Reconstructing Financial Activity from Incomplete and Inconsistent Records
The financial activity underlying a set of records is not always apparent from the records themselves. In complex disputes, transactions may be recorded inconsistently, relevant records may be missing, and evidence of the same activity may be spread across multiple accounts, entities and sources. Establishing what occurred may require those records to be examined together, in their financial and chronological context.
Of the four related aspects considered in Investigating Complex Financial Structures, this article is concerned with what financial activity occurred, and how that activity can be established where the records are incomplete or in conflict.
Determining the scope
The scope of the analysis follows from the question to be answered. In an expert engagement, that question is ordinarily defined by the instructions and the issues in dispute. In an investigation or consulting engagement, it may instead be defined by the particular matter under examination and the information available.
In either case, the analysis need not be an exhaustive review of every transaction, but it must be sufficient to answer the question posed. Where the scope is limited, or relevant records are unavailable, those limitations and their effect on the findings should be stated.
Financial activity in context
Individual transactions often cannot be understood in isolation. A payment recorded as a loan, for example, should be considered alongside any loan documentation, the source and application of the funds, the treatment of the amount in each party's accounts and any subsequent repayments. Accounting entries consistent with a loan may carry less weight where there is no loan agreement, no interest is charged, nothing has been repaid and the funds were applied to personal expenses.
Chronology is often equally significant. The circumstances preceding a transaction, the subsequent movement of the funds and any later repayments or distributions can bear on the nature of the transaction.
Where activity extends across connected entities, the relationships between those entities and the parties involved may also affect how transactions are interpreted. The structure, governance and practical operation of those relationships are considered in Investigating Complex Financial Structures.
Rebuilding the record
Where an entity's own records are missing or unreliable, its financial activity can often be rebuilt from other sources. Bank statements, records produced under subpoena or disclosure, taxation and ASIC filings, and the records of counterparties are prepared independently of the party whose activity is in question and may provide a more complete account than the party's own accounting records.
Analysis of the source and application of funds can establish what was received and where it went, even without a reliable general ledger. Where records for a period are absent altogether, the transactions and balances immediately before and after the gap may still constrain what could have occurred within it.
As third-party records take time to obtain, identifying and seeking them early in a matter will often determine how complete the reconstruction can be.
Incomplete records
Incomplete records do not necessarily prevent a reliable analysis, but care is required to distinguish between established facts and reasonable inferences. A missing record should not be filled by an unsupported assumption. If an assumption is necessary, it must be stated and its basis and effect on findings made clear.
Documentation including correspondence, contemporaneous notes, contractual documents and other records may corroborate or contradict what the financial records show. Digital records such as login and access records, IP addresses, geolocation and device information can also assist.
The absence of particular records may imply they have been destroyed or there has been a failure to disclose, indicating they could have particular significance to the matter and their absence requires explanation.
Inconsistent records
Inconsistent records present a different difficulty. The same transaction may be recorded differently by each party to it, described one way in a general ledger and another in a tax return, or treated inconsistently across accounting periods. Income stated in a finance application may differ materially from income declared for taxation purposes.
The relative reliability of conflicting records depends on when and by whom they were prepared, the purpose for which they were prepared, whether they were created in the ordinary course of business or after the event, and whether they are corroborated by other records such as bank statements.
An inconsistency should not be resolved by preferring whichever record supports a particular position. The inconsistency may itself be relevant to what occurred and how it came to be recorded. Where more than one explanation is reasonably available, each should be tested against the evidence.
From analysis to findings
The analysis will not necessarily resolve every transaction or explain every discrepancy. An unexplained transaction may remain unexplained after the available evidence has been considered. Its significance may nevertheless be established by its timing, its relationship to other transactions, the identity of the recipient, or its subsequent use or treatment.
An anomaly is not necessarily evidence of misconduct merely because it is unexplained. The evidence must be considered as a whole, including whether reasonable alternative explanations exist.
Findings should therefore distinguish between what is established, what may reasonably be inferred, what remains unexplained and where further investigation is required. The strength of each conclusion should correspond with the quality and completeness of the evidence supporting it.
Instructing Hart & Lloyd
Hart & Lloyd undertakes forensic accounting and financial investigations involving complex financial records, significant transaction volumes, contested disclosure and multi-entity structures. This work arises in matters involving fraud, family law property disputes, estate disputes and insolvency.
If you are dealing with a matter of this nature, we welcome an early confidential discussion.