HKA's Jordan Sandberg on forensic accounting tracing methods

Jordan Sandberg, a manager in consulting firm HKA’s Phoenix office, recently examined whether there is a tried-and-true method for tracing commingled funds.

In the article, Sandberg notes there isn’t a specific accounting method that can best deal with all forensic accounting engagements. The American Institute of Certified Public Accountants (AICPA) and the Association of Certified Fraud Examiners (ACFE), as such, don’t provide best practices to select an appropriate accounting method for asset tracing given a certain set of facts.

There are, however, some court decisions that can offer guidance. The infamous Charles Ponzi case from 1924 has the precedent of using the lowest intermediate balance rule (LIBR) – which preserves commingled funds for the benefit of defrauded victims by tracing fraudulent funds only when the balance of clean funds is exhausted.

The 1986 case of “United States v. Banco Cafetero Panama” also determined LIBR as an appropriate methodology for tracing commingled assets.

LIBR is a lesser-known tracing method that operates under the assumption that the owner of a commingled bank account will preserve illicit funds for the benefit of defrauded victims. As such, the illicit funds are only used for tracing when the balance of clean funds reaches zero.

Another method for analyzing commingled accounts is pro rata, where the running balance of clean versus illicit funding into the account determines how much of the withdrawal is allocable to clean or illicit funds.

The first in, first out (FIFO) method operates under the assumption that withdrawals from an account are traceable to the earlier funds that were deposited into the account. The last in, first out (LIFO) method, in contrast, operates under the assumption that withdrawals from an account are traceable to the most recent funds deposited into the account.

When government entities such as the FBI and DOJ attempt to trace illicit funds that are commingled, they are trained to use the most conservative applied methodology that produces the lowest amount of funds traceable to illicit sources.

In Sandberg’s accounting examples within the article, that’s the LIBR method, which results in $500 withdrawn from illicit funds, compared to $2,000 for LIFO. 

Ultimately, Sandberg says there is no single, best method for forensic accountants to use when tracing funds in a commingled account. “When presented with the task, always keep in mind that the tracing analysis may be used in arbitration in the form of a testimony, a deposition, or an expert witness disclosure,” the HKA manager said. “As such, the ultimate goal is to consistently and equitably apply a tracing method that is most appropriate for the underlying facts of the case.”