When difficult questions arise about how a municipality is spending public dollars, calls for a forensic audit are sure to follow. The term carries weight — conjuring images of investigators combing through crumpled receipts and shredded invoices to uncover any possible fraud and its source.
Although the idea of a forensic audit can seem reassuringly in-depth and rigorous, it is generally not the most practical or cost-effective solution for local governments that have misgivings about financial matters. It’s important to consider the characteristics of both traditional audits and forensic audits.
What an audit does — and does not — do
A routine financial audit generally aims to provide reasonable assurance that the financial statements of the entity are free from material misstatement. Usually, an audit will assess whether the financial statements conform with generally accepted accounting principles. It may also evaluate compliance with applicable laws and regulations, though it will typically not provide an opinion on overall compliance.
To make their determination, auditors may test records such as accounts payable and receivable, invoices, general ledgers, contracts and even meeting minutes to ensure balances and processes are consistent and that decision-making is properly documented.
In law and accounting, not all misstatements are considered “material.” A misstatement is deemed material only if it is significant enough to influence the evaluation of a reasonable person. In practice, this means that a municipality’s cash balances could be off by several thousands of dollars before rising to a level of materiality. Although a discrepancy of thousands of dollars could certainly raise eyebrows, it does not necessarily indicate fraud or malfeasance.
Even so, an audit report that finds no material misstatements doesn't guarantee the absence of fraud. Fraud might exist at a level too minor to be considered material, align with the entity's practices to avoid detection, or occur outside the audit’s scope.
Forensic audits: Precision at a price
A forensic audit is a specialized and far more detailed process. Unlike a standard audit, it is designed to detect and document fraud or misconduct.
Forensic auditors dive deeply into transactions, tracing money across accounts, testing for irregularities and sometimes reconstructing records. A forensic audit examines all aspects of a municipality’s finances across multiple disciplines and funds. It might entail an examination of everything from police fines to water bill late fees and credit card usage.
The rigor of a forensic audit makes it a powerful tool, but also a costly one. Fees can quickly rise into the six-figure range, and the process can stretch over many months or years. For many municipalities, the investment of time and taxpayer dollars may be disproportionate to the problem at hand and beyond what is necessary for a municipality with financial irregularities. Because it serves a different purpose than a routine financial audit, a forensic audit does not count toward South Carolina’s requirement of annual audits for municipalities.
For these reasons, a forensic audit is usually appropriate only when there is strong reason to suspect fraud or in connection with a civil or criminal case against a public official.
An agreeable alternative
A forensic audit is not the only option when irregularities are identified or concerns are raised. An agreed-upon procedures engagement may be a more appropriate undertaking for municipalities.
With this engagement, a narrow set of transactions are identified for a detailed review and testing. If a municipality is able to identify a specific area of concern, such as court fines or credit card transactions, an auditor can be engaged to look at the specified area rather than all of municipality’s financial records. If a forensic audit can be considered as both a mile wide and a mile deep, an agreed-upon procedures engagement can be thought of as being an inch wide and a mile deep.
For local leaders, this middle ground can balance the demand for accountability with the need to safeguard limited resources.