Essay: Ethics in Forensic Accounting

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¶ … forensic accountants and their role in detecting / preventing fraud. This will be accomplished by focusing on the most common types of frauds and the way they are impacting stakeholders. Once this occurs, is when we can provide specific insights that will highlight how these challenges can be mitigated over the long-term.

Over the last several years, the issue of ethics in forensic accounting has been increasingly brought to the forefront. This is because there have been a number of high profile scandals highlighting potential abuses that occurred at the hands of actuaries. In some cases, these individuals often overlooked critical information that could have uncovered a potential fraud. While at other times, they were overly influenced by corporate officials. In either case, the long-term impacts are that investors will lack confidence in the firm and the financial system. (Golden, 2011)

Evidence of this can be seen with a study that was conducted by Price Waterhouse Cooper. They found that in 2009, fraudulent incidents impacted 30% of all U.S. publically traded firms over a 12-month time frame. This is lower than 2007, with these figures coming in at 43%. Moreover, European and Russian companies experienced some of the highest levels of fraud. In these cases, firms reported incidents of 43% for Europe and 71% for Russia. This is problematic, as these kinds of challenges can lead to reduced investor confidence. If the situation continues over long periods of time, there is the possibility that this could erode investor sentiment and their access to investment capital. To fully understand the overall scope of the problem we will be focusing on areas where fraud is prevalent in forensic accounting. Together these different elements will highlight the underlying challenges and provide possible solutions for rectifying them. (Golden, 2011)

Ethics and Fraud in Forensic Accounting

Forensic accountants have the responsibility of adhering to various ethical standards that are established by the Securities and Exchange Commission (SEC) along with Financial Accounting Oversight Board (FASB). These guidelines provide a basic foundation for ethical activities embraced corporate executives and actuaries. Moreover, they established different techniques of reporting financial information and determining if fraud is being committed inside the organization. The most notable include: auditing tests, sampling, interview / interrogation techniques, verbal / nonverbal cues and questioning different individuals. This is augmented with a basic standard that requires everyone to follow the most ethical guidelines during the process. The combination of these factors is showing how forensic accountants play an important part in enforcing these standards and detecting possible fraud. (Gray, 2008)

Types of Frauds that are most Prevalent

Misappropriation of Funds

There are many different types of frauds that are committed. One of the most common is the misappropriation of funds. This is when employees, executives or accountants are identifying weaknesses in the firm's procedures and they are exploiting them for their own personal benefit. When this happens, the financial results of the company will be inaccurate by making the firm appear to earn more than they really are. Over the course of time, these kinds of activities can become more common if no one is actively trying to prevent these situations. (Ozkul, 2012) (Ramaswarmy, 2007)

A good example of this can be seen with Tyco. In the late 1990s and early 2000s, Dennis Kozlowski and several key associates were embezzling hundreds of millions of dollars in company funds for their own personal use. On the surface, nothing appeared to be out of the ordinary. (Ozkul, 2012) (Ramaswarmy, 2007)

However, as time went by the scope of the fraud become more brazen with key executives and auditors helping to support these activities. This is because Kozlowski had undue amounts of influence on the board of directors and their ability to independently investigate these issues. Moreover, independent auditors were swayed by their relationship with the management. This meant that they were ignoring key red flags and they failed to report these issues. Once the fraud became larger, is the point that these matters could no longer be overlooked. This is when these activities were uncovered. (Ozkul, 2012) (Ramaswarmy, 2007)

These areas are showing how forensic accountants and auditors could be influenced to look the other way when it comes to the misappropriation of funds. The reason why is because, they will have a close relationship with executives. When this happens, they will ignore critical issues and fail to report what was discovered. (Ozkul, 2012) (Ramaswarmy, 2007)

This is because they believe what they are hearing from company officials and are not following the highest ethical practices. It is at this point that these issues could become dramatically worse by giving these individuals room to engage in a host of illegal activities. After the problem has become severe, is when these problems will become something that cannot be ignored. (Ozkul, 2012) (Ramaswarmy, 2007)

As a result, forensic accountants have an obligation to follow the highest ethical standards at all times. This means that they must immediately report their findings to stakeholders and regulators. Otherwise, there is the possibility that these challenges will affect the operations of the firm and investors' confidence (in the financial data / management of the organization). (Ozkul, 2012) (Ramaswarmy, 2007)

Inaccurately Representing Information inside the Financial Statements

Another common type of fraud is the misrepresentation of information that is presented to investors in various pieces of financial data (i.e. quarterly and annual reports). In the majority of cases, these kinds of activities are tied with the desire of management to help increase the price of their stock or the value of their company. This is because they do not want to take significant losses from particular activities that were unsuccessful (which could hurt perceptions about future growth). It is at this point that executives will engage in actions that are considered to be unethical and illegal. (Healy, 2003)

A good example of this can be seen by looking no further than Enron. During the late 1980s and into the 1990s, the company was aggressively taking advantage of deregulation that was occurring around the world. The way the company was able to increase their profit margins were through: trading in the distribution of key commodities (i.e. electricity and natural gas) along with owning facilities that can produce them. (Healy, 2003)

To take advantage of new opportunities the company began going into developing economies. One of the most notable was the investment the firm made in building a liquefied natural gas power plant in Dabnol, India. At the time, this was supposed to provide the company with a significant footprint in the region through constructing a modern facility. In the future, this would address the current and future needs of region. (Healy, 2003)

However, from the very beginning the company was facing tremendous problems with: cost overruns, they did not account for the loss of electricity (because of theft) and failed to take into account that LNG plants require billions of dollars in infrastructure. Moreover, the local economy was unable to support this kind of facility. The combination of these factors made the underlying situation worse, as the Indian government stopped supporting the development of the plant. When this happened, the company was forced to abandon the project and take a $20 billion loss. (Healy, 2003)

Evidence of this can be seen with observations from Healy (2003) who said, "Enron International, a wholly owned subsidiary of Enron, was created to construct and manage energy assets outside the United States, particularly in markets where energy was being deregulated. They subsequently entered contracts to construct and manage projects in Eastern Europe, Africa, the Middle East, India, China and Central / South America. These projects represented significant investments in these economies. While the privatization of energy producers and deregulation of energy markets created demand for the management of energy assets outside the United States, Enron faced some distinctive risks in entering these new markets. The Dabhol power project in India represented the single largest foreign direct investment until that time in India, and it attracted considerable political opposition and controversy. Given its limited business experience in developing economies, Enron did not have expertise in managing the risk or accounting for if its assets would be expropriated after construction of the plant. Even if Enron was successful in the international energy market, questions could be raised about whether the company can create a sustainable advantages over competitors that later sought to enter the market. As many existing players had expertise in managing the construction and operations of power plants." This is showing how Enron faced tremendous challenges with these projects. In most cases, forensic accountants were able to overlook these issues or were unaware of them. This is because they did not watch for obvious signs of abuse, which allowed the firm to engage in activities that will produce limited long-term rewards for them. (Healy, 2003)

To hide these losses, they created off the book limited partnerships. These were designed to provide investors with larger returns by compensating them… [END OF PREVIEW]

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