Importance of Forensic Accounting in Countries of Business Opacity: A Means to End Fraud

Introduction

When hearing about Enron, Conrad Black, Kimberly Rogers or WorldCom, one will definitely think about theft, bribery and fraud. The key word here is “fraud”; where many studies have been conducted about this subject. What is fraud and how is it detected and dealt with, and how is it possible to be protected from it? Such questions and their answers are key terms in the domain of forensic accounting, since fraud has played a major role in the existence of accounting, hence forensic accounting. Understanding fraud is necessary for those who want to understand what Forensic Accounting is, how it has come into the system, how it exactly deals with the issues we face, and to what degree it has helped in certain issues of fraud, or even in strengthening the accounting system in general (Economist Intelligence Unit, 2007).

Research has been conducted on fraud and has been given different definitions, all which come in line with one another. Other researches were done to highlight the job of internal controls in minimizing the chance of theft or misappropriation. However, little research was done on forensic accounting diffusion and proper implementation.

Fraud activities have been manipulating, stealing, and destroying many businesses and industries. To face such harmful trends, fraud examination has been created; and great efforts have been exerted to detect, investigate, and prevent similar acts from encountering. These preventions have shed lights on a new concept and practice known as “Forensic Accounting (FA)”, which has become a common notion to fight against fraud and similar unethical acts. No matter how much fraud activities increase, there must always be an anti-fraud scheme to shield against it. To provide availability of balance and protection is the main reason why FA existed.

Nonetheless, the legal, supervisory, and regulatory systems of financially corrupted countries create significant opportunities and tools for the laundering and protection of the proceeds of crime, and allow criminals who make use of those systems to significantly increase their chances to evade effective investigation or punishment. A country’s commitment to bank secrecy and the absence of certain key supervisory and enforcement mechanisms aimed at preventing and detecting money-laundering increase the possibility that transactions involving the country’s entities and accounts will be used for illegal purposes.

Since one of the most powerful tools used today is forensic accounting, it is advantageous to study its possible implementation in countries with business opacity, and to probe the essential methods needed to establish the implementation of this procedure in different sectors and at many levels. Therefore, in order to achieve these objectives, there is a need to investigate the following research question: “What are the conditions of possibility for implementing FA in a country characterized by an opaque financial sector?” More specifically, this research has two objectives:

1. To identify the best way to highlight the importance of using forensic accounting activity in order to clear the roads of the future of business activities; by learning from past mistakes such as Enron and WorldCom and by using other cases of financial fraud similar to the international ones.

2. To identify the way to diffuse and implement forensic accounting as a vital tool that, when used professionally, can greatly help fight against fraud activity.

Moreover, the gap is that forensic accounting is not known in many countries. FA is not so much spread in the world, it is only known in USA and some developed nations. The study is contributed in finding the best way to implement FA especially with the existing gap, with the objective of covering it mainly because it is so hard to implement forensic accounting especially that it is not diffused worldwide. The objective is to arrive at an answer to the research question and to show how forensic accounting can be implemented in the countries characterized by an opaque financial sector; the overall aim is to achieve this goal.

Literature Review

Different research has been conducted to define fraud including the types of fraud such as that of Gilbert (1997, p. 124) who defined “fraud” as: “an act using deceit such as intentional distortion of the truth of misrepresentation or concealment of a material fact to gain an unfair advantage over another in order to secure something of value or deprive another of a right. Fraud is grounds for setting aside a transaction at the option of the party prejudiced by it or for recovery of damages.”

Farrell & Healy (2000) revealed about fraud that is increasing worldwide and is becoming more costly to businesses every year as fraudsters use intricate methods to commit and cover their criminal acts. Consequences of fraud can vary from public morality corrosion, weakened faith in the organization, to loss in market valuation and confidence of stakeholders.

