Forensic Audit Case studies ICAI Vadodara 2013 Chetan
Dalal
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Thank you to Vadodara Branch and members of ICAI From Chetan
Dalal
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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.
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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
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1. F ORENSIC A UDIT : WHAT IT MEANS AND W HAT ARE THE TRAITS OF
A GOOD FORENSIC ACCOUNTANT OR AUDITOR ?
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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
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- Accounting - Auditing - Investigating
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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.
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Distrust the Obvious Think differently and Develop an open mind
Look from different angles and all sides. You will get a different
revelation
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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.
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1. Fraudsters/ deceivers are Intelligent 2. Technology 3. Stale
procedures syndrome 4. Lack of perseverance
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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.
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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
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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
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2. M ANIPULATIONS AND FRAUD IN SPREADSHEETS Example using Excel
Sheets
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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
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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
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For example: Can be applied on volume of stocks in a warehouse
or production with actual machine capacity
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Forensic study of alterations try and discern consistency of
cancellations, smudges, spaces and overwritings
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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
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Document comparisons: Contracts agreements copies lying with
different departments Vendor letterheads, bills and letter formats-
all bidderss documents and search for common addresses, telephone
numbers, fax numbers, fax/tel numbers, email 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
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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
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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
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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
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Bombay BrDelhi BrKolkattaChennaiBOM-serLucknowPune
Purchases2076689142728610419191972854101757817236521993621 Staff
Recruitment & Training576109501215365887547304282293.4553065
Travelling Exp -
Foreign493068428969313147468415241603.3409246473345 Repairs &
Maint437968381032278153875936214604.3363513420449 Printing &
Stationery379100329817240766360145185759314653363936 Travelling
Exps301765262536191651286677147864.9250465289694 Tel / Mobile /
Internet11695410175074277.511110657307.4697071.8112276 Electricity
Charges120000104400762121140005880099600115200 Communication -
FBT10695393049.167925.910160552406.9788771102675 Discounts
given10587392109.567239.910057910902387874.6101638 Discounts on
sales206902180005131403196557101382171729198626 Vehicle Running
& Main - R249529217090158476237053122269.2239548 Subscription
Charges14339912475791072.713622970265.51119021137663 Funds
transferred- Kolkatta250000 Funds transferred- Pune50000 Funds
transferred- Chennai125000 Funds transferred- Delhi1437477 Stock in
transit to Kolkatta500000 Security
Charges13954312140288623.813256668376.07115821133961 stocks in
transit209488182255133046199014102649.1173875201108 Stock in
transit to Bom_ser800000696000508080760000392000768000 Postage /
Telegram273491237937173694259816134010.6226998262551 Membership
Fees17408615145511056216538285302.14144491167123 Insurance Prem -
FBT18752416314611909617814891886.76155645180023 Insurance Prem -
Clinical Trials214218186369136050203507104966.6205649 Housekeeping
Services15919113849610110215123178003.59132129152823 Facility
Management17504415228811117016629285771.5145286168042
Conference/Seminar Fees499233434333317063474271244624.2414363479264
Computer Maint AMC Others
Sales142728612417399064691355922699370.211846471370195 HO
account901195784040572349856135441585.6747992865147 Funds
transferred from Bom250000 Funds transferredfrom Delhi Funds
transferred from chennai125000 Funds transferred from Pune1437477
Stocks in transit from Bom800000 Stocks in transit from
Bom500000
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5. U NUSUAL M ETHODS OF INVESTIGATING
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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. Benfords 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
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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
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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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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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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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Management appointed auditors who were specialised
investigators more for studying controls and recommending
preventive measures
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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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Findings good but inadequate to point out any means of
recovery
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Auditors try a new approach The use the space time dimension
approach IDEA_DATA.xls Amazing findings- Late night sales
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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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Relative Size Factor (RSF) Use of mathematical tools 39
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Relevance Scrutiny of individual parties account is humanly
ineffective. It highlights all unusual fluctuations which may be
stemming from frauds or errors 40
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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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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
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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. 0.50 lacs) These single instances could be cases
where there is some foul play. 45
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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
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Luhns algorithm For verifying correctness of credit cards and
other cards which have been generated using the check sum
digit
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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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Surprise tests lose their sting when an auditee can predict an
auditors 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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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