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Financial Audits vs. Forensic Accounting Audits

By Brian Lafountain, on January 16th, 2016

The increasing spotlight on corporate ethics and fraud has resulted in a demand for accountants who have sufficient training and investigative skills to conduct investigations into financial crime in the workplace. The integration of accounting, auditing and investigative skills yields the specialty known as Forensic Accounting. The term “forensic” means suitable for use in a court of law, and the term “forensic accounting” was created to differentiate between accountants who specialize in investigating fraud and the more familiar work of traditional financial statement auditors.

Forensic accounting is a specialty practice area of accounting that focuses on a specialized approach and methodology designed to identify financial fraud. Forensic accountants/fraud auditors are generally accountants or auditors who – by virtue of their attitudes, attributes, skills, knowledge, and experience – are experts at detecting and documenting fraud in accounting and financial transactions. The skills forensic accountants/auditors require include all of those that are required of financial statement auditors, plus knowledge of how to gather evidence of and document fraud losses for criminal and civil purposes, how to interview third party witnesses, and how to testify as an expert witness.

However, while forensic accounting has become more prevalent in the workplace, many individuals still are not clear on the differences between a financial statement audit and a forensic audit/examination. These services are mutually exclusive and have distinctively unique purposes. When engaging the services of a forensic accountant, it is important to understand the process and objectives of a forensic audit and how it differs from a financial statement audit.

Financial Accounting – Financial Statement Audit

A financial statement audit is conducted by a CPA firm to opine whether a company’s financial statements fairly present its financial position as of a particular point in time. The auditors evaluate whether the financial statements prepared by management are stated in all material respects in accordance with Generally Accepted Accounting Principles (“GAAP”). The auditors reach their opinion by examining, on a test basis, the evidence supporting the amounts and disclosures in the financial statements. A financial statement audit does not analyze every transaction or look for fraud specifically. While a properly planned financial statement audit may uncover fraud, the focus is not on uncovering potential fraudulent acts. It is possible for a company to have a significant embezzlement or fraud perpetrated without it being uncovered during a financial statement audit.

Many in the public have questioned why financial statement audits do not detect more fraud. The general public believes that a financial statement audit would detect a fraud if one were being perpetrated. The truth, however, is that the procedures for financial statement audits are designed to detect material misstatements, and thus financial auditors focus on misstatements that singularly or in the aggregate are large enough to be material. Fraud auditors and forensic accountants are not constrained by materiality. .

The financial statement audit reports are typically used for a wide range of purposes by several different corporate audiences and stakeholders. These typically include senior management, the audit committee, the board of directors, owners, shareholders, investors, suppliers and the company’s bank or financial institution. Third parties use audited financial statements to evaluate the financial strength of a company for investing or lending purposes.

Forensic Accounting – Financial/Fraud Investigation

A forensic accounting engagement, on the other hand, is conducted by a forensic accounting expert and is specifically designed to uncover fraud. The objective often includes finding out who committed the fraud, how they did it, how much they took, and how to stop it from happening in the future. A forensic audit is more encompassing than a financial statement audit in terms of assessing the entity’s internal control structure and identification of alleged fraudulent activity or irregularities. While forensic engagements follow the basic rules prescribed under GAAP, it may depart from all or parts of what is stated under GAAP depending on the circumstances. In other words, there are no set guidelines when it comes to forensic accounting. Forensic accountants will generally start with data from a company’s financial statements, but will then move to other procedures in an effort to follow specific circumstances or a series of events that has occurred in the company. The forensic accountant will interview a wide range of company personnel, from the clerical staff to the senior management, as necessary. Based on these interviews, as well as other observations, the examiner will start to identify red flags and design follow up procedures to address the suspicions and/or high risk areas within the organization.

A forensic audit report of findings is a fact-based document that may detail internal control weaknesses, alleged acts of malfeasance, and the magnitude of the alleged loss. In certain circumstances, the forensic audit report may even include recommendation to improve the identified weakness or gaps in internal controls. The forensic audit report can have many purposes, including use by an entity’s management to seek restitution from the alleged perpetrator, use by management to strengthen internal controls to prevent fraud from occurring in the future, or use by law enforcement to bring criminal charges.

Each forensic project is unique and may require the forensic accountant to develop an audit program for the specific objective of the individual engagement. Typically, the forensic accountant will work with a legal team, and will always work under the assumption that he or she will have to testify as an expert in a court proceeding. The qualifications and expertise of the engagement team is paramount as the documents created during the forensic audit may be needed in civil and criminal proceedings, by law enforcement, government agencies, or confidential investigations.

Concluding Thoughts

As a business owner, or as an accounting practitioner, it is imperative that you clearly understand and define your objectives as it relates to an audit engagement. A forensic audit and a financial statement audit have very different objectives that no not overlap. Financial statement auditors and fraud specialists are two different specialized-skills and disciplines in the auditing field.

Brian Lafountain is a partner based out of our Rochester, NY office.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.

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