With the various definitions attributed to fraud, other research done highlighted the importance of having internal control that would limit the continuous fraudulent behaviors. External audits are also undertaken to ensure that internally instituted fraud control mechanisms are adequate in scope, effective in application and complied with. However, it is quite unfortunate to note that the complexity of the human brain and its dynamic method of reasoning have tremendously diversified present-day scams away from the hitherto known modes of fraudulent activities that now render true corporate governance ideals almost unworkable.

It is thus worth mentioning that in an attempt to prevent fraud, the Auditing Standard Board (ASB) in 2002 issued the Statements of Auditing Standard 99 (SAS 99) which introduced a “Fraud Triangle”. Fraud Triangle indicates that the probability of committing fraud is high in situations when managements or other employees have incentive or are under financial pressure, the conditions that provide opportunities for management or employees to commit fraud exists, or the ethical values or characteristics that cause management or employees to rationalize the fraudulent act exists (Maranjan, 2010).

Fraud can be detected and investigated to prevent the possible damages the activity can cause. So what advice would a forensic accountant give to a company suffering from fraud activity? A professional can list four things that can be done to mitigate the occurrence of fraud and they include fraud prevention, fraud detection, fraud investigation and follow-up legal action or resolution. The anti-fraud program of any company should focus on all four.

The past two decades have witnessed significant changes in the business environment including globalization, technological advances and now with reported high-profile financial scandals, ways to improve public trust and investor confidence in financial reports. Emerging regulatory, social, economic, ethical, and legal challenges facing the world of businesses contribute to an increasing demand for FA that encourages accounting.

A study done in October 2003 assures that the demand for an interest in FA will continue to increase in the future and more accounting programs are being planned to provide FA education, The business community and the accounting profession are deeply concerned with reported financial and accounting scandals. However, few to none research were conducted to study the proper diffusion and implementation of forensic accounting in the countries of opaque business practices.

Research Framework

Many factors in a country’s business mechanism contribute to the fraudulent behavior in the financial sectors. For instance, being considered as a tax haven country with banking secrecy regulations, money laundry activities and low corporate governance, fraudulent activities become easy to commit. All of this results in a national wide corruption triggering the need to introduce FA. However, due to the opaque financial nature of the country and prior to the introduction of FA, major changes has to be done to prepare the country for the diffusion and implementation of FA on both the macro and micro levels discussed earlier.

The causes for corruption of which several exist in most corrupted countries as it was previously noted, are attributed to the absence of dysfunctional key anti-corruption institutions, the lack of awareness on corruption, its causes, consequences and the weak legal framework and the absence of proper legal implementation mechanisms. Adding to these are the confessional and feudal mentalities, inefficiency of supervisory bodies, low salaries of public sector employees, political influences on the judiciary, the absence of civic education, foreign interference in domestic affairs, selective or lenient enforcement of the law, and the inefficient media. In other words, the factors contributing to the fraudulent business practices can be categorized under four notion; culture, education, management and government and legislation. Whether it is the lack of awareness regarding FA (culture and education) and the advantages it can bring, corrupt practices of management and the inefficiency of supervisory board or absence of a law that enforces FA (government and legislation), the four categories should be tackled to put an end to the continuous fraudulent acts.

For instance, the lack of whistle-blower protection laws prevented citizens from reporting on political corruption in the legislature or other sections of government. In the private and public sectors, the lack of an access to information law, a whistle-blowers’ protection law, conflict of interest law and other disclosure and transparency mechanisms is a major obstacle to integrity.

Results and Discussion

The literature review explained the different meaning of fraud, forensic accounting, and the characteristics of an opaque business country and how can FA help in limiting fraudulent behavior that is making it easy for money launderers to continue their illegitimate practices. Furthermore, FA can serve as a liberator for countries with opaque business practices such Luxembourg, Austria, Lebanon and many others, putting an end to all the business corruption taking place at the different sectors of the country, be it government or any other private or public sector. However, to reap the best results of FA, a proper diffusion and implementation process must take place that requires the work of the parties in a country, be it government itself, people’s view and awareness of FA on the cultural basis, the companies that must require from its employees to be aware of FA and to employ forensic accountants as well and universities and other academic institutions that bear on its ability to teach FA.

