Shaheed Sukhdev College of Business Studies, University of Delhi

FORENSIC AUDIT
Rohitashwa Aggarwal (15919) Pritom Das (15920) Preetika Gupta (15930) Sarthak Ahuja (15932)

FORENSIC AUDIT: DEFINITION
Forensic audit involves examination of legalities by blending the techniques of propriety (VFM audit), regularity and investigative and financial audits. The objective is to find out whether or not true business value has been reflected in the financial statements and in the course of examination to find whether any fraud has taken place. It encompasses two main areas: Litigation support Investigation

LITIGATION SUPPORT

Is the factual presentation of economic issues related to existing or pending litigation. The forensic accountant quantifies damages sustained by parties involved in legal disputes and assists in resolving disputes, even before they reach the courtroom.

LITIGATION SUPPORT
Arbitration assistance Business valuation for divorce, stockholder disputes Computation of damages resulting from personal injuries, wrongful death, breach of contract, casualty, and fidelity losses Determination of lost profits due to business interruption Testifying as an expert witness Financial review of contractual obligations Investigative services related to fraud and other illegal acts

. securities fraud (including falsification of financial statements). Also includes searching for irregularities associated with civil matters. and insurance fraud have occurred. such as a search for hidden assets in divorce cases.INVESTIGATION Is the act of determining whether criminal matters such as employee theft.

reliance usually results in one or more victims suffering damages. .WHAT IS FRAUD? Fraud This is an intentional misrepresentation of a material point or issue on which a victim relies.

fraudulent disbursements. cash theft. inventory theft) y Bribery and corruption y Intellectual property y .g.TYPES OF FRAUD Occupational Financial statement schemes y Asset misappropriation (e..

TYPES OF FRAUD Other Frauds y Financial institution y Check and credit card fraud y Insurance fraud y Health care fraud y Bankruptcy fraud y Tax fraud y Securities fraud y Money laundering y Consumer fraud y Computer and Internet fraud y Governmental fraud .

The money transferred to the shell companies as payments for assets were returned as payments on accounts receivable.EXAMPLES OF FRAUD A publicly-traded company engaged in sham transactions for more than seven years by using several shell companies. . The company·s assets were inflated by as much as $80 million.

Therefore.650.650  Diagnostic knee arthroscopy 1. the correct amount of the bill is $1.275 The second procedure listed above is included in the first procedure. . X billed a patient·s insurance for the following activities:  Knee arthroscopy with debridement $1.625 Total billed $3.EXAMPLES OF FRAUD Dr.

C.125M Corinna 400K 400K 400K 1. James 375K 375K 375K 1.2M . B.EXAMPLES OF FRAUD Bid was let to construct 3 buildings in the following order: A. Buildings Bidder A B C Total Avalon $510K $250K $240K $1M St.

EXAMPLES OF FRAUD Assume the cost of janitorial services ranges from $1. BBK Company has 1.000 sq. .50 to $2. If JanServ charges 20 ¢ more psf than does an honest service.000. to be serviced.50 per square foot (psf). ft. JanServ will make an extra $200K that can be used to pay a kickback to the employee who helps JanServ obtain the contract.

pp.WHO COMMITS FRAUD? Frauds against the organisation (in %) 19% 40% Employees Management 41% Owners Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse. 42-43 .

2 Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse. 42-43 .WHO COMMITS FRAUD? Frauds against organisations (in %) 61% Males Females 3. pp.

WHY IS FRAUD COMMITTED? The Fraud Triangle Rationalization Perceived Opportunities Perceived Pressure .

managers.PERCEIVED PRESSURE Employees. and owners can feel pressure to commit fraud as a result of       Greed or preoccupation with being successful Living beyond means High personal debts Unexpected financial needs Expensive vices Family-imposed pressures .

PERCEIVED OPPORTUNITIES Opportunities to commit fraud exist when levels of trust in an organization are reached or when controls are weak.      Inappropriate segregation of duties Ineffective supervision Transaction authorization not required Lack of physical controls Lack of adequate audit trail .

    Feeling underpaid or overworked Desire to seek revenge Belief that taking the assets is a loan Belief they are helping others (family.RATIONALIZATION Individuals usually don·t commit fraud unless they can justify their actions in relation to their own code of ethics. employees) .

Identifying other beneficiaries. . Proving the responsibility for the loss. The outcome shall focus on the following. in case of frauds: Proving the loss. Proper documentation is vital in substantiating the findings. Proving the method/motive. Establishing guilty knowledge.OBJECTIVE OF FORENSIC AUDIT Objective of forensic audit is to find whether or not a fraud has taken place.

HOW DO FORENSIC ACCOUNTANTS SEARCH FOR FRAUD? Proactive Fraud Detection Reactive Fraud Detection .

.PROACTIVE FRAUD DETECTION Inductive Approach: Use of data-mining software like MS Excel. and searching for symptoms of these frauds. Deductive Approach: Determining the kind of frauds that can occur. MS Access.

