Forensic Accounting: When Do You Need It?

Of course, engaging an experienced accountant can help you and your client resolve the most puzzling financial mysteries associated with a contentious divorce. Those mysteries might include:

• What special documents should we request?
• Is this a complete accounting?
• Is someone hiding or dissipating assets?

When you need answers to those questions, or when your case begins to involve a mountain of financial documents, numbers and complex calculations, a forensic accountant can help tease out the meaning and issues behind the numbers. Keep in mind that your normal appraiser or CPA is unlikely to have forensic accounting experience. You have to look for additional expertise. In these cases it makes sense to add a forensic accountant to the team. The most highly regarded credentials are Certified Fraud Examiner (CFE) and CPAs who are Certified in Financial Forensics (CFF).

Factors to Consider

There are many things that increase the need for a forensic accountant. On a case-by-case basis, consider these factors:

The size of the marital estate. Generally, as the size of the marital estate increases, the legal team is likely to need a dedicated expert to address the accounting and valuation issues.

The identity of the primary money manager. If the opposing-side spouse was the primary money manager, a forensic accountant can help paint and communicate an understandable, complete and accurate financial picture for your client.

The complexity of the marital estate. Generally, as the complexity of the marital estate increases, the legal team is more likely to need a dedicated expert to help develop questions for the opposing side and “untangle the spaghetti.” This is most often seen when there are numerous companies, either horizontally or vertically integrated, or if other family members own businesses where assets and liabilities are passed to each other with abandon.

The previous history of the opposing spouse. If the opposing spouse has had a history of hiding money, evading income taxes or taking excessive risks, your legal team will need an expert forensic accountant. Any time you find problems with the Internal Revenue Service (IRS), or tax returns in arrears, problems are likely.

The presence of structured transactions. If the opposing-side spouse has the ability to shift marital assets to family, friends or related parties, an expert accountant can track, locate and disclose those structured transactions that are sometimes hidden from a normal balance sheet and operating statement. These types of assets and liabilities may be considered personal in character and not something that would be seen in a business appraisal analysis.

The sources of compensation. Compensation by salary (on a W-2) is easier to verify and track than compensation received from an investment portfolio, a partnership or a sole proprietorship. If the opposing side spouse has control of the finances of a business entity, you may need a forensic accountant to get to the total compensation paid or available to the opposing spouse.

The relative sophistication of the parties. If the opposing legal team and the opposing-side spouse are very sophisticated about financial matters, they may have a distinct advantage over your client. The attorney also needs to weigh his or her client's ability and willingness to testify about their financial affairs. If the client lacks the sophistication or ability to testify, an outside financial expert can offer impartial and experienced insights.

The state of, and access to, financial records. If the opposing side controls physical access to the financial records, they have your legal team at a disadvantage. Your client may not know what documents to request or to expect in compelling the production of financial information. Along those same lines, if the financial records are poorly maintained, it will be difficult to get an accurate financial picture without the help of a forensic accountant.

How Do You Employ a Forensic Accountant?

Most law firms will directly engage the forensic accountant. Under that arrangement, the accountant's work product will be protected by the attorney-client privilege, and it can increase flexibility of the services and the communication of the results. Under this type of engagement, the forensic accountant can freely discuss strategy or provide oral or written reports as needed. It also allows the forensic accountant to maintain his or her independence. However, if it becomes necessary for the forensic accountant to assume an expert role, all of the findings and work papers will likely be discoverable.

Like legal fees, forensic accounting fees can be difficult to estimate. It is unlikely that an attorney or an accountant can accurately estimate the exact amount of time required to handle a case from start to finish. Therefore, you should beware of an all-inclusive, fixed-fee quote. It is also difficult to accurately predict the timetable of findings in a forensic case. Avoid any forensic accounting professional who promises specific results or outcomes within his or her quote.

Many times it's best to start the engagement with a fixed fee, and identify the issues and areas of concern. The team can develop an overview of the documents and suggest additional procedures if certain “smells” arise. If significant issues and concerns are identified, an additional hourly-rate engagement can cover the additional work required. These assignments are not cheap. Forensic accountants, like other client service professionals, can charge fairly substantial rates for their expertise. Rates can range anywhere from $200 per hour to rates in excess of $500 per hour. With substantial hourly rates and the possibility of a variety of findings and outcomes, using forensic accounting services to chase immaterial matters becomes an expensive proposition for your clients.

