Phased Engagement Approach to Forensic Accounting
By M. Jacob Renick
JUNE 2007 -
There are several approaches to a forensic investigation. A phased
engagement approach manages the investigation efficiently because
it controls the engagement with decision points throughout the process.
A phased engagement is a step-by-step methodology that manages time
and fees, and yields conclusions based upon parameters defined by
the client (often an attorney) and the forensic accountant.
years, attorneys, as well as management and other interested parties,
have come to rely on forensic accountants as the primary financial
investigator, the consulting financial expert, or the testifying
expert in financial investigations and disputes. Equally critical
to their investigative skills is forensic accountants’ ability
to communicate financial information in a clear and concise manner.
Forensic reports are written as words with numbers supporting
them, as compared to traditional accountants’ reports, where
numbers are presented with words to support them.
Is It Effective?
engagement is effective because the scope and timeframe of each
phase is controlled. That permits the client to decide whether
to expand or limit the scope of each phase or the scope of the
entire engagement. Accordingly, each phase stands on its own and
has its own parameters and deliverables.
As a result,
costs for each phase and, therefore, the cost of the entire engagement,
can be controlled. A phased engagement also allows faster response
and completion times because all time and energy are devoted to
the completion of each phase before the next phase is commenced.
1: Exploration and Evaluation
work can begin, the client and the forensic accountant must define
the problem, the issues involved, and the scope of the engagement.
Then a projection of the timeframe, cost, and expected deliverables
for each phase can be determined.
the areas to examine, consideration must be given to both the
obvious and the not so obvious. For example, in a potential defalcation
engagement, the obvious areas may include cash, receivables, and
inventory. The not-so-obvious areas may include accounts payable,
payroll, and property assets, as well as intellectual property
and propriety information.
of this phase is to determine if a cause of action is supportable.
A forensic accountant must identify what information is needed
and then perform an initial review sufficient enough to conclude
whether there is a potential cause of action. During phase 1,
the forensic accountant limits the review to readily accessible
information. This information is usually contained in an entity’s
(or individual’s) books and records, third-party documents,
and any information previously obtained during discovery.
Phase 1 concludes
with a report of preliminary findings, written or oral. The report
should indicate what additional information and documents are
needed, a recommendation on how to proceed, and the identification
of any potential risks. These might include risks to the business
from public disclosure or government scrutiny, and to clients
for their actions or inactions, as well as litigation risk. Forensic
accountants must bear in mind that all written communications
may be subject to discovery.
At this point,
a determination must be made whether to continue to phase 2 (i.e.,
expansion of scope) or to conclude the engagement. This determination
is made after the client, the client’s attorney, and the
forensic accountant have discussed the matter. This is where a
major advantage of a phased engagement comes into play. If it
is decided to end the engagement, there will be no further costs.
If it is decided to proceed to phase 2, the problem and the issues
involved have been clearly defined, as to allow for a focused
continuation of the investigation.
2: Expansion of Scope
and tracing. Phase 2 commences with specific document
analysis. This analysis is more in-depth than in phase 1; it will
probably include a review of many more transactions, books, records,
and documents requested from the opposing side. Phase 2 may also
include the verification of certain findings from third parties.
and records that are analyzed generally include the general ledger,
general journal entries, bank statements, tax returns, financial
statements, cash receipts and disbursements, and electronically
stored information. Although some of the same information may
be reviewed during phase 1, the level of review and analysis during
phase 2 is much deeper.
are used in the analysis of books and records. The approach or
combination of approaches used will be based upon what the forensic
accountant is trying to find.
may include one or more of the following:
time-period analysis, or a comparison of similar data for similar
account analysis (e.g., sales and sales commissions); and
several of these approaches, forensic accountants can obtain the
information they are looking for. For example, the analysis may
include all inventory purchases from a specific vendor for a specific
period of time. Those purchases would then be compared to all
purchases from all vendors for that same period of time or for
the whole year, both in quantity and as percentages.
depending upon the nature of the engagement and investigation,
it may be important for a forensic accountant to analyze related-party
transactions, journal entries, and any transactions that relate
to stockholders’ equity (or partners’ capital) accounts.
the analysis. In preparing an analysis, it is important
for a forensic accountant to trace transactions from beginning
to end and from end to beginning, and to review supporting documentation.
