The field of forensic accounting is a specialist branch of the profession carried out by forensic accountants encompassing forensic auditing and investigation.
Forensic engagements require a much broader range of skills than other typical non-audit engagements. However, they still require the application of traditional auditing skills and techniques.
Two articles have been published on this syllabus area by the examining team: ‘Forensic Auditing’ (September 2008) and ‘Massaging the Figures’ (April 2009). These can be downloaded from the ACCA website.
1 What is a forensic audit?
Definitions Forensic audit
This refers to the specific procedures within a forensic investigation in order to obtain .
This could include the use of traditional financial auditing techniques such
as analytical procedures and substantive procedures, for example to quantify a fraud or to determine the amount of an insurance claim.
Some of the major applications of forensic auditing are shown below:
|Application||Examples||Type of work performed|
|Fraud||Theft of company funds,||Funds tracing, asset|
|investigations||tax evasion, insider||identification and recovery,|
|gathering, due diligence|
|reviews, interviews, detailed|
|review of documentary|
|Insurance claims||Business interruptions,||Detailed review of the policy|
|property losses, motor||from either an insured or|
|vehicle incidents,||insurer’s perspective to|
|personal liability claims,||investigate coverage issues,|
|cases of medical||identification of appropriate|
|malpractice, wrongful||method of calculating the|
|dismissal.||loss, quantification of|
|Professional||Loss suffered as a result||Advising on merits of a case|
|negligence||of placing reliance on||in regards to liability,|
|professional adviser.||quantifying losses.|
As part of the assignment a forensic accountant will:
Communicate their findings in the form of reports, exhibits and collections of documents.
Assist in legal proceedings, including testifying in court as an expert witness and preparing visual aids to support trial .
The forensic accountant may be used as an expert witness where:
They have experience, expertise, and training appropriate to the value, complexity, and importance of the case.
They have the expertise relevant to the issue on which an opinion is sought.
It is a reasonable requirement to resolve proceedings.
In 2014, Tesco, Britain’s biggest retailer revealed that it had overstated estimated profits by £263 million by overestimating revenues paid to it by suppliers. Tesco was struggling to maintain market share due to pressure from competitors Aldi and Lidl.
In 2015, the electronics company Toshiba admitted that it had overstated its earnings by nearly $2 billion over seven years. An independent investigation found that “Toshiba had a corporate culture in which management decisions could not be challenged” and “Employees were pressured into inappropriate accounting by postponing loss reports or moving certain costs into later years.
In June 2012, three men were jailed after defrauding the supermarket Sainsbury’s. 2 directors at potato supplier, Greenvale, were found to have overcharged Sainsbury’s £8.7 million in agreement with Sainsbury’s potato buyer, John Maylam. £4.9 million was paid to Maylam as his share and he also received excessive gifts and hospitality. The Sainsbury’s contract was worth £40 million to Greenvale and the directors did not want to risk losing that amount of business and hence bribed Maylam to ensure the contract remained in place.
2 Acceptance considerations
As with any assignment, the practitioner must only take on work of acceptable level of risk. The acceptance matters given in 6 must be considered.
Most importantly for forensic audits, the practitioner must ensure they can comply with the fundamental ethical principles.
Professional competence and due care
Forensic investigations involve very specialist skills, including:
Detailed knowledge of the relevant legal framework.
An understanding of how to gather specialist .
Skills in the safe custody of , including maintaining a clear chain of .
Strong personal skills: interview techniques, presentation of material in court.
During legal proceedings the court will require the practitioner to reveal information discovered during the investigation. There is an overriding requirement to disclose all of the information deemed necessary by the court.
Outside of the court, the practitioner must maintain confidentiality, especially because much of the information they have access to will be highly sensitive.
The practitioner must always be, and be perceived to be, independent.
This is particularly important if the forensic report is going to be submitted to a court of law. Any threat to objectivity could undermine the credibility of the provided. To assess independence, the expert should consider whether the opinion would be the same if they were engaged by the opposing party.
In particular the accountant must safeguard against self-review and advocacy threats.
