What is Forensic Audit & how it is performed

Forensic Audit is a fast-growing assurance engagement that is now offered by almost every audit firm and other assurance provider companies. The primary reason for its emergence is the increased corporate governance expectations. So, what is Forensic Auditing? How is it different from financial auditing and why it is the need of the hour? This article answers these and a lot of other queries related to Forensic Audit.

Definition

Forensic Auditing can be defined as a process in which forensic auditors gather, analyze and report on data for the purpose of finding facts or evidence in the context of legal financial disputes or other irregularities.

That means, it is an engagement in which the forensic auditor undertakes procedures for collecting evidence(s) and analyzing the evidence for the purpose of finding facts that support the issue they are called for. A forensic audit differs from a financial audit in that it is not mandatory or willingly performed but its need is triggered by an event. Some events that result in the need for a forensic audit include:

• Financial disputes between companies
• Insurance disputes
• Frauds
• Money Laundering
• And other civil & criminal investigations.

Let’s say a business has been damaged by a fire and the owner has applied for insurance claim. The insurance company believes that there is something wrong with the event. The fire, their professionals suspect, could be intentionally lit. The insurance company will hire a forensic auditor to dig into the details and find out what happened exactly in light of evidence(s) and facts.

Another primary difference between forensic and financial audit is that in a financial audit, the report is based on the auditor’s opinion while the forensic audit is purely based on facts and evidence. The forensic auditor cannot just make his opinion and will have to find out and present facts and supporting evidence to make the job count.

Now that we know what a forensic audit is and what makes it different from a financial audit, let’s discuss what type of services forensic auditors provide to clients.

Features

Forensic auditors are hired for different types of investigative and research-based services. Some prominent services that a forensic auditor may render include:

• Investigative Questions & Answers: Not everyone has an investigative mind. A forensic auditor can compile a list of questions and answers for an ongoing investigation. The Q&A will be based on the psychological & professional knowledge of the auditor.
• Documentation Services: Being aware of both the auditing standards and legal processes, forensic auditors can provide a wide range of documentation services to clients.
• Research: Forensic auditors are experts in finding facts and unraveling scenarios.
• Evidence: The skillset and characteristics of forensic auditors enable them to investigate, collect and analyze evidence. They are also well aware of the means to preserve the evidence and secure it using different digital options.
• Criminal & Civil investigations: Forensic auditors are hired by companies & auditors to investigate criminal offenses like bribery, money-laundering, and insider dealings. They can also take care of civil cases like professional negligence, employee firings, and disputes between companies, etc…

As you may have figured it out, these services vary in terms of nature and expectations, and no hard & soft rules are followed to perform forensic audits. Experience and professional judgment play an important role in investigating offenses and irregularities. Sometimes, the forensic auditor will go into the details that a normal person cannot relate to. Whereas, in some cases, the issue could be resolved in a matter of minutes by acting smart. Let me tell you a story that explains the point…

Despite its irregular nature, a forensic auditor, like every other assurance professional, follows certain codes and standards to complete the engagement and achieve their objectivity. There are THREE stages involved in Forensic Auditing.

Stages of Forensic Auditing

Like a financial audit, there are THREE stages in performing forensic audits, of course with modifications, and each stage has further sub-stages. The THREE stages are Planning, execution, and reporting.

1. Planning

Before planning a forensic audit, the auditors identify the motive of the engagement, highlight key points and players involved and understand the issue. This stage is called initialization. Once the initialization is completed, the next step is to plan the forensic engagement.

In the planning stage of forensic audits, a methodology is structured based on the intensity, complexity, nature, risk involved, importance, and professional judgment of the forensic auditor. The planning involves deciding what type of procedures will be performed, which individual to investigate and when to perform certain tasks etc…

2. Execution

The forensic auditors gather and retrieve evidence and facts related to the issue. Different investigative tactics are used to collect facts. The most important element in execution is preserving the evidence; unlike financial auditors, forensic auditors, in most cases, deal with corporate criminals and individuals involved in immoral activities. Therefore, preserving the evidence is yet another challenge in the engagement.

The evidence and facts are analyzed and a conclusion is formed based on the supporting documents. In forensic audits, the conclusion is always based on facts and evidence and the auditor’s own opinion has nothing to do with the report.

3. Reporting

Once the planned procedures, tests, and investigations are performed and facts analyzed, the final stage is to conclude a report based on the findings. Sometimes, the report will be presented to courts in which case, the forensic auditor will be dealing with the legal proceedings.

The forensic report is much more detailed than a financial audit as it is evidence oriented and the auditor has to explain, even the minor of details, in language that users of the report can understand. Elements of the forensic report include:

• Summary: A conclusion based on the analysis of facts and supporting evidence. In the summary, the auditor avoids using audit jargon and conveys the message in plain words.
• Risk Analysis: Risk assessment is the foundation of every audit. In a forensic audit report, users are briefed about the risks that lie in the issue/system/event so that they are on the same page with the auditor.
• Audit Process: This section explains the backend of the audit. The auditor explains the process from inception to completion.
• Evidence of the event: The facts & findings related to the event are shared with users and explained to make them more helpful to users of the report.
• Recommendations: To prevent such future events, the auditor points out the flaws in the system and likely solutions.

The above is just a plain & brief overview of how a forensic audit is performed. There are a lot of techniques that auditors use to identify, gather, and analyze evidence in forensic audits. Some techniques that are used in forensic auditing are as follows.

Techniques used in Forensic Audit

There are a number of techniques used in forensic audits ranging from simple mathematical & statistical techniques to advanced digital techniques like using artificial intelligence software in the client’s system to detect unusual events & transactions automatically.

Statistical and mathematical techniques are used to calculate the likely effect of frauds and other events. For example, if a forensic auditor is investigating a money-laundering case, he may perform calculations to find how much money has been laundered. If the launderer has used multiple sources, the weight of each source will be calculated to arrive at the final figure.

Forensic auditors also use computer-assisted techniques including generalized audit software and customized audit hooks. An audit hook is simply a software that is installed on the client’s system that catches irregularities and unusual changes that take place in the business. The use of software makes the job of identifying and collecting the evidence smoother.

Data mining is yet another technique that forensic experts use to analyze data, highlight the key stats and conclude a meaningful message out of rough data. There is no end to the techniques that forensic auditors use as the job requires creativity and smart moves. To deal with white-collar criminals, the forensic auditor has to think like one. Therefore, it is of keen importance that the forensic auditor is well aware of criminology & psychology to better perform the engagement.