One example would be a purchase. The beginning-to-end tracing
may start with the request by the factory foreman for certain
materials. The tracing would include requisition and inventory
logs, the purchase journal, the accounts payable subsidiary ledger,
the cash disbursements journal, and the general ledger. The documents
related to that request might include the materials requisition,
the purchase order, the warehouse receipts journal, the voucher
payable, and the cancelled check.
In an end-to-beginning
analysis, the same items would be reviewed, except in reverse
order starting with the general ledger and working back to the
materials requisition. The beginning-to-end analysis is necessary
to determine the propriety of the transaction and to ensure that
the items have been authorized and properly recorded. The end-to-beginning
analysis assures the forensic accountant that all items recorded
in the particular general ledger account are proper, that the
individual items were authorized, that they belong to the entity,
and that the goods or services were actually received.
generated books and records, a review of systems controls, backups,
and logs is critical, as it is much easier for one to alter information
today than when transactions were recorded in separate physical
books. The need to obtain sufficient documentation to support
certain analyses has not changed much, but the verification and
documentation have become significantly more difficult.
of books and records. At times, the forensic accountant
may have to reconstruct books and records, or specific transactions,
from whatever information is available. The specific information
needed may not be readily available or may not be in a form that
the forensic accountant needs or can use.
the books and records and performing the analyses discussed above,
forensic accountants will look for information or evidence to
support their assumptions. This information may be included in
the books and internally generated records (e.g., inventory logs,
purchase orders, sales and commission reports) or in the form
of externally generated documents (e.g., bank statements and cancelled
checks, leases, contracts, bills of lading).
verification and confirmation. At times, the forensic
accountant may need to obtain third-party verification to confirm
matters that arise during the investigation. These third parties
may include vendors, customers, and banks.
In some instances,
the forensic accountant may need to conduct interviews, with various
parties within and outside of the entity. Before conducting interviews,
the forensic accountant should confer with counsel, because there
are significant legal requirements and ramifications. It is important
to use a forensic accountant trained and knowledgeable in investigative
interviewing techniques and the related legal issues.
of Phase 2. Phase 2 concludes with the delivery
of a report to the client. As compared to the report issued in
phase 1, the phase 2 report is almost always in writing and more
formal. The report in phase 2 should include detailed findings,
any additional potential risks that the forensic accountant believes
are present, any additional information that might still be needed,
and a recommendation as to whether the forensic accountant believes
there is sufficient evidence or information for the process to
phase 1, a determination as to how to proceed must be made: whether
to expand the investigation even further, whether to seek depositions
and further discovery, or whether to conclude the matter for lack
of sufficient cause or evidentiary matter, or because of potential
a forensic investigation can be approached in many ways, the phased
engagement permits a forensic accountant and client to divide
the investigation into distinct phases, allowing for the control
of the investigation and its costs.
their reports, analyses, and notes, forensic accountants should
be familiar with the issues of attorney work product. In addition,
forensic accountants must bear in mind that almost everything
involved in the process, including their drafts and notes, may
be subject to discovery by the opposing party. Scrupulous caution
is advised whenever forensic accountants undertake an engagement.
Jacob Renick, CPA, CIRA, CFE, is director of bankruptcy
and restructuring services at Eisman, Zucker, Klein & Ruttenberg,
LLP, White Plains, N.Y. He is a member of the NYSSCPA’s Litigation
Services Committee and Bankruptcy and Financial Reorganizations
Committee, of which he is also immediate past chair. The author
would like to thank Ciro V. Cuono, CPA/ABV; Daniel Forbes, CPA,
CFE; and Stephen L. Pados, CPA/ABV, CFE, all with Eisman, Zucker,
Klein & Ruttenberg, LLP, for contributing to this article.