FORENSIC AUDIT
DR. MITIL CHOKSHI
CHOKSHI & CHOKSHI
CHARTERED ACCOUNTANTS
For MIPA
2nd May, 2014
Contents

What is Forensic Audit?

Fraud Detection Methodology

Forensic Audit vs.

Controls to avoid Fraud
External Audit

Preventive Measures

Statistics

Emerging Frauds

Recent Frauds

Response to Frauds

What is Fraud?

Synopsis

Difference between
Fraud & Error

Categories of frauds

Detection Techniques
For MIPA
2nd May, 2014
What is Forensic Audit
 The term “Forensic Audit” has not been defined
anywhere
 Forensic Audit involves examination of legalities by
blending the techniques of propriety, regularity and
investigative and financial audits
 “Forensic Audit” refers to specific procedures carried out
in order to produce evidence for investigation and
prosecution of criminal acts such as embezzlement or
fraud
 Findings of a forensic audit could be used in the court of
law as expert opinion on financial matters
 The forensic auditor should have a biased mind and
negative approach and should see everything with
suspicion.
For MIPA
2nd May, 2014
References
 Standard Practices
Engagements
for
IFA
 Managing the Business Risk of
Fraud : A Practical Guide
 Uniform
Guidelines
for
Investigations endorsed by 10th
Conference
of
International
Investigators
 Guidelines issued by International
Financial
InstitutionsAntiCorruption Task Force
For MIPA
2nd May, 2014
Skills-Set
Professional Accounting Skills require the following:
 an understanding of how business activity is documented, recorded, reported,
managed and controlled;
 the ability to identify, obtain, examine and evaluate relevant information;
 the ability to quantify the financial impact of actual or expected transactions or
events;
 the ability to perform and interpret relevant analyses of information;
 the ability to document and explain business information and the results of the
financial analyses for decision-making purposes; and
 the ability to render relevant and appropriate opinions and conclusions based
on the findings and results of the work performed.
For MIPA
2nd May, 2014
Skills-Set
Investigative Skills require the following:
 an understanding of the context within which the engagement is to be conducted ;
 the ability to identify, obtain, examine and assess information relevant to the engagement;
 the ability to analyze and compare various types and sources of information;
 an understanding of the types of information that would assist in establishing motivation,
intent and bias;
 an understanding of the ways in which information could be fabricated or concealed;
 an understanding that information collected and the work performed, including the work
and information of others, may become subject to disclosure and be tendered as
evidence; and
 the ability to document and present investigative findings and conclusions for decision
making purposes.
For MIPA
2nd May, 2014
External Audit vs. Forensic Audit
PARTICULARS
EXTERNAL AUDIT
FORENSIC AUDIT
Objective
Express opinion as to ‘true &
fair’ presentation
Determine correctness of
the accounts or whether any
fraud has actually taken
place
Techniques
‘Substantive’ and ‘compliance’
procedures.
Analysis of past trends and
substantive or “in depth”
checking of selected
transactions.
Period
Normally all transactions for the
particular accounting period.
No such limitations
Adverse findings, if any
Negative opinion or qualified
Legal determination of fraud
opinion expressed, with/without and naming persons behind
quantification
such frauds
Off Balance Sheet Items
Used to vouch the arithmetic
accuracy & compliance with
procedures
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Regularity and propriety of
these transactions/contracts
are examined
2nd May, 2014
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Statistics
Percentage of companies affected by listed types of fraud
Source : 2013/2014 Global Fraud Report - Kroll
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2nd May, 2014
Statistics
Percentage dissuaded from investing in:
Source : 2013/2014 Global Fraud Report - Kroll
For MIPA
2nd May, 2014
Frauds Sector wise
Others (Health Care & Social Sector)
Consumer Markets
Telecom
Real Estate & Infrastructure
Industrial Markets
Information & Entertainment
Financial Services
0%
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5%
10%
15%
20%
25%
30%
35%
2nd May, 2014
Frauds Process wise
Process perceived as most vulnerable to fraud risks
(Ranks are based on total score. Rank “1” indicates most vulnerable process)
PROCUREMENT
01
SALES & DISTRIBUTION
02
INVENTORY
03
FINANCE/PAYMENTS
04
ADMINISTRATION
05
TREASURY
06
HR
07
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2nd May, 2014
Statistics
Percentage Recovery to Fraud Amount
Full 100%
More than 50%
Between 26 to 50%
Less than 25%
NIL Recovery
0%
For MIPA
5%
10%
15%
20%
25%
30%
35%
2nd May, 2014
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Recent Frauds
 Rajat Gupta - Insider Trading
 LIBOR manipulation
 CWG - Embezzlement of Funds
 Adidas – Reebok - Siphoning off Funds
 NSEL - Non-availability of underlying commodities
 Satyam - Fudging of Financial Statements
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2nd May, 2014
Recent Frauds
 Bernard Madoff - Securities Trading
 Viruses and malwares - Rampant IP Fraud
 Counterfeit - Counterfeiting and Piracy
 Enron & AA – Payment for better accounting consequences
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2nd May, 2014
