Providing Forensic Accounting Services as a Small Firm

Written by Tracy L. Coenen, CPA, CFF

FOCUS – Newsletter of the AICPA Forensic & Valuation Services Section

Forensic accounting and fraud investigation are hot specialties in the accounting world. Experts agree that the need for fraud detection services is growing, creating opportunities for small and midsized firms that are looking to start or expand a forensic accounting practice. Building a stable forensic accounting practice takes time because the services and clients are unique. The key to becoming a real competitor in the area of fraud investigation to focus your firm’s strengths on the right quality services and clients to enhance your brand.

Forensic services are usually divided into two subsets: fraud investigation (financial statement fraud, corporate embezzlement, bribery, and insurance fraud) and litigation support services (contract disputes between corporations, shareholder divorces, intellectual property infringement, business insurance claims, bankruptcy consulting, business valuation, and family law issues). Within both service areas exists a variety of potential clients, including attorneys, corporations, government agencies, non-profit organizations, and individuals. Those clients can be divided further according to the industries in which they specialize or the types of matters in which they’re involved.

Defining Services and Clients
Developing a successful small forensic accounting practice depends on selecting particular types of cases and clients because most firms cannot perform at a high level in all types of engagements. A forensic accountant could be involved in many types of cases, so it is critical that a smaller practice define its expertise and specific services.It is not uncommon for a forensic accounting professional to have an expertise in a particular industry such as hospitality or banking, although such specialization is not required. If someone in the practice does have an industry specialty, it makes sense to market heavily within that industry.

Determining a specialty also defines the firm’s marketing message for maximum impact on the intended client base. When practice managers narrow their focus (by either choice or necessity), clients find them more easily. The clients are clear about what the forensic accounting practice’s “sweet spot” is, and they can determine better whether their needs fit within that range.

Competing in the Marketplace
Larger firms carry well known names and usually are perceived as having huge depth and breadth of experience. A very large firm with offices around the world can almost always round up an “expert” on any issue or in any industry. Consequently, some smaller firms may think they can’t compete with those types of resources.

But smaller firms can effectively compete with larger firms by developing a niche and performing at a high level within that area of specialization. Smaller firms may not be able to rely upon their name alone to bring in business, so they have to sell the quality of the services they provide and gradually build a reputation in the industry.

At times, a larger firm will have a competitive advantage for being selected for a forensic accounting engagement. Francine McKenna, President of McKenna Partners in Chicago and former Director in the Internal Audit Services practice at Pricewaterhouse Coopers, says that larger firms are well-positioned to complete very large, long engagements. They’re probably also better equipped to carry out international assignments.

However, in many instances, a smaller forensic accounting practice can provide a distinct advantage to clients. Curtis J. Reynolds, CPA, a shareholder of Peters & Associates, S.C. a small forensic accounting firm with six offices throughout the United States, asserts that small firms can compete with larger firms by banking on the quality of services provided in conjunction with competitive pricing structures.

“Walking into an engagement with a team led by someone with very solid experience and a strong forensic accounting background is definitely an advantage,” says Reynolds. Fraud investigations can become complex, so an investigator with significant experience puts the client at a definite advantage.

McKenna agrees. She suggests that smaller firms highlight their expertise in a particular technical area or industry, rather than trying to “be everything to everyone.” She even recommends that small firms market themselves as “first choice for specific engagements.” Some managers of smaller forensic accounting practices have had great success by maintaining a narrow focus.

Marketing a small forensic accounting practice comes down to highlighting the firm’s strengths and abilities. Reynolds says that his firm’s most successful results have come from personalized marketing. “Our most valuable marketing activities have been networking, making presentations to industry groups, and word-of-mouth. We find advertising in publications helpful, but we believe the activities that allow us to connect personally with potential clients have greater value.”

