In the 1990s, Dennis Kozlowski built Tyco International, a security systems company (not to be confused with the toy division of Mattel, Inc.), into a multi-billion dollar conglomerate. But many of his deals were based on phone calls or handshakes, and the aftermath of those shaky deals drew the attention of Federal prosecutors, who then discovered that Kozlowski had been living a lavish lifestyle far beyond the means of even his generous salary. He was first indicted on delinquent unpaid sales taxes on his purchases of rare art. Even though that suit was thrown out, the accounting trail led to a larger investigation of his use of Tyco funds for lavish spending on opulent parties and personal assets such as his $30 million Fifth Avenue apartment with a $6,000 shower curtain and a $15,000 umbrella stand. In 2005, Kozlowski was convicted on criminal charges for taking unauthorized bonuses, abusing corporate loan programs, falsifying records, and conspiracy. He went to prison and was released in 2015.

Because of the prevalence of this kind of financial scandal, many companies are showing an urgent and growing interest in investigative accounting, also known as forensic accounting.

Forensic accountants typically begin an investigation of a company by interviewing high-level executives. Team members pursue tips from employees or outsiders and then comb through e-mails, searching for suspicious words and phrases. The combination of interviews and e-mails may lead investigators to specific accounting files or ledger entries. According to Al Vondra, partner in Forensic Services and a Certified Fraud Examiner at PricewaterhouseCoopers, some of the most common fraudulent practices involve hiding revenues and expenses under phony categories, such as “Total Noncurrent Assets” or “Other Current Liabilities.” For instance, India’s Satyam Computer Services Ltd. founder and former CEO Ramalinga Raju was arrested after admitting he falsified accounts that deceived investors for years. The Indian government’s Serious Fraud Investigation Office is searching to identify collaborators who falsely reported more than $1 billion in cash and assets that didn’t exist at India’s fourth-largest software company.1

Although accounting scandals have always existed, they spike upward in economic downturns. Data from the Association of Certified Fraud Examiners (ACFE) indicate that corporate fraud cases began increasing significantly early in the 2008 recession, and worldwide fraud losses reached $3.5 trillion in 2012. At the same time, more than 3,000 fraud-related reports and whistle-blowing tips were reported from within U.S. firms. ACFE members believe the increase stems from heavier financial pressures: When employees feel less secure, they may falsify data to show better performance, or they may take greater risks that need to be covered up to show financial success.

The most common kind of fraud is asset theft—stealing cash, falsifying business expenses, forging checks, and stealing noncash assets. The chief financial officer of a Florida tree farm, for example, falsified checks and misused company credit cards to embezzle $10 million, earning a 96-month prison sentence and a $14 million fine.2 The least-common organizational fraud, and the costliest by far, is financial statement manipulation. In 2012, for example, the financial officer of an energy company was convicted of lying to investors while raising funds for the company’s energy projects. Instead, the funds were used for salaries for himself and others. Unsuspecting investors lost some $4.3 million in the scam. The culprit received a 97-month prison sentence.

Fraud also exists among the public at large. Fraudulent insurance claims are on the upswing: A private investigator films an injury victim throwing the neck brace into the back seat of his car after leaving the doctor’s office, a homeowner inflates the cost of articles stolen in an alleged burglary, and victims of car wrecks from years past suddenly submit injury claims. Employees, too, are a source of fraud; the U.S. Commerce Department estimates that one-third of business shutdowns are the result of employee theft. Inventory stolen from the firm’s warehouse is resold; the company’s strategic inside information is stolen and sold to a competitor; and employees receive reimbursement for falsely inflated business expenses.3

Because the accounting systems and records—and the accountants that tend to them—are designed to capture all of the financial transactions of the company, it is often those records that lead to fraud detection. But even more significantly, a well-designed accounting system can prevent fraud. And although fraud gets a lot of attention, the day-to-day operational information provided by accountants helps managers create a more profitable business, report results of operations to stakeholders, and manage the long-term health of the company through budgeting, capital acquisition analysis, business segment analysis, and a world of other financial decision-making processes. (After studying the content in this chapter, you should be able to answer a set of discussion questions found at the end of the chapter.)