What Is Fraud ?
 From an auditor’s point of view, fraud is
any act :
- Which results in a financial loss /
reputational damage
- With a malafide intention
- Usually it is suppressed or
camouflaged.
For MIPA
2nd May, 2014
Difference Between
Fraud & Error
FRAUD
ERROR
 Stems from intelligence.
 Stems from inefficiency.
 Usually camouflaged.
 Generally open.
 Intentional.
 Unintentional.
 Deliberate concealment of the
facts.
 Omission of amount or
disclosure
For MIPA
2nd May, 2014
Categories Of Fraud
Financial Statement
Fraud
Diversion of Funds
Bid rigging
Insider
Trading/Misuse of
Information
Fraudulent
encashment through
forgery
Fictitious accounts
and conversion to
property
Kickback/ secret
commissions
Irregularity in Forex
transactions
Cheque kiting
Unauthorized credit
facilities granted for
reward or for illegal
gratification
Negligence and False
information
Purchase for personal
use
Grant of loan against
non-existent security
Unauthorized
relaxation in standard
terms & conditions
for grant of loan
No proper KYC of
Client
Manipulation of
payment instruments
For MIPA
2nd May, 2014
Typical Business Frauds
Trojan
Horse
Frauds
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Disaster
Frauds
Achilles
Heel
Frauds
Piggyback
Fraud
Red
Herring
Frauds
Duplicate
Purchases/
Expenses
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Fraud Triangle
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2nd May, 2014
General Susceptibility
People most susceptible to commit fraud
(Ranks are based on total score. Rank “1” indicates most vulnerable process)
VENDORS/AGENTS
01
MANAGEMENT EMPLOYEES
02
NON MANAGEMENT EMPLOYEES
03
BUSINESS ASSOCIATE
04
CUSTOMER
05
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2nd May, 2014
VIDEO CLIP
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2nd May, 2014
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
FORENSIC AUDIT
PROPRIETY AUDIT
Aims at lending assurance that
economy, efficiency and efficacy have
been achieved in the transactions for
which expenditure has been incurred
or revenue collected is usually applied
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2nd May, 2014
Fraud Detection Methodology
 Management Interviews:
• Interview of current as well as ex employees
• Minutes of the organization to be critically reviewed
• Preparation of a detailed questionnaire to extract constitutive
information
• Questions so intended that they draw out the best possible
information from the interviewee
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Verification of Applications:
• Confirming data not recreated/
modified
• Checking the control structure
• Checking Integrity and Reliability
of data.
• Verifying size and version of
data.
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Preliminary steps for Review :
Identifying weaknesses in internal controls
Inference Trends, Ratios
Checking bank reconciliation statements
Review Minutes, Statutory Registers, contracts, Audit/other Reports, etc.
Review of Standard Operating Procedures
Modification in the processes and reasons thereof
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Verification of authenticity of Legal Documents like minutes,
statutory registers, contracts:
Examples –
• Signature Analysis – Consistency and genuineness of signatures
on all documents.
• Testing the senility of the papers to verify if the documents
have been created in order to make justifications available to
the auditors.
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Theory of Inverse Logic:
• Process of proving the truth in the reverse order
• Determining what is fallacious and eliminating it
 Two useful methods of determining the truth:
•
The Mathematical or axiomatic approach
• Clues don’t fit or the reductio ad absurdum approach
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Axioms/ Theories / Mathematical tools/ etc.
• Benford’s Law of appearance of digits
Transactions
payments
of
cheque
First Digit
125,000
1
76,000
7
456
4
98,765
9
8745
8
12
1
For MIPA
2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
Pattern of naturally occurring numbers – Benford’s Law
Digit
1
2
3
4
5
6
7
8
9
30.10%
17.60%
12.50%
9.70%
7.90%
6.70%
5.80%
5.10%
4.60%
• Relative Size Factor
• Statistical measures such as regression which indicate the
dependence of one variable upon another
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2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Related Parties:
•
Identifying Related Parties and transactions
•
Investigating favors given for any hidden considerations
 Verification Of Movement Of Funds:
•
Tracing the movement of funds to identify the ultimate source of
funds and the ultimate beneficiary
•
Checking if there exists funneling of cash or other funds from illegal
activities through legitimate financial institutions and businesses to
conceal the source of the funds
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2nd May, 2014
Fraud
Detection
Methodology
Fraud
Detection
Methodology
 Exit Interviews:
• Evaluation of the Exit interviews that were conducted with
departing employees
• The primary aim of the exit interview is to understand the
rationale behind the person's departure
 Verification of the Internal and External communications
through all modes
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Documentation
The following documents or summaries should be retained on file:

