice, but that does not

necessarily mean that each practice can provide the other service interchangeably, as

the abilities and required focus of the practitioners is different in each practice.

After evaluating the results, several elements of forensic accounting can be

deemed an important part of the practice. An important element of forensic

accounting is that the accounting knowledge is not of utmost importance to become a

proficient forensic accountant, since practitioners agree that this knowledge can be

developed on the job, but the investigative mind set is posed as more important and

harder to acquire. Thus, previous education is important but not definitive when it

comes to forensic accounting. Another important element in forensic accounting is

the scope of the engagement and how unique each engagement is. Practitioners

asserted that forensic accounting has a narrow and limited scope and that this is

always agreed with the client to avoid misunderstandings and to decrease litigation

risk by denying responsibilities with third-parties.

Firstly, the findings suggest that forensic accounting is now, in a practical

environment in Mexico, just one section of a broader section related to investigation

of fraud and anticorruption. The existence of the antimoney laundering department,

the business intelligence department and the computer forensics department as

complementary services to forensic accounting supports this. Therefore, it is

important to understand how forensic accounting complements with its specialized

focus to a company and how it can be complemented by other services such as

computer forensics. The findings advise computer forensics play an important role to

39

complement an investigation in order to find missing pieces that help the investigator

understand underlying motives for the misconduct.

40

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Appendix A. Interview Guide

SEMI-STRUCTURED INTERVIEW GUIDE

1. What are the main reasons to provide Forensic Accounting services?

a. What are the most common types of engagement? Why?

2. How does FA differ from the Auditing practice?

a. Are there important similarities?

b. Can you provide audit and FA services simultaneously?

3. What are the required skills for a profficient forensic accountant?

a. Are these skills learned on the job or before joining the firm?

4. Is there specific training/previous education needed for forensic accountants?

a. What academic background is most common? Why?

5. How is litigation risk perceived in a FA setting?

a. Is it similar to the audit practice?

6. What role does IT play in forensic accounting engagements?

a. Is it an important component of the practice?

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Appendix B. Interviewee Details

Interviewee ID Position Gender

I1 Partner Female

I2 Partner Male

I3 Director Male

I4 Manager Male

I5 Manager Male

I6 Manager Male

I7 Senior Associate Male

I8 Senior Associate Female

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Appendix C. Codes, Categories and Concepts

Codes Categories Concepts

Financial crime Fraud identification FA vs Audit

Anonymous whistleblowing Fraud identification FA vs Audit

Fraud patterns Fraud identification FA vs Audit

Unique cases per client Fraud identification FA vs Audit

Law firm requirement Fraud identification FA vs Audit

Fraud suspicion Fraud identification FA vs Audit

In-depth review of allegation Phases of investigation FA vs Audit

Deliverable Phases of investigation FA vs Audit

Fraud allegation Phases of investigation FA vs Audit

Calculate loss Phases of investigation FA vs Audit

Scope of investigation Phases of investigation FA vs Audit

Employee responsibilities Phases of investigation FA vs Audit

Policies and procedures Phases of investigation FA vs Audit

Employee interviews Phases of investigation FA vs Audit

Transaction review Phases of investigation FA vs Audit

Confront suspicious actions or employees Phases of investigation FA vs Audit

Follow up interviews Phases of investigation FA vs Audit

Independence Service provision limitations FA vs Audit

Conflict of interests Service provision limitations FA vs Audit

Providing FA and Audit simultenaeously Service provision limitations FA vs Audit

Fraud investigation Type of investigation FA vs Audit

Anticorruption Type of investigation FA vs Audit

Preventive fraud assessment Type of investigation FA vs Audit

Accounting review Type of investigation FA vs Audit

Antimoney laundering Type of investigation FA vs Audit

Compliance issues Type of investigation FA vs Audit

Litigation support Type of investigation FA vs Audit

Computer forensics is expensive IT limitations IT role

Hard to understand IT limitations IT role

Importance of IT IT usefulness IT role

Computer forensics IT usefulness IT role

Better focus investigation resources IT usefulness IT role

Review of email communications IT usefulness IT role

Confidentiality Client relation Litigation risk

Low litigation risk Client relation Litigation risk

Intentional malpractice Client relation Litigation risk

Ethical principles Client relation Litigation risk

Reports for internal use Purpose of service Litigation risk

External reporting Purpose of service Litigation risk

Third party-use, higher risk Purpose of service Litigation risk

Law background Education background Skills and knowledge

Accounting, economics education Education background Skills and knowledge

Actuarial science, international relations Education background Skills and knowledge

Intuitive person Investigative traits Skills and knowledge

Investigative mind-set Investigative traits Skills and knowledge

Analytic skills Investigative traits Skills and knowledge

Follow rules and standards Investigative traits Skills and knowledge

Team work Investigative traits Skills and knowledge

Detail oriented person Investigative traits Skills and knowledge