Forensic Audit Meaning Reasons Steps How It Works

Forensic Audit Meaning

Reasons for Conducting Forensic Audit

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#1 – Conflict of Interest

When an employee misuses their position for personal gains and causes the company to incur a loss, a forensic audit comes into the picture.

For instance, a manager approving an employee’s excess/unwanted expenses due to personal relations will get some leverage over the employee on a personal level. However, in this case, the manager will not benefit financially from this activity.

#2 – Bribe

An organization offering money or giving expensive gifts to get things done or making the situation in its favor is a bribe.

For example, the head of the purchasing department approves purchases from a vendorVendorA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers.read more that will supply the material at a higher cost or cost less than other vendors. Although the quality of the product is not good, the head is getting some personal compensation from that vendor.

#3 – Misappropriation of Assets

It is the most prevalent type of fraud where employees misuse the company’s assets for their benefit.

For example, an employee submitting a fake bill for using the company stationery or showing the damaged or expired inventory (primarily in FMCG companies) and receiving funds.

#4 – Misrepresentation of Financial Statement

This type of fraud generally happens at a higher level of the company by showing better business performance against the actual performance. Thus, investors will not hesitate to invest in the company, and lenders can easily offer loans at lower interest rates. Top management will also benefit by getting bonuses or incentives based on the company’s 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.read more 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. read more, and not giving the proper disclosure about the information which can influence investors or lenders.

Steps of Forensic Audit

#1 – Planning the Investigation

Auditors will plan the investigation to leave nothing out and achieve the audit’s objectiveAudit’s ObjectiveThe 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.read more. Below are some points which auditors keep in mind:

Planning the investigation Collecting evidence Reporting Court Proceedings
Identifying the fraud being carried outThe period during which fraud has been carried outReason or root cause of fraudFind out employees involved in the fraudThe loss suffered by the company because of the fraud, whether it is financial or non-financialEstablishing evidence collection by copying in court proceedings.Suggesting actions for preventing these types of frauds in future

#2 – Collecting Evidence

It is an essential part of forensic audits. After identifying the fraud, the auditor will collect the evidence, which can be substantiated and accepted in court. These documents must reflect how the fraud has happened, who has done it, and what amount of loss the company has suffered.

For example, a vendor has finalized the purchase of raw materialRaw MaterialRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more. If it suspects that some malicious things happened in that finalization, the auditor will examine the below things:

Who has approved the vendorWhether company policy was followed at the time of finalizingQuotation from other 3-4 vendors has been taken or notIf taken, whether all these quotations were compared with each other in terms of pricing and qualityAfter finalizing, whether the vendor provided the same quality of material, which it has shown at the time of selection

#3 – Reporting

After completing the above process, a forensic auditor will prepare a report summarizing the audit and present it to the management/client. The report contains the below points:

Observation/findings during the auditEvidence gathered which will substantiate the fraudHow much loss the company has sufferedHow the fraud has been conductedWhat steps should be taken to stop this type of fraud

Based on the report, the management can decide whether they should go for legal proceedings or not.

#4 – Court Proceedings

Suppose management decides to take legal action based on the forensic audit report. In that case, the auditor should also be present at the court to explain how the fraud has been done and how the evidence will support the statement. The forensic auditor will also simplify the accounting fraud in simple language so that everyone can understand it.

Forensic Audit vs. Internal Audit

A forensic audit is done to find the fraud that 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.read more is done to find the lapse in accounting or company policies.Forensic auditors must have expert knowledge of the law, whereas this is not compulsory for internal auditors.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 committed fraud for personal gain. In contrast, an internal audit is done regularly to check whether all 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.read more and accounting standards have been followed, but mistakes have not been made.

Conclusion

A forensic audit is required for a specific purpose like finding the fraud or misrepresenting a 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.read more by examining the past transaction and collecting evidence that will prove that some fraud has happened and can be used in court for legal proceedings. At the same time, internal audit is focused on compliance, policies, accounting standards, and other controls that companies need to follow for their operation.