Different Objectives and Responsibilities
By L. Erik Ringoen, CPA, CFF, CIRA
There is a popular misconception that financial statement audits are conducted with the primary objective to detect fraud. Since the collapse of Enron, independent external financial statement auditors (auditors) have made great strides in improving on communicating the true objective of an audit and who holds the responsibility for detecting fraud. But auditors must continue to battle the misconception and need to continue to reinforce that a financial statement audit (audit) is not a forensic accounting fraud investigation (forensic investigation).
Auditing is a process of determining whether a company’s reported financial position and performance are fairly represented and in accordance with certain standards. A forensic investigation is an examination of specific records and information to help determine facts related to a suspicion or allegation of fraud. Audits and forensic investigations are different services that are planned and performed to accomplish unique objectives. While both have a responsibility to detect fraud, the degree of that responsibility is substantially different.
Auditors help provide confidence in the world’s financial system by performing audits of financial statements to provide assurance that company management is presenting a “true and fair” view of a company’s financial position and performance. Forensic accountants1 assist entities in conducting an investigation by providing their expertise, from the initial allegation or suspicion of fraud to resolution, whether the end result is restitution, litigation, an insurance claim, or a referral to a law enforcement agency.
This blog is the first in a series of three in which I will compare the roles of the auditor and the forensic accountant. In this blog, I compare the auditor and forensic accountant’s objectives, responsibilities, professional standards, and engagement terms. In the following blogs, I discuss risk assessment, the concept of materiality, and building the right team (Part 2), and gathering evidence and reporting (Part 3).
Objectives and Responsibilities
The overall objective of an audit is to obtain reasonable assurance about whether financial statements as a whole are free from material misstatement, whether due to fraud or error. This enables the auditor to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework; and to report on the financial statements, and communicate as required by generally accepted auditing standards (GAAS), in accordance with the auditor’s findings.2
A forensic investigation is performed to assist an entity in gathering sufficient relevant data to assist a trier of fact in its determination of whether or not fraud was committed. The forensic investigation’s objectives include gathering evidence to identify the type of fraud, quantifying the amount of loss; determining who was involved, when it began, why it was able to be perpetrated, and how it was concealed; and reporting the findings verbally or in a written report along with supporting evidence. “Forensic,” as defined by Black’s Law Dictionary, is something used in or suitable for use in courts of law or public debate; therefore, a forensic investigation requires a very high standard of support that can sustain the scrutiny of a court of law. “Fraud” is defined by Black’s Law Dictionary as the knowing misrepresentation of the truth or the concealment of a material fact to induce another to act to his or her detriment. Forensic accountants should avoid opinions on whether “fraud” exists, as they cannot opine on someone’s “intent” and are not the trier of fact. The forensic accountant’s role in litigation is to report on legally obtained evidence objectively, succinctly, and with a sufficiently explained foundation. For matters in litigation, there must be evidence provided to the trier of fact – beyond a reasonable doubt in criminal cases, and by a preponderance of the evidence in civil cases.
An auditor owes primary allegiance to the investing public, and the objective is general in nature. A forensic accountant is not concerned with reaching a general opinion on the financial statements as a whole; his or her objective is more specific in nature as defined by the scope of services in the engagement letter, and the work is typically directed through counsel and, therefore, privileged and confidential. In addition, the forensic accountant may be asked by the company to advise on internal controls that can be implemented to prevent a discovered fraud from happening again.
Auditors and forensic accountants adhere to different sets of professional standards in performing their work. The auditor follows GAAS, and the forensic accountant follows the standards for consulting services.3 An auditor of a public company’s financial statements is required to adhere to all applicable PCAOB standards; for all other entities, the applicable standards are those issued by the AICPA.
A forensic investigation is considered by the AICPA to be a consulting service. Consulting services differ fundamentally from the auditor's function of attesting to the assertions of other parties. In an attest service, the practitioner expresses a conclusion about the reliability of a written assertion that is the responsibility of another party – such as company management. In a forensic investigation, the practitioner develops findings, conclusions, and recommendations based on the evidence discovered during a forensic investigation. In addition to the standards for consulting services, a forensic investigation may be subject to requirements of the Department of Justice, Securities and Exchange Commission, or other regulators. If the forensic investigation becomes subject to litigation, the forensic accountant may be subject to further requirements, such as Federal Rules of Civil Procedure, as well as state court and other jurisdiction and venue requirements.
Auditors and forensic accountants must develop a clear understanding with their clients about the nature and extent of the professional services to be performed, including the scope and limitations. An auditor must adhere to applicable auditing standards and include prescribed engagement terms. For example, an auditor should include a statement that because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk exists that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with GAAS.4
A forensic accountant is typically hired by counsel on behalf of a client to maintain the privilege of communications, and adheres to less restrictive engagement term standards as those by an auditor. The forensic accountant’s engagement terms should be customized to define the client, to limit assistance to certain issues, to establish the boundaries of the investigation and applicable standards, and to describe the roles and responsibilities of the parties. A forensic investigation cannot describe expected results or make any guarantees regarding the findings or outcomes of a forensic investigation. The trier of fact determines guilt, innocence, or liability, so a forensic accountant should avoid opinions regarding guilt, innocence, or liability of any party involved in the forensic investigation.5
Other Notable Differences
- Timing – Audits are planned periodically and on a recurring basis. Forensic investigations are unforeseen and nonrecurring.
- Predication – A forensic investigation begins with an allegation or suspicion of fraud. The allegation or suspicion of fraud is not the basis of an audit.
- Obligatory – Forensic investigations are typically conducted voluntarily because a company has a suspicion or allegation of fraud. An audit is an obligatory engagement for which a company must hire an auditor to provide an opinion on the truthfulness and fairness of its financial statements.
- Performance – An audit is performed by auditors who are CPAs. A forensic investigation is typically performed by a multidiscipline team of experts that often includes CPAs.
- Appointment – The appointment of an auditor is made by the shareholders of the company. A forensic accountant is appointed by the owners/management or a third party.
Audits and forensic investigations are different services, each with their own unique objectives, standards, and responsibilities, among other difference as described above.
In my next blog, I will discuss the auditor’s risk assessment, the concept of materiality, and building the right team for the execution of an audit and a forensic investigation. In my third blog, I will conclude with discussion on the gathering of evidence and reporting for audits and forensic investigations.
1 For the purposes of this article, a forensic accountant is a CPA certified in financial forensics with the American Institute of Certified Public Accountants.
2 AICPA AU-C Section 200.12
3 AICPA CS Section 100, Consulting Services: Definitions and Standards, Code of Professional Conduct, and VS Section 100, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset, where applicable.
4 AICPA AU-C Section 210.10
5 AICPA Forensic & Valuation Services Practice Aid – Forensic Accounting – Forensic investigations
L. Erik Ringoen, CPA, CFF, CIRA, is a director with Forensic Resolutions Inc., which has offices in Westmont, N.J., and Philadelphia. He can be reached at email@example.com.