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Kenneth Neumann
Kenneth Neumann

Connecting the Dots and Striking Gold

Think outside the accountant’s box.

April 27, 2009
by Kenneth Neumann, CPA/CFF

Traditional accountants tend to think in debits and credits, relying on the basic double-entry bookkeeping system that has been around for years. They are accustomed with disbursement journals, payroll registers and general ledger entries and can prepare a trial balance that ultimately provides the basis of a financial statement. When reporting on a company’s performance, traditional accountants work with the hard, salient facts found in the financial statements to develop a “report card” on the company’s financial performance. This report card and the financial systems that support it, encompass the contents of what I call the Accountant’s Box.

Forensic accountants, on the other hand, are trained to think outside the Accountant’s Box. While the information within the Box still provides the foundation for their work, forensic accountants look beyond traditional source documents and explore peripheral, operational connections to determine economic truths that may not be readily apparent through analysis of information found within the Accounting Box.

Why Do Forensic Accountants Need to Think Outside the Box?

In the traditional accounting role, we use the Accountant’s Box to provide answers to questions of What happened? What were sales in each of the last five years? How were expansion activities funded? What profits were generated from each business segment? These questions are familiar to accountants and have a common theme: history of global operations. However, for a forensic accountant, the questions change. What was the cost to operations after losing the use of a key piece of equipment? Is there a causal relationship between specific increased costs and certain events? These questions still relate to historic activities, but seek answers to very focused issues. The questions are sometimes so specific that the information needed may not be detailed in records routinely used by the accounting department. This means the forensic accountant must search outside the Box for support.

This is not to say that the traditional accounting records should be ignored. Forensic accountants use information from within the Box to answer many questions. Where did the cash go? How was the internal system of controls circumvented? How did the financial results change after the contract was cancelled? But the forensic accountant is also asked to answer hypothetical questions. What would have happened to sales but for certain events? What will likely happen to profits because of this action? Answers to these questions are not going to be found in the historic records and the forensic accountant will have to go outside the Box — and sometimes even outside the company itself — to find the answers.

What Does Looking Outside the Box Really Mean?

A company’s source records and internal financial reports provide a vast resource for historic financial activity and are relevant to the forensic accountant for discovering hidden assets or identifying fraudulent financial activities. However, these records are only a starting point for the kind of “what if” questions that need to be considered when performing economic damage analyses. Armed with an understanding of internal accounting systems, the forensic accountant can uncover a wealth of additional information by thinking outside the Box. By learning more about the operations of an organization and by delving into operational issues important to management, the forensic accountant can often uncover documents, reports and data systems dealing with significant factors considered critical by management. Much of this operational information is found within the traditional financial systems — inside the Box — but is only readily available from sources outside the Box.

For example, an accounting system for the revenue cycle will likely include a sales journal summarized in the general ledger and, ultimately, in the income statement. There will also be reports summarizing sales by state that may be sent to the tax accountant for purposes of filing state tax returns. This is all information that is in the Box. But some of the information captured in the accounting system — zip codes, for example — may end up only in detailed sales reports used by the sales department for assessing regional market penetration — thereby falling outside the Box. Additionally, there are often parallel and concurrent nonfinancial systems created for one purpose only: management of the business. A contact management system would fall into this category. Based on the questions and issues presented to the forensic accounting team, they will also consider the relevance and competence of the information that falls outside the Box. Depending on the significance of the information, they might consider the source of information and the testing it was subjected to, or they may consider performing independent tests against known data.

Connecting the Dots

A frequently overlooked benefit of consulting forensic accountants is that they help connect the dots of “cause and effect.” There are many forces that impact the operations of a business and forensic accountants can often assess the strength of the connection between the investigated event and the subsequent changes in financial performance. In performing this analysis, the forensic accountant will look outside the Box and ask, “Are there other explanations for the change?”

Take, for instance, the company which experiences sharply dropping sales and ends up in liquidation. The owner blames the business loss on a neck injury. The injury resulted from an accident and there were numerous documented trips to a chiropractor in an effort to alleviate pain. The owner claimed the pain rendered him ineffective in running his business. Charting actual sales before and after the accident appeared to support the owner’s claim of a direct relationship between the injury and the decline in sales. But, thinking outside the Box, the forensic accountant tells another story. It is discovered that six months prior to the injury, the owner had invested substantial funds in a new venture that overran cost projections, drying up every bit of available cash. The owner’s vendors got caught in the squeeze and had refused to ship new seasonal products until they had received payment on past due balances. By reviewing loan applications, correspondence with vendors, industry publications and trade journals, the forensic team was able to correlate the declining sales to inventory problems that predated the accident. It was only coincidence that the accident occurred as new product shortages began negatively impacting sales.

Striking Gold in Administrative Reports

In the process of pulling financial information together, accountants use their analytic skills to categorize and organize information. Internal accounting systems are often defined based on the operational functions under which they are generated — such as Revenue, Inventory/Production, Purchasing, Treasury and Payroll Cycles. These systems not only assist the accountant in evaluating internal accounting controls, but also serve as the operational groupings that management uses to manage business. As a result, the accounting systems that capture and catalog financial data in the Accountant’s Box also tend to capture and report information for operational management. These operational reports often contain hidden treasure for the forensic accountant.

Consider the revenue/cash receipts cycle. In a typical company, this cycle produces documents that record the sale in the accounting system. These records usually include information that management needs to ship the product, collect from the customer, identify the sales representative and monitor and evaluate its sales force. In most cases, the accounting system accumulates sales by month and produces reports used to record sales to the general ledger — in other words, to feed the Accountant’s Box.

At the same time, the accounting system generates volumes of non-financial operational reports for management. These reports may never be reviewed by the accountant and never distributed to the controller’s office. Still, they contain a wealth of important information, including sales information broken down by product, sales representative and/or region. These reports, which fall outside the Accountant’s Box, often contain critical information on operations and are relied upon by management as it monitors sales and staff performance and evaluates market share. Operational managers may slice and dice the information they obtain from the internal accounting systems and prepare additional analyses that compare company performance across regions or to industry data and competitor information. This information may not be relevant to the company’s audit team but, for the forensic accountant investigating the financial impact of a disputed event within one region of a company, these reports from outside the Box are invaluable.

The Last Piece of the Puzzle

Forensic accountants love a challenge and a puzzle. When only a portion of the facts are disclosed, it is up to the forensic accountant to think creatively — outside the Box — to complete the puzzle. While the accounting records still form the foundation of our work, it is often the nontraditional sources of data that can bring clarity and resolution to financial investigations.

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Kenneth R. Neumann, CPA/CFF, CFE, is a partner and the national director of Litigation, Valuation and Technology Services at the international forensic accounting firm, RGL Forensics. He may be reached at 312-251-4500. *Portions of this article originally appeared in the April 2007 issue of The Business Edge, the newsletter of the Michigan Association of CPAs.