Countries with opaque business practices tend to share similar characteristics that justify the prevalence of fraudulent activities. As it was mentioned earlier, the factors that contribute to the fraudulent behavior in the financial sector can be categorized under four categories; culture, government and legislation (macro-level), management, and education (micro-level).

The importance of adopting forensic accounting is thus highlighted, however, the process of introduction is not an on the spot process. On the contrary, it requires time and effort in terms of shifting cultural awareness to realize the importance of FA. That being said, the government as a primary facilitator and the educational systems should take part in creating awareness and shifting cultural mentality towards FA. Managements must also educate employees on FA and to adopt it as part of its system.

A. Forensic Accounting in Culture

Koh et al., (2009) conducted a study to examine the acceptance level of the public in Malaysia regarding forensic accounting. The study revealed that problems arise from the fact that FA service is still new to most of the businesses and even to the public in Malaysia. This leads to confusion among the public and some may even be unaware of the existence of the system. Therefore, the importance of the service is disregarded (goes unnoticed).

Two variables affect the acceptance levels of the public for the practice of forensic accounting as the main tool in investigating a company’s account to detect fraud. The variables include the public’s understanding level on forensic accounting functions and the perception regarding the implementation of forensic accounting in the investigation. The understanding level of the public and the functioning of forensic accounting will determine whether the public in Malaysia will accept it as the main tool in investigating a company’s account in case of fraud. The perception of the public on the implementation of forensic accounting in the investigation of a company’s financial statement also determines the acceptance level of forensic accounting in the country.

This study shows the importance of two basic components that should be available to create a ground for forensic accounting implementation; these elements are awareness and knowledge of forensic accounting as an anti-fraud tool and the perception of implementing forensic accounting, whereby these two elements are considered as major factors for the level of acceptance of such tool.

In other words, if a change is made in cultures of financially corrupted and opaque business practices, it will result in changes in the people’s practices, norms, and values, hence their behaviors; at the end, it will create an awareness and knowledge about fraud and how to fight it and the tools that could be used to inhibit it. In addition, this process similarly applies to forensic accounting.

B. Forensic Accounting in Education:

Although there is a growing demand for fraud and forensic accounting globally, much of its advancement and adoption in the accounting curriculum in the universities are taking place in the developed economies. The adoption of forensic accounting into the universities accounting curriculum has a huge potential to enhance students’ skills and competencies and could be used as a veritable resource from which fraud could be mitigated.

Many cases reveal that those who commit fraud are not necessarily geniuses or have a creative mind. They are typical accountants who copy fraud schemes from the past. Therefore, the importance of the programs for fraud prevention/detection education and training is emphasized, and the question is raised about whether the business school at universities offers enough programs to educate accounting and auditing professionals for fraud prevention/detection.

Forensic Accounting is not only restricted to university programs, there is also a specialized certificate that is concerned with forensic accounting, which is the Diploma in Investigative & Forensic Accounting (DIFA) program. DIFA is designed to provide a broad range of knowledge and skills to carry out financial investigations. This range includes accounting, audit, income tax knowledge, fraud knowledge, knowledge of law and rules of evidence, an investigative mentality and critical skepticism, understanding of psychology and motivation, and strong communication skills.

The DIFA program focuses on knowledge and skills that can be best taught and examined in person: such as handling a face-to-face meeting with a client, interviewing skills, and testifying in court as an expert witness.

In conclusion, the base of forensic accounting is a knowledge in accounting, auditing, internal controls, risk assessment and fraud detection, a basic understanding of the legal environment since the legal environment is essential in order to support the litigation, acknowledging their competence, obtaining a diploma specialized in forensic accounting which could be given by educational institutions that grant certifications such as DIFA. These formal certificates can deepen the students’ knowledge and sharpen their skills in forensic accounting.

C. Forensic Accounting in Management:

Poor corporate governance will lead a certain individual or a group of people with the same interest to act upon it to commit fraudulent activities in the company. This can be reinforced by the fact that top-level management should follow the policies of the firm, which will help the company to perform better.

