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Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal.

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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

3  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 1. Forensic Audit: introduction and traits of a forensic accountant and forensic accounting and examples of some unusual frauds in business world 2. Fraud and manipulations in excel reports 3. Simple forensic tests which can be conveniently used to detect fraud 4. Red flags and early warning bells of possible fraud 5. Unusual methods of investigating


6 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. accountancylitigation Forensic accountants, also referred to as forensic auditors or investigative auditors, often have to give expert evidence at the eventual trial. Forensic Audit- Technical definition-Wikipedia, the free encyclopedia

7 - Accounting - Auditing - Investigating

8  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.


10  Distrust the Obvious  Think differently and Develop an open mind  Look from different angles and all sides. You will get a different revelation

11 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 1. Fraudsters/ deceivers are Intelligent 2. Technology 3. Stale procedures syndrome 4. Lack of perseverance

13  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  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  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


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

18 3. S OME 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 For example: Can be applied on volume of stocks in a warehouse or production with actual machine capacity

20 Forensic study of alterations – try and discern consistency of cancellations, smudges, spaces and overwritings

21  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  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 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. E ARLY 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  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 BrDelhi BrKolkattaChennaiBOM-serLucknowPune Purchases Staff Recruitment & Training Travelling Exp - Foreign Repairs & Maint Printing & Stationery Travelling Exps Tel / Mobile / Internet Electricity Charges Communication - FBT Discounts given Discounts on sales Vehicle Running & Main - R Subscription Charges Funds transferred- Kolkatta Funds transferred- Pune50000 Funds transferred- Chennai Funds transferred- Delhi Stock in transit to Kolkatta Security Charges stocks in transit Stock in transit to Bom_ser Postage / Telegram Membership Fees Insurance Prem - FBT Insurance Prem - Clinical Trials Housekeeping Services Facility Management Conference/Seminar Fees Computer Maint AMC Others Sales HO account Funds transferred from Bom Funds transferredfrom Delhi Funds transferred from chennai Funds transferred from Pune Stocks in transit from Bom Stocks in transit from Bom500000



29 1. Secret reserve search 2. Mirror image evaluation approach to find inconsistent results 3. Relative Size Factor in stocks, debtors, creditors to detect error or manipulation 4. Illogical events- loans taken when huge liquid assets are available such as fixed deposits 5. Impossibility of certain results based on events known 6. Duplicate Numbers- could stem from error or fraud 7. Cash /stock shortages indicated by illogical withdrawing/purchasing 8. Negative asset / expense balances could be errors or fraud 9. Ghost workers search 10. Use Test Packs to check software bugs where audit train is invisible 11. Benford’s theorem test results 12. Spreadsheet forensics and Ratio Analysis for trends 13. Physical verifications of assets, processes, and walk through tests, including tiger team tests

30  The excel UFSRD method U- unhide F- font coloration S-Show Formula R- rectify and replace D-duplication check..\collections\financialsA.xls..\collections\financialsA.xls

31 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

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

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

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

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?

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

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

38 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

39 Relative Size Factor (RSF) Use of mathematical tools 39

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

41 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 41

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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. 45

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

48 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

49  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.

50  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


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