Forensic accounting, investigation and audit

When money goes missing, someone has to find out who took it, how, and how much. When a company sues its former auditors, a court needs a clear account of what the audit file did and did not do. When a business loses stock in a fire, an insurer wants a number it can test. In each case the accountant is working for the law. That work is called forensic.

This topic separates three terms that exam questions use interchangeably: forensic accounting, forensic investigation and forensic audit. It covers the applications, the role of an expert witness, how the ethical principles apply, the procedures, the report, and the Nigerian agencies that investigate economic crime. The competence on the syllabus also asks you to select procedures and work out the amount of a loss, so there is a worked calculation below.

Forensic accounting, investigation and audit

In general terms, forensic means used in connection with courts of law. In accounting, it means using accounting information for legal purposes, to resolve legal disputes or disputes that a court of law decides. It applies to criminal cases, such as fraud, and to civil ones.

Forensic accounting therefore has two aspects, forensic investigations and forensic audits. The terms are closely connected, and an exam question may use any of the three.

Forensic investigations are usually reactive, since they seek to prove or disprove suspicions. They can also be proactive or preventative: forensic techniques can identify risks of wrongdoing so that steps can be taken to improve the position.

Put together, forensic auditing is the process of gathering, analysing and reporting on data, much of it financial, in the pre-defined context of a legal dispute or an investigation into suspected irregularities, and in some cases giving preventative advice.

Applications and the expert witness

Forensic work arises where disputes or wrongdoing lead to criminal or civil action in court. The general areas are:

• fraud investigation;
• negligence investigation; and
• insurance claims and the assessment of losses.

In any of these a forensic accountant may be called by the court as an expert witness, to give evidence on the financial implications of a situation, or on whether there is evidence for claims of fraud or negligence.

Example: a fraud investigation

A forensic accountant may be engaged to:

1. investigate whether fraud has actually occurred and, if so, get evidence to support that in a court;
2. identify those who committed the fraud and get evidence linking them to it, including evidence that they had the opportunity; and
3. estimate the financial loss.

The forensic accountant is not a policeman and does not prosecute. The investigating authorities engage the accountant to get evidence for a prosecution, or to conclude that sufficient evidence cannot be obtained.

Example: negligence

If an accountant is asked whether an audit file was prepared negligently, the accountant reviews the file and compares the procedures carried out with the requirements of the auditing standards.

Applying the ethical principles

The fundamental principles apply to forensic work as they do everywhere, with these special points.

• Integrity. In legal disputes people may lie. The forensic accountant must still act with honesty at all times.
• Objectivity. A client pays for the work and probably hopes for a result. Criminal investigators may hope for evidence of guilt. The accountant must stay independent, in spite of the advocacy threat, and look for evidence that supports a fair opinion.
• Professional competence and due care. Forensic accounting is specialised, so the individual must be competent for the work.
• Confidentiality. The normal rule is not to disclose client information without consent. The exception is that the duty gives way to a court’s request for evidence. Legal requirements for disclosure override confidentiality.
• Professional behaviour. Forensic accountants appear as witnesses, often in public view, so they must act in a way that does not harm the image of the profession.

Three further considerations apply:

• to whom a duty of confidentiality is owed, especially when acting as an expert witness for both sides of a legal claim;
• duties to the court; and
• legal privilege in the context of money laundering.

The last is important. Most accountancy work, such as auditing, gives rise to duties to report suspicions of money laundering. But where the accountant works in a legal capacity, information obtained may be subject to legal privilege, in which case a report of suspicion would be wrong. Whether privilege applies is a complicated question, and the accountant should take legal advice.

Procedures in a forensic investigation

The procedures depend on the terms and objectives of the engagement. Often they are like audit procedures. A useful way to answer is to follow the elements of a normal audit:

1. Set the objectives.
2. Plan the investigation to achieve them. In a suspected fraud, plan how to establish whether fraud has occurred, how it could have happened, how long it has been going on, who committed it and how much was lost.
3. Gather evidence strong enough to stand up in court. In fraud cases, try to establish the motive, the opportunity and any evidence of steps to conceal the crime.
4. Use the usual methods, including interviewing individuals, among them those suspected.
5. Form an opinion on the evidence. If it is not enough, get more.
6. Report to the client.

