ABA 401: AUDITING PRACTICE AND INVESTIGATION

TOPIC 5: AUDIT INVESTIGATIONS

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 TOPIC 5: AUDIT INVESTIGATION

TOPIC 5: AUDIT INVESTIGATIONS

Normally where auditors or accountants are involved in investigations, it will require specialized skills to carry out
the assignment.

5.1: FRAUD
- ISA 240 para 6 defines fraud as on intentional act by one or more individuals among management, employees or 3rd parties involving use of
deception to obtain an unjust/illegal advantage
Para 7 of identifies to forms of misstatement due to fraud;
1) Fraudulent financial reporting
2) Misappropriation of assets

5.1.1: Fraudulent financial reporting

- This involves intentional misstatements including omission of amounts or disclosures in financial statements to deceive financial statements
users while influencing their perception on entity’s performance and profitability. This involves engaging in complex transactions that are
structured and mis-represent the financial position/performance of an entity i.e creative accounting – It’s mostly commitment when
management is under pressure from outside or inside to achieve an unexpected/unrealistic goal
Example: a) Deception such as manipulation, falsification or alteration of accounting records or supporting decisions from which financial statements
are prepared e.g creation of a revaluation reserve(secret reserve when not approved) .
b) Mis–representation or intentional omission from financial statements events, transactions or other significant information e.g
contingent liabilities
c) Intentional mis-application of accounting principles related measurement, recognition, and classification, maneuver of presentation
or disclosure

5.1.2: Misappropriation of Assets

– Employees utilize loopholes in internal control systems e.g absence of segregation of duties, excessive power among management. It
involves theft of entity’s assets often perpetuated by employees, relatively small and immaterial amounts. It can also involve management
who are more intent to conceal misappropriations.
Example
a) Stealing physical asset or intangibles e.g intellectual property
 Stealing inventory for personal use
 Stealing scrap for resale
 Colluding with competitor’s by disclose technological data
b) Embezzling of receipts e.g misappropriating collections of accounts receivables by discerning receipts for personal accounts.
c) Attempt on entity to pay for goods and services not received.

- ISA 240 Para 5 Error –

This is an unintentional misstatement including omissions of an amounts and disclosures such as:
1) Mistakes in gathering or processing data from which financial statements are prepared e.g mathematics /decimal mistakes (error of
commission, omission, principle; compensating, duplication and
2) Unreasonable accounting estimates arising from over sight or misinterpretation of facts e.g provision of doubtful debts, depreciation e.t.c

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 TOPIC 5: AUDIT INVESTIGATION

3) Mistake in application of accounting principles relating to measurements, recognition classification ,presentation or disclosures (IAS 18)
&(IAS 38)

5.1.3: Auditor’s responsibility in respect to reporting fraud discovered during clients audit
- ISA 240 states that; when an auditor has obtained evidence that fraud exist or may exist, it is important that the matter be brought to the
attention of appropriate level of management as soon as is practical. This is so even if the matter is considered inconsequential.
Determination of level of management is appropriate, and is a matter of professional judgment and is affected by such factors as like hood of collision
and nature and magnitude of suspected fraud. Ordinary appropriate level of management is at least one level above the person who appear to be
involved in the fraud
- If auditor has identified fraud he/she should involve the following;
1) Management
2) Employees who have significant roles in internal controls
3) Where fraud results in material misstatement then;
- Auditor should communicate this to those charged with governance as soon as practicable.
- If auditor suspects that fraud involves management then the auditor should communicate such to those charged with governance and also
discuss with them the nature, timing and extent of audit procedures necessary to complete the audit. If integrity/honesty of management and
those charged with governance is doubtable then the auditor should consider seeking legal advice for appropriate course of action

5.1.4: Management responsibility

a) Comply with corperate governance where there are supposed to put procedures to detect and control activities in achieving objectives.
b) Develop code of conduct in monitoring compliance and taking action against fraud and irregularities.
c) Develop/Establish a system of internal control, monitor its effectiveness and take corrective measures.
d) Establish an internal audit function which reports objectively and in a timely manner to prevent, detect and correct fraud and irregularities.
e) Establishing an audit committee to facilitate independence to both internal and external auditors and solve any disagreements between auditors
and management.

5.1.5: Sarbanes – Oxley Act – 31th July 2002 in the U.S

 Most significant legislation since securities exchange act in 1934
 New 5 member publics companies accounting oversight board was formed
 Authority to set and enforce auditing attestation quality control and ethical standards for auditors of public companies.
 Empowered to inspect auditing operations of public accounting firms that audit public co.’s as well as impose disciplinary and remedial
sanctions for violation of board auditing rules.
 Rotation of lead audit partner every 5 – years

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5.2: INVESTIGATIONS

Financial reporting fraud Misappropriation of asset fraud

 Improper asset valuations  Using of company credit card for personal use
 Unrecorded liabilities  Employees remaining on payroll after leaving employment
 Timing differences i.e bringing fraud recognition of  Unauthorized discounts or refunds to customers
revenue and delaying recognition of expenses  Theft of inventory by employees or customers
 Recording fictitious assets  Using companies car for unauthorized personal use
 Understating expenses
 Inappropriate application of accounting principles

5.2.1:Incentives and pressures to commit fraud

When an auditor becomes aware of any of the following risk factors in isolation or combination they should plan
audit to obtain evidence in relation to each factor. Examples of incentives and pressures that increase risk of client
committing fraud:
1) Operating in a highly competitive industry
2) Significant decline in demand for services and products
3) Falling of profits
4) Threats of takeover
5) Threat of bankruptcy
6) Planning to raise debt or a negative a loan
7) Ongoing losses
8) Rapid growth
9) Pressure to meet market expectations
10) Planning to list on stock exchange
11) About to enter into a signification new contract

5.2.2:Opportunities to perpetrate fraud

- After identify one or more incentive/pressures, an auditor will assess whether a client had an opportunity to perpetrate fraud. An Auditor will
frequently use past experience and knowledge of client. In assessing the following list, auditor must use professional judgment to assess each
opportunity in the context of the risk indicators and consider available evidence thoroughly. Examples include;
1) Account that rely on estimates and judgment
2) High variations of transaction to year end
3) Significant adjusting entries and reversals after year end
4) Significant related party transactions
5) Poor corporate governance
6) Poor internal controls
7) High turnovers of staff
8) Reliance on complex transactions
9) Transactions cut of character of a balance sheet e.g if a client leases its motor vehicles, it should not have car registration expenses

5.2.3: Attitudes and Rationalization to Justify Fraud

- Together with identification of incentives to commit a fraud and opportunities to perpetrate a fraud, an auditor will assess the attitude and
rationalization of client management and staff to fraud. Attitude refer to ethical beliefs being right and wrong
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Rationalization – an ability to justify an act. Following indicate characteristics which may indicate presence of fraud:-
1. A poor tone at the top i.e- A Senior Manager
2. Implementation of an effective internal control structure not seen as priority
3. An excessive focus on maximization of profits and or share price
4. Rationalization that other companies make the same inappropriate accounting choices

5.2.4: FORENSIC AUDITS

- This has a broad spectrum of activities with a terminology not strictly defined in regulatory framework and generally the term forensic
accounting is used to describe the wide range of investigative work which accountants in practice will be asked a perform.
- The work normally involve an investigation into financial affairs of an entity often associated with investigation into alleged fraudulent
activity.
Forensic accounting refers to the process of investigating financial matters including potentially acting as an expert witness if fraud comes to trial.
This term forensic accounting including forensic investigation which itself refers to practical steps that forensic accountant takes to together evidence
relevant to the alleged fraudulent activity.
The investigation is similar in many ways to an audit of financial information. Generally it takes the following stages:
1) Planning stage
2) Period when evidence’s is gathered
3) Review process
4) Report to client
5) Financial auditing refers to specific procedures
6) Auditing techniques are used to identify and gather evidence e.g
 How long fraud has been carried out
 How it was conducted and concealed by perpetrators
 Evidence may also be gathered to support other issues which could be relevant in event of a court case e.g
i.Suspect motives and opportunity to commit fraud
ii.Whether fraud involved collusion between several suspects
iii.Any physical evidence of scene of crime or contained in documents
iv.Comments by suspects during interview and or at time of arrest
v.Attempts to destroy evidence

5.2.5:Types of investigations

Generally 3 categories of fraud;

i.Corruption
ii.Asset misappropriation
iii.Financial statements fraud

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Corruption

3Types of corruption fraud

a) Conflict of interest
b) bribery
c) extortion

Research shows that corruption is involved in a third of all fraud.

a) In conflict of interest fraud, the frauds-star exerts influence to achieve personal gain which detrimentally affects the company. The fraud-
star may or may not benefit financially but rather receive un authorized personal benefit as a result of the situation eg A manager may
approve expense of an employee who is also a personal friend in order to maintain that friendship even if expenses are inaccurate.
b) Bribery is when money or something else of value is offered in order to influence a situation.
c) Extortion is opposite off bribery and happens when money is demanded rather than offered to seek a particular outcome.

FORENSIC ACCOUNTI
NG

FORENSIC
ACCOUNTANT

FORENSIC
FORENSIC INVESTIGATION
AUDITING
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5.2.6:FORENSIC ACCOUNTING

 Uses accounting auditing and investigating skills to conduct an examination into a co.’s financial statements.
 Most often used to produce an accounting analysis to enable lawyers, insurance co.’s. or others to resolve disputes.

a.)Forensic accountants
 Trained to look beyond numbers and deal with business reality of the situation.
 Require an ability to analyze, interpret, summarize and present complex financial and business related issues.
 Will be familiar with legal concepts and procedures
 Require ability to communicate financial information and concisely in court room

b.)Forensic investigation
 Involve use of specialized investigation skills to carry out inquiries in such a manner that the outcome will have application to court of law.
 May be grounded in accounting, medicine, engineering or some other discipline.

c.)Forensic audit
 Application of auditing shills to situations that have legal consequences.
 Examination of evidence regarding an assertion to determine correspondence of established criteria carried out in a manner suitable to the
court.

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The following are major application of forensic auditing:

APPLICATION EXAMPLES TYPE OF WORK

PERFORMED
i. Fraud investigations -employee embezzlement - fund tracing.
of Co. funds -asset identification and recovery

-Tax evasion - forensic intelligent gathering

in order dealings.

-due diligence reviews.

-Interviews.

-detailed review of

documentary evidence.

ii. Insurance claims business interruptions -detailed review of policy from

either insured or insurers
perspective.

Property losses

Motor vehicle evidences

Personal liability claim

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Cases of medical malpractices

As part of assignments, forensic accountant will;

i. Communicate their findings in form of a report, exhibits and collections of documents.

ii. Assist in legal proceedings including testifying in court as an expert witness and preparing virtual aids to support trial evidence.
iii. Forensic accountant may be used as expert witness in the following situations:
 Where it is relevant for a matter that is in dispute between the parties.
 It is reasonably required to resolve the proceedings.
 Have expertise relevant to the issue in which opinion is sort.
 Have experience, expertise and training appropriate to revalue complexity importance of case.

d.)Forensic accountant must observe fundamental ethical principles such as;

1. Objectivity- In particular accountant must safeguard against self-review and advocacy threats. Advocacy threats arises because firms may
feel pressed into promoting the interest and point of view of their fee paying client which breach concept of objectivity of audit preceding
self-review. Threats arise when an auditor also becomes involved in some form of forensic work because the investigation is likely to
involve some form of fraud potential misstatements to accounts.
2. Integrity- Given their nature of work, forensic professionals are likely to deal frequently with individuals who lack integrity or may be
involved in criminal behavior hence forensic accountant must observe integrity (auditors independence).
3. Professional competence and due care- Forensic investigations involves very specialized skills including:
 Detailed knowledge of relevant legal framework.
 Understanding on how to gather specialized evidence.
 Skills in safety of court of evidence including maintaining, a clear ‘chain’ of evidence.
 Strong personal skills, interview techniques and presentation of matters at court.
4. Confidentially – In court and out of court
5. Professional behavior – Fraud investigations has become a matter of public information which draws media attention often focused on work
of forensic investigator hence high professional attitude is necessary at all times

e.)Gathering and evaluating evidence

Types of evaluation and analysis required largely depend on nature of assignment undertaken. However this will
cover the following elements;

Investigative procedures Evaluations

i. Locate documents, economic information, assets, i) calculate economic damage

a person or company

ii. Identify an expert’s witness ii) perform regression and sensitivity analysis

iii. Gather proofs of occurrence of an event iii. Summarize large no. of transactions
iv. Carry out interview s iv. Perform present value calculations
v. Carry out detailed review of documentary v. utilize computerized applications to
evidence analyze data
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vi. Perform due diligence review vi.use charts and graphs to explain analysis

f.)A REPORT

Once a forensic investigation is complete, a forensic accountant will write and submit the forensic findings. It will
address terms of the assignment eg quantification of a loss. The report may include the following:

i. Nature of the assignment.

ii. Scope of investigation.
iii. Approach utilized.
iv. Limitation of scope.
v. Findings and or opinion.

The report will include situation and graphics as necessary to support and explain the findings.

g.)Elements of an Expert Report

 Gives details of expert’s qualification, relevant experience and accreditation.

 Give details of any literature or other information that the expert has relied on in making the report.
 Contain a statement setting out the substance of all facts given to courts as material to opinion expressed in the report or upon which those
opinions are based.
 Make clear which of the facts stated on the report are within experts own knowledge.
 Say who carried out any examination, measurement, test or experiment that the expert used in the report and;
 Give qualification, relevant experience and accreditation.
 Say whether or not examination, measurement, or test was carried out under expert supervision.
 Summarize findings of the experts views.
 Where there are a range of opinion matters;-summarize range of opinions, Give reasons for his/her own opinion.
 If expert is not to give his opinion without qualification, state qualification.
 Contain summaries of conclusion reached.
 Contain a statement that expert understand his/her duty to the court and has complied and will continue to comply with that duty.
 Contain the same declaration of truth as a witness statement.

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