Conclusion

Good case management requires an early assessment of the strengths and weaknesses of your client's case and that of the opposing side. If you identify a significant weakness on your team, or strengths on the opposing side, you should carefully weigh your options and develop plans to compensate for the differences. If your team is faced with complex financial matters or incomplete or inaccurate accounting records, you should locate a forensic accounting professional.

The art and science of forensic accounting has grown dramatically in scope and sophistication as specialization, training, data extraction and computing power have increased. Look for the Certified Fraud Examiner (CFE) or the Certified in Financial Forensics (CFF) credentialed professionals. These individuals will give you the advantage you need for your clients when the size of the marital estate is substantial or involves a business. The forensic accountant will be a valuable asset in discovering pertinent evidence to the case, as well as in testifying in court as to his or her findings. If the situation does call for these services, a solid forensic accounting analysis should help you and your client leave mediation or the court room feeling satisfied with the financial presentation.

*****
Ken Stalcup is a Director with Houlihan Valuation Advisors in Indianapolis, IN. He is a Certified Public Accountant, Certified in Financial Forensics, a Certified Fraud Examiner and is a Chartered Global Management Accountant. Penny Lutocka is a Principal with the firm. She is a Certified Public Accountant, Accredited in Business Valuation, an Accredited Senior Appraiser and a Certified Fraud Examiner. Ross Koble is a Valuation Analyst at the firm, and will be moving to Ernst & Young to begin practicing in public accounting in the fall of this year.

“Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold.” — Leo Tolstoy

Most matrimonial attorneys have heard a client, typically the “out-spouse” in a marriage with a business interest, say, “The books are cooked,” or “Personal expenses are being paid by the business,” or “The accounting records are fiction.” Failing to probe these issues may cost your client a lot of money when the asset division takes place, and may leave him or her dissatisfied with your representation.

Adding a forensic accountant to the team, under the right circumstances, can make a lot of sense. You have to weigh several factors. Your decision to hire a forensic accountant is good if you have critical financial issues to be resolved, but if you hire a forensic accountant to simply chase a client's dream, you will likely end up with a big expense and little to show for the effort.

Of course, engaging an experienced accountant can help you and your client resolve the most puzzling financial mysteries associated with a contentious divorce. Those mysteries might include:

• What special documents should we request?
• Is this a complete accounting?
• Is someone hiding or dissipating assets?

When you need answers to those questions, or when your case begins to involve a mountain of financial documents, numbers and complex calculations, a forensic accountant can help tease out the meaning and issues behind the numbers. Keep in mind that your normal appraiser or CPA is unlikely to have forensic accounting experience. You have to look for additional expertise. In these cases it makes sense to add a forensic accountant to the team. The most highly regarded credentials are Certified Fraud Examiner (CFE) and CPAs who are Certified in Financial Forensics (CFF).

Factors to Consider

There are many things that increase the need for a forensic accountant. On a case-by-case basis, consider these factors:

The size of the marital estate. Generally, as the size of the marital estate increases, the legal team is likely to need a dedicated expert to address the accounting and valuation issues.

The identity of the primary money manager. If the opposing-side spouse was the primary money manager, a forensic accountant can help paint and communicate an understandable, complete and accurate financial picture for your client.

The complexity of the marital estate. Generally, as the complexity of the marital estate increases, the legal team is more likely to need a dedicated expert to help develop questions for the opposing side and “untangle the spaghetti.” This is most often seen when there are numerous companies, either horizontally or vertically integrated, or if other family members own businesses where assets and liabilities are passed to each other with abandon.

The previous history of the opposing spouse. If the opposing spouse has had a history of hiding money, evading income taxes or taking excessive risks, your legal team will need an expert forensic accountant. Any time you find problems with the Internal Revenue Service (IRS), or tax returns in arrears, problems are likely.

