Forensic Audit
Introduction
With the growing complexity of business environment and other complex issues of financial market, cases of scams and financial irregularities are on a spree. None the less, these scams are highly affecting the Indian business environment and thus act as a key factor for downgrading the Indian economy. Subsequently the number of litigations or court cases is increasing manifold day by day. These court cases require concrete evidences that are suitable for use in the court of law. The term “Forensic” itself denotes the meaning “suitable for use in a court of law”. Forensic Accountants are trained to look beyond the numbers and deal with the business reality of the situation.
Forensic Accounting
Accounting is an age old system with conventional idea of a numeric transaction purpose wise and chronologically. Forensic accounting, forensic accountancy or financial forensics is a practice area of accounting, which is specially designed, that describes engagements that result from actual or anticipated disputes or litigation. In fact the forensic accountants have to work extensively on data mining or data analysis. They need to be highly expert in analyzing the data. Forensic accountancy is often called the base for giving expert advice on trials involving financial irregularities. As a result of recent financial scandals, increases in corporate fraud, and rising concerns over money laundering to support terrorism and other illegal activities ,there is a growing demand that have heightened the necessity to further define the auditor’s and accountant’s responsibility for detecting fraud within organizations. Successful fraud or forensic accounting analyses and findings reported by practicing professionals may be the expert advice for crucial trials involving frauds. In most cases, success is directly and primarily dependent upon the knowledge, skills, and abilities of the professionals performing the work. Consequently, the demand for entry-level professionals with formal education in fraud and forensic accounting has grown. Forensic accounting is a specialized branch of accounting that requires training in fraud detection. Some forensic accountants may, for example, just specialize in insurance claims, personal injury claims, fraud, Anti-Money Laundering, construction or royalty audits. Forensic accountants may be involved in recovering proceeds of crime and in relation to confiscation proceedings concerning actual or assumed proceeds of crime or money laundering.
Nature of Forensic Accounting
– It provides assistance of an accounting nature in a matter involving existing or pending litigation. It deals primarily with issues related to the quantification of economic damages. A typical litigation support assignment would be calculating the economic loss resulting from a breach of contract
– It is often associated with investigations of criminal matters. A typical investigative accounting assignment would be an investigation of employee theft. Other examples include securities fraud, insurance fraud, kickbacks and proceeds of crime investigations.
Type of Forensic Accounting
In general Forensic Accounting is classified into two (2) broad categories-
(1) Investigative Services
(2) Litigation Services
Investigative Services
Investigative services of is more identifying nature. Thus it aims to identifying asset-theft fraud as well as identifying the perpetrator.
Litigation Services
This is another category of forensic accounting. Its main functional area is to gather evidence from each sphere and finally helping to convict the perpetrator. Thus it is a testimony oriented service.
Forensic Auditing
A forensic auditor examines a company’s system of internal controls to identify any weaknesses in the controls designed to safeguard assets from any possible theft or loss and to determine whether anyone in the Company has exploited control weaknesses to misappropriate assets for personal gain.
Difference between Financial Audit and Forensic Audit
The Forensic accounting in its functional area differ very much from Financial Accounting.
(1) While the financial audit seeks to provide information on financial health of the Company, the forensic audit seeks to provide information on assets-theft fraud
(2) The main duty of a financial auditor is to express an opinion on financial statement while the main duty of a forensic auditor is not to express any opinion.
(3) A Financial auditor needs not to be a certified fraud examiner. But a certified fraud examiner needs to be a certified financial auditor.
(4) The financial audit provide “assurance” on a particular date, however forensic audit do not provide any assurance.
(5) Forensic audit do not relate to any particular date but financial audit relates to a particular date rather a particular financial year.
(6) A financial audit is expected to identify financial statement fraud but not expected to identify asset-theft fraud, while the forensic audit is expected to identify only asset-theft fraud.
(7) Forensic Accounting being a separate and specialized branch of accounting requires training in fraud and asset-theft fraud detection. However no specialized training is required to perform financial audit, although the specialized knowledge about accounting concepts and various methods are always required for performing a fruitful financial auditing.
