What does a forensic accountant do in divorce?
When a couple decides to dissolve their union and go down the road of getting a divorce, traditionally each side will obtain their own attorney and begin the process. If the divorce is contentious, there may be concerns over hidden income and hidden assets. When this concern comes about, the attorney (and client) will engage a forensic accountant to investigate whether the concern is valid.
Usually a forensic accountant is brought into the divorce proceedings when there is substantial amount of wealth involved, particularly if there is mutual ownership in a business. While a forensic accountant can investigate hidden income on the personal level, this article will focus mainly on when there is a business involved.
So…what exactly does a forensic accountant do in a divorce?
When a forensic accountant examines the business involved in the divorce proceedings, they first will gain access to the accounting records. Not only current year records, but several years of them. The more historical information that is available, the easier it is to identify trends.
From here they initiate the process of fully understanding the company, the records, and most importantly who has control over the assets. The accountant will start very broad, then zero in on the biggest focal point. When you hire a forensic accountant, you want to know if assets are missing, but the cost to examine every single transaction individually would be astronomical.
Understand the Internal Controls
Step one is to review the internal controls. Most theft of assets happens due to a lack of internal controls. In a divorce proceeding, the most pressing issue is: where did the company cash go? Not just for the current year, but over the life of the business. Many times, with a business, there is one spouse who is the controlling owner of the company. The other spouse is lightly involved or not involved at all. A forensic accountant needs to be able to understand who had control over the cash and where it was spent. With an understanding of internal controls, they can modify their procedures to focus on where the weaknesses are and trace assets from there.
Map Out a Genorgram
When I talk about this step with my clients, they always stare at me like I am just making something up. I assure you I didn’t make up, nor invent, the genogram. In a nutshell, a genogram is a flow chart of all the respective parties involved in the case and how they are all related. In a divorce proceeding, it is never just the two spouses. There are always more people involved in the business aspects—staff and business associates.
When the accountant maps out the ‘who’s who’ they get a better picture of company relationships and a true grasp on the flow of funds.
After the forensic accountant has gained an understanding of the internal controls and built an initial genogram, they will request source documents. Typically, these are:
- Bank statements
- Tax returns
- General ledgers.
However, some documents that may be a surprise are:
- Original loans
- Car leases
- Credit card statements
Testing the Information
The testing phase is where a traditional financial statement audit and a forensic investigation split. The traditional financial statement audit will set a limit on information observed. They will look at all large balance sheet accounts.
In the forensic investigation, the accountant looks at specific transactions and how the transactions flowed through to the final destination.
Generally, the spouse and attorney are not concerned whether the prepaid account is correctly stated. They want to know if cash left the company and the amount.
In testing, the forensic accountant will heavily examine the bank statements, as ultimately for the cash to be removed from the business it will have to flow through the bank account.
They also will utilize the respective tax return. The reasons they don’t totally rely on the tax return are:
- The tax accountant will not audit the information they receive for the tax return.
- Some spouses have been known to take a distribution and record it as an ‘expense’ rather than a distribution. So if a spouse is deceptively removing cash out of a business, they traditionally try to bury it in an expense account.
Who pays for a forensic accountant in a divorce?
Traditionally, the spouse who believes there are funds missing will be the one who pays for a forensic accountant. The forensic accountant is usually hired by the spouse’s attorney, and depending on the situation, may or may not also be engaged as an expert witness. A forensic accountant can be costly, especially if there are multiple years to be examined and the extent of possible hidden assets.
Divorce Forensic Accounting Tips
The best advice I can give someone if they are going through a divorce is to fully understand who has access to the cash of the business and who records the transactions. If you have a spouse with access to the cash and they are the only one recording the transactions, consider looking at the monthly bank statements.
When you get the statements, have the bank give you copies of all cleared checks for those months.
Then, look and see if the payee is not one you recognize or is different from what is recorded in the accounting records.
While this isn’t the only step in an investigation, it allows the spouse to have a place to start.
Steven D Hovland is a Certified Public Accountant and a Certified Forensic Accountant. He has 20+ years experience in auditing, accounting, and forensic investigations. He is the founder of Hovland Forensic and Financial, a virtual CFO service company as well as forensic litigation services.
For a free consultation https://hovlandforensic.com/scheduling