1. Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal

2. Thank you to Vadodara Branch and members of ICAI From Chetan Dalal
A warm welcome to all
Thank you to Vadodara Branch and members of ICAI
From Chetan Dalal

3. Very Important to remember:
All case studies / exhibits / example are adaptations of real life situations, and any resemblance or use of any name, logo or symbol of any entity is purely for academic purposes and to facilitate better understanding. Case studies discussed in the seminar are imaginery and at no point is there any direct or indirect implication of fraud in or by any entity referred to anywhere.

4. Agenda
Forensic Audit: introduction and traits of a forensic accountant and forensic accounting and examples of some unusual frauds in business world
Fraud and manipulations in excel reports
Simple forensic tests which can be conveniently used to detect fraud
Red flags and early warning bells of possible fraud
Unusual methods of investigating

5. 1. Forensic Audit: what it means and What are the traits of a good forensic accountant or auditor?

6. Technical definition-Wikipedia, the free encyclopedia
Forensic Audit-
Technical definition-Wikipedia, the free encyclopedia
Forensic accounting is the specialty practice area of accountancy that describes engagements that result from actual or anticipated disputes or litigation. "Forensic" means "suitable for use in a court of law", and it is to that standard and potential outcome that forensic accountants generally have to work.
Forensic accountants, also referred to as forensic auditors or investigative auditors, often have to give expert evidence at the eventual trial.

7. Accounting Auditing Investigating
Forensic Audit is all about examination and collection of evidence admissible in a court of law. It utilizes the following skills of CAs-
Accounting
Auditing
Investigating
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8. What distinguishes a forensic audit from a normal audit?
Forensic audit is issue based or related to a specific problem
It has several components and could include any or all of the following:
Financial and accounting review
Digital forensic analysis
Field investigations
Data mining at an advanced level
Application of Interviewing skills
Technical assistance such as handwriting, specimen signatires, QC evaluation etc
Audit relies on documentary evidence, whereas a forensic audit actually examines the reliability of documentary evidence itself
Forensic accounting emphasizes the need to look for other evidence available as well.

9. For example a bank manager committing suicide on desk with a suicide note under his hand

10. The most important traits of an investigator
Distrust the Obvious
Think differently and Develop an open mind
Look from different angles and all sides. You will get a different revelation

11. Learnings from Ravana- a great Scholar and Shiva Bhakt useful for auditors and investigators
Laxman was sent by Ram when Ravana was dying to get advise and some learnings:
He got the following tips
- Never underestimate your adversary- he made this mistake with Hanuman
Trust only those advisors who have the courage to criticize you.
Treat your servants, driver (charioteer), close family members with discretion and keep your secrets close to you. They can harm you.
You cannot win always, sometimes you may think that you may be winning, but you may not be.

12. Common reasons why fraud goes unnoticed and forensic audits are needed
Fraudsters/ deceivers are Intelligent
Technology
Stale procedures syndrome
Lack of perseverance

13. Two facets which are applicable to all investigations
Use of desktop internet investigation (useful in audit too)
Use of the theory of impossibility and absurdity to detect fraud.
If an investigator habitually applies these his success rate will increase phenomenally.

14. Concept of desktop audit and investigation
This is a technique you must use to conduct verifications, research and information regarding vendors, products, third parties, and almost anything you are auditing or investigating
Do this as frequently as possible to spot forgeries or establish the authenticity of third parties, entities, documents such as invoices, letters, agreements, wills, old records, title deeds, letters of guarantee, LCs, and on rare occasions forgeries in passports, treasury bonds, fixed deposit receipts from banks etc

15. Apply the theory of absurdity and impossibility
When you identify what is not possible or very unlikely, the fallacy or deceit in given submissions will be exposed.
Also, in investigations evidence is often destroyed or changed or altered or hidden. To find the supporting evidence is therefore practically difficult.
Make it a habit to think of what is not possible or impossible or unreasonable

16. 2. Manipulations and fraud in spreadsheets
Example using Excel Sheets

17. An illustration of presentation fraud in a spreadsheet
Consider a spreadsheet containing some data of two years’ comparisons
The CEO wanted to show a good performance….Excel-Book1_cd.xlsx
Excel Forensic.xls
Star-Contest-Result.xlsx

18. 3. Some simple forensic tests
- Juxtaposition test for testing authenticity of documents format and content
Test of reasonableness or absurdity
Test of replication of content
Test of impossibility
Scrutiny of suspicious documents particularly those having alterations

19. Test of IMPOSSIBILITY: identify events which are not possible and check them out
For example: Can be applied on volume of stocks in a warehouse or production with actual machine capacity

