Forensic
Accounting 101

  • addWhat is Forensic Accounting?
    Forensic accounting is a detailed method of examining and analyzing publicly available financial statements. This approach often searches for the “red flags” of aggressive accounting and revenue recognition practices that some companies have been found to employ.
  • addWhat are some of the red flags forensic accounting attempts to identify?
    Red flags that forensic accounting attempts to identify include fictitious revenue, accelerated revenue recognition, inventory issues, unsustainable margin expansion and financial ratio adjustments.
  • addWhat do these “red flags” mean?
    Red flags may indicate underlying business problems that negatively impact the value of a company’s stock.
  • addHow might an unexamined financial statement mislead investors?

    There are numerous ways that company management may overstate revenues to make things look better in the present, even though the revenues may not be sustained or may eventually suffer.

    For example, company management may offer an existing customer an incentive to sign a contract today, allowing the company to immediately book the revenue. Without that incentive, the customer might have signed the contract next quarter and the revenue would be booked then.

    This practice isn’t illegal or even unethical, but it distorts the real performance of the company’s underlying business. It does this by stealing revenue from the future and pulling it into the present. In this example, if demand to sign contracts with the company was strong, management would have never engaged in this practice in the first place.

  • addSo how can forensic accounting and investing be used together?

    Forensic accounting pulls back the curtain on financial statements and assesses the quality of revenues, sustainability of margins, sources of earnings growth, and consistency of cash flow. This may help investors identify and avoid stocks that are on course to potentially lose value due to the poor underlying business results being currently masked.

    Besides simply avoiding companies with “red flags,” forensic accounting identifies financial statements that are attractive because of their avoidance of aggressive accounting tactics. These companies are dubbed to have “high quality earnings” and may be favorable to investors over the long term.

  • addHow can I access the benefits of forensic accounting?
    Instead of hiring a forensic accountant, a more convenient and cost efficient way to access forensic accounting analysis is to consider the Forensic Accounting Long-Short ETF™ (FLAG). FLAG seeks to track The Forensic Accounting Long-Short Index™. The index combines the science of accounting with the art of investing through a rules based stock selection process.

Exchange Traded Concepts, LLC serves as the investment advisor, and Vident Investment Advisory serves as a sub advisor to the fund. The Funds are distributed by SEI Investments Distribution Co., which is not affiliated with Exchange Traded Concepts, LLC or any of its affiliates. Check the background of SIDCO on FINRA’s BrokerCheck. WeatherStorm Capital™ have been licensed for use by Exchange Traded Concepts, LLC. FLAG Funds are not sponsored, endorsed, issued, sold, or promoted by IDS, nor does this company make any representations regarding the advisability of investing in the FLAG Funds.

Carefully consider the Fund's investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Fund's prospectus, which may be obtained by visiting www.flagetf.com. Read the prospectus carefully before investing.

The Fund's short sales effectively leverage the Fund's assets. It is possible that the Fund may lose money on both long and short positions at the same time. If the Fund sells a security short and subsequently has to buy the security back at a higher price, the Fund will lose money on the transaction. The amount the Fund could lose on a short sale is theoretically unlimited (as compared to a long position, where the maximum loss is the amount invested).

Investments involve risk. Principal loss is possible. The Funds have the same risks as the underlying securities traded on the exchange throughout the day at market price. The Fund’s investments will be concentrated in an industry or group of industries to the extent the Index is so concentrated, and the Index is expected to be concentrated in real estate-related industries. The composition of the Index is heavily dependent on a proprietary quantitative model as well as information and data supplied by third parties (“Models and Data”). The Fund is a recently organized, non-diversified management investment company with no operating history. As a result, prospective investors have no track record or history on which to base their investment decision. the Fund will be considered to be non-diversified, which means that it may invest more of its assets in the securities of a single issuer or a smaller number of issuers than if it were a diversified fund. The Fund is expected to invest substantially all of its assets in real estate-related companies. Investments in real estate companies involve unique risks. Real estate companies, including REITs, may have limited financial resources, may trade less frequently and in limited volume, and may be more volatile than other securities. The risks of investing in real estate companies include certain risks associated with the direct ownership of real estate and the real estate industry in general. Securities in the real estate sector are subject to the risk that the value of their underlying real estate may go down. The equity securities of smaller companies have historically been subject to greater investment risk than securities of larger companies.

Diversification does not guarantee a profit or protect from loss in a declining market.

1 Correlation is a mutual relationship or connection between two or more things.