How to pick the right method for forensic accounting tracing

Jordan Sandberg, a forensic accountant and investigator at consulting firm HKA, in a recent article examined how forensic accountants decide on the most appropriate method to use in flow-of-funds tracing analysis.

In the article – “Choosing the trail: Strategic selection of forensic accounting tracing methods” – Sandberg examines a scenario and weighs which of the four major methods are the best choice.

The four best-known tracing methods are first in, first out (FIFO); last in, last out (LIFO); pro rata; and the lowest intermediate balance rule (LIBR).

Sandberg notes that there is no established legal standard or authoritative guidance from organizations prescribing a single method for conducting tracing analysis. Instead, forensic accountants have to lean on broader key principles from the AICPA.

These key principles are professional competence, integrity and objectivity, due professional care, adequate planning and supervision, use of sufficient relevant data, and proper communication with clients.

With no one-size-fits-all approach, the accountant must remain attentive to the facts of the case and patterns within bank account activity to determine the appropriate method – while also prioritizing integrity and neutrality.

FIFO and LIFO can be considered more uncompromising measures of tracing, Sandberg says, so starting with them makes sense.

Meanwhile, pro rata and LIBR are sometimes held in higher regard by courts because they rely less on the specific timing of a bank account’s transactions. However, they can pose greater risk to the validity of tracing analysis if not applied correctly.

LIBR tracing, for example, can create issues for accountants because it is often seen as a benefit to the accused party, as illicit funds are preserved in the account until all clean funds are spent. Pro rata, on the other hand, analyzes the account on a rolling bases and should nearly always be considered in a tracing exercise, Sandberg says.

“A thorough, case-specific process is essential (even when the forensic accountant must be mindful that each tracing analysis performed is not identical),” the HKA associate director concludes.