Special Audit

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21 Aug, 2024

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A special audit refers to a thorough investigation of a particular aspect of the organization's process or activities, going beyond standard auditing procedures. Its purpose is to gauge the discrepancies or false practices during the ordinary audit process.

The organization initiates these investigations in response to specific concerns, such as suspected fraud or irregularities, requiring a detailed examination to address the unique circumstances. They focus on the specific issue or area that prompted the need for the investigation.

What Is Special Audit?

Special audit refers to the in-depth and focused examination of specific areas, concerns, or issues in an organization.
An independent investigation aims to spot and probe into cases of misstatement, fraud, embezzlement, or any other discrepancies in financial reporting, management, and system.
There are different types of special investigations, including fraud, compliance, cost, tax compensation, royalty, control, and construction audits.
Moreover, the purpose of these is to investigate and provide an independent assessment of a specific area of concern.

Special Audit Explained

Special audit refers to a thorough and focused examination of specific financial accounts, business processes, or activities within an organization. Hence, it can be initiated by government agencies, regulatory bodies, or stakeholders who are concerned with an organization's financial activities. Additionally, such inquiries may be conducted as a result of specific events, concerns about fraud, or suspicions of irregularities within a company. Therefore, the request for a comprehensive examination beyond the regular financial audits is often circumstantial. The special audit of banking companies when money laundering is suspected is a typical example of such an investigation.

Given below is a structured approach to performing them:

Selection of Team: The board engages an external firm specializing in forensic accounting and possessing extensive experience in the relevant matter.
Definition of Scope: Here, the focus is explicitly outlined to centralize the focus on critical issues.
Evidence Collection: The investigation team initiates the process by systematically gathering reports, raw data, and pertinent communications with research teams, data analysts, and management members.
Analysis: Discrepancies and manipulations between reported results and raw data are identified during the analysis.
Reporting: The team prepares a comprehensive special audit report to provide investigation details and recommendations for internal control.
Action: The company responds to the audit findings with corrective actions, as suggested in the report.

However, special auditors may need help in the examination of complex financial transactions. To secure comprehensive and accurate information and ensure independence while investigating sensitive matters. Moreover, having complete knowledge of dynamic regulatory frameworks and adjusting these procedures is crucial for overcoming these challenges. Therefore, special audit assessments are crucial for organizations facing specific challenges or suspicions of misconduct.

Scope And Need

The scope and necessity of these investigations extend to specific circumstances where a standard audit proves insufficient or shady. It is considered crucial for the following reasons:

Fraud Investigation: When suspicions or signs of fraud emerge within an organization, it becomes imperative to scrutinize financial records and transactions meticulously.
Addressing Regulatory Compliance Issues: Conducted to ensure compliance with specific regulatory requirements or industry standards that might extend beyond the purview of regular audits.
Due Diligence: During mergers, acquisitions, or significant organizational changes, this audit may be necessary to assess financial health and associated risks.
Internal Control Evaluation: Organizations may opt for these investigations to evaluate and enhance internal controls, particularly following significant structural or procedural changes.
Responding to Audit Request: Many times, external parties like stakeholders or regulatory bodies demand these inquiries of an organization's activities by citing specific issues.
Legal Disputes and Claim Investigation: They are essential in legal conflicts or disputes. Thus, it serves to examine financial evidence impartially and provide an unbiased assessment for legal proceedings. It, thus, ensures validation or refusal of claims made on the company.

Types

The critical issue and the area of investigation determine the type of investigation required in a particular situation. Given below are the common forms of such auditing:

Fraud Audit - Investigates financial irregularities or fraud, often for legal purposes. This includes embezzlement, misappropriation of funds, kickbacks, and other forms of financial fraud.
Compliance Audit - Ensures adherence to specific laws, regulations, or industry standards. It ensures that the organization complies with legal requirements and industry standards.
Cost Audit – Find discrepancies in the cost sheets or cost records of the organization.
Information Systems Audit - Evaluates the controls, functioning, and security measures of an organization's information systems and software.
Tax Audit - Reviews an organization's financial information and income tax return for compliance with tax laws.
Compensation Audit - Annually analyzes the workers' compensation, including wages, salary, bonuses, incentives, etc.
Royalty Audit – Investigates the payment of license fees and royalties by the licensee to the licensor.
Control Audit - Examines and evaluates an organization's internal control systems, including policies, guidelines, standards, etc.
Construction Audit - Reviews financial aspects and costs of construction projects.

Examples

Let us understand the concept better with the help of examples:

Example #1

Suppose a special audit is conducted on ST Inc. The audit was initiated due to concerns about financial irregularities and possible embezzlement. As the audit progressed, it uncovered suspicious transactions, inflated revenues, and manipulated expense records.

Thus, the team found that certain employees were involved in siphoning funds through dummy companies and offshore accounts. Moreover, the company's financial statements could have been more accurate, presenting a different picture than the actual financial health.

Moreover, the auditors examined the company's internal controls and discovered weak oversight, allowing these fraudulent activities to persist. The findings prompted immediate corrective actions, including restructuring internal controls, terminating involved employees, and initiating legal proceedings.

Example #2

As per the special or forensic audit published by KPMG in April 2020, EY's (earlier Ernst and Young's) audit of Wirecard over several years was found to have violated accounting standards, with numerous fraud risk indicators in the third-party acquiring business going unnoticed. The parliamentary inquiry uncovered shortcomings in EY's audits, including a failure to request crucial account information from Singapore's OCBC Bank. Moreover, the audit partner vigorously defended Wirecard's Asian business just months before its collapse, despite doubts raised by a draft forensic audit commissioned by KPMG.

Executives at Wirecard set up fictitious merchants to deceive EY auditors during a shopping exercise. Hence, this resulted in a falsely positive evaluation of Wirecard's financial health. EY partners were investigated by criminal prosecutors and the audit watchdog Apas for their role in the Wirecard scandal. However, the company denied any wrongdoing, attributing the failure to an extensive fraud involving fake online shops and corrupt bank employees. It expressed regret for not identifying the fraud sooner; EY emphasized lessons learned and planned to invest $500 million in new audit technology.

The alleged audit partner faced criticism for treating money listed on Asian escrow accounts as Wirecard's cash under the fraud practices. Therefore, the decision-making process within EY during the crisis, including considerations to resign mid-audit, was scrutinized. As a result, EY Germany suffered a loss of €42 million in annual auditing business after several prestigious clients disassociated with the company. Also, the audit partner faced potential lawsuits from Wirecard shareholders, and investigations by Munich prosecutors and Apas are ongoing.

Frequently Asked Questions (FAQs)

1. What are the features of a special audit?

Given below are the various characteristics of this investigation:
- Concerned with a specific organizational area or concern,
- Investigate discrepancies in financial reporting,
- Conducted within a limited timeframe,
- Involves preparation of special audit reports
- Need intensive communication with relevant stakeholders throughout the audit process.

2. What is a special audit report?

This report comprises the findings, recommendations, and management's responses to the identified issues on the suspicious facet or operation within an organization.

3. What is the difference between a statutory audit and a special audit?

A statutory audit is a legally mandated, routine examination of a company's financial statements, ensuring adherence to relevant laws and accounting standards. In contrast, these are initiated for a specific purpose, usually in response to a particular concern or circumstance, such as fraud investigation, assessment of internal controls, or ensuring compliance with specific regulations.