POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

FORENSIC AUDIT
Forensic Auditing

Forensic Accounting
Definition Forensic Investigation
Forensic Audit

Forensic means: Suitable for Court use

Forensic Accounting

Forensic Investigation Forensic Audit

Forensic Accounting – The combination of accounting, auditing and investigation skills to

provide accounting analysis (prepare financial paper) useful for court / Legal proceedings.

Forensic investigation – Refers to the practical steps used to obtain encloses relevant to the
resolution of legal / financial / Administration dispute in response to a suspicion or allegation. It
involves planning, evidence gathering, review and reporting
Forensic Audit – Refers to the specific procedures performed to obtain evidence usually for the
purpose of quantifying a financial loss.
Differences between external Audit and forensic Audit

S/N External Audit Forensic Audit

1 Regulated by external / professional body Little or no regulation
2 Opinion / Assurance report No Opinion
3 Sampling is needed Not likely - extensive testing
4 Persuasive Evidence Water-tight (conclusive) evidence
5 Financial / Accounting and auditing skill Accounting / Auditing / Legal
investigations
6 Materiality level and determined No materiality level

Common Areas of Forensic Audit Application

- Fraud Investigation
- Matrimonial Dispute
- Insurance Claim
- Bribery & Corruption

99
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

- Bankruptcy Settlement & Insolvency

- Payment relating to Act of Negligence
- Tax Evasion
- Money Laundering
- Partnership Disagreement
- Terrorism financing

Question:
Explain how the fundamental principles could be applied to a forensic audit assignment.
- What happened?
- When did it happen
- Who was involved?
- Why did it happen?
- How much is involved?

PRACTICE QUESTION A
Question:
Your audit client of 6 years (ABC) PLC) is a big manufacturer of electrical equipment with market
capitalization of N756 billion. Recent newspaper publication about a suspected fraud of N300m
on their Lagos office has led to a reduction of their share price from N25/unit to N16/unit.
Worried about this development, the Board of ABC PLC has invited your firm to carry out a
forensic audit at their Lagos office to determine the actual lost and those who were involved. The
group MD/CEO has threatened to charge every staff involved to the Lagos high court. Please note
that the fraud relates to payment of fictitious suppliers.

Requirement
a. Explain the factors your firm would consider before accepting the new assignment
b. Describe 5 forensic audit procedures you will perform to achieve the objectives
c. Outline the likely contents of your final report.
Solution 1
a. Significant ethical threats that includes self-interest, self-review and advocacy threat
b. Competence required to perform the job
c. Level of knowledge the auditor already has about the Lagos office activities
d. Reporting deadline
e. Legal issues (laws and regulations) guiding forensic Auditing
f. Willingness of the management to grant access to the Lagos office.
Solution 2:
a. Discussion with the Head of Lagos office to understand the issue at hand.
b. Determine the extent of work already performed by the internal auditors regarding the
issue by discussing with them.

100
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

c. Develop a profile of all the suspects by conducting a background check on all the suspects.
d. Extract the list of suppliers paid from the bank statement / cash book and match them to
the approved supplier list.
e. Verify the suppliers on the approved supplier list to that of the company registry
f. Match the staff profile list to the approved supplier list for matching records of name of
directors, phone number, next of kin
g. Match the goods received / delivery note to that of the invoice.
h. Review the correspondence between the company and relevant third party such as
policemen, solicitors etc.
i. Content of the forensic report.
• Cover page
o Name of partners that
o Title
o Period reviewed
• Table of contents
• Executive summary
• Background information / introduction/objective of the assignment /
• Procedures performed (discussions and meetings held, conclusions from evidence)
• Factual findings
• Any limitation encountered
• Internal control weaknesses that led to the fraud / preventive measure for future use.
• Declaration stating that information in the report is to the best the forensic knowledge,
truthful.
• Name and signature of the forensic auditors
• CV of the Forensic Auditors on the back page of the report.

PRACTICE QUESTION B
Forensic audit covers a broad spectrum of activities whose terminology is not strictly defined in
regulatory guidance.
Required:
a. What is Forensic Audit?
b. State TEN situations which might require the services of a forensic auditor.

c. State FIVE qualities of a forensic auditor.

d. State THREE differences between forensic audit and financial audit.