The key to competing with larger firms has three clear components. First, the forensic accounting practice must find and market a narrow service-offering. Next, they must always provide the absolute highest quality work product, relying upon the depth of expertise within their firms, rather than the number of people. And finally, they must be customer friendly, avoiding the bureaucratic problems many larger firms face.

Case Administration
Although forensic accounting engagements will have many administrative issues similar to those of a traditional engagement (budget, staff assignments, and engagement letters, for example), there are distinct differences between the two types of engagements.

A traditional audit, for example, has a level of service that is fairly predictable from year to year. However, the boundaries of a forensic engagement are sometimes hard to define, making it difficult (especially on larger engagements) to create an accurate budget. The easiest way to deal with budget issues is by breaking up the forensic accounting engagement into incremental phases for the work. This approach defines the tasks and makes the overall process easier.

One creative way to bill forensic accounting work is on a “fixed fee”  structure, rather than charging clients by the hour for an investigation. This method of billing offers the advantage of capping the client’s costs at a predetermined level. It allows the client to know exactly the price of the services before the project is started.

A fixed fee engagement involves some risk for the accounting firm. It is their responsibility to define an appropriate fee up front or risk losing money if staff time exceeds the initial budget. At the same time, it allows the forensic accounting practice a greater profit if the investigation team can work efficiently. Fixed fee engagements work best when the boundaries of the work are well defined. When a client isn’t sure how deeply they want an issue investigated, it may help to develop phases for the work and fees. The client can proceed with the first phase or two and then decide whether to continue the investigation with the additional phases. This arrangement is also a plus for the accounting firm because the work and the fees for the later phases can be adjusted based on information gathered in early stages of the investigation.

No matter how the billing is arranged, smaller forensic accounting practices should not position themselves as the least expensive alternative. True, smaller firms often can be more competitive on fees. However, Michelle Golden, president of Golden Marketing says “The belief that you get what you pay for is strong. Set the price in accordance with the value you are delivering, which should be based on your ability to solve and resolve.”  Golden suggests that smaller firms may be able to charge a premium for their services because of the personal attention and responsiveness that they can offer in the course of providing high quality services.

Like any traditional accounting engagement, an investigation should start with an engagement letter that outlines the agreed-upon scope of work and fees. It also outlines the timing, document availability, client participation required, and details about administrative issues such as conflicts of interest and nonpayment of invoices.

The big departure from a traditional engagement, however, is the lack of standard work programs to guide the investigation. Although a firm should still have guidelines and checklists in place to assist staff, each fraud examination is quite different from the next, so standard work papers are nearly impossible to craft.

In general, the principal investigators should provide staff with some basic guidelines on administrative details, evidence handling, document management, and process management. Checklists are helpful, especially for some for the more standard tasks, such as document requests and financial statement analysis. The actual performance of investigative tasks will vary from project to project, but general guidelines should be in place to monitor the completion of engagement tasks.

Without standard work programs, staff supervision is critical to ensure the proper handling of evidence and thoroughness in investigative procedures. Because smaller firms or fraud investigation practices typically have fewer staff members involved, staff supervision and control over documents and evidence are more manageable.

Performing Forensic Accounting Engagements
Forensic accounting engagements are to be performed in accordance with the AIPCA’s  Statement on Standards for Consulting Services. As with other services provided by CPAs, the professionals involved in a forensic accounting engagement are required to adhere to the basic standards of professional competence, due professional care, planning and supervision, and sufficient relevant data.

Although there is no requirement that an accountant be independent in a forensic or litigation engagement, AICPA Ethics Rule 101, Independence (AICPA, Professional Standards, vol.2, ET sec. 101) must be considered in light of other engagements performed by the firm and the potential that lack of independence could impair the credibility of an expert witness.

During a traditional engagement, staff typically has the prior year’s working papers to follow when deciding what procedures to perform. On a fraud investigation, however, there is no such “cheat sheet,” so closer supervision of staff is necessary.  Less experienced staff can feel lost on an engagement like this, so the more experienced investigators should be alert to this and willing to lend a hand.