20. Scrutiny of Alterations and suspicious documents or large value cash payments
Forensic study of alterations – try and discern consistency of cancellations, smudges, spaces and overwritings

21. Juxtaposition test
In simple words it means placing side by side for comparison and spotting differences, where there should be none. This can be very effective in spotting manipulations

22. Where would one apply the juxtaposition test?
Document comparisons: Contracts agreements – copies lying with different departments
Vendor letterheads, bills and letter formats- all bidders’s documents and search for common addresses, telephone numbers, fax numbers, fax/tel numbers, addresses?
HR frauds- Juxtapose degree certificates, signatures on certificates, multiple reference letters, etc
Fictitious Expense or purchase bills. Juxtapose bills from large volume vendors
Documents lying in multiple departments- eg copies of minutes of meetings or letters or memoes issued to different departments
Signatures on important documents –

23. Test of absurdity or reasonableness
Think of events which may be possible but not probable. Can a person arrive and depart at exactly the same time every day ? If smart/swipe card analysis shows such a pattern it is likely to be a phantom employee

24. 4. Early warning bells and red flags
Close nexus with suppliers, customers and third parties
Missing records, details, etc
Discrepancies in inventories, cash, and assets
Behavioural indicators- chronic late sitting, arrogance and known bad habits like gambling, alcoholic traits etc
Too much of power and authority in one or few individuals
Mismatch between standard of living and known sources of income
Arrears and sloppiness in bookkeeping, reconciliations etc

25. Common accounting manipulations likely in
Cash Contras
Stock in transit
Accounting favours to debtors
Non reversal of stale cheques to create secret reserves
Not redepositing unpaid cash expenses such as wages, reimbursements etc
Recycling of petty cash advances or IOUs

26. Bombay Br
Delhi Br
Kolkatta
Chennai
BOM-ser
Lucknow
Pune
Purchases
Staff Recruitment & Training
576109
501215
365887
547304
553065
Travelling Exp - Foreign
493068
428969
313147
468415
409246
473345
Repairs & Maint
437968
381032
278153
875936
363513
420449
Printing & Stationery
379100
329817
240766
360145
185759
314653
363936
Travelling Exps
301765
262536
191651
286677
250465
289694
Tel / Mobile / Internet
116954
101750
111106
112276
Electricity Charges
120000
104400
76212
114000
58800
99600
115200
Communication - FBT
106953
101605
88771
102675
Discounts given
105873
100579
109023
101638
Discounts on sales
206902
180005
131403
196557
101382
171729
198626
Vehicle Running & Main - R
249529
217090
158476
237053
239548
Subscription Charges
143399
124757
136229
119021
137663
Funds transferred- Kolkatta
250000
Funds transferred- Pune
50000
Funds transferred- Chennai
125000
Funds transferred- Delhi
Stock in transit to Kolkatta
500000
Security Charges
139543
121402
132566
115821
133961
stocks in transit
209488
182255
133046
199014
173875
201108
Stock in transit to Bom_ser
800000
696000
508080
760000
392000
768000
Postage / Telegram
273491
237937
173694
259816
226998
262551
Membership Fees
174086
151455
110562
165382
144491
167123
Insurance Prem - FBT
187524
163146
119096
178148
155645
180023
Insurance Prem - Clinical Trials
214218
186369
136050
203507
205649
Housekeeping Services
159191
138496
101102
151231
132129
152823
Facility Management
175044
152288
111170
166292
145286
168042
Conference/Seminar Fees
499233
434333
317063
474271
414363
479264
Computer Maint
AMC
Others
Sales
906469
HO account
901195
784040
572349
856135
747992
865147
Funds transferred from Bom
Funds transferredfrom Delhi
Funds transferred from chennai
Funds transferred from Pune
Stocks in transit from Bom

27. 5. Unusual Methods of investigating

28. Chetan Dalal

29. Thirteen point programme to detect symptoms of fraud during audit of financial statements
Secret reserve search
Mirror image evaluation approach to find inconsistent results
Relative Size Factor in stocks, debtors, creditors to detect error or manipulation
Illogical events- loans taken when huge liquid assets are available such as fixed deposits
Impossibility of certain results based on events known
Duplicate Numbers- could stem from error or fraud
Cash /stock shortages indicated by illogical withdrawing/purchasing
Negative asset / expense balances could be errors or fraud
Ghost workers search
Use Test Packs to check software bugs where audit train is invisible
Benford’s theorem test results
Spreadsheet forensics and Ratio Analysis for trends
Physical verifications of assets, processes, and walk through tests, including tiger team tests

