Presentation on theme: "Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal"— Presentation transcript:
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 allThank you to Vadodara Branch and members of ICAIFrom 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 AgendaForensic Audit: introduction and traits of a forensic accountant and forensic accounting and examples of some unusual frauds in business worldFraud and manipulations in excel reportsSimple forensic tests which can be conveniently used to detect fraudRed flags and early warning bells of possible fraudUnusual 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 encyclopediaForensic 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-AccountingAuditingInvestigatingChetan Dalal
8 What distinguishes a forensic audit from a normal audit? Forensic audit is issue based or related to a specific problemIt has several components and could include any or all of the following:Financial and accounting reviewDigital forensic analysisField investigationsData mining at an advanced levelApplication of Interviewing skillsTechnical assistance such as handwriting, specimen signatires, QC evaluation etcAudit relies on documentary evidence, whereas a forensic audit actually examines the reliability of documentary evidence itselfForensic 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 ObviousThink differently and Develop an open mindLook 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 HanumanTrust 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 IntelligentTechnologyStale procedures syndromeLack 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 investigatingDo 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’ comparisonsThe CEO wanted to show a good performance….Excel-Book1_cd.xlsxExcel Forensic.xlsStar-Contest-Result.xlsx
18 3. Some simple forensic tests - Juxtaposition test for testing authenticity of documents format and contentTest of reasonableness or absurdityTest of replication of contentTest of impossibilityScrutiny 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 testIn 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 departmentsVendor 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, etcFictitious Expense or purchase bills. Juxtapose bills from large volume vendorsDocuments lying in multiple departments- eg copies of minutes of meetings or letters or memoes issued to different departmentsSignatures 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 partiesMissing records, details, etcDiscrepancies in inventories, cash, and assetsBehavioural indicators- chronic late sitting, arrogance and known bad habits like gambling, alcoholic traits etcToo much of power and authority in one or few individualsMismatch between standard of living and known sources of incomeArrears and sloppiness in bookkeeping, reconciliations etc
25 Common accounting manipulations likely in Cash ContrasStock in transitAccounting favours to debtorsNon reversal of stale cheques to create secret reservesNot redepositing unpaid cash expenses such as wages, reimbursements etcRecycling of petty cash advances or IOUs
26 Bombay BrDelhi BrKolkattaChennaiBOM-serLucknowPunePurchasesStaff Recruitment & Training576109501215365887547304553065Travelling Exp - Foreign493068428969313147468415409246473345Repairs & Maint437968381032278153875936363513420449Printing & Stationery379100329817240766360145185759314653363936Travelling Exps301765262536191651286677250465289694Tel / Mobile / Internet116954101750111106112276Electricity Charges120000104400762121140005880099600115200Communication - FBT10695310160588771102675Discounts given105873100579109023101638Discounts on sales206902180005131403196557101382171729198626Vehicle Running & Main - R249529217090158476237053239548Subscription Charges143399124757136229119021137663Funds transferred- Kolkatta250000Funds transferred- Pune50000Funds transferred- Chennai125000Funds transferred- DelhiStock in transit to Kolkatta500000Security Charges139543121402132566115821133961stocks in transit209488182255133046199014173875201108Stock in transit to Bom_ser800000696000508080760000392000768000Postage / Telegram273491237937173694259816226998262551Membership Fees174086151455110562165382144491167123Insurance Prem - FBT187524163146119096178148155645180023Insurance Prem - Clinical Trials214218186369136050203507205649Housekeeping Services159191138496101102151231132129152823Facility Management175044152288111170166292145286168042Conference/Seminar Fees499233434333317063474271414363479264Computer MaintAMCOthersSales906469HO account901195784040572349856135747992865147Funds transferred from BomFunds transferredfrom DelhiFunds transferred from chennaiFunds transferred from PuneStocks in transit from Bom
29 Thirteen point programme to detect symptoms of fraud during audit of financial statements Secret reserve searchMirror image evaluation approach to find inconsistent resultsRelative Size Factor in stocks, debtors, creditors to detect error or manipulationIllogical events- loans taken when huge liquid assets are available such as fixed depositsImpossibility of certain results based on events knownDuplicate Numbers- could stem from error or fraudCash /stock shortages indicated by illogical withdrawing/purchasingNegative asset / expense balances could be errors or fraudGhost workers searchUse Test Packs to check software bugs where audit train is invisibleBenford’s theorem test resultsSpreadsheet forensics and Ratio Analysis for trendsPhysical 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 methodU- unhideF- font colorationS-Show FormulaR- rectify and replaceD-duplication check..\collections\financialsA.xls
31 SPACE TIME DIMENSIONBOTH 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 StudyChetan Dalal
32 A robbery took place in a mall in January 2006 Thieves broke in through the doorThey stole case worth more than Rs. 40 lacsPolice complaint lodgedPolice made inquiries with staff, neighbourhoodChetan Dalal
33 Findings of the PoliceThey concluded that this was the work of a local gang of thieves operating in the area and this mall was the latest victimThey suspected that some employee may have helped but could not get specific clues against anyoneThey recommended better locks and greater security. Case virtually closedChetan Dalal
34 Management appointed auditors who were specialised investigators more for studying controls and recommending preventive measuresChetan 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 themThe door that was broken was done with crude tools- not the work of a professional gangOut 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 approachIDEA_DATA.xlsAmazing findings- Late night salesChetan Dalal
38 The log in id was traced – the store manager The log in id was traced – the store manager. On being questioned he confessedThere was no robbery- it was a stage managed robbery to cover up stock shortagesThe shortages were built up over a period of time. The store manager panicked when he was told that a stock taking was to take placeHe 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 robberyChetan Dalal
39 Relative Size Factor (RSF) Use of mathematical toolsRelative Size Factor (RSF)
40 Scrutiny of individual parties account is humanly ineffective. RelevanceScrutiny 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 NumberSecond 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 mistakesAlterations in decimalsWrong coding with masters (vendors, customers, employees, etc.)Revenue items charged to capital accounts and vice versaExcess 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 TestsTests 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 testingChetan Dalal
49 Surprise Repetitive Tests Surprise tests lose their sting when an auditee can predict an auditor’s planTiming 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 testsTests of processes, operations and controls across similar unitsAnomalies should be explained, else something is amiss:Case of discounts in chocolate shopsCase of repairs to moulds in two identical processing units