The presence of structured transactions. If the opposing-side spouse has the ability to shift marital assets to family, friends or related parties, an expert accountant can track, locate and disclose those structured transactions that are sometimes hidden from a normal balance sheet and operating statement. These types of assets and liabilities may be considered personal in character and not something that would be seen in a business appraisal analysis.

The sources of compensation. Compensation by salary (on a W-2) is easier to verify and track than compensation received from an investment portfolio, a partnership or a sole proprietorship. If the opposing side spouse has control of the finances of a business entity, you may need a forensic accountant to get to the total compensation paid or available to the opposing spouse.

The relative sophistication of the parties. If the opposing legal team and the opposing-side spouse are very sophisticated about financial matters, they may have a distinct advantage over your client. The attorney also needs to weigh his or her client's ability and willingness to testify about their financial affairs. If the client lacks the sophistication or ability to testify, an outside financial expert can offer impartial and experienced insights.

The state of, and access to, financial records. If the opposing side controls physical access to the financial records, they have your legal team at a disadvantage. Your client may not know what documents to request or to expect in compelling the production of financial information. Along those same lines, if the financial records are poorly maintained, it will be difficult to get an accurate financial picture without the help of a forensic accountant.

How Do You Employ a Forensic Accountant?

Most law firms will directly engage the forensic accountant. Under that arrangement, the accountant's work product will be protected by the attorney-client privilege, and it can increase flexibility of the services and the communication of the results. Under this type of engagement, the forensic accountant can freely discuss strategy or provide oral or written reports as needed. It also allows the forensic accountant to maintain his or her independence. However, if it becomes necessary for the forensic accountant to assume an expert role, all of the findings and work papers will likely be discoverable.

Like legal fees, forensic accounting fees can be difficult to estimate. It is unlikely that an attorney or an accountant can accurately estimate the exact amount of time required to handle a case from start to finish. Therefore, you should beware of an all-inclusive, fixed-fee quote. It is also difficult to accurately predict the timetable of findings in a forensic case. Avoid any forensic accounting professional who promises specific results or outcomes within his or her quote.

Many times it's best to start the engagement with a fixed fee, and identify the issues and areas of concern. The team can develop an overview of the documents and suggest additional procedures if certain “smells” arise. If significant issues and concerns are identified, an additional hourly-rate engagement can cover the additional work required. These assignments are not cheap. Forensic accountants, like other client service professionals, can charge fairly substantial rates for their expertise. Rates can range anywhere from $200 per hour to rates in excess of $500 per hour. With substantial hourly rates and the possibility of a variety of findings and outcomes, using forensic accounting services to chase immaterial matters becomes an expensive proposition for your clients.

Conclusion

Good case management requires an early assessment of the strengths and weaknesses of your client's case and that of the opposing side. If you identify a significant weakness on your team, or strengths on the opposing side, you should carefully weigh your options and develop plans to compensate for the differences. If your team is faced with complex financial matters or incomplete or inaccurate accounting records, you should locate a forensic accounting professional.

The art and science of forensic accounting has grown dramatically in scope and sophistication as specialization, training, data extraction and computing power have increased. Look for the Certified Fraud Examiner (CFE) or the Certified in Financial Forensics (CFF) credentialed professionals. These individuals will give you the advantage you need for your clients when the size of the marital estate is substantial or involves a business. The forensic accountant will be a valuable asset in discovering pertinent evidence to the case, as well as in testifying in court as to his or her findings. If the situation does call for these services, a solid forensic accounting analysis should help you and your client leave mediation or the court room feeling satisfied with the financial presentation.

*****
Ken Stalcup is a Director with Houlihan Valuation Advisors in Indianapolis, IN. He is a Certified Public Accountant, Certified in Financial Forensics, a Certified Fraud Examiner and is a Chartered Global Management Accountant. Penny Lutocka is a Principal with the firm. She is a Certified Public Accountant, Accredited in Business Valuation, an Accredited Senior Appraiser and a Certified Fraud Examiner. Ross Koble is a Valuation Analyst at the firm, and will be moving to Ernst & Young to begin practicing in public accounting in the fall of this year.