When the accounting process is complete a set of financial statements is issued. Financial statements are crucial for investment decisions, tax assessments, conflicts resolution, etc.
The accounting process involves five steps:
Although all these steps are very important, analyzing a transaction grants reliance and relevance to the financial information. To be useful, accounting information must be both reliable and relevant. Decision-makers seek valuable information in which they can rely on when making informed decisions.
When analyzing transactions the following questions should be posted and answered:
1) What are the accounts involved in a transaction?
2) What are the classifications of the accounts involved? Are they Assets, Liabilities, Owners’ Equity, Revenue, or Expense accounts?
3) Are the accounts increased?
4) Are the accounts decreased?
Forensic accountants must be proficient in making inferences about accounting transactions. For example, if a forensic accountant is hired to help solve a dispute between two stockholders of a corporation, he or she will analyze the business transactions of the entity, establishing meaningful relationships among different accounts. From this initial input the accountant will have a road to other sources of information that validates his or her initial findings.
Business transactions are events that have a direct economic impact on an entity and are expressed in terms of money.
When confronted with a set of business transactions, we look for the impact they have on the stockholders’ equity. Each share of stock has certain rights and privileges spelled out when the shares are issued. The forensic accountant analyzing information will examine the articles of incorporation, stocks certificates, and laws and regulations.
The following are the rights that each share carries, unless differently stated in corporate documents:
o To share proportionately in profits and losses
o To share proportionately in management
o To share proportionately in corporate assets upon liquidation.
When analyzing Enron transactions, forensic accountants determined that Enron issued shares of common stock to special purpose entities, SPEs in exchange for notes receivables. This practice was deceitful to investors, creditors, and suppliers. The impact of recording those notes was an increase on the accounting assets when the following entry was made:
Notes Receivable $ xxxx
Stockholders’ Equity $xxxx
The Securities and Exchange Commission, SEC, emphasized that it was an accounting error since equity cannot be recorded until cash is collected.
Those analyzing these transactions had different points of view about the presentation of those accounts receivables. The SEC settled that issue by requiring this type of transaction to be recorded as a contra-equity account, a deduction from stockholders’ equity.
Properly analyzing transactions prevents the issuance of misleading financial statements and increase reliance on financial information and helps re-gain trust in the accounting profession.