Over the previous four issues of Forensic Accounting Today, I have provided an overview of how law practices account for revenue and expenses, and introduced the background of an actual case study concerning income reporting. In this issue, I am providing the final portion of the case study. If you would like to review part one, two, three or four of this article, please visit our blog (http://blog.anfusocpa.com) and click on the link Forensic Accounting Today Newsletter Archive.
Finding Other Unreported Income
Identifying personal expenses is one of the steps in our forensic investigation. Another step is examining the client’s and/or spouse’s bank accounts for money not accounted for in the tax returns. In cases in which there are business or personally guaranteed loans, personal financial statements of the parties may be on file with the bank. Banks normally maintain customers’ records for at least two years and often for as long as seven years. Attorneys can subpoena deposit slips, cancelled checks, signature cards, bank statements and other relevant information that can assist in the forensic investigation.
We look for patterns in checks deposited or issued. Red flags are large deposits made to the personal account that do not constitute either regular salary checks or expense reimbursement checks. For example, we found four large checks totaling more than $425,000 deposited into Mr. Smith’s personal bank account during a twomonth period. We verified that these checks were not regular salary checks or expense reimbursements. A closer examination of the accounts receivable aging report for the same period revealed that there was approximately $1.3 million of accounts receivable written off with no explanation. This amount represents just over three times the amount deposited into Mr. Smith’s personal account. We requested that the attorney subpoena the records from the various clients and when the documentation was produced we had clear and convincing evidence that the three shareholders had colluded with one another to not report this income. Is this evasion of income taxes? You bet.
We get further clues as to the nature of unreported income by taking photocopies of the front and back of other checks produced pursuant to subpoena from the law firm’s clients and examining both who endorsed them and where they were cashed. This information may establish a money trail leading to the attorney or other parties and entities directly related to the lawyer. If the link is established, it is possible to determine other amounts of income, which has been diverted from the books and records of the practice.
Debit and credit memos can be another source of information. In our experience, we have discovered other bank accounts by examining these documents, which can point to international or domestic wire transfers, payments or repayments of loans, transfers between accounts (thereby leading to discovery of accounts previously unreported), and purchases of cashiers’ checks.