Financial Audit vs. Forensic Audit - Meaning, Differences, and More

Financial Audit vs. Forensic Audit

Auditing is an inseparable part of a business, and every business is required to conduct an audit to evaluate the company’s financial health. But many types of audits can be done depending on the purpose of the audit.

For example, an Information Technology (IT) Audit will evaluate whether a company’s IT infrastructure is proper and is according to the set policies and standards. Similarly, financial and forensic audits are often confused, and you must understand the difference between the two. A regular financial audit primarily checks for accuracy in financial records, while a forensic audit is more investigative in nature.

This blog will explain financial and forensic audits, why you need a financial audit or forensic audit, and key differences between the two. A forensic audit involves a detailed examination of financial records to uncover and document evidence of illegal activities such as fraud or misconduct.

What is a Financial Audit?

Also known as the Financial Statements Audit, the financial audit has an overall objective to evaluate the material segments of the balance sheet, statement of profit & loss, and cash flow statements. Financial auditors ensure that companies adhere to financial reporting standards when preparing their financial statements. They also examine accounting records to detect errors or misrepresentations. This process helps the company determine the current financial position and assists the board of directors to improve them.

The outcome of the financial audit in the form of the audit report is usually made available to the stakeholders of the company, which assists them in understanding the company’s financial position and helps in making investment decisions.

The company’s material aspects or non-recurring activities are being disclosed annually to shareholders that uncover the indicative signs of errors, misrepresentations, mistakes, or frauds if found during an audit. Financial statement fraud typically involves misrepresenting financial data to improve company performance. Misrepresenting financial statements to deceive potential investors is a common type of fraud uncovered in forensic audits.

When Should You Conduct a Financial Audit? 

Financial audits are mandatory for all companies, including Small and Medium Enterprises (SMEs), under the new Commercial Companies Law. But, most SMEs get the audit done only in the following circumstances:

• Branch of a foreign company

• Liquidation of the company

• Free zone company 

However, you can get the financial audits done voluntarily when management is willing to analyse the current financial position, compare the current with the old audited balance sheet to recognise its growth trend, give stakeholders a clear picture of the company, and determine the ratio of profits to be distributed as dividends and retained for further investments.

What is a Forensic Audit and Financial Statement Fraud?

The facet of forensic audit is similar to a financial audit, except that the depth of investigation required in a forensic audit is more than that of a financial audit. A forensic audit involves a forensic accountant who applies specialised accounting skills to examine complex financial transactions and the company's financial records. This forensic audit function is a vital tool for uncovering financial misconduct and illegal activities, as well as for enhancing regulatory compliance. Forensic audits are a type of auditing services that differ from internal auditing and internal audit, which are typically performed by internal auditors for routine compliance and operational efficiency. A forensic audit is not mandatory to be conducted every year; the law requires it to the company when any illegal or fraudulent activities are found or when regulatory compliance is required to conduct business. Forensic audits are conducted by professionals who specialise in detecting fraud, financial misconduct, and illegal activity. Forensic auditors track balance sheets and locate inconsistencies leading to fraudulent conclusions, using forensic accounting methods such as analytical procedures to detect fraud schemes and irregularities. The role of forensic auditors includes understanding various frauds, such as asset misappropriation (for example, stealing company inventory or misusing company assets for personal gain), conflict of interest, and presenting fraudulent numbers in financial statements to deceive stakeholders. Forensic audits may examine an individual's financial records as well as a company's records to uncover alleged fraud or illegal activity.

Interest protection of the investors is one of the main objectives behind forensic audits. Forensic investigation includes gathering evidence, collecting evidence, and employing forensic investigations to gather sufficient evidence and derive evidence that can support a legal case or legal proceeding. The investigator will present the audit findings, with accuracy, in front of the court regarding a specific operation or department of the company. Forensic audits are guided by a legal framework to ensure that evidence presented in court is admissible and that the findings of the investigation are credible. Forensic auditors may serve as expert witnesses to explain the evidence presented and the findings of the investigation. The execution of a forensic audit includes planning, gathering and collecting evidence, documentation, and often a court appearance. Forensic auditing often involves collaboration with legal teams to define the objectives of the audit. Forensic audit reports detail the findings of financial investigations, relevant evidence, financial loss suffered, parties affected, and recommendations for future prevention, often in the form of a written report. Forensic investigations can help detect and prevent financial losses, protect company assets, and clarify accounting issues for non-expert individuals in court, ensuring that the evidence and findings are comprehensible to all parties involved.

When Should You Conduct a Forensic Audit? 

Your company needs a forensic auditor to conduct a forensic audit for them only in specific circumstances, such as: Forensic auditing is often required when there is suspicion of fraud, embezzlement, or other financial crimes. Asset misappropriation is the most prevalent form of fraud occurring within organizations, often involving manipulation or theft of company inventory. A forensic audit may also be necessary to uncover a fraud scheme, detailing how the fraud was carried out and identifying those involved. Corruption in the workplace can manifest as bribery or conflicts of interest among employees. Forensic auditors gather a wide range of evidence, including financial statements and electronic data, and are responsible for examining financial records to detect irregularities and support legal proceedings. Forensic auditors may interview suspects or witnesses as part of their investigation process. The evidence collected during forensic audits must meet litigation standards for court use.

• You need strong evidence to support the findings in the court of law

• You have suspected theft or fraud in your organisation

But how do forensic and financial audits differ? Let’s understand the differences between them.

