Companies need to improve their risk management in an increasingly volatile environment. Forensic Accounting can be used to spot problems before they become too serious.
Authors are experts in their field and only write about topics where they have experience. Toptal experts who are also in the field review and validate all of our content.By Christopher Holloway
Christopher was a Senior Editor at AmericaEconomica for 13 years. He has also worked as a business and technology editor with Sony Pictures, Johnson & Johnson and Mini.
Experts Featured
Neel is an experienced finance and strategy advisor with 27 years in the industry. He has extensive experience in navigating businesses across cultures, countries and regions. He was a former South East Asia CFO for Johnson & Johnson and a former Asia Pacific CFO for Medtronic. John Lee
Deloitte was my previous employer
John is an expert in business and finance strategies. He specializes in tax complications and regulatory risks that are associated with remote working. He is a co-founder of 2 startups and an alumnus of Deloitte & CRH. Erik Stettler
Formerly at NERA Economic Consulting
- Erik is the co-founder and CEO of Firstrock Capital. This global venture capital firm has invested in more than 50 startups, which have raised over $500 million. Erik is a data scientist and Harvard MBA graduate with distinction. He serves as Toptal’s Chief Economist.
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Neel Augusthy, a forensic accountant at Toptal who previously held regional and divisional roles as CFO at Medtronic, Johnson & Johnson, and Johnson & Johnson, was reviewing a company’s performance a few years back at the request of its owner, a large conglomerate. He uses both quantitative and qualitative methods in his work, as is common for forensic accountants.
August started this particular investigation as he often does by looking at audits from similar companies. He discovered that the company’s profitability was lower than other companies of similar size and did not match its expenditures. Both were red flags. He spent a lot of time listening and talking to the employees and vendors.
He says that asking questions will help you open up with people. You almost have to act childlike and ask out of sheer ignorance: “Can you explain how that works?” How do you explain it? You tell me one thing, but my other source here says another.
August spoke to vendors of the company, and many complained about the low margins. This was strange, considering how much they claimed the company paid them. He invited the general manager of the company to dinner under the pretext of catching up and discussing possible improvements.
August says that when people feel comfortable and talk, they will say things they shouldn’t. “I asked him why vendors complained about low margins when we paid them so much. He replied, ‘Oh, these guys keep complaining without reason.’ He suddenly has a lot of cash to buy these things.
“That’s when I figured out he had been skimming from the business by taking money that was due to the vendors,” Augusthy says. As a result of the investigation, the conglomerate removed the manager and improved checks and balances to make sure it didn’t happen again.
What Is Forensic Accounting?
Forensic accountants, also called investigative accountants, are commonly associated with investigating criminal activity, but that’s not all they do. These specialized practitioners are equipped with specific accounting skills and tools to dig into what lies beneath financial statements and uncover other hidden problems and risks, including those related to:
Forensic Accounting and Fraud Risk
When looking into questions of fraud, investigative accountants typically ask themselves what they would expect to see if all is well, just as a physician might review a patient’s vitals with a “normal” benchmark in mind. Then they assess statistically whether what the company is reporting matches up, Stettler says.
Just as Augusthy did, investigative accountants also look at whether certain transactions or financial statements are based on persuasive economic and financial logic. If a financial record reports that an asset was sold for 100 times more than comparable transactions or an independent valuation suggests, the transaction may still be valid in the strict sense of the word–but it represents a suspiciously large departure from economic logic. In that case, not only should that transaction be scrutinized, but so should others, to see if there’s a pattern.
When investigative accountants have historical data, another key step is looking at statistical structural breaks, such as changes in the way that an asset was priced or in how cash flows or earnings occurred. “This generally entails looking at the correlation of financial or stock price performance versus benchmarks and seeing if there is a point at which the relationship breaks down or changes, meaning financial activity within the company is now being driven by something other than market factors,” Stettler says.
Comparing earnings history against analyst consensus expectations is another tactic. When companies consistently beat consensus by a small margin, that success may reflect legitimate decisions related to depreciation or when to recognize revenue, but it may also hint that they’re managing their earnings to produce financial statements that reflect a rosier picture. Either way, Stettler says, a consistent margin like this can signal a need for a closer look.
Forensic Accounting and Regulatory Compliance Risk
When it comes to staying in full compliance with government regulations, companies face a range of risks, including those related to disclosure, minimum-wage laws, mandated time off, and tariff and trade policy changes. These risks are particularly acute when a company maintains a presence in more than one state or country.
With increasing acceptance of remote work, more and more companies face significant regulatory compliance risks tied to work-from-anywhere arrangements, explains Toptal finance specialist and remote work expert John Lee. These compliance risks, which can result in significant monetary losses, touch on a wide range of areas, including taxes, immigration, insurance, talent management and benefits, and data privacy and security.
Since the COVID-19 pandemic, businesses are taking greater advantage of remote work talent pools outside of their immediate metro areas. But applicable tax laws are complex and differ from country to country and state to state, Lee says, and companies that offer robust remote work opportunities would do well to enlist forensic accountants to assess and help mitigate financial risks associated with cross-border hiring and digital nomad workers.
