2 nd may, 2014for mipa forensic audit dr. mitil chokshi chokshi & chokshi chartered accountants

2nd May, 2014For MIPA

FORENSIC AUDITDR. MITIL CHOKSHI

CHOKSHI & CHOKSHICHARTERED ACCOUNTANTS


Contents What is Forensic Audit?

Forensic Audit vs.

External Audit

Statistics

Recent Frauds

What is Fraud?

Difference between

Fraud & Error

Categories of frauds

Detection Techniques

Fraud Detection Methodology

Controls to avoid Fraud

Preventive Measures

Emerging Frauds

Response to Frauds

Synopsis


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.


References Standard Practices for IFA

Engagements

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 Institutions- Anti-Corruption Task Force


Skills-SetProfessional 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.


Skills-SetInvestigative 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.


External Audit vs. Forensic AuditPARTICULARS 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 theparticular accounting period.

No such limitations

Adverse findings, if any Negative opinion or qualifiedopinion expressed, with/withoutquantification

Legal determination of fraud and naming persons behind such frauds

Off Balance Sheet Items Used to vouch the arithmetic accuracy & compliance with procedures

Regularity and propriety of these transactions/contracts are examined


Source : 2013/2014 Global Fraud Report - Kroll

StatisticsPercentage of companies affected by listed types of fraud


Source : 2013/2014 Global Fraud Report - Kroll

StatisticsPercentage dissuaded from investing in:


Frauds Sector wise

Financial Services

Information & Entertainment

Industrial Markets

Real Estate & Infrastructure

Telecom

Consumer Markets

Others (Health Care & Social Sector)

0% 5% 10% 15% 20% 25% 30% 35%


Frauds Process wise

PROCUREMENT 01

SALES & DISTRIBUTION 02

INVENTORY 03

FINANCE/PAYMENTS 04

ADMINISTRATION 05

TREASURY 06

HR 07

Process perceived as most vulnerable to fraud risks(Ranks are based on total score. Rank “1” indicates most vulnerable process)


Statistics

NIL Recovery

Less than 25%

Between 26 to 50%

More than 50%

Full 100%

0% 5% 10% 15% 20% 25% 30% 35%

Percentage Recovery to Fraud Amount


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


Recent Frauds Bernard Madoff - Securities Trading

Viruses and malwares - Rampant IP Fraud

Counterfeit - Counterfeiting and Piracy

Enron & AA – Payment for better accounting consequences


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.


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


Categories Of FraudFinancial

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

Manipulation of payment instruments

Grant of loan against non-

existent security

No proper KYC of Client

Unauthorized relaxation in standard

terms & conditions for grant of loan


Typical Business Frauds

Piggyback Fraud

Red Herring Frauds

Disaster Frauds

Duplicate

Purchases/

Expenses

Trojan Horse Frauds

Achilles Heel

Frauds


Fraud Triangle


General Susceptibility

VENDORS/AGENTS 01

MANAGEMENT EMPLOYEES 02

NON MANAGEMENT EMPLOYEES 03

BUSINESS ASSOCIATE 04

CUSTOMER 05

People most susceptible to commit fraud(Ranks are based on total score. Rank “1” indicates most vulnerable process)


VIDEO CLIP


Detection Techniques

FORENSIC AUDIT

CRITICAL POINT AUDITING

PROPRIETY AUDIT

Aims at filtering out the symptoms of fraud from regular and normal transactions in which they are mixed or concealed

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



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


Verification of Applications:

• Confirming data not recreated/ modified

• Checking the control structure

• Checking Integrity and Reliability of data.

• Verifying size and version of data.

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



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.



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



Axioms/ Theories / Mathematical tools/ etc.

• Benford’s Law of appearance of digits

Transactions of cheque payments

First Digit

125,000 1

76,000 7

456 4

98,765 9

8745 8

12 1



Digit

1 30.10%

2 17.60%

3 12.50%

4 9.70%

5 7.90%

6 6.70%

7 5.80%

8 5.10%

9 4.60%

• Relative Size Factor

• Statistical measures such as regression which indicate the dependence of one variable upon another

Fraud Detection MethodologyPattern of naturally occurring numbers – Benford’s Law



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



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



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;

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.

Documentation


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.

Reporting


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


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


Controls to avoid Frauds

Detection & Deterrence

Whistleblower Hotline

Risk Management

System

Data Analytics

Internal Audit


Emerging Frauds


Response to Fraud

38%

32%

31%

Internal Investigation Modification of Controls Disciplinary Action


To sum up….

Forensic Audit is an exception to the clause:

‘Auditors can be watchdogs and not blood- hounds’.

2 nd may, 2014for mipa forensic audit dr. mitil chokshi chokshi & chokshi chartered accountants

Documents

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business information

forensic auditor

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