What is a Forensic Audit?
The examination a company’s financial records to derive evidence which can be used in a court of law is a Forensic Audit.
For example, Telemart, on the recommendation of its CFO, entered into a contract with RJ Inc for the supply of carts. RJ Inc was not authorized to conduct business as its license was suspended due to certain irregularities in taxes paid. The CFO had knowledge about this still it recommended and made Telemart enter into a contract with RJ Inc for his vested interest.
A forensic audit can reveal such cases of fraud.
Why is a forensic audit conducted?
Forensic audit investigations that are made for several reasons, including…
In Forensic audit, while investigating fraud, auditor would look out for:
- Conflicts of interest – When fraudster used his/her influence for personal gains detrimental to company. For example, if a manager allows and approves inaccurate expenses of employee with whom he has personal relations. Even though the manager is not benefitted from this approval but he is likely to receive personal benefits after making such inappropriate approvals.
- Bribery – As the name suggest offering money to get things done or influence a situation one’s favour would be bribery. For example, Telemith bribing an employee of Technosmith company to provide certain data so that Tender offer to Technosmith can be made accordingly by Telemith.
- Extortion – In above example, if Technosmith demands money so as to award Tender to Telemith then it would amount to extortion
This is the most common and prevalent fraud carried out by fraudsters. Misappropriation of cash, raising fake invoices, payments made to non existing suppliers or employees, misuse of assets or theft of Inventory are few examples of such asset misappropriation.
Financial statement fraud
Companies get into such type of frauds so as to show a better performance of the company than what it is actually. This is done so as improve liquidity or ensure top management keep earning the bonuses or due to market pressure on performance.
Some examples of such frauds are – Intentional forgery of accounting records; omitting transactions – either revenue or expense transactions, non disclosures of relevant details from the financial statements; or not applying the requisite financial reporting standards.
Procedure for a forensic audit investigation
A forensic auditor is required to have specialist training so that he can understand the legal framework and also has the knowledge of forensic audit techniques.
Forensic audit has few additional steps that need to be performed apart from regular audit procedures.
The steps would be:
- Plan the investigation – When the client hires a Forensic auditor, the auditor is required to understand what is required to be achieved. For example, the client would be suspecting of fraud in terms of quality of raw material supplied. In such scenario the forensic auditor will plan investigation accordingly. Forensic auditor needs to achieve the objectives such as:
- Identify the fraud if any is being carried out;
- Time period for which this fraud has been conducted in the organisation
- How the fraud has been concealed so far?
- Identify the fraudsters
- Quantify the loss suffered due to this fraud
- Gather relevant evidence that is admissible in the court
- Suggest measures that can prevent such frauds in the company in future
- Collecting Evidence – Forensic auditor is required to understand the possible type of fraud that has been carried out, and how it has been committed. The evidence so collected should be adequate enough to prove the identity of the fraudster/(s) in the court, the technicalities of the fraud scheme, the amount of financial loss suffered and parties effected.
Having the technical knowledge in collecting evidence that can be used in a court case is important. It is also important to keep clear sequence of custody until the evidence is presented in court. A logical flow of evidence helps in understanding the fraud and evidence presented in a better manner. If the same is not done then the evidence can be challenged in court, or the court would not admit it.
Investigators are required to be alert to ensure that the evidences & documents so collected do not get damaged or destroyed by the suspect(s).
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Common techniques used for collecting evidence in a forensic audit
- Substantive techniques – For example doing a reconciliation, review of documents etc
- Analytical procedures. These procedures help in comparing trends over a certain time period or to get comparatives among segments
- Applying computer assisted audit techniques
- Understanding internal controls and testing them so as to understand the loopholes which allowed fraud perpetrated.
- Interviewing the suspect, observing him/her is necessary so as to collect sufficient evidence and make the fraudster admit his/her fraud.
- Reporting – A report is required so that it can be presented to client about the fraud. The report would have the findings of the investigation done, evidence so collected in summarised form, loopholes that caused the fraud and how internal controls can be improved to prevent such frauds in future. The report needs to be presented to client so that they can proceed to file a legal case against fraudster.
- Court Proceedings – Investigations done by auditor would obviously lead to legal proceedings against suspected fraudster. The team that carried out the Forensic auditor need to be presented during the court proceedings as they would be required to explain the evidence collected and how suspect was identified. They are required to simplify the complex accounting issues and explain in layman language so that people who have no understanding about the accounting terms can also understand the fraud that was carried on by the suspect.
To summarize, a forensic audit is a detailed engagement which requires expertise of not only accounting and auditing procedures but also expert knowledge and experience about the legal framework. A Forensic auditor is required to have understanding of various frauds that can be carried out and also how the evidence needs to be collected. Having a understanding of legal framework and ability to face the court and the stress put in by defence counsel is also required.
More learning and resources
At CFI we are on a mission to help you advance your career. We hope this has been a helpful guide to forensic audits and believe you will benefit from our additional resources below: