Nature, objectives and types of forensic accounting services

A Lagos company finds that ₦150 million has gone missing over two years. The board calls its external auditors, but the audit report was clean. The board then hires a different type of accountant, one who can trace the money, name those responsible, put a figure on the loss and prepare evidence that will stand up in court. That accountant is a forensic accountant.

The word "forensic" means usable in a court of law, and this branch of accounting is built to produce evidence a court will accept.

This topic covers the meaning and nature of forensic accounting, forensic investigation and forensic auditing, the objectives of a forensic engagement, the services forensic accountants provide, the skills they need, the types of fraud, fraud risk assessment, ethics in a forensic assignment, the steps and procedures of a fraud investigation, and a comparison with the statutory audit. The previous topics covered technology in audit, and the next covers economic damage.

Key terms in plain English

Syllabus check

This topic is in syllabus area D, forensic accounting services (15% of marks). It covers:

• the meaning, nature and objectives of forensic engagements
• types of forensic accounting services
• types of fraud and fraud risk assessment
• ethics in forensic investigations

CAMA 2020 and forensic work

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

What forensic means

In general terms "forensic" means usable or acceptable in a court of law. It also relates to the use of science and technology to produce evidence for the courts. The American Heritage Dictionary describes forensics as the use of science and technology to investigate and establish facts in criminal and civil courts.

Forensic services play a key role in resolving crimes, civil or criminal, by collecting and analysing data from many sources and using the outcome in court proceedings. They can help to identify the suspect, the crime committed, the scene, and the amount of money, damage or documents stolen.

Forensic services are usually an independent and comprehensive review of an individual's activities or a company's financial statements to find out whether they are accurate and whether any financial benefit has been obtained by presenting an unrealistic picture or by illegal activity. When illegal activities occur, damage follows, and the party affected may seek redress in court to claim damages.

Evidence is needed to prove or disprove the illegal or unethical activity.

Forensic accounting, investigation and auditing

In the accountancy profession the basic terms are forensic accounting, forensic investigation and forensic auditing.

• Forensic accounting is the preparation of financial information to be used as evidence in court. It divides into forensic investigation and forensic auditing.
• Forensic investigation is carried out in response to a suspicion of wrongdoing, usually to prove or disprove assumptions, for example that A is carrying out a fraud or that B was negligent in some work. It involves the practical steps used to prepare and analyse financial information to resolve an allegation of wrongdoing. Part of the objective is to obtain evidence for use in legal proceedings to resolve a dispute or to prove innocence or guilt in a criminal case, such as evidence of money laundering.
• Forensic audit is an element of forensic investigation. It refers to the methods and procedures used to obtain audit evidence in the investigation. It is the process of gathering, analysing and reporting on data, much of it financial, in the defined context of a legal dispute or an investigation into suspected irregularities, and in some cases of giving preventive advice.

The three terms are closely connected, and an exam question may use any of them.

Nature of forensic work

• It is an investigative assignment.
• It is mostly required by a court in settling disputes.
• Its outcome often results in economic or commercial damages.
• An individual or organisation must have behaved unethically.
• Tort and negligence are issues, especially in civil matters.
• It requires skill, expertise and experience.

The forensic engagement and its objectives

A forensic engagement is the process of applying forensic accounting, investigation and analytical skills to help resolve a dispute, investigate an allegation of unethical conduct or analyse financial information for litigation. The objectives vary with the client's needs, but the common ones are:

• Investigative: collect and analyse data, documents and witness evidence to prove or disprove allegations; determine the extent of the wrongdoing, who was involved and the method used; and find hidden assets or transactions by tracing.
• Analytical: examine records and statements to find irregularities, discrepancies or signs of unethical conduct; evaluate the credibility of witnesses; and assess the validity of documents.
• Litigation support: give expert opinion and testimony; prepare reports and exhibits, such as clear and brief reports and visual exhibits; and help with the production and disclosure of documents.
• Risk management: identify and assess financial, operational and reputational risks; evaluate vulnerabilities; and advise on improving internal controls, policies and procedures to prevent, detect or correct wrongdoing.
• Regulatory compliance support: help the organisation meet regulatory requirements and comply with relevant laws and standards.

In terms of the type of work, forensic engagements involve litigation support, which is helping lawyers in financial disputes; fraud detection and prevention; damage computation, which is determining losses in a dispute; and regulatory compliance.

Forensic accounting services and skills

Forensic accounting services apply accounting, auditing and investigative skills to resolve disputes, investigate allegations of wrongdoing or analyse financial data for litigation. Forensic accountants use:

• accounting and auditing skills to analyse financial data, identify irregularities and track transactions;
• investigation skills to gather evidence, interview witnesses and analyse documents; and
• analysis and interpretation skills to interpret data and find trends, patterns and anomalies.

A good forensic auditor needs:

• accounting skill
• data analysis skill
• fraud detection skill
• interrogative skill, which is questioning
• skill in custody and preservation of evidence
• legal skill
• presentation skill, the ability to communicate findings in language a lay person understands as an expert witness
• investigation skill

Types of forensic accounting services

Forensic services are applied in:

• fraud investigations, such as bribery, embezzlement and money laundering
• financial statement analysis for irregularities
• asset tracing and recovery, which is finding hidden or misappropriated assets
• damages computation for negligence, tort, breach of contract or business interruption claims
• business valuation, for example in divorce, shareholder disputes or partnership disagreements
• financial forensic analysis, which analyses data for trends and anomalies
• litigation support, such as expert testimony on lost profit from a breach of contract

Red flags of fraud

A forensic accountant looks for warning signs. In people, these include an employee who lives beyond visible means, never takes leave, refuses to share duties, is under financial pressure or is unusually close to a supplier or customer.

In records, they include missing or altered documents, photocopies where originals should exist, unexplained differences between ledgers and bank statements, round-sum or unusual journals, transactions just below approval limits, duplicate payments, payments to unknown or new suppliers, and adjustments made late at night or at weekends.

In the business, they include weak controls, high staff turnover in key finance posts, pressure to meet targets, complex structures and frequent changes of auditors. A red flag is not proof. It tells the investigator where to look.

Kinds of evidence and how to preserve it

Evidence for a court may be documentary (invoices, contracts, bank statements, e-mails), physical (assets, original documents), electronic (files, logs, messages) and testimonial (statements by witnesses and the suspect). It must be relevant, reliable and obtained lawfully. The investigator keeps a chain of custody: a record of who handled each item, when and where, so that the court can be sure it is unchanged.

Original documents are secured, copies are marked and logged, electronic data is copied by methods that do not change it, and every step is written down. Evidence obtained by illegal means, such as unauthorised access to a private account, may be excluded, so the accountant takes legal advice before acting.

Interviewing witnesses and suspects

Interviews are planned. The investigator starts with the people furthest from the suspect and gathers documents first, so that questions are specific. Open questions are used to get the witness's account, followed by closed questions to check detail. The suspect is interviewed last, with the evidence in hand, and in line with the law and the company's policy, usually with a witness or a lawyer present.

Notes are made at the time and signed where possible. The investigator does not threaten, promise anything or suggest answers, because that can make a statement unusable and damage the investigator's credibility.

A forensic report must also deal with the limits of the work: what documents were not available, which witnesses declined to be interviewed and which conclusions rest on assumptions. A court gives more weight to a report that is open about its limits than to one that claims certainty it cannot support.

Early in an engagement the forensic accountant should also agree in writing who the client is, who will receive the report, whether the work is for a court or for internal use only, and what fees and access rights apply. The terms protect both sides if the work later becomes part of legal proceedings.

Benefits of forensic accounting services

• An objective, unbiased analysis of financial data.
• Specialised skill and training that give users confidence in the report.
• It can be cost-effective compared with traditional litigation or audit approaches.
• It can resolve disputes and investigations faster than the traditional approach.
• The evidence generated is relevant and reliable in court.

Types of fraud

The Association of Certified Fraud Examiners (ACFE) outlines three categories:

Fraud risk assessment

Eliminating fraud risk may not be possible if the organisation wants to stay in business. The aim is to reduce it to an acceptable level. A risk analysis looks at the impact and the probability of fraud: risk is the product of the two. Impact shows the likely damage, and probability shows the threats and vulnerabilities.

Factors in probability are the industry, the ethical values of senior management and staff, the effectiveness of preventive and detective controls, the business environment and the whistleblower process. The assessment decides the level of control to apply and finds the potential areas of fraud, internal or external, direct or indirect. Things that limit fraud are segregation of duties, physical safeguards of assets, independent checks, proper authorisation and proper recording.

The classic causes are pressure, opportunity and rationalisation: the fraud triangle.

Case: Jentus company

Jentus has 89 staff and a monthly payroll of about ₦28 million. After a fraud by a former director and the sales manager, it redesigned its controls and put the senior accountant in charge of payroll (Tope) and the chief internal auditor (Jaiye) on the committee. Jaiye needed ₦12 million for a family problem and was turned down by a bank.

He approached the director of audit, Jegede, whose approval was needed to release salaries. Jaiye promised Tope a good appraisal. Tope added ₦25 million to the payroll for fictitious bonuses and allowances, when management had approved ₦3 million. The director of audit received his share, and Tope was promoted. The company lost ₦23 million.

Lessons: those who designed the controls knew how to override them; collusion defeated segregation and approval; the pressure was financial, the opportunity was an unreviewed payroll and the rationalisation was the belief that the company would not miss it; and the victim relied on senior staff of long standing, so trust was not matched by independent checks.

Ethics in forensic investigation

The fundamental principles apply:

• integrity (honest and truthful findings and testimony)
• objectivity (unbiased, impartial and avoiding conflicts of interest)
• professional competence and due care (the firm must have the resources and skill)
• confidentiality (protect sensitive information)
• professional behaviour (acting in a way that does not harm the profession's image, as the accountant often appears in court)

Objectives of a fraud investigation

1. To prove that a deliberate fraud has taken place.
2. To identify the perpetrators.
3. To quantify the loss.
4. To gather evidence useful in court.
5. To advise on preventing a recurrence.

Steps in a fraud investigation

1. Establish the type of fraud, for example intentional material misstatement of inventory.
2. Identify how it was carried out and escaped detection, for example by overriding internal control.
3. Gather evidence that proves or disproves that the fraud took place, who committed it, the amount stolen or the asset misappropriated, and that is relevant to the allegation.
4. Report to the client, summarising the evidence, the detailed amount of the loss and the suspects.

Planning. Identify the objective; understand the circumstances and events, including whether fraud occurred, how, and for how long; understand the context, such as the laws and regulations that govern the investigation; identify any limit on the scope, since the investigator should be allowed to obtain evidence from all sources he identifies; evaluate resources; choose the team; develop hypotheses; decide the approach; develop strategies to obtain information; and decide the effect of timing on reporting.

General procedures. Ask management and understand the context; find out the objectives and the action taken so far.

For a fraud allegation, procedures include:

• develop a profile of the entity and its personnel
• identify weaknesses in internal control and basic record keeping, such as monthly bank reconciliations
• do trend analysis and analytical procedures to find significant transactions and variations
• identify unusual account balances, such as credit balances on debit accounts
• review the records for unusual transactions, such as those not at normal commercial rates
• review documents, such as invoices, for disagreement and inconsistency
• identify changes in patterns of purchases, cost of sales and sales
• obtain information on the responsibilities of the people involved in the transactions
• trace the individual responsible
• consider other business activities of that individual and perform analytical procedures there to find other discrepancies

Statutory audit compared with forensic audit

Similarities. Both go through acceptance, planning, evidence gathering, review and reporting. The same fundamental ethical principles apply. Both use tests of controls and substantive procedures, and the same techniques, such as enquiry, observation, analytical review and confirmation. Both require a high level of professional scepticism and quality control.

Worked examples

1. This is corruption: bribery and a conflict of interest.
2. The investigator traces the orders, prices and payments to the supplier.

1. That is a forensic investigation: reactive, specific, no opinion and evidence for court.
2. A statutory audit would give an opinion on the whole statements, using materiality.

1. The probability of fraud is high.
2. If cash receipts are large, the impact is high, so risk is high and controls must be strengthened.

1. An unusual balance is a red flag.
2. The investigator traces the entries to documents and to the person who posted them.

How to score full marks

• Define the three terms and show how they are connected.
• List the objectives and the services.
• Use the ACFE three categories of fraud.
• Compare with the statutory audit using a table.

Common mistakes in the exam

• Saying a forensic audit gives an audit opinion.
• Applying materiality as in a statutory audit.
• Missing the ethics principles.
• Omitting how the fraud escaped detection.

Quick revision

• Forensic: usable in court. Accounting, investigation, audit.
• Services: fraud, statements, tracing, damages, valuation, litigation.
• Fraud: corruption, misappropriation, statement fraud.
• Five ethical principles; no opinion and no materiality.

Practice questions

Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.

Model answers

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