101
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

SOLUTION
(a) Forensic audit refers to the procedures carried out in order to obtain reliable and acceptable
evidence for anticipated disputes or litigation. It involves the use of auditing and investigative
techniques to identify and gather evidence. The forensic auditor is often required to act as an
expert witness when matters are brought up in court.
(b) Situations requiring the services of a forensic auditor include:
(i) Theft and frauds
(ii) Bribery allegations
(iii) Tax evasion
(iv) Insider dealings
(v) Wrongful dismissals
(vi) Business interruptions
(vii) Property losses
(viii) Insurance claims
(ix) Personal liability claims
(x) Construction claims

(c) Qualities of a forensic Auditor

(i) Ability to identify fraud with minimal information
(ii) Identification of financial issues significant to the matter
(iii) Knowledge of investigative techniques
(iv) Knowledge of the rules of evidence in court
(v) Ability to interpret financial information
(d) Differences between Forensic Audit and Financial Audit
(i) Financial audit aims at giving an audit opinion on the financial statements while forensic audit
aims at detecting material frauds and misstatements
(ii) Financial audit depends on examination of audit trail while forensic audit depends on
examination of events and activities behind the documents
(iii) Financial audit is conducted strictly according to standards, guidelines and
applicable legislations whereas no such restriction is placed on the scope of forensic audit
(iv) Financial audit is usually statutory whereas forensic audit is on ad hoc basis
(v) The financial auditor reports to members of the auditee while forensic auditor
reports to the persons who appointed him.

PRACTICE QUESTION C
(a) The audit committee of the Group has contacted Kennel & Co to discuss an incident that
took place on 1 June 2013. On that date, there was a burglary at the Group's warehouse where
inventory is stored prior to dispatch to customers. CCTV filmed the thieves loading a lorry
belonging to the Group with boxes containing finished goods. The last inventory count took place
on 30 April 2013. The Group has insurance cover in place and Kennel & Co's forensic accounting

102
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

department has been asked to provide a forensic accounting service to determine the amount to
be claimed in respect of the burglary. The insurance covers the cost of assets lost as a result of
thefts.
It is thought that the amount of the claim will be immaterial to the Group's financial statements,
and there is no ethical threat in Kennel & Co.’s forensic accounting department providing the
forensic accounting service.
Required:
In respect of the theft and the associated insurance claim:
(i) Identify and explain the matters to be considered, and the steps to be taken in planning the
forensic accounting service; and
(ii) Recommend the procedures to be performed in determining the amount of the claim.
Note: The total marks will be split equally between each part.
(b) Bulldog Co
Bulldog Co is a clothing manufacturer, which has recently expanded its operations overseas. To
manage exposure to cash flows denominated in foreign currencies, the company has set up a
treasury management function, which is responsible for entering into hedge transactions such as
forward exchange contracts. These transactions are likely to be material to the financial
statements. The audit partner is about to commence planning the audit for the year ending 31 July
2013.
Required:
Discuss why the audit of financial instruments is particularly challenging, and explain the matters
to be considered in planning the audit of Bulldog Co's forward exchange contracts.

SOLUTION -fKennel & Co.)

(a) (i) Planning a forensic investigation
Planning the investigation will involve consideration of similar matters to those involved in
planning an audit.
The planning should commence with a meeting with the client at which the investigation is
discussed. In particular, the investigation team should develop an understanding of the events
surrounding the theft and the actions taken by the client since it occurred. Matters that should be
clarified with the client include:
- The objective of the investigation - to quantify the amount to be claimed under the
insurance cover;
- Whether the client has informed the police and the actions taken by the police so far;
- Whether the thieves have been captured and any stolen goods recovered;
- Whether the thieves are suspected to be employees of the Group;
- Any planned deadline by which time the insurance claim needs to be submitted;
- Whether the client has contacted the insurance company and discussed the events leading
to the potential claim.

