Understanding Forensic Audit

In a global review conducted by Ernst & Yong, on the question of auditors' responsibility, in 1996, the finding was: "Over seven out of ten of the respondents believed that auditors should have the responsibility to detect substantial fraud. Of these eight out of ten believe that this should be part of their normal audit and not by special one-off reviews"

The main theme of the last (XVI) INCONSAI, at Montevideo, in 1998, was "The role of SAI's in Preventing and Detecting Fraud and Corruption". Yet, on the basis of responses received from individual Supreme Audit Institution's (SAI's) to a survey conducted in preparation for the congress, it emerged that:

"SAI's generally agree that the primary responsibility for the prevention of corruption rests with the administrative authorities, the police and other investigative institutions, and cannot be counted among the main tasks of SAIs".

On the matter however a related finding was that:

"Also most of the SAI's make clear that they see their main goal more in preventing corruption than in the field of actually detecting such illegal activities."

INTOSAI Auditing standards, adopted by INCOSAI XV at Cairo in 1995, while stipulating standards of 'due care' provide:

"Auditors need to be alert for situations, control weaknesses, inadequacies in record keeping, errors and unusual transactions or results which could be indicative of fraud, improper of unlawful expenditure, unauthorized operations, waste, inefficiency or lack of probity." (General Standards, Chapter II, Para 90)

We are faced with the inescapable conclusion that there is a difference between what is expected of auditors and what auditors acknowledge as being their role in relation to fraud and corruption, the so called 'expectation gap'. Even though no formal survey on this aspect has been carried out, it may be advisable to address the issue with a view to identifying, and to the extent possible, defining our positions on the several issues that are involved. In this context we need to understand, adopt and use of Forensic Auditing.

Definition:

The application of accounting methods to the tracking and collection of forensic evidence, usually for investigation and prosecution and prosecution of criminal acts such as embezzlement or fraud is generally referred as Forensic Audit.

Forensic auditing could also be defined as the application of auditing skills to situations that have legal consequences.

Thus, a forensic audit is an examination of an organization's or individuals economic affairs, resulting in a report designed especially for use in a court of law. A forensic audit is similar to the tax audits performed by the Inland Revenue Office; both strive to establish a comprehensive picture of an entity's finances (assets, liabilities, total incomes and cash flow). However, while a tax audit is intended to determine the true size of one's tax liability, a forensic audit can have several goals, including mapping cash flow or cash transactions, identifying accounting errors and enumerating total assets.

When Are Forensic Audits Used?

Some of the instances where forensic audits are used are given below:

-          Forensic audits are used whenever lawyers or law enforcement officials need reliable data on a party's financial status or activities. For example, while determining a total amount of excess fare charged by a travel agent, a company may request chartered accountants firms to carry out a forensic audit of all travel related expenses booked during the time from contracting the travel agent till date.

-          If you want to sue auditors (or the accounting firm) for negligence, you would request a separate forensic audit to determine how much the botched job cost you.s accused of accepting bribes, the CIAA could set up a forensic auditing team.     

    

-  Forensic audits are sought by CEOs, chief financial officers or board members who suspect embezzlement within the company.

Types of Forensic Audits

As defined above, an obvious example of forensic auditing is the investigation of a fraud or presumptive fraud with a view to gathering evidence that could be presented in a court of law. However, there is an increasing use of auditing skills to prevent fraud by identifying and rectifying situations which could lead to frauds being perpetrated (i.e. risks). It might be useful, therefore, to discuss forensic auditing as being either 'Reactive' or 'Proactive'.

a.      Proactive forensic auditing:

Proactive forensic auditing can be used either by management or by auditors to carry out general reviews of activities to highlight risks arising either out of fraud or from any other source with the purpose of initiating focused reviews of particular areas, targeting specific threats to the organization.

b.     Reactive forensic auditing:

The objective in case of reactive forensic audit is to investigate cases of suspected fraud so as to prove or disprove the suspicions, and if the suspicions are proven, to identify the persons involved, support the findings by evidence and to present the evidence in an acceptable format in any subsequent disciplinary or criminal proceedings.

Who performs the audit?

Forensic audits are performed by special class of financial experts know as forensic accountants. This class includes certified fraud examiners (who have passed the CFE test) or Chartered Accountant.

Chartered Accountants specializing in forensics understand finance as well as criminal law. This allows them to translate audit results into language useful to prosecutors trying to build a case.

Forensic accounting draws its name from association with a court of law. It is performed to accomplish an objective that involves a judicial process. Examples of forensic accounting objectives includes: fact-finding to see whether embezzlement has taken place, in what amount, and whether criminal proceedings are to be initiated; and the collection of evidence in a criminal proceeding. Forensic accounting is focused upon both the evidence of financial transactions and reporting as contained within an accounting system, and the legal framework which allows such evidence to be suitable to the purpose of establishing accountability.

Forensic accountant's job is to detect and interpret the evidences of both normal (non-fraudulent) and abnormal (fraudulent) transaction in the books and records of an accounting system and the subsequent effect upon the accounts, inventories, and the presentations thereof. It is imperative; therefore, that forensic accountants first understand what normal accounting procedures and processes are.

Issues for consideration:

Our audits are carried out an reported within a framework which assumes that the top echelons of management both at the political and civil service levels are responsive to the need for good governance and accountability, and therefore would act upon the audit findings which indicate that there was cause of concern in the adequacy and implementation of internal controls and inevitably of mala fide action on the part of officials.

Conclusion:

In conclusion, forensic accounting is sufficiently thorough and complete so that an accountant, in his considered independent professional judgment, or can deliver a findings as to accounts, inventories, or the presentation thereof that is of such quality that it would be sustainable in some adversarial legal proceeding, or within some judicial or administrative review. 

Reference: This article written by CA. Nanda Kishore Sharma (CA. Sharma is Fellow Member of ICAN)