FORENSIC ACCOUNTING AND AUDIT AS A PANACEA FOR PREVENTING CORPORATE FRAUD IN NIGERIA

CHAPTER TWO

REVIEW OF LITERATURE

INTRODUCTION

Fraud and corruption are fundamental problems of third world countries, particularly Nigeria were officialcorruption has become endemic.(Akram 2009). The spate of world-wide corporate scandals involving Enron,Worldcom, Global Crossing, Tyco International, Xerox (USA); Parmalat (Italy) and corporate fraud perpetuatedin Nigeria by management of Lever Brothers, Union Dicon Salt, Cadbury (Nigeria), and the 14 distressed banksas exposed by audit of the Central Bank of Nigeria has shown the failure of traditional audit techniques inunraveling corporate fraud and have rejuvenated interest in forensic accounting. So also are the increasinggovernment concerns over official corruptions and the doggedness of the various anti corruption agencies atunraveling them through the deployment of forensic accounting methodology.

Companies are now beginning tobe more determined than ever to ensure that their operations are above board and in no way connected withfinancial frauds. These have resulted in a steadily growing demand for sophisticated accounting and auditingtechniques as provided by forensic accounting in detecting, correcting and preventing fraud as well as deceptiveand creative accounting practices. Until recently, the detection of fraud or white collar crimes was generallythought to be part of the conventional accounting and auditing functions. Generally, Fraud was something thatinternal or external auditors were supposed to guard against through their periodic audits.

However, the failure oftraditional audit in curtailing the menace of official corruption and white collar crimes is inflaming passion forforensic accounting techniques. The extent to which forensic accounting is gaining relevance in Nigeria in the fight against corruption in Nigeria, the investigative capacity of Nigerian accountants and the pace of development of forensic accounting in Nigeria are among the principal objectives of this paper.

Our focus in this chapter is to critically examine relevant literatures that would assist in explaining the research problem and furthermore recognize the efforts of scholars who had previously contributed immensely to similar research. The chapter intends to deepen the understanding of the study and close the perceived gaps.

Precisely, the chapter will be considered in two sub-headings:

• Conceptual Framework
• Theoretical Framework

2.1 CONCEPTUAL FRAMEWORK

Forensic Accounting

To date, various definitions have been given to describe forensic accounting. Thornhill (1995), positsthat forensic accounting discipline is relatively new and that up to date, there has been no formal definition thatis being accepted as the standard. Webster’s Dictionary defines forensic as “pertaining to, connected with, or usedin the courts of law or public discussion and debate”. Hence, forensic accounting is closely related to the legalprocess and has the potential to be involved in proceedings in the civil and criminal courts. Forensic accountingprovides an accounting analysis to assist in legal matters which will form the basis for discussion, debate and ultimately dispute resolution. Manning (2002) also defined forensic accounting as the application of financialaccounting and investigative skills at a standard acceptable by the courts, to address issues in dispute in thecontext of civil and criminal litigation.

Bologna and Lindquist (1987) provide the definition of forensic accounting as:

…. application of financial skills and investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As a discipline, it encompasses financial expertise, fraud knowledge, and a sound knowledge and understanding of business reality and the working of the legal system. Its development has been primarily achieved through on-the job training as well as experience with investigating officers and legal council. p.47

In the views of Razee, Crumbley and Elmore (2009), Forensic Accounting is simply a specialty field inAccounting that deals with the identification of financial fraud, and reports in a way that it would be suitable foruse in a court of law. Howard and Sheetz (2006) defines Forensic accounting as simply the process ofinterpreting summarizing and presenting complex financial issues clearly, succinctly and factually often in acourt of law as an expert witness. It is concerned with the use of accounting discipline to help determine issuesof facts in business litigation. Forensic Accounting is the fastest growing and highest paying field of Accounting,and with the integration and complexity of the global markets and financial institutions, it would be in greaterdemand within the next few decades. The needs of governments, regulatory authorities and courts for high level of expertise for the analysis of intricately devised frauds underlie the importance of forensic accounting(Ramaswamy,2005). Forensic accountants provide services in accounting, auditing investigation, damagesclaims, analysis valuation and general consultation and also have critical roles in divorce, insurance claims,personal damage claims, fraud claims, construction, auditing of publication right and in detecting terrorism byusing financial precedence (Hassan &Morteza, 2012).

