What Is a Forensic Audit? (With Steps and Benefits)

By Indeed Editorial Team

Published June 2, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Businesses typically conduct audits to clarify their financial position and ensure regulatory compliance. A forensic audit helps companies make sure that there are no fraudulent or illegal operations in the workplace. If you manage a company's finances, understanding this auditing process can help you determine when to recommend it to the management team. In this article, we explain forensic auditing, highlight the differences between a forensic and internal audit, outline steps forensic auditors follow when conducting them, describe common reasons for these audits, and list their benefits.

What is a forensic audit?

A forensic audit involves examining and reviewing the financial records of an individual or organization to seek evidence of fraudulent dealings. The forensic auditing process is an aspect of accounting and may be necessary during legal proceedings. It usually focuses on investigative activities to ensure the company's operations comply with legal stipulations within its province or territory.

Forensic auditors might also review a company's or individual's financial accounts for other purposes. For example, during the dissolution of a partnership, a forensic auditor may assess the company's assets to ensure that the parties aren't concealing valuable goods, documents, or finances. They may also verify and confirm financial documents after an individual or company has filed for bankruptcy.

Related: How to Become a Forensic Accountant (With Crucial Skills)

Forensic vs. internal audit

Internal audits typically evaluate the company's records and accounting processes to ensure compliance with relevant laws and regulations. Internal auditors also identify operational issues and challenges and recommend solutions or corrections to these problems before submitting their report to the external audit committee. Unlike forensic auditing, internal auditing processes can also be used as a management tool to assess the feasibility of the company's projects.

Forensic auditing typically involves identifying fraud in the company's operations, while internal auditing processes evaluate the relevance and usefulness of the company's internal policies. Companies usually perform internal auditing annually, unlike forensic auditing, which professionals conduct when there's an ongoing investigation of fraudulent practices in the company. Forensic auditors' extensive knowledge of the law is a compulsory requirement, but this isn't mandatory for internal auditors.

Related: Accountant vs. Auditor: Differences and Similarities

How to perform forensic auditing

Here are the steps that professionals can follow when conducting a forensic audit:

1. Prepare for the investigation

Forensic auditors possess multiple skills and qualifications that help them understand accounting processes. Once they receive an investigation request, these professionals plan the objectives of the investigation. Outlining these objectives may guide the inquiry process and helps them understand the necessary tools for the investigation. Forensic auditors also conduct background checks on the company to understand its management hierarchy and internal policies.

Forensic auditors typically identify the type of fraud that has been going on within the company and its duration. They may also prepare a potential list of suspects and measure the company's losses due to the fraudulent activities. To understand the company's structure in greater detail, forensic auditors can review previous audits conducted by the company.

2. Interview potential suspects or witnesses

Interviewing employees is an essential aspect of the auditing process because it allows forensic auditors to cross-check information and details mentioned in company files. It can also help them gather background information on employees, incriminating evidence on suspects, and potential witnesses for court proceedings. Most forensic auditors set basic rules for the questioning process of the interview, and they might focus on the body language of employees to understand their opinions.

3. Gather relevant evidence

While making inquiries concerning the company's records, forensic auditors record valuable evidence that explains the details of the fraud. They may assess company files to understand when the fraudulent activity began and the employees involved in it. The process also involves collecting evidence to demonstrate any intentional concealment of the fraud within the company.

Forensic auditors use a variety of different techniques to gather evidence. For example, they can review the company's internal checks and policies, identifying any weaknesses that allowed the commission of fraud. Forensic auditors may also compare various financial documents and identify discrepancies that prove the commission of fraud. Some auditors use software programs to assess the company's digital information and highlight fraudulent activities.

4. Write and document reports

Forensic auditors compile and analyze the evidence and draw reasonable conclusions. They usually document the investigation process to aid their reporting. Documents often contain a summary of the evidence of fraudulent activities, employees involved in the fraud, and recommendations on handling and preventing this type of fraud. Forensic auditors can then present these reports to the company or as evidence during court proceedings.

5. Contribute to court proceedings

Companies may decide to initiate legal proceedings and investigations after identifying issues in their annual audits. Forensic auditors can submit their findings to the court to aid these proceedings. Their presence in the courtroom may be required to explain their findings, act as expert witnesses, and outline the investigation process. They may also be called upon to explain complex accounting processes in simple terms.

When do forensic auditors conduct audits?

Here are some situations that make this type of audit necessary:

Conflict of interest

A conflict of interest occurs when an individual's personal life or interests interfere with their decisions and performance in the workplace. For example, if an employee uses their position for personal gain, their actions may affect the productivity and profit of the company. Depending on their role and sector, these actions may be fraudulent, requiring investigation by forensic auditors. Investigating conflict of interest is necessary, as it can affect the company's public image.

Corruption

If the company's management team suspects that employees are engaging in corrupt activities within the workplace, they may request a forensic investigation. One typical example of corruption is bribery. Bribery usually involves offering money or something of value to influence the judgment or conduct of an individual in a position of trust. Another example of corruption in the workplace is extortion. This is the illegal use of intimidation, force, or threats to gain money or other benefits.

A company may initiate a forensic investigation to dispel rumours about bribery and extortion among its employees. They might also initiate the investigation to learn more about these activities in the workplace and identify the individuals involved in them.

Asset misappropriation

Asset misappropriation is a fraudulent activity that typically involves the misuse or theft of company assets and resources by employees. One example of this is the embezzlement of company funds, which may include the creation of false invoices and accounts to alter company records. Asset misappropriation also includes payroll fraud, where employees may access company staff records and divert funds into their own accounts. Other examples of this corrupt activity include stealing supplies and creating fake payments. Companies may initiate forensic investigations to identify the individuals misappropriating company assets.

Related: Common Jobs in Auditing (Duties, Skills, and Salaries)

Misrepresentation of financial statements

Misrepresentation of financial statements or financial statement fraud usually occurs when companies falsify their records to deceive potential investors about the company's financial strength. They may engage in this illegal activity to improve market performance. It usually occurs among the management team of the company. Financial statement fraud may involve reducing expenses or overstating revenue values to show a false high growth rate. For instance, a company may conceal its bankruptcy by creating false balance sheet statements that inflate its profits. When discovered, this illegal activity affects investors' confidence in the company and negatively impacts its brand image.

Benefits of forensic auditing

Here are some benefits of forensic auditing:

Reduces potential losses

Fraudulent activity in the workplace can often result in reduced profits for the company. Conducting a forensic investigation into company accounts can help a business identify and stop fraudulent activity early. This usually minimizes or prevents financial losses.

Strengthens internal policies

The broad scope of this type of investigation usually ensures that employees use company assets properly to prevent misappropriation. A forensic investigation typically shows the loopholes in the company's internal policies and structure that may aid the commission of illegal activities. Forensic auditors can study company accounts and make recommendations that help the company upgrade its processes and standards.

Avoids legal issues

Conducting a forensic investigation can help the company prevent or resolve fraudulent activities before they cause legal issues. These legal issues often take up a lot of time and resources. If legal proceedings have started, these investigations may act as evidence to prove or dispel the allegations.

Improves company image

Claims of illegal activities made against the company can sometimes be false or exaggerated as well. By conducting a forensic investigation, the company can provide an accurate report that restores its reputation and investors' confidence. It also shows the company's willingness to ensure and verify the integrity of its records and operations.

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