Forensic Audit Meaning
Forensic Audit is a structured examination of the financial records of a business entity in an investigative manner in order to find out the evidence that can be used for legal proceedings in court. It is one step ahead of an internal audit and the person who conducts such audit should have knowledge of the law & legal framework along with expert knowledge of accounting & auditing.
Reasons for Conducting Forensic Audit
#1 – Conflict of Interest
When an employee misuses his position for personal gains at the cost of company loss in such a case, a forensic audit comes into the picture.
E.g., Manager approving the excess/unwanted expenses of an employee with whom he has personal relations. In this case, the manager will financially not benefited from this activity, but on personal, he will get some leverage over his employee.
#2 – Bribe
In an organization offering money or giving some expensive gifts for getting the things done or making the situation in his favor is a bribe.
E.g., the Head of Purchase department approves purchase from that vendor who will supply the material at a higher cost or cost less than comparing to other vendors. Still, the quality of the product is not good, and he is getting some personal compensation from that vendor.
#3 – Misappropriation of Assets
It is the most common and most prevalent type of fraud. These employees are misusing the assets of the company for their benefit.
E.g., Releasing the money based on fake bill submission. Using the company assets for his personal use most common is stationery of company, Using the company inventory by showing that particular inventory is damaged/expired (this mostly happened in FMCG companies).
#4 – Misrepresentation of Financial Statement
This type of fraud generally happens at a higher level of company for showing the better performance of the company against the actual performance so that investors will not hesitate to invest in the company and lenders can easily offer loans at the lower interest rates. Top management will also get benefited by getting bonuses or incentives based on company performance. Misrepresentation can be done by showing less provision against accrued expensesAccrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited. or debtors, hiding any contingent liabilityContingent LiabilityContingent Liabilities are the potential liabilities of the company that may arise at some future date as a result of a contingent event that is beyond the company's control. , not giving the proper disclosure about the information which can influence the investor or lenders.
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Steps of Forensic Audit
There are four steps of forensic audit:
- Planning the investigation
- Collecting Evidence
- Court Proceedings
#1 – Planning the Investigation
Auditors will plan their investigation in a way that nothing should be left out, and the objective of an auditObjective Of An AuditThe primary objective of an audit is to obtain reasonable assurance regarding the financial statements being free from any misstatement either by error or fraud. Another objective is to report the findings of the independent examination so performed. will be achieved. Below are some points which auditor will keep in mind:
- Identifying the fraud which is being carried out
- The period during which fraud has been carried out
- Reason for fraud or root cause of fraud
- Find out the employees who are involved in the fraud
- The loss suffered by the company because of fraud whether it is financial or non – financial
- Collecting evidence can be established by fraud in court proceedings.
- Suggesting action which needs to be taken for preventing these types of fraud in future
#2 – Collecting Evidence
It is the most essential part of forensic audits. After identifying the fraud auditor will collect the evidence which can be substantiated and acceptable in court, and these documents must be in a manner that will reflect how the fraud has happened, who has done, and what amount of loss the company has suffered.
Example – Assume one vendor has finalized for purchasing raw material and it suspects that there are some malicious things happened in that finalization then the auditor will examine and collect the below documents
- Who has approved the vendor
- Whether company policy followed at the time of finalizing
- Quotation from other 3 -4 vendors has been taken or not
- If taken then whether all these quotations compared with each other in terms of pricing and quality
- After finalizing, whether the vendor provided the same quality of material or not which he has shown at the time of selection;
#3 – Reporting
After completing the above process, a forensic auditor will prepare a report which is a summary of his audit for presenting to the management/client. The report contains below point:
- Observation/Finding during an audit
- Evidence gathered which will substantiate the fraud
- How much loss suffered by the company
- How the fraud has been conducted
- What steps should be taken to stop this type of fraud
Based on it, Report management can decide whether they should go for legal proceedings or not.
#4 – Court Proceedings
If management is deciding that they will go for legal action based on the forensic audit report, then the auditor should also be present at the court during the proceeding to explain how the fraud has been done and how the evidence will support his statement. The forensic auditor will also simplify the accounting fraud in simple language so that everyone can understand easily.
Forensic Audit vs. Internal Audit
- Forensic Audit is done for finding the fraud if anything happened in the company, whereas an internal auditInternal AuditInternal audit refers to the inspection conducted to assess and enhance the company's risk management efficacy, evaluate the different internal controls, and ensure that the company adheres to all the regulations. It helps the management and board of directors to identify and rectify the loopholes before the external audit. is done for finding the lapse in accounting or company policies.
- Forensic Auditors must have expert knowledge of the law, whereas this is not compulsory for internal auditors.
- Evidence gathered in the forensic audits can be used for legal proceedings, whereas evidence gathered in an internal audit will not be acceptable in legal proceedings.
- A forensic audit is required when there is suspicion that an employee has intentionally done fraud for his personal gain. In contrast, an internal audit is done as a regular activity for checking whether all the accounting policiesAccounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level., accounting standard has been followed, but mistakes have not done intensely.
Forensic Audit is required for a specific purpose like finding the fraud or any misrepresentation of financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. by examining the past transaction and collecting evidence which will prove that some fraud has happened and that can be used in court for legal proceedings. Whereas internal audit is basically focused on compliance, Polices, accounting standards & other control that companies need to follow for their operation.
This article has been a guide to Forensic Audit and its meaning. Here we discuss steps for conducting forensic audit along with its example, reasons, and differences from internal audit. You may learn more about financing from the following articles –