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Forensic reviews and financial statement audits; how do they differ?

  1. Overview of the audit
    • An audit, usually conducted annually, is a properly planned and conducted independent outside examination of financial statements, permitting a chartered accountant to provide an opinion as to whether the financial statements present fairly the results for the period and the financial position at the end of that period on a basis consistent with prior years and in accordance with Generally Accepted Accounting Principles (GAAP).
    • The auditorís opinion as to whether the financial statements "present fairly" the results for that period and the period-end position does not mean that the auditors have addressed transactions that are below a certain size or scope, in that they are not considered "material" to the financial statements.
    • Auditors are clear that it is not their responsibility to detect fraud or illegal acts. That is considered to be the responsibility of management through its system of internal control and its code of corporate conduct.
    • However, when auditors do find fraud they will investigate it and report on their findings.
    • An audit can either be substantive in nature, which means that the internal control systems cannot be relied on for providing financial information that can be examined, or it can be reliance based, meaning that the internal controls and internal audit procedures permit the auditors to rely on the internally generated financial information in the conduct of their audit.
    • Substantive audit procedures include:
      • confirmations with outside third parties (i.e. banks and custodians of assets);
      • reviews of documents;
      • test vouching of balance sheet items including receivables and capital assets;
      • analytical review of accounts payable and revenues and expenses; and
      • test vouching of significant revenue and expense items.
  2. Overview of a forensic review
    • A forensic review is undertaken on an "as required basis". The catalyst for such a review can be a prospective change in ownership, requiring a due diligence forensic review, or a change in management or the existence of red flags that suggest that there may have been and may be on a continuing basis, acts that violate criminal law, common law or the accepted code of corporate conduct.
    • The forensic accountant accepts that his or her responsibility is to detect fraud or illegal acts, not as a by-product of another procedure, but as the main purpose of the assignment. This responsibility is usually clearly set out in the letter of engagement.
    • The forensic review looks at substance over form and all the details of the transactions over a period of time to gain a more complete understanding of the underlying purpose of what was being done, as well as the ostensible purpose of what was done.
    • The forensic review looks at documents on a much more complete basis, without regard for the quantum. Further, the non-financial documentation is analyzed in detail to determine if the extent to which it supports or contradicts the financial information.

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We provide on the attached page a short table that sets out some of the other aspects of how a financial statement audit and a forensic review differ.

Factor Financial Statement Audit Forensic Review
Users The financial statement audit reports to the shareholders and other stakeholders on whether the financial statements present fairly the results for the period. The forensic review is directed to the courts as well as the stakeholders and shareholders.
Client The financial statement audit is provided for the shareholders. The forensic review is generally provided to the clientís lawyer, either external counsel or in-house counsel. On this basis, communications between forensic accountant and lawyer are generally privileged.
Independence Auditor cannot be a shareholder, officer, director or with any linkages which would cause perceived independence from audit client to be questioned. In addition to restrictions for the auditor; forensic accountant should avoid being in a conflict of interest arising from being a supplier to both sides of a dispute or of being the financial statement auditor in a review concerning undetected fraud.
Approach Financial statement auditors are analytical, methodical and use reasonable scepticism. A forensic review endeavours to determine what should have been and uses much more detailed analysis for that assessment. Unusual, complex or convoluted transactions without a valid business reason are scrutinized carefully.
Improper acts Financial statement audits are not directed to discovering fraud; they are deductive rather than intuitive. The forensic review is focused on addressing red flags concerns and suspicions. The forensic review relies on deductive skills as well as intuitive skills and to identify previously unidentified problems. Forensic accountants often will role play what auditors do.
Basis of reporting A financial statement audit reports on whether the statements examined present fairly in accordance with GAAP and consistent with prior years. The forensic review is investigative in its orientation.

Documentation, interviews and other evidence support the reporting on any wrongdoing. The forensic review reports on whether, on the balance of probabilities or beyond a reasonable doubt, improper acts have occurred.

Time period The financial statement audit concentrates on the one-year period being examined. The forensic review looks at the entire period activity, whether it is less than or more than one financial year. The "big picture" is sought.
Materiality Materiality, being the amount that would affect the opinion of the users of the financial statements, is typically set as a percentage of the balance sheet assets and/or as a percentage of the statement of income and expenses.

Transactions below this threshold are generally not examined, as they would be immaterial to the opinion being expressed.

The forensic review is not limited by quantum issues. It is driven by the concept of substance over form. The emphasis is on addressing the concerns about the organization and in reviewing the documentation to determine if these concerns are warranted, and if so to what extent.
Emphasis The financial statement audit concentrates on the accuracy, timeliness and completeness of the recording of the transactions. Limited testing is performed. The forensic review looks at the weak links in an organizationís system of internal control. Transactions are reconstructed through third parties, interviews and other evidence. Evidence is carefully gathered and preserved for reporting and for possible use in the courts.
Documentation review and retention The trend in audits is for the "paperless audit" in that the audit files contain a minimum of supporting documentation with the working papers being the main source of audit evidence. The forensic review gathers, analyzes, compares and safeguards documentation.

The forensic review examines documents to determine if there are indications of forgery, alternation, and file culling, for example. The reasonableness and underlying purpose of the documents are assessed.

The forensic review endeavours to differentiate between items to "paper" the file and the underlying purpose of the transactions.

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