Forensic Accountants And Auditors

Forensic accountants and traditional auditors, though have different roles, knowledge and skills, sharesome common goals that includes the detection of fraud.However, unlike financial audit which, as illustrated inTable 1 below, aims mainly at uncovering (identifying and preventing) material deviation (errors) in financialdata and significant variances from acceptable accounting and auditing standards, forensic accounting looksbeyond the transactions and audit trail to focus on substances of the transaction instead, with a view toidentifying fraud.

Forensic accounting investigations include litigation services related to a variety of situations including businesspurchases, valuation of divorce assets, property damage, lost profits due to embezzlement and other illegal acts,tax evasion, and money laundering schemes. (Gray 2008).

History Of Forensic Accounting

Forensic accounting is by no means a new field as evidences prove that the profession has been in existence fora long time despite the fact that the profession was not yet recognised as a distinct one or called forensicaccounting (Grippo,2003). Forensic accountants in ancient Egypt who inventoried the grain, gold and otherassets of Pharaohs were called the ‘eyes and ears’ of the Pharaohs. Another evidence of the existence of forensicaccounting is traceable to the year 1817 when the accountants who examined the bankrupt’s account wasrequired to testify in the court (Crumbly, 2001). Other sources traced the origin of forensic accounting practiceto as far back to the 19th century Scotland when a young Scottish accountant issued a circular advertising his

expert in arbitration support in 1824. It was from the late 1800’s and 1900’s that articles began to appeardiscussing expert witnessing, evidence arbitration and awards. The phrase ‘forensic accounting’ was said to havebeen first published in an article in 1946 by Maurice E. Peloubet, a partner in a New York accounting firm.Peloubet, (1946) explained that, during the war both the public and industrial accountant have been engaged inthe practice of forensic accounting.

Forensic Accounting Practice, Fraud And Corruption From Global And Nigerian Perspectives

KPMG’s Fraud Survey (2003) reveals that more corporate entities are experiencing incidents of fraud than inprior years; while more sophisticated measures are being adopted to combat fraud through the launching of newantifraud initiatives and programs that include the deployment of forensic accounting techniques in response tothe Sarbanes-Oxley Act of 2002. Pricewaterhouse Coopers’ (PWC, 2003) Global Crime Survey showed that 37percent of respondents in 50 countries reported significant economic crimes with the average loss per companyof $2,199, 930. These survey results underscore the importance of forensic accounting practice and education.Corruption is considered the bane of the Nigerian society which has dogged the country and plagued all attemptsto improve the lives of the citizens (Oyewole, 2007; Nwachukwu, 2010). Although, corruption is by no meansexclusive to Nigeria, the prevalence and the amounts involved in Nigeria is mind bugling. (Nwachukwu, 2010).The 2010 Corruption Perception Index of Transparency International which placed Nigeria in the lower quartileof the corruption index with a score of 2.4 on a scale of 0 to 10 seems to have corroborated these views. Ibid. Ina very legitimate sense, corruption auditing is expected to remain a major concern of government auditors just asin the same way fraud auditing is to auditors of private establishments. But unfortunately, government auditorshave remained significantly dormant in corruption audit methodology development (Khan, 2009). It is thebelief of some experts in the financial industry that forensic accounting will increase risk control mechanism andlimit ‘fraud vulnerability of companies and corruption in the public sector.

There is a gradual rise in the application of forensic accounting in the investigation of corporate fraud as it tookthe application of forensic accounting by the Economic and Financial Crimes Commission (EFCC) to unravelthe corruption mess in the Nigerian Securities and Exchange (NSE), which was allegedly claimed to have beenladen with numerous instances of over-invoicing, gross breaches of financial guidelines, multiple payments,

falsification of accounts, illegal sharing of funds and fragrant disregard for budgets and expenditure limits.However, while most other countries have been able to reduce the occurrence of financial fraud in both theprivate and public sectors, the menace is rather on the increase in Nigeria, despite the establishment of theIndependent Corrupt Practices and Other Related Offences Commission (ICPC) and the Economic and FinancialCrimes Commission (EFCC), ( Efiong, 2012). Nigeria is still ranked very low by the Transparency InternationalCorruption Index. The 2010 survey places Nigeria at the 134th position out of 178 countries that were sampled.

