Forensic Accounting Exams: Uncovering Partner Misappropriation & Financial Irregularities

Forensic Accounting Exams: What Is a Forensic Accounting Examination?

Forensic accounting plays a vital role in uncovering financial irregularities and bringing perpetrators to justice and in civil litigation to recoup losses. By combining accounting expertise with investigative skills, forensic accountants provide crucial support in legal matters. They help to ensure that financial transactions are accurate, reliable, and transparent.

Unlike an audit, which is designed to express an opinion on whether financials are fairly stated, a forensic accounting exam starts with the assumption that financials may be wrong – and looks for irregularities, unfair, or inaccurate transactions. I rely on the original financials, and assume they are correct unless proven otherwise, then I prove otherwise.

As a CPA, CVA, CFE, and CFO Expert Witness, I am hired by business litigation attorneys when the books don’t make sense.

My Recent Cases: Partner Disputes and Misappropriation of Assets

Recently I have been hired on more cases which involve disputes between partners. Usually one partner (or both) accuse each other of misappropriating assets. There are several issues that come up in every case:

• When did this start? Is it 6 months or 6 years of misappropriation? This drives statute of limitations and damages.
• How to quantify/document this? How do we turn a bank statement with 10,000 transactions into a damages number a jury understands?
• How to sift through the evidence to help the client in the case? Attorneys give me a data dump – QuickBooks files, bank statements, credit card statements, Venmo, Zelle – and need it turned into an expert report under CCP 2034.

One recent case included millions of dollars of distributions to some partners but not others. The client wasn’t aware of all of this, and it became the focus of my work and conclusions. The operating agreement said pro-rata distributions, but the managing partner took $1.2M extra over 3 years coded as “management fees” and “loans” that were never repaid.

What they do with my findings is up to the attorney/courts but at least I have thoroughly reviewed the financials, somewhat like an auditor would do. The difference between my work and that of an auditor is that the auditor is mainly interested in preparing the financials in an accurate manner. Whereas I am looking for irregularities or unfair/inaccurate transactions.

The Forensic Accounting Exam Process: From Data Dump to Damages

Many times I receive a large data dump, and it can sometimes be in an unworkable format. For example, bank statements have thousands or tens of thousands of transactions, and often don’t have good descriptions. There are incomplete names and accounts/transactions referenced. It is of little help.

Here is my 5-step forensic accounting exam process for partner disputes in California:

Step 1: Define the Allegation and Time Period
Often I have counsel go back to those who made the accusations and get more detail and evidence of the wrongdoings, and this becomes a starting point for my work. I need specifics: “Partner A took $50k in 2021-2023 via personal expenses on company Amex” is actionable. “He stole money” is not.

I send attorneys a discovery checklist for forensic accounting:

• 3 years of bank statements (all accounts)
• 3 years of credit card statements
• QuickBooks / Xero general ledger detail, not just summary
• Payroll records, including officer payroll
• Loan agreements between partners and company
• Operating agreement / bylaws on distributions
• Tax returns – do distributions on K-1 match cash actually received?

Step 2: Organize the Chaos
If there is a bookkeeper or CPA or if the client has already prepared spreadsheets tracking the transactions this helps to organize the case file. But most spreadsheets I get are incomplete.

I rebuild the accounting in a forensic database. I categorize every bank transaction by: date, payee, amount, source document, and alleged misappropriation category: personal expenses, excess compensation, unapproved loans, hidden distributions, related party transactions.

For a recent case with 18,000 bank transactions, we coded them into 12 categories in 2 weeks.

Step 3: Analyze for Trends and Ratios That Are Out of Whack
Once I know where to start I can re-check their work, summarize it and calculate damages. Or I can analyze summary financial statements for trends, ratios that are out of whack or otherwise determine malfeasance or irregularities.

Red flags I look for in partner disputes:

• Officer compensation spiking 40%+ with no board approval
• Company paying for personal: Tesla leases, family vacations, kids’ tuition, coded as “travel” or “consulting”
• Loans to shareholder that are never repaid and no interest
• Distributions not pro-rata per ownership – one partner gets $500k, other gets $200k same year
• Gross margin drop while revenue stable – suggests inventory or cash theft
• Vendor that is owned by partner’s spouse – related party

Step 4: Quantify and Document Damages
I calculate damages under three theories California courts accept:

1. Direct Misappropriation: Sum of personal expenses paid by company
2. Excess Compensation / Unjust Enrichment: Market rate vs actual taken
3. Lost Profits to the Harmed Partner: Value of unpaid pro-rata distributions plus interest at 10% (California prejudgment interest rate)

Every number ties to a source document with Bates stamp – bank statement page, Amex receipt, QuickBooks entry. This is what survives Sargon and cross-examination.

Step 5: Report and Testify
I provide a report compliant with CCP 2034.260, with exhibits, and am available for deposition and trial. Unlike many forensic CPAs, I have been deposed and testified, and I prepare every exam as if it will be shown to a jury.

H2: Forensic Accounting vs Audit vs Business Valuation – What’s the Difference?

• Audit: Provides reasonable assurance financials are materially correct. Auditor is independent, but not looking for fraud specifically.
• Forensic Accounting Exam: Assumes fraud may exist. Deep dive into specific transactions, intent, and damages. Done for litigation.
• Business Valuation: Values the business as of a date. Often needed alongside forensic exam when misappropriation depressed business value.

In many partner disputes, I do both: forensic exam to quantify stolen, then valuation to show how theft reduced company value.

Why Hire a CFO Expert Witness for Forensic Accounting Exams?

Most CPAs have never run a company. I have been Controller/CFO for 35 years, raised $35M, managed 100+ audits/reviews, and been on 6 public boards. I know how expenses are buried because I’ve seen it as CFO.

I also now hold Esq. designation – so I understand Evidence Code 1271 (business records exception), hearsay issues, and how to draft a report that gets admitted.

If you are a business litigation attorney in the Bay Area or California with a partner dispute, shareholder oppression, or employee embezzlement case, and you received a data dump of bank statements that is “of little help,” contact me at hpaccounting.com.

I turn unworkable data into a damages number that settles cases.