Role of internal control in financial audit as well as forensic audit
Since early days of accounting, internal control has been playing a crucial role in financial accounting. With the lapse of time and with the growing business volumes, it has become obvious to give more thrust on internal checks and internal audit. As a result of which, the newly enacted companies’ act 2013 has recognised and prescribed a separate section on internal audit. Nowadays internal control / Internal audit has become the back bone of financial audit, because the financial/statutory auditor needs to give an elaborate statutory explanation on the internal control of the Company with reference to internal audit report prepared by the internal auditor. With increasing covering area, internal auditor plays a very crucial role in financial accounting rather to say in the financial auditing.
Despite of having different objects of financial auditing and forensic auditing, internal control is equally important for both the field. While the financial auditor takes into consideration the overall internal control to assess the chances of mistakes done intentionally or unintentionally, a forensic auditor takes into consideration company’s system of internal controls to identify any weaknesses in the controls designed to safeguard assets and to determine whether anyone in the company has exploited control weaknesses to misappropriate assets for personal gain.
Various categories of financial forensic engagement
(a) Economic damages calculations either suffered from breach of contract or tort.
(b) Criminal investigation
(c) Shareholders and partnership disputes
(d) Bankruptcy, insolvency and reorganization.
(e) Securities fraud.
(f) Tax fraud.
(g) Business interruption or other type of insurance claims
(h) Employee fraud investigation.
(i) Professional negligence
(j) Money laundering.
(k) Business valuation.
(l) Computer forensic / cyber crime.
(m) Marital and family law for analyzing lifestyle for spousal support purposes, determining income available for child support and equitable distribution.
Various steps of financial auditing
Specialized forensic accountants perform various detailed forensic analysis which is a combined process of various steps for –
(1) Procurement and analysis of electronic data to reconstruct
(2) Detect, or otherwise support a claim of financial fraud.
The main steps in forensic analysis are
(a) Data collection
(b) Data preparation
(c) Data analysis
And
(d) Reporting
While performing these functions, one must have understanding of economic theories, source and various implications of business information, different formats of financial reporting systems, implication of accounting and auditing standards and procedures, methodology of data management & electronic discovery, detailed data analysis techniques for fraud detection, evidence gathering and investigative techniques, litigation processes and procedures to perform their work.
Various tools of data management
Data management is an important tool of Forensic Auditing. As an important aide of Forensic auditing, some of the tools are as follows:-
(1) Data Base Administration (DBA) tool which include Performance, Administration and Recovery tools.
(2) Database log analysis tools are useful for security as well because they can be used to examine log in entries.
Use of Integrated data management in forensic auditing
There are different tools of approaches for data management. However integrated data management is the foremost important tools to be used. It is a tool for approach to facilitate data management and improve performance. IDM consists of an integrated, modular environment to manage enterprise application data, and optimize data-driven applications over its lifetime. The IDM is widely used to improve data access, speed iterative testing. It also facilitates proper channel to find out the loopholes of internal checking system, due to which the fraud has been occurred.
General methodology to be used for forensic audit
In each and every case separate methodology would be used, however a general methodology is as follows.
(1) Meeting with the client
It is helpful to meet with the client to obtain an understanding of the important facts and issues.
(2) Perform a conflict check
A conflict check should be carried out after the identity relevant parties are established.
(3) Perform an initial investigation
It is often useful to carry out a preliminary investigation prior to the development of a detailed plan of action. This will allow subsequent planning to be based upon a more complete understanding of the issues.
(4) Develop an Action Plan
This plan will take into account the knowledge gained by meeting with the client and carrying out the initial investigation and will set out the objectives to be achieved and the methodology to be utilized to accomplish them.
(5) Obtain the relevant evidence
Depending on the nature of the case this may involve locating documents, economic information, assets, a person or company, another expert or proof of the occurrence of an event.
(6) Perform the analysis
The actual analysis performed will be dependent upon the nature of the assignment and may involve:
• calculating economic damages;
• summarizing a large number of transactions;
• performing a tracing of assets;
• performing present value calculations utilizing appropriate discount rates;
• performing a regression or sensitivity analysis;
• utilizing a computerized application such as a spread sheet, data base or computer model; and
• utilizing charts and graphics to explain the analysis.
(7) Prepare the report
Often a report will be prepared which may include sections on the nature of the assignment, scope of the investigation, approach utilized, limitations of scope and findings and/or opinions. The report will include schedules and graphics necessary to properly support and explain the findings.