Forensic Accounting Education

The prior researches of Rezaee, 2002 and Crumbley 2001 provide evidence that forensic accounting educationhas evolved from being limited to continuing professional education sessions for practicing accountants tobeing offered as a credit course by several universities. Buckhoff and Schrader (2000,) posits the addition of

forensic accounting course to the accounting curriculum can greatly benefit the three major stakeholders inaccounting education academic institutions, students, and employers of accounting graduates.”

The study of Effiong, 2012 found that there is a very low level of awareness on forensic accounting amongundergraduate students basically because of its complete omission or very insignificant place given to it in thecurriculum of both the academic institutions and professional examination syllabus of the professionalaccounting bodies in Nigeria and contend that the adoption of forensic accounting into the universitiesaccounting curriculum would have a huge potential to enhance students skills and competencies that could beused veritable resources to mitigate fraud. The lack of legal framework and statutory recognition of the role offorensic accounting that is similar to the legal status given to financial audit by the Nigerian Companies andAllied Matters Act (CAMA) 2004, has not made it necessary for traditional statutory auditors to incorporate somemeasures of forensic enquiries into their audit services for effective fraud detection.

Forensic Accounting And Corporate Fraud Prevention

Okunbor and Arowoshegbe, (2012) shows that the quality of forensic accounting services in Nigeria is determined by the quality of forensic accounting personnel and the methods/approaches employed by the forensic accountant. Huber (2013) strongly suggest that forensic accountants they did not consider and use due diligence in investigating the firms that issued their dedication prior to obtaining their certifications. Failure to use due diligence in investigating forensic accounting firms is especially perplexing since the Codes of Ethics of two forensic accounting businesses require the exercise of due diligence A study by Kasum, (2009) shows a positive attitude toward forensic accounting. The study shows that the services of the forensic accountant are required in both the private and public sector of the Nigerian economy especially in relation to fraud and corruption issues. Temitope (2014) found that forensic investigation and forensic litigation were significant factors in explaining changes in financial performance of commercial banks in Nigeria. It also found that forensic financial information significantly improved the performance of commercial banks in Nigeria. Modugu and Anyaduba (2013) concluded that there is significant agreement amongst stakeholders in the effect of forensic accounting in fraud prevention, improving financial reporting and internal control. Madumere and Onumah (2013) study shows that there is a significant and positive association between forensic accounting, and financial reporting, economic performance and cost of capital. Muthasamy (2010) shows significant positive influence of attitude, organisational ethical climates stakeholder’s pressure on the occurrence of frauds.

Albrecht, (2005) argued that fraud is rarely seen. He said that the symptoms of fraud are usually observed. The symptoms do not necessarily mean fraud is being undergone as it may be caused by mistakes. The writer advices are mainly to be cautious when fraud is reported as it may be false allegations. Fraud is not easily proven since frauds have themselves at a safe line where authority could not convict them. This shows that the author is explaining that the fraud defaulters are getting smarter due to the possible mistakes human can cause. This has made detecting and proving fraud a hard work fora forensic accountant. There is a need for deeper understanding on how these defaulters work their fraudulent act. Without constant involvement of the public and improvement in forensic accounting, fraud cases will be hard to detect and thus lead to greater success in financial fraud, which also translates into the failure to meet the expectations of the public,shareholders or even other stakeholders.

Ramaswamy (2005) states that poor corporate governance and accounting failure is one of the reasons why fraud casesemerge. This is because poor corporate governance will lead to the ability of certain individual or a group of people withthe same interest to act upon it to commit fraudulent activities in the company. He also states that the problems within thecorporate reporting system as a reason because of lack of well implemented policy of corporate governance. This can bereinforced by the fact that top level management should follow the policies of the firm which will help the company toperform better. The problem comes from the fact that certain corporate leaders do not have positive attitude regarding thepolicies.

Therefore, lack of honesty and transparency in reporting financial statement is another problem. It is agreeable that anauditor does not have the absolute duty to uncover fraud, but they should practice fair and true reporting to ensure that theinterests of the public as well as the employees are protected. With the use of forensic accounting guidelines, auditors canact as forensic accountants in cases of suspicious fraud or criminal activities in a company. Ineffective and inefficientsystem of internal control which is stated by the author points out that a weak management cannot be changed withinternal control system. Even if a company applies good internal control systems, the management will still be the majorfactor influencing the implementation. Companies should look towards new approaches rather than follow the traditionalapproach as forensic accounting may be the next best alternative in resolving problems.Ramazani and Refiie (2010) studied the accountants’ perception of prevention methods of fraud. In this research theyexamined accountants’ perception of forensic accounting which demonstrates the low extent of accountant's perception offorensic accounting. Forensic accounting is considered as one of the factors in fraud prevention. (Bierstaker,Brody andPacini, 2006).

