The article briefly explains the concept of Forensic Auditing and the use of the technique in the detection of the frauds. The relevance of the concept has been highlighted -especially in the emerging scenario of continuous development in the fields of accounting and auditing. The article also touches upon the various inter-related concepts and the vital areas where the technique of Forensic Auditing can be best used in detecting the misappropriations and manipulations in the financial as well as operational matters.
CA Rubneet Kaur
B.Com, M.Com, MBA
rubneet@gmail.com
Introduction
The manipulations and misappropriations in the corporate world relates back to Sept 1720 when after the War of Spanish Succession, the UK signed the Treaty of Utrecht 1713 with Spain, ostensibly allowing it to trade in the seas near South America. In fact, barely any trade took place as Spain renounced the treaty; however this was concealed on the UK stock market. A speculative bubble saw the share price reach over £1000 in August 1720, but then crash in September. A Parliamentary inquiry revealed fraud among members of the government, including the Tory Chancellor of the Exchequer John Aislabie, who was sent to prison.(source-online published story)
And since then there has been a steep rise in such manipulations being continuously occurring all over the world, such as Quintex-Real Estate(1989), Poly Peck-Electronics, Food, Textiles(1990), Bre-X-Mining(1997), Equitable Life Assurance Society-Insurance(2000),WorldCom-Telecommunication(2001), Enron-Energy(2001), Arthur Anderson-Accounting(2002), Parmalat-Food(2003), Refco-Brokering(2005) and ofcourse the securities scam by Harshad Mehta and Ketan Parekh , C.R. Bhansali ,Home Trade fraud and the most recent one by M/s Satyam Computer Services Ltd.
Statutory
Provisions covering the reporting of Fraud
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SA
240- prescribed auditing standard as per Sec 143(10)
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Sec
143(12) of Companies Act 2013
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Rule
13 of Companies Act 2013
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Form
ADT 4
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CARO
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Communication
of fraud/ fraudulent matters to management
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Reporting
to the Central Government/ Audit committee as the case may be, if an offence
involving fraud is being or has been committed against the company by
officers/ employees of the company.
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Specifies
the manner for reporting the fraud to the Central Government
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Format
and information to be included in such report.
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It
does not require the auditor to discover the frauds on/ by the company but to
inquire and present the frauds noticed/ reported during the year to
management.
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Suspected
frauds by vendors, customers and other third parties
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Fraud
by officers/ employees of the company
Officer-
includes any director, manager, KMP or any person on whose directions, the
board or a single director is accustomed to act., Employee- persons who are
on the payroll of the company
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With
the advent of definition of fraud in the Companies Act 2013, the concept of
Forensic Auditing as a practice and methodology has gained immense importance
and relevance in addition to the regular auditing techniques already in place.
The explanation given
in Sec 447 of the Companies Act 2013
says that-
“fraud”
in relation to affairs of a company or any body corporate, includes any act,
omission, concealment of any fact or abuse of position committed by any person
or any other person with the connivance in any manner, with intent to deceive,
to gain undue advantage from, or to injure the interests of, the company or its
shareholders or its creditors or any other person, whether or not there is any
wrongful gain or wrongful loss;
A Forensic Audit
is a comprehensive and systematic processinvolving a series of activities and
tasks undertaken for establishingthe accuracy and authenticity of the
transactions under review.
It
may include-
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investigative
techniques with an understanding of accounting principles,
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review of financial
statements to determine if they are accurate and lawful,
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application of
accounting methods to the tracking and collection of forensic evidence
examination of legalities 
Why
Are Forensic Audits required?
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to find out whether or
not true business value has been reflected in the financial statements
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to find whether any fraud
has taken place
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to determine if there are
suspicious practices hiding beneath company or individual financial records and
statements.
Various
international laws and legislations such as Foreign Corrupt Practices Act 1977,
Sarbanes-Oxley Act 2002, Public Companies Accounting Oversight Board (PCAOB)etc
also depicts the importance of Forensic Auditing in the recent corporate
scenario.
When
Are Forensic Audits required?
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wherever an entity's
finances present a legal concern,
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in cases of suspected
embezzlement or fraud,
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to determine tax
liability,
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to investigate
allegations of bribery,
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to strengthen a
company's already good business practices,
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to either determine
the lost income as a result of a fraudulent financial/ operational report,
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orto determine the
damage that falsified reports caused to shareholders, clients or employees.
Types
of Frauds detected by Forensic Auditors
Forensic Auditors being the professionals carrying
high degree of skepticism, effective probing techniques, highly analytical and
well versed I documentation and evaluation usually detects the following types
of frauds in the financial statements-
1.
Frauds related to
Revenue and Sales- such as showing fictitious sales revenue(inflated/ deflated)
2.
Frauds with respect
to falsifying the market position of the company by either showing false
results or deceiving the shareholders by showing inflated share prices and
consequently lower debts.
3.
Other frauds may also
consist of various deceptive sale practices being undertaken by the company
itself in order to capture market share or sustaining the present market
position. This is generally done by selling defective parts or even re-imbruing the expenses which have
not been actually incurred / covered in the policies.
4.
Various third party
frauds may also comprise of recording of deceptive allowances from vendors in
order to falsify the revenue(inflated/ deflated) and even sometimes
underachievement to vendors is also reported.
5.