Characteristics of a Forensic Auditor
Keeping in view the different kind of role of forensic auditor, the following are the list of general qualities that a forensic auditor should possess.
• curiosity;
• persistence;
• detail-oriented;
• creativity;
• discretion;
• skepticism;
(a) organization;
• confidence; and
• analytical proficiency
• sound professional judgement.
• effective oral communication
• function well under pressure
• team player
• makes people feel at ease
• adaptive
• ethical
• responsive
• insightful
• intuitive
Apart from the general qualities, some of the core skills are as follows:
• Effective oral communication
• simplify the information
• Strategic thinker
• Identify key issues
• Auditing skills
• Investigative ability
• Effective written communicator
• Investigative intuitiveness
• Synthesize results of discovery and analysis
• Think like the wrongdoer
• Understand the goals of a case
• Tell the story
• See the big picture
• Organize an unstructured situation
• Solve unstructured problems
• Research skills
• Solve structured problems
There is an exhaustive list of enhanced skills of a forensic auditor
(b) Analyze and interpret financial statements and information
(c) Testifying
(c) Knowledge of relevant professional standards
(d) Audit evidence
(e) Fraud detection
(f) Asset tracing
(g) Electronic discovery
(h) General knowledge of rules of evidence and civil procedure
(i) Interviewing skills
(j) Possess specialized technical skills
(k) Internal controls
(l) Conflict negotiation and resolution
(m) Knowledge of law enforcement
Important Protocols of Forensic Auditor
Having a complex nature of work, there are some protocols / statutory duties, which need to be, abide by the Forensic Auditor.
(1) Discovery of the facts
(2) Analysis of the facts
(3) Communication of the findings
A forensic auditor needs to incorporate all the protocols in order to arrive at steady result/findings. Even though “Discovery” precedes “Analysis” in a forensic accounting engagement, the apparent ability of the forensic accountant to incorporate the information toward a solution is most critical.
The ability of the forensic accountant to effectively communicate and effectively convey findings or opinions in a court of law is most critical. These results stress the importance of the forensic accountants’ ability to be an effective oral communicator and simplify the information from the perception of the respective respondents.
Despite of having good scope of work, Forensic Auditors are very less successful, however some of the reasons identified for their unsuccessful attempt are as follows:
(1) Inability to simplify the information
(2) Ineffective oral communication
(3) Inability to understand the goal of any case
(4) Inability to identify the key issues
(5) Lack of investigative intuitiveness
(6) Ineffective written communication
(7) Inability to synthesize
(8) Close-minded
Detection of fraud by Forensic Auditor
Although there is no fixed source for identification / detection of fraud, the forensic auditor can detect the fraud only if they used the adequate skills, expertise and compile all the sources of information to form a rationale and logical ground that led to the occurrence of fraud. However a research study reveals that only 8% fraud cases are detected by external audit. About 40%fraud cases are detected by whistleblowers and about 31% fraud cases are detected by use of internal control. Apart from that 20% fraud cases are accidently detected. Among the whistleblowers, employees were the biggest source of information i.e. about 57%. Customers and vendors accounts for only 18% and 13%.
Frequent loopholes responsible for corporate fraud
Generally some of the loopholes are responsible for corporate frauds. However there are some of the indicators, which a forensic auditor must consider for identification of a fraud. Some of the indicators are as follows:
(a) No written policies /procedures in the Company.
(b) Lack of internal control
(c) Frequent occurrence of related party transactions.
(d) Management override of internal control
(e) Unreconciled subsidiary and general ledger accounts
(f) Continuous adjustment of book to physical inventories
(g) Excessive number of manual checks.
(h) Failure of employees to take vacations
(i) Insider trading
(j) Early arrival and late departure of employees.
Some of the documents to be verified to trace a corporate fraud:
(1) Website of the Company
(2) Company registration details
(3) Real estate records
(4) Stock transfer records
(5) Accounting data
(6) Vendors ledger
(7) Customers ledger
(8) News sources
(9) Legal resources
(10) Government sites
Laboratory analysis of physical and electronic evidence
Laboratory analysis is also a good evidence that led to the establishment of fact of occurrence of a fraud. Some of the physical and electronic evidences that be used to establish the fact are as follows:
(a) Physical examination
(b) Fingerprint analysis
(c) Forgeries
(d) Ink sampling
(e) Document dating.