Okoye and Gbegi (2013) carried out a study on the evaluation of forensic accountants to planning management fraud riskdetection procedures. The study reveals that forensic accountants effectively modify the extent and nature of audit testwhen the risk of management fraud is high, forensic accountants propose unique procedures that are not proposed byauditors when the risk of management fraud is high, forensic accountants can make to the effectiveness of an audit planwhen the risk of management fraud is high, involving forensic accountants in the risk of management fraud assessmentprocess leads to better results than simply consulting them.

According to the US General Accounting Office (GAO) (1996), there is now a strong emphasis on fraud prevention anddetection during statutory audits. In fact the United States and international standards setters have increased theresponsibility of auditors to consider the risks of fraud while conducting audits of financial statements. There is even a callfor stronger forensic skills in those who perform these audits. This has been collaborated by Enyi (2009) who submits thatall normal statutory audits should contain some elements of forensic enquiry as the evidence of fraudulent activities can beeasily discovered if a thorough evaluation of the adequacy and compliance of the internal control mechanism is made. Allthese are aimed at fraud prevention and detection. But, this may not be achieved by an auditor without someunderstanding of forensic accounting methods (Efiong, 2012).

The Role And Skills Of Forensic Accountants And Auditor

An understanding of effective fraud and forensic accounting techniques can assist Professional Forensic Accountants in identifying illegal activity and discovering and preserving evidence (Houck et al 2006). Hence, it is important to understand that the role of a forensic accountant is different from that of regular auditor.

It is widely known that an auditor determines compliance with auditing standards and considers the possibility of fraud. Crumbley and Apostolou (2005), claim that a Professional Forensic Accountant has a single-minded focus on the detection, and deterrence of fraud.

Roche, as cited by Crumbley and Apostolou (2005), describes a forensic accountant as someone who can look behind the faced-out, accept the records, at their face value-someone who has a suspicious mind that (considers that) the documents he or she is looking at may not be what they purport to be and someone who has the expertise to go out and conduct very detailed interviews of individuals to develop the truth, especially if some are presumed to be lying.

Krell (2002) says forensic accounting often involves an exhaustive, detailed effort to penetrate concealment tactics. Stephen Seliskar says, “in terms of the Sheer labor, the magnitude of effort, time and expense required to do a single, very focused (forensic) investigation –as contrasted to auditing a set of the financial statements-the difference is incredible.

The above views imply that the role of Professional Forensic Accountant is different from that of other accountants. They are different in their further education and training of years of experience. In addition, forensic accountant, are closer to being investigators, economists who do economic and market estimation and appraisers-who are typically trained in finance or valuation theory in business.

As an investigator a Professional Forensic Accountant can be seen as those who are specialist in fraud detection, and particularly in documenting exactly the kind of evidence required for successful criminal prosecution; able to work in complex regulatory and litigation environments; and with reasonable accuracy, can reconstruct missing, destroyed, or deceptive accounting records. Meanwhile, as an economist, they are particularly effective at economic loss, damage and social harm estimates; familiar with the assumptions, algorithm, and calculations in econometric models and opportunity cost scenarios; can measure and quantify such things as loss of goodwill and reputation. Finally, as an appraiser, forensic accountants should be able to reliably express informed opinion on matter of business value, based on generally accepted theory; effective at evaluating the historical and projected degrees of risk and return of any going concern as well as any and all financial transactions involving assets, property taxes, and equities (Bologna and Lindquist, 1995).

Moreover, bologna and Lindquist (1995) assert that the characteristic that differentiates fraud auditors and Professional Forensic Accountants from regular auditors is the persistence and doggedness to which a suspicion is followed upon. Professional Forensic Accountants may be ordered in by a regulatory agency after receiving notice from an employee whistle blower, or press coverage may make it know that the company has a scandalous ECO or history (Bologna and Lindquist 1995). There are no professional standards for when regular auditors should become whistleblowers, and unfortunately, the involvement of a forensic accountant is almost always reactive. There is a need for more proactive monitoring of the signs of financial crime.