Research;

Accounting, banking and other business records, and agreements;

Pleadings, criminal or regulatory charges, and other legal claims;

Affidavits and discovery transcripts;

Engagement letters and other correspondence;

Reports issued;

Schedules and calculations, including all necessary explanations;
For MIPA
2nd May, 2014
Documentation
The following documents or summaries should be retained on file:

Notes and other recordings of interviews, meetings and discussions;

Documentation of key issues considered and key assumptions made;

The approach(es) taken and specific techniques used;

A record of the nature, extent and timing of procedures performed and the
results of such procedures;

A record of the identities of the individual(s) performing the IFA engagement and
a record that the work performed by assistants was supervised and reviewed;

Where the work of others is relied upon, their findings and conclusions.
For MIPA
2nd May, 2014
Reporting
Auditors may communicate their findings and conclusions in a
number of different forms:
 written, oral or visual;
 draft, interim or final;
 point-form or narrative; and
 formal, affidavit or letter form.
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Fraud: Red Flags
 Large amount of cash in hand
 Lack of segregation of duties
 Lack of mandatory time off for
employees performing key control
functions
 Resource Constraints
 External pressure on employees
 Changes in employees behavior
For MIPA
2nd May, 2014
Fraud: Preventive Measures
 Ethics Statement/ Employees Code of Conduct
 Training & Communication
 Written Policies & Procedures
 Segregation of Duties
 Access Controls
 Monitoring lifestyle of Employees
 Employee Background Screening
For MIPA
2nd May, 2014
Controls to avoid Frauds
Detection & Deterrence
Whistleblower
Hotline
Internal
Audit
Risk Management
System
Data
Analytics
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2nd May, 2014
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2nd May, 2014
Emerging Frauds
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2nd May, 2014
Response to Fraud
Internal Investigation
Modification of Controls
Disciplinary Action
30%
38%
32%
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2nd May, 2014
To sum up….
Forensic Audit is an exception to the clause:
‘Auditors can be watchdogs and not blood- hounds’.
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2nd May, 2014
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