103
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

The insurance policy should be scrutinized to clarify the exact terms of the insurance, to ensure
that both the finished goods and stolen lorry will be included in the claim. The period of the
insurance cover should be checked, to ensure that the date of the theft is covered, and the client
should confirm that payments to the insurance company are up to date, to ensure the cover has
not lapsed.
The audit firm should also consider the resources that will be needed to conduct the work. Kennel
& Co has a forensic accounting department, so will have staff with relevant skills, but the firm
should consider if staff with specific experience of insurance claims work are available.
The client should confirm that the investigation team will have full access to information required,
and are able to discuss the matter with the police and the insurance company without fear of
breaching confidentiality. The output of the investigation should be confirmed, which is likely to
be a report addressed to the insurance company.
It should be clarified that the report is not to be distributed to any other parties. Kennel & Co
should also confirm whether they would be required to act as expert witness in the event of the
thieves being caught and prosecuted.
Tutorial note: Credit will also be awarded for explanations of acceptance issues such as the need
for a separate engagement letter drawn up to cover the forensic investigation, outlining the
responsibilities of the investigation team and of the client. Fees should also be discussed and
agreed.
(ii) Procedures
- Watch the CCTV to form an impression of the quantity of goods stolen, for example, how
many boxes were loaded onto the lorry.
- If possible, from the CCTV, determine if the boxes contain either mobile phones or
laptop computers,
- Inspect the boxes of goods remaining in the warehouse to determine how many items of
finished goods are in each box.
- Agree the cost of an individual mobile phone and laptop computer to accounting
records, such as cost cards.
- Perform an inventory count on the boxes of goods remaining in the warehouse and
reconcile to the latest inventory movement records.
- Discuss the case with the police to establish if any of the goods have been recovered and
if, in the opinion of the police, this is likely to happen.
- Obtain details of the stolen lorry, for example the license plate, and agree the lorry back
to the non-current asset register where its net book value should be shown.
(b) The audit of financial instruments
There are many reasons why financial instruments are challenging to audit. The instruments
themselves, the transactions to which they relate, and the associated risk exposures can be difficult
for both management and auditors to understand. If the auditor does not fully understand the
financial instrument and its impact on the financial statements, it will be difficult to assess the

104
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

risk of material misstatement and to detect errors in the accounting treatment and associated
disclosures. Even relatively simple financial instruments can be complex to account for.
The specialist nature of many financial instruments means that the auditor may need to rely on an
auditor's expert as a source of evidence. In using an expert, the auditor must ensure the objectivity
and competence of that expert, and then must evaluate the adequacy of the expert's work, which
can be very difficult to do where the focus of the work is so specialist and difficult to understand.
The auditor may also find that there is a lack of evidence in relation to financial instruments, or
that evidence tends to come from management. For example, many of the financial reporting
requirements in relation to the valuation of financial instruments are based on fair values. Fair
values are often based on models which depend on management judgement.
Valuations are therefore often subjective and derived from management assumptions which
increase the risk of material misstatement.
It is imperative that the auditor retains professional scepticism in the audit of financial
instruments, but this may be difficult to do when faced with a complex and subjective transaction
or balance for which there is little evidence other than management's judgement.
There may also be control issues relating to financial instruments. Often financial instruments are
dealt with by a specialist department and it may be a few individuals who exert significant
influence over the financial instruments that are entered into. This specialist department may not
be fully integrated into the finance function, leading to the accounting treatment being dealt with
outside the normal accounting system. Internal controls may be deficient and there may not be
the opportunity for much segregation of duty. However, some companies

105
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

SOCIAL & ENVIRONMENTAL AUDIT

Social and environmental Audit
Environmental Footprints

Emissions consumptions

INTRODUCTION
In the last few years, social and environmental audit have become increasingly important mainly
due to the realization by major stakeholders that every entity needs to account for the impact of
its activities on the environment and humans. It appears that it is no longer enough for entities to
prepare financial statements which only accounts for their annual incomes, costs, assets and
liabilities without much regard to their social and environmental impacts. The argument is that
both the directors and auditors of a company should recognize the need to bring satisfaction to all
stakeholders (the employees; regulators; environment and society) beyond the shareholders.

Social and environmental audit is a periodic evaluation of the activities of an entity to determine
their impact on the environment (environmental footprint) and social landscape and as to whether
they comply with relevant environmental & social legislations & regulations. There seem to be
an unwritten global agreement and acceptance that the corporate environmental footprints of
emissions (e.g. greenhouse gas, carbon pollution, waste, etc.) and consumptions (e.g. depletion
of non-renewable energy) need to be significantly reduced.

As there are hardly any legislation on this area, social and environmental audit is a type of risk
audit which the management of an entity may decide to undertake, either as part of its overall risk
management process or in order to address the ever-growing concerns of stakeholders. Any failure
to manage social and environmental issues may create a significant risk to shareholders7
investment. For instance, where the employees and consumers of a company's product are no
longer happy, they may decide to look elsewhere and it would become difficult for that entity to
continue in business.