DEDUCTIVE APPROACH TO DETECTING FRAUD Involves a 5-step process:      Understanding the business environment. Using databases and systems to search for the fraud symptoms. Following up on discoveries to determine the likelihood of existence of fraud. Understanding the kinds of fraud that can occur in this environment. . Determining the most likely symptoms.

Usually the area in which fraud has been committed is known.REACTIVE FRAUD DETECTION  Fraud accountants are often engaged after someone in the entity suspects that fraud has been committed. the entire area is examined.  . Often.

(iv) Accumulation of debit balances in loosely controlled accounts (like deferred revenue expenditure accounts) (v) False credits to boost sales with corresponding debits to non-existent (dummy) personal accounts. like delayed/non-preparation of bank reconciliation statements. (vii) Weaknesses/inadequacies in internal control/ check systems. . (vi) Cross debits and credits and inter-account transfers. (iii) Discrepancies in receivable or payable balances/inventory as evidenced from the non-reconciliation between financial records and corresponding subsidiary records. Financial statements and records are analyzed mainly to find out: (i) Trend-analysis by tabulating significant financial transactions (ii) Unusual debits/credits in accounts normally closing to credit/debit balances respectively. etc.FRAUD DETECTION TECHNIQUES Critical Point Auditing aims at filtering out the symptoms of fraud from regular and normal transactions in which they are mixed or concealed.

Financial frauds are results of wasteful. efficiency and efficacy have been achieved in the transactions for which expenditure has been incurred or revenue collected is usually applied.FRAUD DETECTION TECHNIQUES Propriety Audit is conducted by Supreme Audit Institutions (SAI). . applies in forensic audit to establish fraudulent intentions if any. with modifications to the principles of propriety of public finance. ´Value for Money auditµ technique aims at lending assurance that economy. The same analogy.e.. i. to report on whether Government accounts. unwarranted and unfruitful expenditure or diversion of funds by the investigated entity to another entity. In conducting the propriety audit. all expenditure sanctioned and incurred are need-based and all revenues due to Government have been realized in time and credited to the government account. on the part of the management. like the CAG in India.

EXAMINATION METHODS Action Checklist Interview & Interrogation Test of Reasonableness Off Balance Sheet Transactions Historical Comparisons .

. and the tools available to detect abuses. Investigate possible reasons for inconsistencies. comparing actual costs against expected costs. External auditing specialists with extensive experience of complex forensic audits can offer industry specific experience. routes to their potential exploitation. and advanced interviewing techniques.ACTION CHECKLIST Understand your risks. Consider whether covert detection techniques might be more appropriate when investigating cases of possible fraud. fraud. auditing management expertise. or wastage. Analyze numerical data.

like improper account. pricing. etc. Identify questionable transactions ² indicating wide fluctuations from the normal ones and not. or claims. related to main objectives. in general. invoicing. classifications. Review questionable transaction documents for peculiarities. .TEST OF REASONABLENESS Check weaknesses in internal controls.

fraudulent transactions. and financial misstatements. Gather and preserve evidence corroborating asset losses. Identify questionable accounts. for finding out variances from current expectations and past relationships. account balances. and relationships between accounts. using available information. .HISTORICAL COMPARISONS Develop a profile of the entity under investigation. its personnel and beneficiaries.

raw materials/ components. Over/under-invoicing for capital goods.OFF BALANCE SHEET TRANSACTIONS These may encompass: Significant purchases/sales of raw materials and/or finished goods with only a particular dealer or group companies of such vendor. to pass on otherwise accrued benefit. Alteration of contractual terms. . on technical grounds. Diversion of funds through group companies and setting off such debits as expenditure. to holding/group companies. Pattern of consumption of major raw materials/components. Cost over²runs in major capital expenditure without corresponding benefit or convincing reasons. services. Justifications for non-maintenance of certain basic records. etc. but with intention to defraud.

INTERVIEW & INTERROGATION Interview and interrogation as evidence-gathering techniques involve asking people questions. the interviewer records both the answers to the questions and physical behaviors. . The basic difference is that interrogation is confrontational while interviewing is not. Key information to gather centers on the suspect·s pressures: Being deep in debt. In either case. perceived opportunities such as having access to the organization·s assets. and rationalization due to being passed over for a promotion.

Knowledge and skills include the following: investigation skills. (c) Innovative approach and skeptic of routine audit practices. finance. They possess skills such as: (a) Knowledge of entity·s business and legal environment. research. law. (b) Awareness of computer assisted audit procedures. auditing. accounting and law enforcement officer insights.FORENSIC ACCOUNTANTS AND SKILLS FOR FORENSIC AUDIT Forensic accountants are viewed as a combination of an auditor and private investigator. quantitative methods. .

