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Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal

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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 Chetan Dalal

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 Chetan Dalal

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 Chetan Dalal

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 Chetan Dalal

34 Management appointed auditors who were specialised investigators more for studying controls and recommending preventive measures Chetan Dalal

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? Chetan Dalal

36 Findings good but inadequate to point out any means of recovery
Chetan Dalal

37 Auditors try a new approach
The use the space time dimension approach IDEA_DATA.xls Amazing findings- Late night sales Chetan Dalal

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 Chetan Dalal

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 Chetan Dalal

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. Chetan Dalal

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

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