Even if a company applies good internal control systems, the management will still be the major factor influencing the implementation. Companies should look towards new approaches rather than follow the traditional approach, as forensic accounting may be the next best alternative in resolving problems.

Loebbecke and Willingham (1998) conclude that the probability of material financial misstatements due to fraud is a function of three factors. The factors include the degree to which those in authority in an entity have reason to commit management fraud, the degree to which conditions allow managerial fraud to be committed, and the extent to which those in authority have comply to ethical values that would facilitate fraud commitment. These three factors show that the management could simply commit fraudulent activities since the public including shareholders are unaware of the countermeasure to be taken to prevent financial crimes. It argues that there should be a set of guidelines created for the public and management to ensure that actions should be taken when financial fraudulent activities occur.

The main problem or issue is the constant misunderstanding of the role and responsibility of the auditor as the public expects auditors to detect financial asset misstatement or even fraudulent activities from the financial statements. This has been the long perception of what an auditor’s responsibilities are. Therefore, this perception should be regenerated and corrected. Auditors with forensic accounting background would be allotted as forensic accountants specifically to investigate the company’s financial statement. These people would be responsible for detecting financial misstatements. With the proper education given to the public, this perception of auditors could be enhanced.

D. Forensic Accounting in Government and Legislation:

Forensic accounting has played a major role in the improvement of detection, investigation, and representation of all cases at hand in law courts in judicial formalities.If companies wish to utilize information regarding a fraudulent activity in a court law, they may acquire the skills of forensic accountant because they can handle investigations in a way that is completely acceptable in a court of law.

Forensic accounting is the specialty practice area of accountancy that describes engagements resulting from actual or anticipated disputes or litigation. “Forensic” means “suitable for use in a court of law,” and it is to that standard and potential outcome that forensic accountants generally have to work. Forensic accountants often have to give expert evidence at the eventual trial.

Forensic accounting should be part of criminal investigation, for the matters relating to financial implications where the report of forensic accountants must be considered as evidence and proof to be presented in court trials.

Countries that established forensic accounting in their legal system, have forensic accountants who work with law enforcement and the district attorney’s office. Just as with other types of evidence, the prosecution obtains search warrants to locate financial information and compel knowledgeable people to conduct or hold interviews about the situation in question.

Forensic accountants can also provide litigation support. Attorneys engage the services of forensic accountants to review existing documentation and testimony and explain their financial significance. A forensic accountant can tell the attorney about the additional information needed to prove the case and questions to ask the witnesses. The forensic accountant may also review damaged reports and state whether the report was put together accurately and supports the case.

Government agencies like the FBI, the Internal Revenue Service, and the Bureau of Alcohol, Tobacco and Firearms have forensic accountants to investigate everything from money laundering and identity-theft-related fraud to arson for profit and tax evasion. Law firms often use forensic accountants to help divorcees uncover their exes’ hidden assets.

Conclusion

This article deals with the importance of having an investigative system that would limit the frequent financial frauds and business opacity taking place worldwide. In this context, forensic accounting has been presented as a tool to inhibit the prevailing frauds, money laundry and theft. However, to the reap better results forensic accounting must be properly diffused and implemented with a great emphasis on enhancing public (cultural) awareness, attributing a major role to managements, education and governments/legislation.

For instance, the public may be unaware of the significance of forensic accounting and may lack the needed knowledge for implementing it in investigative matters. Thus, the need to incorporate forensic accounting in the culture of financially corrupted countries in order to create awareness of forensic accounting as an anti-fraud tool and the means of implementing it in the investigation of financial statements. This step can be handled by government and legislation as primary facilitators.

Furthermore, the importance of adopting forensic accounting in the universities’ accounting curriculum is highlighted especially that the demand for it is increasing gradually. Such adoption has a huge potential to enhance students’ skills and competencies and could be used as a veritable resource from which fraud could be mitigated. Fresh graduates can as well attain a diploma in Investigative & Forensic Accounting (DIFA) program that provides a broad range of knowledge and skills to carry out financial investigations.