Governmental Accountability Office (GAO) in the USA. Internal Revenue Service (IRS). In this capacity. They do not testify as to whether fraud has occurred. the Crime Branch of India (CBI). Other employers of forensic accountants include financial intermediaries such as banks and insurance organizations plus divorce attorneys. they are serving as expert witnesses. Bureau of Alcohol. Forensic accountants often testify in civil and criminal court hearings. This is the court·s decision. Homeland Security.FORENSIC ACCOUNTANTS AND SKILLS FOR FORENSIC AUDIT Forensic accountants have been employed by the FBI. and the Comptroller and Auditor General (CAG) in India. CIA. The expert witness presents evidence. Federal Trade Commission (FTC). . Tobacco and Firearms. the Income Tax Department.

.APPLICATION Forensic Accounting and Audit may be applied in the following areas besides fraud detection: (a) Conducting due-diligence (especially for segment wise profitability analysis) (b) Business valuation (c) Management auditing (d) Assessing loss before settling insurance claims.

DISTINCTION BETWEEN STATUTORY AUDIT AND FORENSIC AUDIT .

It provides a sound base of factual information that can be used to help resolve disputes. It plays an important role for companies under review by regulatory authorities. . It can improve efficiency by identifying areas of waste. It can help with the detection and recording of potential conflicts of interest for executives by improving transparency and probity in the way resources are used.ADVANTAGES OF FORENSIC AUDIT It strengthens control mechanisms.

Some employees can interpret a proactive forensic audit as a slight on their integrity.DISADVANTAGES OF FORENSIC AUDIT A poorly managed forensic audit could consume excessive amounts of management time. . The scope of the audit may need to be extended. with a corresponding increase in the budget.

manufacturing company based in Pune. .CASE STUDY: VIVITA LTD. Vivita Limited is an agriculture products processing.

FACTS OF THE CASE Based on Balance Sheet as on 30th June 2002.48 crore without any explanation/justification. that: (a) Requisite number of directors did not attend the meeting of Board of Directors of the company held to decide on reference to BIFR. 1985. 3. . iii.97 crore on account of foreign exchange fluctuations. Secured creditors objected on the grounds. Company had written off Rs. Vivita Ltd. amongst others. filed a reference U/S 15(1) of Sick Industrial Companies (Special Provisions) Act.6. Gave a huge discount of Rs. showing erosion in net worth. Company devalued its investments by 90% without explaining reasons for such a devaluation. (b) Company indulged in the following:i. ii.

. all together to the extent of Rs 43 crore.24 crore on a sale of Rs.1.64 crore without any proper/cogent explanation. However. viii.02 to Rs. the company reported a huge loss of Rs. It was suspected that these funds had been diverted/siphoned off to one of the related/or group companies.iv.40 crore on a marginal fall in sales during 2001. v. ix. Steep reduction in the sundry debtors during 200102 without any cogent explanation.26 lakhs as land development expenses. secured loans. Availed unsecured.39.87 crore. Addition to gross block included Rs.96 crore. Depreciation increased by Rs. vii. actually not incurred. Loans and advances had increased by Rs.84 crore despite a fall in fixed assets. as per inspection carried out by banks.12. Profit earned (operating profit) during the previous year was Rs. and increased drawings from cash credit account. vi.

though engaged in different activities. Marginal fall in the sales and huge losses accompanied with large discounts in a single financial year was common to all the companies. adopted the pattern of reporting huge losses on slight fall in sales.FACTS OF THE CASE BIFR observed that the group companies (to which Vivita belonged) referred to BIFR. .

in respect of accounting for foreign exchange fluctuation on P&M.O. Devaluation of investments not admitted as Vivita Ltd failed to submit copy of B. as it feared trademark infringement proceedings by another company.D. Accounting jugglery has been committed. BIFR did not accept this as sufficient evidence was not made available and hence heavy increase in discounts and losses were not allowed. . resolution to ascertain whether it was long-term or short-term investment.VIVITA·S REPRESENTATIONS AND DECISION OF BIFR Vivita stated huge discounts were offered to liquidate stock. Hence not allowed. only to make its net-worth negative.

Increase in loans and advances. BIFR set aside Vivita Ltd·s contention of losses in trading activities and ruled that losses of the company were overstated by Rs. Considering the market practice in the industry of taking advance from buyers and passing the same to the suppliers. on the one hand and sundry creditors/other liabilities. . Explanation of Vivita Ltd as for increase in depreciation was acceptable. 34. on the other. For want of complete details.61 crore on account of increase in raw material consumption. BIFR noted that selling prices and the procurement prices are fixed in advance. this issue was kept open. could mean a diversion of funds of the company and increase in losses by providing interest on borrowed funds.

BIFR observed that Vivita Ltd. had given preferential treatment in the payment of unsecured loans at the cost of secured loans. but in case of unsecured loans. . Vivita has not submitted any explanation. As to increase in loans. details were not available.40 crore on a marginal fall in the sales. Reduction in sundry debtors could mean diversion of cash flow as the company did not submit explanation. Regarding loss of Rs.

. based on above rulings. re-worked.JUDGMENT BIFR. the networth to be positive and hence rejected the reference u/s 15(1).

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