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JOSH SHILTS | Forensic Accounting
Hidden Income and Assets: A Forensic Accountant’s Process
I’ve conducted hundreds of inves- tigations involving allegations of fraud and abuse. I have person-
ally seen the number of hours it can take to investigate broad or impre- cise allegations, all to come up with nothing. What I have learned is that concerns that come in the form of “I know he/she moved money here,” or “how else would he/she pay for this” are no di erent from allegations I received regarding corporate fraud from employees who said, “I know something bad is going on.”
Both parties are scared and unin- formed. ey have a real belief some- thing is wrong, but the fact is, it usu- ally stems from their lack of under- standing or possibly other feelings. is is not to say we dismiss these concerns. However, we shouldn’t be- gin an investigation into fraud or pos- sible asset dissipation without under- standing the big picture.
e purpose of this article is to ex- plain how forensic accountants look at the big picture, both nancially and by understanding past behaviors, to uncover items that may help you or your client. Some of my biggest “wins” in fraud investigations started with broad allegations; however, the techniques used to identify and quan- tify these allegations were what really lead me to success.
First, we need to understand what red ags or “fraud indicators” are there. is helps us narrow the scope of the analysis and understand what the issues are needing attention.
Accountants know the basic ac- counting equation: Assets – Liabilities = Net Worth (Equity)
What needs to be further explained and understood is how income and expenses interact with the equation above. It is really quite simple: Income – Expenses = Excess Asset or Increased
Liability
What forensic accountants do dur- ing is understand how income & ex- penses interact with and a ect assets & liabilities. Where many practitio- ners get caught is in de ning “in- come”. Taking income from a tax re- turn will not provide a complete and accurate picture of what is called free cash ow. Too many times the indeci- sions of accounting practitioners and the lack of understanding by attorneys and the courts have led to inaccurate communication of income. e good news is that a method is available that can accomplish a reconciliation be- tween the assets, liabilities, income and expenses.
e Net Worth Method looks at the di erence between a person or busi- nesses net worth (total assets less total liabilities) on any two given dates. If the evidence collected can establish that net worth increased more than the receipts (i.e., income) received by a person/business in the form of mon- ey or property, less expenses, then this excess would be additional taxable in- come to that person or business. Also considered is discretionary spending, capital improvements, taxes, etc.
In “ e Net Worth Method,” An- drew Ross states: “ e Net Worth Method has been endorsed by the U.S. Supreme Court and every circuit court. Its use is not limited to matters of tax fraud. Forensic accountants can also apply this technique to a wide array of cases, such as divorce litiga- tions, shareholder/partnership dis- putes and fraud investigations. e Net Worth Method is considered an indirect method of proof that, if ap- plied properly, presents compelling circumstantial evidence of a target’s hiding of unreported income.”
How do we determine income? If the 401K account and savings account
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balances have increased by more than the disposable income identi ed on a nancial a davit we know income hasn’t been completely and accurately accounted for by the other side. Con- sequently, if the argument is that in- come has been accounted for, then there exists a possibility than another asset has not been disclosed. e point and purpose of the Net Worth Method is to “root out” any inconsis- tencies and place them up for discus- sion. As the saying goes “lay all the cards on the table.”
I don’t think you will nd an attor- ney who wouldn’t be happy to work collaboratively with the other side to ensure assets and income are fully understood and accurately reported. e Net Worth Method allows for such transparency in cases deserving of it. In cases where the other side is not open to collaboration, it will al- low the forensic accountant to scien- ti cally explain how one side must meet the other. More importantly, it takes a broad allegation and can then narrow the scope of areas where a fo- rensic accountant should be working. For example, tracing bank accounts to uncover further hidden accounts or reviewing corporate tax returns in depth to understand cash ow avail- able for support that has been used to secure other assets or reduce liabili- ties.
I like this method because rst and foremost it is accounting at its best. No grey area, just black numbers on white paper telling us what is and isn’t. Second, it employs a transparent approach for both sides to become aware of assets, li-
abilities, income, and expenses that will arm them with the information they need.
Josh Shilts is a partner with Villela & Shilts LLC. He assists attorneys, individuals and businesses with complex nan- cial matters and disputes. He has held roles with international consulting and public accounting rms in Miami and New York City as well as positions with large public organizations. Josh is a frequent lecturer on forensic accounting matters. He has been involved with hundreds of forensic investigations dealing with a variety of matters involving personal and business disputes as well as identi cation and mitigation of fraudulent activities. Clients have sought his advice and services because of his unique industry experience and knowledge.
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