Razae (2002) stated that, furthermore, Professional Forensic Accountants react in response to criminal complaints, statements made in civil litigation, and rumors that come to the attention of authorities. Suspicion should perhaps refer to sings of cover up or disguise class action suits by shareholders may stimulate a forensic accounting investigation, but class-action suits only hurt the corporation, and let the offending CEO go free. Regular auditors, as have been seen, also tend to not make good witness in court, and they sometime are more a hindrance than help for law enforcement. There may be a need for the auditing and assurance professions to change their ways before new, emerging fields move in to fill the gap.

In regard to the above arguments, forensic accounting should play an important role as expert witnesses and fraud investigators. Accordingly, forensic accountant should posses a specific skills and training that enable them to play their roles as expert witnesses and fraud investigators.

The area of forensic accounting, as Houck et al (2006) argue, consists of a rather unique skill set that ordinarily requires additional expertise and training beyond an academic degree inaccounting, and beyond being a CPA (Certified Public Accountant), a CFE (Certified Fraud Examiner) or CIRA (Certified Insolvency and Restructuring Advisor). Certifications are good in designating a high degree of professional expertise in rather specialized areas, but further graduate education and continuing education programs in more general fields would be better. More specifically, entry-level fraud and forensic accounting professional should posses knowledge, skills and abilities in the following areas (Houck et al 2006):

1. Criminology specifically oriented to the nature, dynamics, and scope of fraud and financial crimes; the legal, regulatory, and professional environment; and ethical issues.
2. Fraud prevention, deterrence, detection, investigation and remediation in the following areas: asset misappropriation, corruption, and false presentations, financial statement fraud; and fraud and forensic accounting in a digital environment, including computer-based tools and techniques for detection and investigation, electronics case-management tools, and other issues specific to computerized environments.
3. Forensic and litigation advisory services, including research and analysis, valuation of losses and damages, dispute investigation, and conflict resolution (i.e. arbitration and mediation).

Considering the above views, it seems that forensic accounting plays a significant role in preventing and detecting possibilities of fraudulent financial reporting. It can be seen as an attainable effort to improve quality alternative research in accounting.

2.2 THEORETICAL FRAMEWORK

The basic theory that has been established in this research work is “white collar crime theory by Sutherland (1949) as cited in Michael (2004).

White Collar Theory by Sutherland

The term white-collar crime dates back to 1939. Sutherland (1949) as cited in Michael (2004) was the first to coin the term, and hypothesis white-collar criminals, attributed different characteristics and motives than typical street criminals. Sutherland originally presented his theory in an address to the American Sociological Society in attempt to study two field, crime and high society which had no previous empirical correlation. He defined his idea as “crime committed by a person respectability and high social status in the course of his occupation (Sutherland 1949, cited in Michael 2004). Sutherland noted that in his time, less than two (2) percent of the persons committed to prison in a year belong to the upper class.” His goal was to prove a relation between money, social status, and likelihood of going to jail for a white-collar crime, compared to more visible, typical crimes, although, the percentage is a bit higher today.

Much of Sutherlands work was to separate and define the difference in blue collar street crimes, such as arson, burglary, theft, assault, rape and vandalism which are often blamed on psychological, associational and structural factors. Instead, white-collar criminals are opportunists, who over time learn they can take advantage of their circumstances to accumulated financial gain. They are educated, intelligent, affluent, individuals who arequalified enough to get a job which allows them the unmonitored access to often large sum of money.

But the federal Bureau of Investigation (FBI) has adopted a narrow approach defining white-collar crime as those illegal acts which are characterized by deceit, concealment, or violation of trust and which are not dependent upon the application or threat of physical force or violence.

The blue collar crime will more often use physical force, whereas, in the corporate world, the identification of a victim is less obvious and the issuer of reporting is complicated by a culture of commercial confidentially. Fredrichs (2007) stated that the only way one crime differs from another is in the backgrounds and characteristics of its perpetrators. Most, if not all white-collar offenders are distinguished by lives of privilege, much of it with origins in class inequality. It is estimated that a great deal of white-collar crimes is undetected or if detected, it is not reported. Because of the high status of the perpetrators of these crimes, a highly trained and experienced examiner or investigator like the Professional Forensic Accountant is needed to forestall the occurrence of such high profile fraud