Reynolds says that the key to successful teamwork at his firm has been the clear division of responsibilities along with regular communication about the status of an investigation. He says outlining expectations and roles makes things easier, especially in light of the fact that the firm uses few traditional work programs, in favor of basic procedural checklists.

However, because each forensic accounting engagement is unique,Reynolds says it’s important that staff not become too reliant on checklists. “They need to be able to think on their feet and independently develop strategies for obtaining and examining documentation, all the while keeping the manager of the file updated on their progress.”

Fraud investigations often begin with a document request list. Part of this task can be standardized; much cannot be. Routine procedures include examination of financial statements and tax returns. A complete copy of the detailed general ledger for the periods in question is desirable, but is not always possible, especially at smaller companies. If a perpetrator has been identified, it is also standard to see that person’s personnel file and disciplinary records.

Analytical review may be an important part of a fraud investigation, especially if the client is unsure of where fraud lies in the accounting system. Although looking at comparative figures and analyzing ratios will not provide proof of a fraud, they can help in identifying vulnerable areas of the financial statements. They also can sometimes even help identify an account with apparent manipulations and create a roadmap for the investigation.

From this point forward, each investigation will take on a life of its own. The detailed records requested will vary, depending upon the individuals under suspicion and the accounts potentially affected by a fraud or legal matter. For example, a case involving lost profits will likely require examination of detailed sales records for the period in question. Forensic accountants will also have to examine income statement items in detail to help determine profit levels to be used in damage calculations.

A fraud investigation may require the examination of a completely different set of accounting documents. In a case involving allegations of collusion between a purchasing manager and a supplier, the forensic accountants will likely want to see detailed documentation of the transactions with that supplier.

Proper document management procedures must be implemented from the start of the forensic accounting engagement. It is imperative that the team be able to quickly locate key documents, and easily find other pertinent documents, if requested.

A database should be created to track documents, the dates on which they were received, who provided the documents, and a short description of each item. If evidence has already been numbered or otherwise stamped as part of a lawsuit, those numbers should also be logged in the database. They will be important when referring to the documents.

Document management tasks are easily neglected, especially on smaller engagements. It can be time consuming to inventory the many documents that a fraud investigation can accumulate, but neglecting this important task can cost the team more time and money in the long run. It can also impede the process of preparing a final report or testifying in court.

The detailed examination of accounts and transactions is the most difficult part of an investigation to discuss in an article, primarily because such a wide variety of techniques can be used and a multitude of concerns are specific to each investigation. Suffice it to say that this is the heart of all forensic examinations, and an experienced investigator will know how and where to look for fraud, so he or she should be directing all activities of the engagement staff.

Attention to quality control will be paramount in all fraud investigations because a small firm attempting to compete with larger firms will need a strong reputation to succeed. One botched engagement can ruin many future prospects; therefore, it is critical that the work product be of the highest quality, presenting the image that you want future clients to see.

Building for the Future
Developing a fraud examination practice is challenging, from an acquisition perspective as well as a performance perspective. Because the  process of a fraud investigation is almost impossible to standardize, putting the appropriate systems into place can be difficult. By creating administrative tools to manage engagements, a firm’s experienced investigators can work with newer staff to develop a standard investigation approach that works and that can be applied to future engagements. Once a forensic accounting practice is able to produce good results in its early engagements, it is on the right path toward developing a reputation in a specialty area and will be able to cite success  stories when selling forensic accounting services.

Courtesy: Providing Forensic Accounting Services as a Small Firm | Sequence Inc. Forensic Accounting – http://www.sequenceinc.com/providing-forensic-accounting-services-as-a-small-firm/

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What do you think? What strategies do you, or your company, use to manage the risk of fraud and error in your organisation? Are you primarily proactive or reactive in your approach to risk management? Share your experience in the Comment box below.

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