Fraudulent acts of
providing mis-statement in the financial statements by the directors such as no
violation of law has taken place or Internal Financial Controls are in place
etc.
6.
Frauds related to
tampering of bank records and taking the monetary advantage thereof.
7.
Theft of competitor secrets or third party
intellectual property rights may also amount to fraudulent act which also comes
under the purview of forensic auditors.
8.
Various other frauds
may also include-
a.
Showing financial
statements as these are in line with the standards set or budgeted tasks.
b.
Falsifying the value
of the business
c.
Using business
resources for personal purposes
d.
Accepting bribes form
the customers/ dealers/ vendors in order to facilitate business to them
e.
Representation of
dummy workers/employees in the manpower sheets and consequently higher wage
cost/ employee cost.
f.
Fictitious expenses
and inflated incomes
g.
Showing dummy
suppliers/ vendors and payments thereof
h.
Representing excess
recoverable/ payables in the financials
Constituents
of Forensic Audits-
1.
Assessment of fraud
risk factors and evaluating internal controls and standards
2.
Comparison and
contrast of various fraud schemes to devise the appropriate internal controls
3.
Developing
off-setting internal controls that would limit or prevent these fraud schemes
4.
Using data analysis
techniques to identify high-risk transactions for further review and
investigation
5.
Evaluating internal
controls and identifying ways to plan audits to take advantage of available
information systems resources
6.
Evaluating financial
and program risk for potential fraud
7.
Applying various
evidence-gathering techniques used to detect fraud
8.
Justifying the
auditor’s conclusion of fraud by providing the evidence needed to support legal
and investigative staff
9.
Documenting the
evidence and data-gathering process
10.Sharing the findings
with the agency and advise them on how to avoid the fraud in the future
Distinction
between Forensic Auditing and Financial Auditing
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Financial
Auditing
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Forensic
Auditing
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1.
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Examination of the financial
statements in accordance with the applicable standards and norms.
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Identifying and analyzing the
possibility of fraudulent financial reporting and misappropriation of assets.
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2.
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The techniques mainly comprises of
compliance and substantive testing of eth transactions.
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The techniques usually comprises of
scrutiny and in-depth review of specific transactions.
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3.
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Audit opinion is on the whole set of
the financial statements being audited.
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The main concern is on heightening
of the awareness of the specific irregularities reported
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4.
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Audit is in the nature of public
interest
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Audit is conducted considering the
interest of specific persons who have hired them.
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5.
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Auditor's work
stands on its
own
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Forensic
Auditor’s work supports
the work of the legal counsel or the board
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6.
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The financial auditor only expresses
the opinion
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In addition to the opinion , the
forensic auditor also identifies the causes of the irregularities and may
also recommend requisite changes.
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7.
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Management representations for
valuation of stock, bank accounts etc are used.
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The auditor gathers each single
evidence on its own during the whole examination.
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8.
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Auditors are concerned with errors
and irregularities
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forensic accountants are concerned
with distinction between errors of judgement& deliberate
misrepresentations
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9.
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Working without indemnification
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work usually has both
indemnification and hold-harmless protections
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10.
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Auditor determines the nature, scope,
and extent of the audit
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Client determines the nature, scope,
and extent of the audit
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How
are frauds detected in the Forensic Audit?
In
this type of audit, the forensic auditor specifically looks for the financial
misconduct taken place in the financial records and statements of the entity.
As against the regular review or audit of financial statements, it focuses on
the gathering of the evidence to be produced in the court of law during the
proceedings taking place.
Various
detecting techniques used by Forensic Auditors may include the investigation,
pro-active detection, identifying the absence of moral rules in the
organization, weaknesses in the line of defense
such as ineffective internal control/ audit, other tests can be
conducted such as tests of reasonableness, historical comparisons of eth
entity’s key performance indicators, evaluating other off-balance sheet
transactions etc.
Internal
Audit and Internal Control- A line of defense
According
to the Business Dictionary, Internal Control are systematic measures, such as
reviews, checks and balances, methods and procedures instituted by an
organization to conduct its business in an orderly and efficient manner,
safeguard its assets and resources, deter and detect errors, fraud and theft,
ensure accuracy and completeness of its accounting data, produce reliable and
timely financial and management information and ensure adherence to its
policies and plans.
In order to achieve all
these objectives, an organization must have an effective Internal Audit system
in place. In the recent scenario, when the scope of the term Internal Control
has been extended to Internal financial Controls, the functionality of the
internal Auditor of the company has also changed. The responsibility of
detecting the fraud has increased and measures for preventing and mitigating
such recurrences needsto be identified by the professionals.The governing
forces behind the effective and efficient Internal Audit and control review can
be summarized as below-
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Control
Environment
(Physical
or Documentary)
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Control
Activities
(Operational
or Financial)
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Risk
Assessment
(All
types of risks)
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Information
and Communication
(Effective
and Efficient)
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Conclusion
In the present scenario of
revival of corporate law and norms being made stringent, there is an ample
space for the overall recognition of such an important technique for
identifying frauds. The technique altogether different from the traditional
auditing approach has also got its significance where the concept of due diligence has to be applied. Forensic
Auditing not only identifies the
factors/ reasons adversely affecting the trust in mechanism of trade, finance
and investment but also helps in recognizing the destabilizing effect on
commercial institutions and corporate houses directly affecting the national
progress and putting strain on national resources.
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