Though both social and environmental reports are usually prepared together by organizations,
they actually deal with distinct matters. While social audit refers to the process of evaluating a
firm’s various operating procedures, code of conduct, and other factors to determine its effect on
society and human endeavour (its employees and other external people), environmental audit
deals with the assessment of the activities of an entity to ascertain their impact on the
environment.

106
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

Examples of relevant laws and standards:

Environmental laws or standards Social laws
1. Environmental Protection Act 1. Human rights laws
2. Waste disposal act 2. Child labour act
3. ISO 14000 on Environmental 3. Health & safety laws
Management Systems
4. Global reporting initiative (GRI) 4. Labour related laws
Framework

ELEMENTS OF SOCIAL & ENVIRONMENTAL AUDIT

There are three basic elements in Social & Environmental audit:
1. The agreed metrics what should be measured and how?) - The agreed metrics would most
likely be in response to legal or regulatory requirements. Examples of metrics where
targets could be set are emissions and consumptions levels.
2. Performance Measures - The measurement and documentation of actual results of
performance in terms of the agreed metrics.
3. Compliance Reporting - Reporting on the level of compliance and establish variance
against set targets. The reasons for significant variances should be explained.

Social & Environmental (S&E) audit could either be performed by internal auditors or external
auditors as there is hardly any legislation that specifies who and how it should be done in any part
of the world. Most organizations that go for external auditors do so to add credibility to the report
or due to lack of internal capacity.
Though there are no generally accepted legislations or standards for the performance of social
and environmental audit, most organizations carry out the exercise and include the report in their
annual report document.

The following are the key social and environmental risks that an entity might face:
1. Bad publicity
2. Lack of patronage of its goods and services
3. Possibility of litigation
4. Possible payment of fines
5. Strike Action by employees
6. Aggression by host community

FACTORS THAT FACILITATE SOCIAL AND ENVIRONMENTAL AUDIT

One can say that the engagement of audit firms to report on this specialized & non- statutory
information is on the increase globally due to the following factors:
1. The push/protest by environmental activist

107
 POCKET NOTE ADVANCED AUDIT AND ASSURANCE ICAN NOV 2019 DIET

2. Desire to be seen as an ethically compliant entity resulting in:

3. More patronage by environmentally-sensitive customers
4. Attraction of ethical funds from environmentally-sensitive investors
5. Little or no penalty for infractions by regulators
6. Boost to organization’s reputation
7. Desire to be more transparent by way of environmental accounting & reporting in addition
to financial reporting.
8. Give impression of a credible, honest & risk-conscious entity.
9. Desire to be more CSR complaint and attract less negative reporting & reactions from host
community.

IMPACT OF SOCIAL & ENVIRONMENTAL ISSUES ON STATUTORY (EXTERNAL)

AUDIT
The main reason social and environmental issues are considered important to the external audit
engagement is because they are primarily essential to the company's long-term success (as
discussed above) and therefore would affect their financial statements which is the subject matter
of statutory audit. The impact of these issues can be categorized into three broad areas of audit as
follows:
1. Planning stage: The external auditor has a duty to consider the risk from the environment
in compliance with ISA315 - Assessing & identifying the risk of material misstatement through
understanding the entity & its environment. Compliance with ISA 315 would imply:
a) Understanding the entity's environment with focus on relevant environmental laws and
standards.
- b) Inherent risk. -assessment arising from social and environmental issues:
c) Control risk. assessment on the adequacy and operating effectiveness of Environmental
management system.
The auditor is required to respond to any risk identified in line with ISA 330.
2. During substantive stage: The auditor needs to determine the completeness, accuracy &
validity of the possible impacts of social and environmental issues on:
- Amounts of penalties paid for non-compliance (if any)
- Provisions made in respect of cleaning cost, restoration costs, decommissioning costs,
fines, compensations, etc.
- Liabilities & Contingencies (e.g. pending litigation) arising from environments issues.
- Amounts recognized as impairment losses on assets affected by environments changes.
- Treatment of development costs for new products.
3. During evaluation & review stage - the auditor needs to assess the impact of
environmental issues on the entity's going concern assumptions. The possible implications on
going concern from any case of non-compliance with social and environmental laws and
regulations needs to be assessed. For instance, any company that stands to lose its operating
licence in the event of any non-compliance implies that environmental legislation is fundamental

108