Business valuation analysts rely on the financial statements provided by the parties involved. Analysts are not seeking out hidden assets or looking for fraud. In fact, as part of their valuation opinions, valuation analysts include “assumptions and limiting conditions” verbiage, stating that the appraiser accepted the company’s financial statements as “complete and accurate without verification.”
However, not all financial statements are complete and accurate, and sometimes the valuator suspects fraud. When this happens, forensic accounting can help.
Forensic accounting is a specialty in which a CPA uses accounting, auditing, and investigative skills to analyze a company’s financial statements. Forensic accountants uncover and investigate financial crimes such as fraud, embezzlement, or corruption and can provide litigation support by testifying in court as an expert witness.
Forensic accountants often also have specialized training in calculating and quantifying losses and economic damages. Some CPAs have earned the Certified in Financial Forensics (CFF) credential from the AICPA, underscoring their expertise in the forensic accounting field.
Valuation analysts discover financial irregularities in a variety of ways. Sometimes during a valuation, the numbers just don’t look right. Or, especially in cases of divorce or shareholder disagreements, fraud comes to light because one party snitches on the other.
For example, in the case of divorcing spouses with interest in a closely held company as an asset, one spouse may accuse the other of not reporting all revenue (possibly decreasing business value), treating personal expenses as business expenses (possible decreasing value), incorrectly classifying loan proceeds as revenue (possibly increasing value), or classifying loan principal payments as expenses (possibly decreasing value).
Some misdeeds are easy to see, such as mortgages, car payments, or sports tickets categorized as business expenses. Others, such as a too-high standard of living based on reported income, can be more subtle.
Depending on the magnitude of these wrongdoings, business value may be significantly affected—and may constitute tax fraud. In addition, snitching can be problematic from a legal perspective because accusing a spouse of tax fraud may implicate the accuser as well.
Because of the nature of forensic accounting work, it is common for forensic accountants to be hired directly by the parties’ legal counsel so that any work performed and any conclusions reached can be considered attorney work product and therefore privileged and confidential.
And because it can be difficult to estimate the amount of time required for a financial investigation, it is wise to work with a forensic accountant in phases. Controlling the engagement in this manner controls costs: You don’t want the investigation’s cost to outweigh its benefits.
Note that if the engagement uncovers serious financial irregularities, it will likely be more advantageous to settle in private rather than in a public court battle.
Don’t wait until you need a forensic accountant to find one. Having an existing relationship with a forensic accountant allows you time to determine how you might work together, adding speed and efficiency to future engagements.