30. Forensic Testing of spreadsheet data eg even MIS reports can be falsified
The excel UFSRD method
U- unhide
F- font coloration
S-Show Formula
R- rectify and replace
D-duplication check..\collections\financialsA.xls

31. SPACE TIME DIMENSION
BOTH SPACE AND TIME OFFER TESTING YARDSTICKS FOR AUDIT PURPOSES.
e.g. How much quantity can be stored in a warehouse, container, truck, box can be very useful for corroborative tests of inventory, sales, purchases.
Time can be used in several ways, time of transaction, time taken for the transaction, time difference between two events etc.
Case Study
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32. A robbery took place in a mall in January 2006
Thieves broke in through the door
They stole case worth more than Rs. 40 lacs
Police complaint lodged
Police made inquiries with staff, neighbourhood
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33. Findings of the Police
They concluded that this was the work of a local gang of thieves operating in the area and this mall was the latest victim
They suspected that some employee may have helped but could not get specific clues against anyone
They recommended better locks and greater security. Case virtually closed
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34. Management appointed auditors who were specialised investigators more for studying controls and recommending preventive measures
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35. Auditors spot red flags
The time element indicated that the thieves had only 20 minutes to complete the robbery while the patrolling guards were circling the mall.
How could they throw about all contents of all drawers?
Where did they have time to steal a few cell phone handsets which were on a different floor?
The alarm had been switch off. Therefore it was certain that someone had helped them
The door that was broken was done with crude tools- not the work of a professional gang
Out of two safes only one was broken into and robbed. The second was left untouched?
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36. Findings good but inadequate to point out any means of recovery
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37. Auditors try a new approach
The use the space time dimension approach
IDEA_DATA.xls
Amazing findings- Late night sales
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38. The log in id was traced – the store manager
The log in id was traced – the store manager. On being questioned he confessed
There was no robbery- it was a stage managed robbery to cover up stock shortages
The shortages were built up over a period of time. The store manager panicked when he was told that a stock taking was to take place
He converted the stock shortages into ‘artificial’ sales by entering sales at midnight along with his accomplice the head cashier during the previous two nights. This resulted into stock shortages being converted into cash shortages.
This shortage was then palmed off as robbery by breaking open the door and throwing papers and documents in the cash room to make it look like a robbery
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39. Relative Size Factor (RSF)
Use of mathematical tools
Relative Size Factor (RSF)

40. Scrutiny of individual parties account is humanly ineffective.
Relevance
Scrutiny of individual parties account is humanly ineffective.
It highlights all unusual fluctuations which may be stemming from frauds or errors

41. RSF = Largest Number Second Largest Number What is RSF ?
RSF is the ratio of Largest Number to the Second Largest Number of a relevant set.
RSF = Largest Number
Second Largest Number

44. RSF- Relative Size Factor
RSF= highest value divided by the second highest value in a ledger account of debtors, or creditors Even a comparison of prices, quantities or values in an inventory If the RSF > 10, chances of error or fraud are great

45. How does RSF Work ?
Any set of transactions take place in certain range. E.g. A vendor XYZ may have normal pattern of bill value range of Rs. 13k to 50k.
If there is any stray instance of single transaction which is way beyond the normal range than that ought to be looked into. E.g. in above case, if there is bill of Rs. 5 lacs.
RSF is above case will give a ratio of 10 (I.e. ratio of Rs. 5lac to Rs lacs)
These single instances could be cases where there is some foul play.

46. Types of frauds that RSF can unearth
Data entry mistakes
Alterations in decimals
Wrong coding with masters (vendors, customers, employees, etc.)
Revenue items charged to capital accounts and vice versa
Excess payments in payroll

47. Useful algorithm Luhn’s algorithm
For verifying correctness of credit cards and other cards which have been generated using the check sum digit

48. Tiger Team Tests
Tests used to assess the robustness of a system by actually carrying out penetration tests or walk through tests of processes as in ethical hacking for IT process testing
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49. Surprise Repetitive Tests
Surprise tests lose their sting when an auditee can predict an auditor’s plan
Timing is very effective: one way to throw a suspected auditee completely off guard is to repeat a test in quick succession. Complacency, cover-ups and even frauds are likely to be exposed in the repeat test.
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50. Mirror Imaging tests
Tests of processes, operations and controls across similar units
Anomalies should be explained, else something is amiss:
Case of discounts in chocolate shops
Case of repairs to moulds in two identical processing units

51. Open Session…. Thank you