In a matrimonial proceeding, a forensic accountant can be an essential member of a valuation team working to determine an equitable settlement – particularly if a business is involved.
Analyzing a couple’s finances to uncover hidden assets is of key importance in ensuring that the valuation is accurate and the settlement is fair.
The starting point is analysis of the business and personal income tax returns of the spouses –along with an investigation to uncover any hidden income or expenses.
If either party owns a closely held business, a comparison of the company’s gross profit margin to industry standards can often highlight inconsistencies.
For example, if the business buys materials for 100 widgets it sells but reports only the income from the sale of 80 of them, the gross profit percentages will vary from industry norms.
Unfortunately, people who are trying to hide income are aware of this and may be clever enough to pay cash for the materials, thereby keeping the gross profit percentage in line. Thus, using industry standards is not always the only or principal tool for analyzing financial data of a business.
A thorough examination of sales and purchase invoices may reveal cash items. By tracing them to the reported business income and expenses, a forensic accountant can determine if they were properly reported. Personal observations are also often beneficial, especially in businesses that cater to the public.
A forensic accountant also looks for unreported income by comparing the income reported by the business owners to the lifestyle they are living. If the reported income is $50,000 and the owners live in a $1 million house, the accountant will trace the source of the funds for the mortgage payments.
The use of the case information statement (CIS) could be critical for this type of analysis. A carefully completed CIS will show the family’s spending patterns. If spending exceeds income, and there is not an increase in debt and borrowing by the owner, a red flag is raised.
Sometimes a CIS is incomplete or the information it contains is only estimated. A forensic accountant can also perform a lifestyle analysis, in which personal records including bank accounts, brokerage accounts and interests in other entities, inheritances, loan documents and credit card statements are analyzed to recreate a spending history.
As part of the investigation of expenses, a forensic accountant can perform statistical analyses on business records to highlight potential problems and determine whether expenses being paid through the business are valid.
The accountant begins with reported expenses, then traces them to source documents such as paid invoices, purchase orders and cancelled checks.
Example: The accountant is reviewing a dental practice’s records and notes that the dentist had regular payments to a dental laboratory elsewhere in the country. While this might not raise immediate suspicion, the accountant spot checks the payments and asks the dentist for copies of the paid invoices. After weeks of stalling, the dentist admits there are no invoices.
It turns out, the laboratory owner is a personal friend, and the two wrote checks to each other’s businesses, cashed the checks and returned the money to the other. The business showed a payment to the dental lab but, in fact, the dentist got the money back.
The schemes people devise are endless. Detailed analysis is the key to getting the complete picture.
A forensic accountant takes on the role of detective, code breaker and even confidant of an owner’s partner or employee. Discussions with the business owner and key personnel can yield valuable information. Letting other people do most of the talking often results in disclosure of useful information or clues to items that require further examination.
Visits to a business location are particularly valuable because they enable the accountant to verify the types of operations, the number of employees, the physical needs and uses of the business and other important issues.
Every category of income and expense has the potential to create unknown cash flow. A forensic accountant must use skilled training, an analytical mind and creative thought processes to assure cash flow is properly determined.
When handling a divorce case, the valuations team must be thorough. The use of a forensic accountant to calculate the accurate level of cash flow in a business – a figure needed to determine a fair and equitable level of support – can make or break a case.
To present clear, concise, defensible information to an adversary or the court will enhance the valuation team’s ability to get the best possible and truly equitable result for their client.
Adding a forensic accountant to the valuations team can help achieve the desired outcome.