As for managements, there is a need to develop a proper corporate governance and internal control systems in which those of high authority are held liable and responsible for any fraudulent and unethical misbehavior.

In sum, it is somehow a long process to start incorporating forensic accounting in academic curricula. A first step that needs to be established is creating awareness on ethical issues. As it was discussed, cultural shifts towards the importance of FA is must be maintained, governments, legislation, educational systems as well as managements should share their part in the diffusion and implementation of forensic accounting.

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Why Insure Your Business?

Your business represents a considerable investment of your ideas, time, and money. In today’s operating and legal environment your business faces a diversity of risks e.g., assets damage, larceny, personal injury claims, and natural disasters. Therefore most business owners would want to safe guard their investment. Your Business is also liable to a number of 3rd parties in the event of an accidents including (and based on the nature of the business), false advertising, discrimination, professional malpractice, harassment, etc.-more reasons for this type of general insurance.

Usually when it comes to selecting business insurance for a business, you will require some sort of all-purpose Business Property insurance which will protect and shield you from a wide variety of losses. This insurance policy would preferably include protection on Buildings, office furniture, office machines & electronics, to possible Loss of Income due to accidents on premises or business or coverage against natural disasters. The loss or damage of business assets could result in a disruption of business systems and may even lead to a total shutdown of business operations. The right mix of purchased insurance can be the thing that prevents a closure of your business due to losses from accident and emergency, and instead enables a business reopening after time-closed for repairs.

For example, suppose a fire damages your business’s main building and contents. Without insurance, you could be out of business and probably even personally liable for any outstanding debts and contractual agreements. However, if you carried business & property insurance on the building, your business could meet the cost of restoring or reconstructing the building. Insurance coverage on the business’s plant and machines would also provide finances to refurbish damaged machinery.

Another rationale as to why your business should have insurance is to protect against employee malpractice. Employment Practices Liability insurance is a coverage that is beginning to be required by more organizations. While employment malpractice liabilities are rarely encountered in small and medium sized enterprises, the threat of wrongful dismissal or harassment lawsuits, which are disqualified under most business policies, become more widespread as the size of your organization grows.

Through personal injuries suffered on your business premises, your company could face liability claims and lawsuits. For example, trade outlets can be found liable if a shopper is injured on the property. Industrial companies can be found liable if merchandise is defective and causes injury. Also, a business owner of a Service provider can be found liable for providing inadequate care or misleading advice be it intentionally or not. Liability insurance can provide the funds to settle liability claims, basically by separating your business from you in a legal context and protecting you from losses due to litigation.

If your business has employees, worker’s compensation insurance will be compulsory. This is a form of insurance that provides medical cover for employees who are injured in the course of employment, in exchange for mandatory relinquishment of the employee’s right to sue his or her employer for the tort of negligence. Other Insurance which may be important for a business is Auto coverage for company vehicles and Health insurance plans tailored to the needs of a organization & business.

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Influence of Economic Environment on Business and Its Management!

The management of a firm is influenced and affected by many factors that exist in the external environment, also called as macro environment. These are beyond the scope of business control and affect the functioning of a business enterprise. These factors may present themselves in the form of opportunities or threats and it is the responsibility of a manager to identify the changes in the external environment, be it, social, economic, political, legal, technological, demographic or ecological and devise action plans accordingly, to suit the changing demands and needs of the macro environment.

The most important and prime factor that affects a firm’s operations and its basic survival is the economic factor. Economy of a country is prosperous only when it is self sufficient and withstands the pressure of inflation or recession. Businesses can flourish only if there is a regular demand for the products manufactured. The buying power of people and their willingness to pay are also important economic factors that affect demand. In developing countries, where people concentrate on “saving”rather than spending, the economy is showing steady growth. For instance in India, people invest their money in gold and land, as both are considered to be assets and savings as well. Also the value of these assets get appreciated in due course of time.