An advocacy threat arises because the firm may feel pressured into promoting the interests and point of view of their fee paying client, which breaches the concept of objectivity in court proceedings. In particular, the forensic expert has a duty to provide to the court which overrides any obligation to the client paying them. The practitioner must communicate this duty to the client to prevent any misunderstanding.
A self-review threat arises when an auditor also becomes involved in some form of forensic work because the investigation is likely to involve fraud or potential misstatement within the financial statements. Separate teams must be used for the different engagements.
Given the nature of their work, forensic professionals are likely to deal frequently with individuals who lack integrity or may be involved in criminal behaviour. It is imperative that the practitioner recognises this, and does nothing to damage their own reputation, such as accepting bribes or giving in to other forms of coercion/intimidation.
Fraud investigations can become a matter of public interest, and much media attention is often focused on the work of the practitioner. A highly professional attitude must be displayed at all times in order to avoid damage to the reputation of the firm, and of the profession. Any lapse in professional behaviour could undermine the credibility of the practitioner, especially when acting in the capacity of an expert witness.
3 Level of assurance
Forensic engagements are generally conducted as ‘agreed upon procedures’ assignments. This means:
No assurance is given.
The practitioner will report factual findings to the client.
The procedures are dependent on the requirements of the client.
4 Planning and performing forensic audits
Procedures may include:
Enquiries/interviews of key staff.
Detailed inspections and analysis of documentary .
Tests of control.
Analytical procedures to compare trends over time or between business segments.
Computer assisted audit techniques.
Hold a meeting to clarify:
– The objective of the investigation.
– The actions taken so far e.g. contact with the police and the result of any investigations carried out by them/contact with the insurance company.
– The planned deadline for the report.
Confirm that the investigation team will have full access to the information required, and are able to discuss the matter with the police without fear of breaching confidentiality.
Confirm the output of the investigation and to whom the report will be addressed. It should be clarified that the report is not to be distributed to any other parties.
Confirm whether the firm will be required to act as an expert witness in the event of a prosecution.
Consider the resources and skills that will be needed to conduct the work. If the firm has a forensic accounting department it is likely they will have staff with relevant skills, but the specific type of investigation must be considered as each will be different.
For fraud investigations:
– Determine the type of fraud that has taken place.
– Consider how the fraud could have taken place. For insurance claim verification:
– Inspect the insurance policy to clarify the exact terms of the insurance. The period of the insurance cover should be checked to ensure that the client is covered for any claim they intend to make.
– Inspect bank statements to confirm payments to the insurance company are up to date to ensure the cover has not lapsed.
Examples include fictitious employees being set up on a payroll system or fictitious suppliers being set up on a purchases system.
Objectives and scope
With most fraud investigations, the basic objectives of a forensic engagement include:
– the type of fraud that has occurred
– how long it has been occurring for
– how the fraud was concealed
– the main suspects.
Quantification of the financial losses.
Gathering of to support legal action/recovery of losses.
Providing advice to prevent fraud.
Inspect payments for of authorisation.
Using computer-assisted audit techniques (CAATs), trace all payments made to a particular bank account number.
Using CAATs, identify employees who have not taken any annual leave entitlement or sick leave.
Inspect reports detailing changes of standing data to identify whether these changes were authorised.
Use analytical procedures to identify any trends that may indicate when the fraud commenced and the extent of the fraud.
Interview the suspect to obtain an explanation of what has happened or to obtain a confession.
Inspect supporting documentation (e.g. contracts of employment, GRNs, invoices) for expenditure to identify whether the expenditure is legitimate or fraudulent.
Inspect the company’s insurance policy to identify whether fraud is covered. If so, the loss to the company will be limited to the extent of any excess on the insurance policy or any limit imposed by the insurance company.
Insurance claim verification
Examples include insurance claims for theft of assets or claims for business interruption if the business has been affected by a flood or fire.
For assets being claimed, inspect the asset register or invoices to verify the value of the asset.
Where insurance replaces on a new for old basis, inspect price lists to identify the current price of an asset.
For business interruption insurance, analyse the level of business generated in previous years’ and any growth achieved in the current year to date to quantify the level of business lost during the relevant period.