If an accountant is asked whether inventory has been misappropriated, the procedures may include analytical review (comparing margins year on year), tests of cut-off and inventory counting to make sure the figures are not misstated. Tests of controls to see whether they could prevent fraud and were applied.

Reporting on forensic audits

The key issues are:

1. whom the report is intended for, and restriction of liability to others;
2. the type of assurance required, since as in any assurance engagement it affects the level of evidence; and
3. the purpose of the report, for example to support an insurance claim or give evidence to a court.

Government agencies associated with forensic auditing

The Nigerian government has set up agencies to tackle economic and financial crime. The syllabus lists these with their enabling Acts.

Some of the Acts above have since been replaced: BOFIA 2020 replaced the earlier BOFIA, the Money Laundering (Prevention and Prohibition) Act 2022 replaced the 2011 Act, and the NRS has been replaced by the Nigeria Revenue Service under recent tax reform laws. In the exam, use the names in the syllabus unless the question gives the newer ones.

The rules in more depth

Why the evidence must stand up in court

A normal audit asks whether the financial statements are free of material misstatement. A forensic investigation asks whether a specific person did a specific thing, and the answer will be tested by lawyers. That is why the accountant documents carefully, keeps the evidence safe and records how it was obtained. The later topic on digital forensics deals with electronic evidence and the chain of custody.

Reactive and proactive

Most investigations start after a suspicion arises. But the same techniques, such as analysis of journals or payments for patterns, can be used before a fraud is found, to see where controls are weak. That is a preventative use.

Expert witness and advocate

An expert witness owes a duty to the court, not to the party who pays. The temptation is to act as an advocate for the client. The objectivity principle guards against that.

Worked example: working out the loss

Scenario. Panther Stores Ltd suspects that inventory is being stolen from its main depot. For the year, opening inventory was ₦120 million, purchases were ₦900 million and sales were ₦1,150 million. The normal gross margin is 25% of sales. The year-end count shows inventory of ₦112 million.

Step 1: expected cost of sales. Cost of sales should be 75% of sales, which is ₦1,150 million × 75% = ₦862.5 million.

Step 2: expected closing inventory. ₦120 million + ₦900 million − ₦862.5 million = ₦157.5 million.

Step 3: the shortfall. Expected closing inventory less counted inventory is ₦157.5 million − ₦112 million = ₦45.5 million. That is the possible loss, which is 45.5 ÷ 157.5 = 29% of expected inventory.

Step 4: test the figure before using it. A change in margin, price cuts, returns, count errors, cut-off errors or theft of cash instead of inventory could also explain the gap. The accountant compares margins year on year and by depot, tests cut-off and the count, reviews the controls over access and dispatch and interviews the staff who handle the inventory.

The report sets the shortfall out as an estimate with the assumptions it depends on, and does not state that theft has been proved.

How to score full marks

• Distinguish the three terms. Accounting prepares evidence. Investigation responds to suspicion. Audit is the method.
• For fraud, cover motive, opportunity and concealment.
• Use the facts. If the case involves payroll, say what the accountant would test in payroll.
• Mention confidentiality overridden by the court and legal privilege where money laundering is raised.
• Name the agency and its Act when the case names a type of crime.
• Show the loss calculation and say it is an estimate.

Common mistakes in the exam

• Saying the forensic accountant prosecutes the offender.
• Saying confidentiality can never be breached.
• Forgetting the advocacy threat to objectivity.
• Treating forensic work as an ordinary audit with the same standard report.
• Giving a loss figure with no workings or assumptions.
• Confusing the EFCC with the ICPC. The ICPC receives complaints about corrupt practices from the public.

Quick revision

• Forensic accounting: financial evidence for courts. Investigation: response to suspicion. Audit: the methods.
• Applications: fraud, negligence, insurance claims. Expert witness gives evidence to the court.
• Ethics: integrity, objectivity (advocacy threat), competence, confidentiality overridden by court, professional behaviour, privilege.
• Procedures: objectives, plan, evidence (motive, opportunity, concealment), interviews, opinion, report.
• Report: intended users and liability, assurance type, purpose.
• Agencies: EFCC, ICPC, Money Laundering Act, NRS, BOFIA.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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