The ability of people to buy largely depends on their employment, income tax and price of the product. The disposable income of people in developing countries is very minimum and it further decreases if the rate of tax increases. This also affects his or her ability to buy. If his concentration is on “saving”, again his ability to purchase is restricted. Even if the individual has the purchasing power, there is no assurance that he or she will buy, it all depends on their willingness to buy. The purchasing power parity of developing countries is very low when compared to developed countries.

In recent times, technology also has played an enormous role in bringing an array of new products into the market, and has improved man’s preference for better products. For a business firm, it is very difficult to predict people’s preference as well as changes in their preferences. It needs a great deal of market research and regular updations. If the prices are in decreasing trend, people will not buy the product immediately, they will wait for some more time to derive maximum benefit or value out of their purchase. So, people’s perception about the market economy, social influences and changing preferences definitely affect the willingness to buy.

Managing the competition proves to be a tough task for each and every individual business firm. In today’s modern high flying business environment, people always expect value added services for the products purchased. So, business firms are in a position to compete for customer’s interest as well as income. Firms think of price reductions, aggressive promotional efforts, attractive offers, differentiated product offerings and customer service as competitive tools to have a sustainable and distinctive advantage over others. Offering new product designs, attractive packing, extended credit facilities, free door delivery and fast and competent repair services also differentiate firms from their competitors.

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Legal Strategies in Business Plans

Writing a Business Plan these days is tough, venture capitalists are busy and there are so many ideas to choose from. Bankers want a tight, sweet and to the point business plan. Family Members who may lend you money are generally worrisome due to lawsuits and liability. This is why you need to pay particular attention to the Legal Section of your Business Plan.

Below is a sample legal section of a business plan written for a mobile car wash company, which is part of a franchise system. Now that is a truly simple business, but it serves also as a very good sample in that it is easy to follow. I recommend that you print this article and make notes in the margins about your own business concept and then modify this sample to fit your business. In doing so you can create a strategic plan and legal strategy, which can protect your assets and put your investors at ease.

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LEGAL STRATEGIES:

Licensing

All city and county licenses will be acquired and paid for by the franchisor as part of our turn-key franchise package. This will include:

City Business License

County Permits

Fictitious Business Name Statement

Home Occupation Permit

Soliciting Permit (If Applicable)

Regulations

There are presently some state requirements for discharging water into storm drains. These regulations are locally regulated and mandated as part of the Federal Clean Water Act. These regulations are now administered by California’s Regional Water Quality Control Boards. They can be viewed in the California Water Code books under sections 13.260.1-13.263.4. Although cities cannot enforce the California Water Code, they can deny a business license application or a home occupation permit. Many counties have adopted “Best Management Practices” for wastewater run-off. Usually counties have chosen not to try to regulate mobile car washers or mobile detailers because they use biodegradable products, which are harmless to the environment and they are considered non-point source discharges. Nevertheless, some agencies feel it is in their power to protect themselves by simply denying everything that has a discharge.

The Car Wash Guys have received the only letter of exemption to section 13.260 of the California Water Code from the chairman of a regional board. This was a major accomplishment for the founder of Car Wash Guys International, Inc. after a three year legal battle started in 1990.

Insurance

As specified in the Franchise Offering Circular, we must maintain certain insurance policies. The standards and specifications of these policies are set forth in our borrowed copy of the confidential operations manual. These policies include the following limits of liability and comprehensive coverages:

1) Comprehensive General Liability Insurance in the amount of $1,000,000 bodily injury per occurrence and $500,000 property damage

2) Vehicle Insurance in the amount of $1,000,000 single limit, including comprehensive and collision

3) Worker’s Compensation and Employer’s Liability Insurance

4) Equipment Insurance for the value of all The Car Wash Guys equipment

Our franchisor will help us secure this insurance and will make the initial monthly payment to start the policies. As per our Franchise Agreement, our franchisor will be named as additionally insured.

We expect to pay between $250.00-$500.00 per month for this coverage the first year. We don’t expect any claims so our insurance will drastically be reduced at the end of our first year. Claims in our industry are very rare.

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