Perform a reconciliation of records to physical items to quantify the number of goods lost or destroyed for which insurance can be claimed.
Discuss with the police whether any items being claimed for have since been recovered.
Once a forensic investigation is complete, the forensic accountant will submit a report of their findings.
As an agreed upon procedure the most important factor of a forensic report is that the practitioner adequately addresses the requirements of the client, as established in the engagement letter.
|A basic report will include:|
|a summary of the procedures performed|
|a summary of the results of procedures|
|any limitations in the scope of the engagement|
|Test your understanding 1|
|Your firm performs the audit of Jarvis Co, a company which installs|
|windows. The company’s year-end is 31 July 20X2. Jarvis Co uses sales|
|representatives to make direct sales to customers. The sales|
|representatives earn a small salary, and also earn a sales commission of|
|20% of the sales they generate.|
|Jarvis Co’s sales manager has discovered that one of the sales|
|representatives has been operating a fraud, in which he was submitting|
|false claims for sales commission based on non-existent sales. The sales|
|representative started to work at Jarvis Co in January 20X2. The forensic|
|investigation department of your firm has been engaged to quantify the|
|amount of the fraud.|
|Recommend the procedures that should be used in the forensic||(5 marks)|
|investigation to quantify the amount of the fraud.|
|Test your understanding 2|
|You have been asked by the management of The Marvellous|
|Manufacturing Company to carry out a forensic audit into a suspected|
|expenses fraud within the marketing department.|
|During a routine annual spend review, management noticed that the|
|expenses budget of $300,000 had been exceeded by nearly $30,000 with|
|no known increase in activity.|
- Set out the matters you would consider when planning the forensic
|(ii) Identify the procedures to be performed to determine whether or not|
|an expenses fraud has taken place.||(5 marks)|
|(Total: 10 marks)|
Test your understanding 1
Obtain all of the claims for sales commission submitted by the sales representative since January 20X2 and total the amount of these claims.
Reconcile the sales per the sales commission claims to the sales day book.
Agree all sales per the sales commission claims to customer-signed orders and to other supporting documentation confirming that window installation took place, for example, customer-signed agreement of work carried out.
Obtain external confirmations from customers of the amount they paid for the work carried out.
Perform analytical procedures to compare the weekly or monthly sales generated by the sales representative committing the fraud to other sales representatives.
Test your understanding 2
- Matters to consider when planning a forensic audit
– Consider the scope and depth of the investigation and therefore the nature, timing and extent of procedures.
– Determine which staff will perform the assignment ensuring the appropriate skills are included on the team. Consider the availability of the staff and whether any other work needs to be rescheduled and whether this is possible.
– Prepare the budget for the assignment in terms of hours, grades of staff and costs.
– Calculate the fee for the assignment based on the budget.
– Discuss with management why they believe the overspend is through fraudulent behaviour.
– Consider who the intended users of the report will be as this will affect risk and liability levels and therefore the amount of work undertaken.
– Develop an engagement plan that focuses on the areas where fraud could have taken place.
– Ensure the team are fully briefed on the client and the assignment.
– Obtain confirmation from management that the expert will have full access to information needed to perform the investigation.
– Enquire whether the practitioner will be required to be an expert witness if it is found to be fraud and the suspect it taken to court.
– Identify risk areas that would provide opportunities for fraud to
take place e.g. lack of segregation of duties, poor control environment, etc.
– Obtain management accounts and perform analytical procedures to see if any other significant variances have occurred.
– Speak with the marketing director to identify if there have been more trips required this year that could explain the reason for the increase.
– Enquire if any new customers/contracts have been won in the year that might explain an increase in marketing expenses e.g. entertaining to win new business.
– Enquire with the marketing director whether expenses are authorised and what the authority limits are.
– Enquire if there has been any change in expenses policy that might explain the increase e.g. an increase in the standard of hotels used, meal allowances, etc.
– Enquire when the spending increase was first identified and what measures were taken by the client to find reasons for the increase.
– Analyse expense claims by individual to try to identify a suspect.
– Analyse expenses by type to identify which category of expenses has seen the biggest rise. For example, an increase in fuel costs might be due to fuel prices increasing rather than fraud.