# What Is a Forensic Audit, How Does It Work, and What Prompts It?

![Forensic Audit: An examination and evaluation of a firm's or individual's financial records to use as evidence in a court of law or legal proceeding.](https://www.investopedia.com/thmb/FKgEMD_GgF08U_dsFRNMC9v_V60=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Forensic-audit_final-f214fbe3a8054b868f51deb083653d8e.png)

*— Investopedia / Michela Buttignol*

## What Is a Forensic Audit?

A forensic audit involves a detailed examination and evaluation of a firm’s or individual’s financial records. The goal is to derive evidence that can be used in a court of law or other legal proceedings. Forensic auditing is a specialization within [accounting](https://www.investopedia.com/terms/a/accounting.asp), and is often required when there is suspicion of fraud, embezzlement, or other financial crimes.

Forensic audits cover a wide range of investigative activities. A forensic [audit](https://www.investopedia.com/terms/a/audit.asp) is often conducted to prosecute a party for [fraud](https://www.investopedia.com/terms/f/fraud.asp), embezzlement, or other financial crimes. In the process of a forensic audit, the auditor may be called to serve as an expert witness during trial proceedings. Forensic audits could also involve situations that do not include financial fraud, such as disputes related to [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp) filings, business closures, and divorces.

### Key Takeaways

*   A forensic audit is an examination and evaluation of a firm's or individual's financial records.
*   During a forensic audit, an auditor seeks to derive evidence that could potentially be used in court.
*   A forensic audit is used to uncover criminal behavior such as fraud or embezzlement.
*   When you are a forensic auditor, you specialize in a particular brand of accounting. Smaller firms may not have a forensic auditor on the payroll, but most large, commercial accounting firms have forensic auditing departments.

Forensic audit investigations can [uncover or confirm various types of illegal activities](https://www.investopedia.com/terms/f/financial-forensics.asp). Usually, a forensic audit is chosen instead of a regular audit if there's a chance that the evidence collected would be used in court.

## How Forensic Audits Work

The process of a forensic audit is similar to a regular financial audit—planning, collecting evidence, writing a report—with the additional step of a potential court appearance. The attorneys for both sides offer evidence that either uncovers or disproves the fraud and determines the damages suffered. They present their findings to the client, and the court should the case go to trial.

> **Warning**
>
> If you've ever padded an expense report—or even thought about it—know that that is an example of fraud and could be uncovered easily via a forensic audit.

### Planning the Investigation

During the planning stage, the forensic auditor and team will plan their investigation to achieve objectives, such as

*   Identifying what fraud, if any, is being carried out
*   Determining the period during which the fraud occurred
*   Discovering how the fraud was concealed
*   Naming the perpetrators of the fraud
*   Quantifying the loss suffered as a result of the fraud
*   Gathering relevant evidence that is admissible in court
*   Suggesting measures to prevent such frauds from occurring in the future

### Collecting Evidence

The evidence collected should be adequate to prove the fraudster's identity (s) in court, reveal the fraud scheme's details, and document the financial loss suffered and the [parties affected by the fraud](https://www.investopedia.com/common-traits-of-financial-fraud-victims-11711737).

A logical flow of evidence will help the court in understanding the fraud and the evidence presented. Forensic auditors are required to take precautions to ensure that documents and other evidence collected are not damaged or altered by anyone.

### Reporting

A forensic audit requires a written report about the fraud to be presented to the client to proceed to file a legal case if they so desire. At a minimum, the report should include

*   The findings of the investigation
*   A summary of the evidence collected
*   An explanation of how the fraud was perpetrated
*   Suggestions for preventing similar frauds in the future—such as improving internal controls

### Court Proceedings

If the case goes to trial, the forensic auditor may be called to testify as an expert witness. The auditor will explain the findings, walk through complex accounting issues, and ensure that the evidence is clear to the court and any non-expert individuals involved in the case.

## What Necessitates a Forensic Audit?

In a forensic audit, an auditor would be on the lookout for:  

### Corruption or Fraud

*   [Conflicts of Interest](https://www.investopedia.com/terms/c/conflict-of-interest.asp)—when a fraudster uses their influence for personal gains to the company's detriment. For example, if a manager allows and approves inaccurate expenses of an employee with whom they have a personal relationship.
*   Bribery—offering money to get things done or to influence a situation in one’s favor.
*   [Extortion](https://www.investopedia.com/terms/e/extortion.asp)—the wrongful use of actual or threatened force, violence, or intimidation to gain money or property from an individual or entity.

### Asset Misappropriation

[Asset](https://www.investopedia.com/terms/a/asset.asp) misappropriation is the most prevalent form of fraud. Examples include: misappropriating cash, submitting falsified invoices, making payments to non-existent suppliers or employees, misusing assets (like company equipment), and stealing company inventory.

### Financial Statement Fraud

A company can get into this type of fraud to try to show that its financial performance is better than it is. The goal of presenting fraudulent numbers may be to improve liquidity, ensure that [C-level](https://www.investopedia.com/terms/c/c-suite.asp) executives continue to receive bonuses, or cope with the pressure to perform.

## Example of a Forensic Audit Case

Let's say that a fictional computer manufacturer, WysiKids, on the recommendation of its [chief financial officer](https://www.investopedia.com/terms/c/cfo.asp) (CFO), entered into a contract with Smart Chips, Inc. to supply WysiKids with processors. However, when the contract was signed, Smart Chips was not authorized to conduct business because its license had been indefinitely revoked based on certain irregularities in a recent [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) filing. WysiKids' CFO knew that Smart Chips' license was suspended, yet still suggested that their company sign on with Smart Chips, as they were secretly receiving compensation from Smart Chips for doing so.

The fictional example of fraud depicted above could be uncovered by investigating the interpersonal relationships involved and exposing a conflict of interest.

## When Might a Forensic Audit Be Necessary?

A forensic audit may be prompted by suspicions of financial crimes, such as asset misappropriation, bribery, conflicts of interest, or financial statement fraud. It’s also used in legal disputes like [divorce settlements](https://www.investopedia.com/how-to-un-merge-your-money-in-a-divorce-4687311), bankruptcy cases, and business closures.  

## How Is a Forensic Audit Different From a Regular Financial Audit?

A regular audit simply reviews financial records for accuracy, while a forensic audit is specifically designed to identify and document fraudulent activities. Forensic audits also involve preparing evidence that can be presented in court if necessary, and forensic auditors may serve as expert witnesses.  

## What Types of Fraud Are Commonly Uncovered in a Forensic Audit?

Forensic audits commonly uncover asset misappropriation (like stealing company funds or inventory), financial statement fraud (misrepresenting financial data), and corruption (such as bribery or conflicts of interest). These fraudulent activities are often hidden within a company’s financial records.  

## The Bottom Line

A forensic audit is critical for investigating financial misconduct and gathering evidence for potential court proceedings. Whether it’s fraud, embezzlement, or financial statement manipulation, forensic audits help uncover illegal activities and provide essential evidence that can be used in court. Forensic auditors play an important role in simplifying complex financial matters and ensuring justice is served  

> **Article Sources**
>
> 1.  Association of Chartered Certified Accountants. "[Forensic Auditing](https://www.accaglobal.com/an/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/forensic-accounting.html)."