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Scrutinising a financial document. Forensic accounting requires training in fraud detection. PHOTO | FILE 

By PETER WERE

As a business owner, you need to determine reasons for requesting an audit. A forensic audit and a financial statement audit have different objectives that do not overlapinShare

Request a forensic audit if you suspect asset-theft fraud. Request a financial statement audit for assurance that your business’s financial statements fairly state the company’s financial position as of a certain date.

An auditor conducting a financial statement audit is charged with performing procedures to discover financial statement fraud but not asset-theft fraud.

Forensic accounting is a specialised branch that requires training in fraud detection. Why are auditors not good at detecting fraud? The reasons are many.

Use of internal controls

The depth of audit testing and the types of procedures used are heavily influenced by the assessment of internal controls by auditors. They look at the company’s policies and procedures which help ensure accurate financial statements.

Auditors determine whether those controls exist, are adequate and enforced.

Auditors will then plan their work based on their assessment of the risk and controls. Any faulty assessment at this stage can be detrimental to the entire audit. If auditors are not in control of risks they cannot plan to deal with them.

Predictable audit tests

When employees know the risk and accounts the auditors will target, the effectiveness of audit testing is affected. The element of surprise is quite effective in unveiling fraud, yet auditors do not often employ this technique.

Surprise helps to prevent fraud because employees do not know which accounts will be investigated.

Audit sampling

The heart of an audit is testing transactions. Auditors select a sample and test transactions to ensure that they were properly recorded in the accounting system.

The limitation in sampling is that all transactions are not tested. It is not possible for auditors to examine all transactions a company enters into in a year. So many transactions are not tested which means that there is a chance that a fraudulent item can elude testing.

Focus on large transactions and balances

To make matters worse, management knows that auditors generally choose larger transactions for testing. This creates a huge opportunity for someone perpetrating a fraud.

If someone wants to manipulate records he will use several small transactions that will most likely never be examined by the auditors.

Dynamic business environment

Gone are the days when a company’s business changed little from year to year. Mergers and acquisitions and development of new products and services lead to businesses changing faster than ever.

Comparing the financials of a company from year to year becomes nearly impossible because of the changes. Today’s businesses are harder to audit and fraud risks change rapidly but the audit process has been slow to catch up.

The right audit approach of the past could be outdated today, yet many audit processes are largely the same. Fraud perpetrators know that auditors cannot keep up with all the changes in their businesses which they easily exploit.

Use of estimates

Critical parts of a company’s financial statements are often based on the judgment of management, which has to use its knowledge of the business to make estimates.

Unfortunately, management’s judgment and estimates are difficult to audit. How can forensic accounting fill the gap? 

First, forensic accounting is conducted at the request of a firm’s management. Forensic accounting is a targeted assessment of specific areas of a business; it is not general assessments of the business or its financial statements.

Forensic accounting engagements can be specifically tailored to deter fraud and potentially prevent
it. 

Forensic accounting techniques can be used in many instances, including deterring fraud. More specifically, forensic accountants can analyse an organisation’s internal control process to determine areas of weakness and help the organisation remedy arising issues.  

Fraud deterrence focuses on removing one or more of the three causal factors: motive, opportunity and rationalisation.

Only when each of these factors is present can a fraud occur. Motive and rationalisation are generally dependent on personal situations over which the organisation may have little control.

This is why the opportunity for fraud is often the prime target of deterrence engagements, as this factor can be controlled by an organisation.