Financial Audit and Forensic Audit - Key Differences

Every business should perform a financial audit irrespective of the company’s size, nature, or capital. It is a voluntary audit up to a specific limit, and a forensic audit is to be performed only when mandated by the court of law.

A financial audit is for routine assessments of the company. In contrast, a forensic audit is for an in-depth examination of activities in a specific department(s) or operation(s) to find evidence of illegal or fraudulent activity. Both audits involve reviewing financial documents, but forensic audits require advanced accounting skills for detecting fraud and uncovering financial misconduct. A regular audit simply reviews financial records for accuracy, while a forensic audit is more investigative in nature.

Financial audits require general knowledge of auditing, while forensic auditing requires specific expertise with long-term experience in the relevant subject matter.

Every firm and company must understand the purpose of the audit and then decide which type of audit will serve its purpose the most. The above-mentioned vital differences will give you a general idea of when you need a financial audit and when you will need a forensic audit. During the planning stage, the forensic auditor and team outline objectives to guide the investigation.

How to determine which type of audit your firm needs?

The following questions related to the respective audits must be kept in mind while making decisions regarding the selection of an audit.

Financial audit

• Do you want to assess the financial health of the firm and use it as an assistance to prospective investors?

• Do you want to analyse whether your firm is losing money or gaining adequate profits?

Forensic audits

• Are you in need of any strong evidence or support regarding any court proceeding?

• Do you have any suspicions regarding any financial fraud or malpractices, or found someone conducting misappropriations?

• Do you need to collect evidence and ensure that sufficient evidence is available to support legal proceedings?

The above difference may be helpful for a firm to make informed decisions regarding the audit it wants to conduct. Before conducting an audit, the firms must go through all their requirements and must select the appropriate audit as per the need. Conducting a forensic audit can strengthen internal controls and financial reporting processes to deter future fraud. Forensic audits assess the risks of fraud during investigations and recommend improvements to prevent such activities. Forensic auditors document their findings in a report, which includes evidence of fraudulent activities and recommendations for future prevention. The evidence collected in a forensic audit must be sufficient to prove the fraudster’s identity in court and document the financial loss. The courts rely on forensic audits to provide evidence that can prove fraud beyond a reasonable doubt. Both the audits have their own unique uses, which may be required only during specific circumstances.

Role of Technology in Forensic Accounting

In today’s rapidly evolving financial landscape, technology has become an indispensable ally in the field of forensic accounting. The integration of advanced technological tools has revolutionised the way forensic auditors conduct investigations, making the forensic audit process more efficient, accurate, and comprehensive.

Forensic auditors now rely heavily on computer-assisted audit techniques (CAATs) to examine vast amounts of financial data. These tools enable the detection of financial statement fraud, asset misappropriation, and other financial crimes by identifying unusual patterns, discrepancies, or anomalies within a company’s financial records. By leveraging data analytics, forensic auditors can quickly sift through complex accounting issues and pinpoint transactions that warrant further investigation.

The use of technology extends to the collection and analysis of electronic evidence. Forensic audit investigations often involve gathering digital records such as emails, transaction logs, and other electronic documents. This digital evidence is crucial for reconstructing financial events, tracing the flow of company funds, and supporting findings in legal proceedings. Technology also enhances the ability to present complex financial data clearly and compellingly, making it easier for courts and stakeholders to understand the evidence gathered during a forensic audit.

How Can Flyingcolour Tax and Consultant Help?

We at Flyingcolour Tax and Consultant can help you conduct forensic and financial audits as one of the audit assistants in the UAE. Our qualified professionals can also assist you in accounting, taxation, financial modelling, company registration, and PRO requirements. The knowledge that forensic audits are regularly conducted can deter employees and management from engaging in fraudulent activities. Documentation from forensic audits is critical and must be thoroughly prepared for court proceedings. Forensic auditors explain complex accounting issues to help the court comprehend the evidence.

Register your free consultation with us to know more about the comprehensive services. 

FAQ

 

Q1. What is a forensic audit?

The main purpose of a forensic audit is to investigate financial fraud or irregularities and collect evidence that can be used in a court of law or legal proceedings. It’s to find out what happened, who was involved, how it was done and how much was lost.

Q2. What is an example of a forensic audit?

A common example is asset misappropriation like an employee submitting false invoices, stealing company inventory or making fraudulent payments. Other examples are bribery, financial statement fraud (like inflating revenues) or complex financial disputes in bankruptcy or divorce cases.

Q3. What is the role of a CA in a forensic audit?

A Chartered Accountant (CA) or Certified Public Accountant (CPA) is usually the forensic auditor. He combines his expertise in accounting and auditing with investigative skills and knowledge of the legal framework. He collects evidence, analyses complex financial data, interviews parties, prepares detailed reports and may appear in court as an expert witness.

Q4. Who initiates a forensic audit?

A forensic audit is initiated when financial wrongdoing is suspected. It can be requested by:

• Company Management or the Board of Directors (Internal investigation).

• Regulatory Authorities (e.g., RBI, SEBI, SEC) or Government Agencies.

• Courts of Law or Law Enforcement Agencies.

• Shareholders or Creditors who suspect financial misconduct.

To learn more about Financial Audit vs. Forensic Audit - Meaning, Differences, and More, book a free consultation with one of the Flyingcolour team advisors.

Disclaimer: The information provided in this blog is based on our understanding of current tax laws and regulations. It is intended for general informational purposes only and does not constitute professional tax advice, consultation, or representation. The author and publisher are not responsible for any errors or omissions, or for any actions taken based on the information contained in this blog.