FORENSIC AUDIT - REPORTING PRESPECTIVE

I.     INTRODUCTION

Forensic Auditing covers a broad spectrum of activities, with terminology not strictly defined in regulatory guidance. Generally, the term ‘forensic accounting’ is used to describe the wide range of investigative work which accountants in practice could be asked to perform. The work would normally involve an investigation into the financial affairs of an entity and is often associated with investigations into alleged fraudulent activity.

It refers to the specific procedures carried out in order to produce evidence. Audit techniques are used to identify and to gather evidence to prove, for example, how long the fraud has been carried out, and how it was conducted and concealed by the perpetrators. Evidence may also be gathered to support other issues which would be relevant in the event of a court case. 

II.     ROLE OF FORENSIC AUDITORS

A Forensic Audit is often retained to analyze, interpret, summarize and present complex financial and business - related issues in a manner that is both understandable and properly supported. Forensic Auditors can be engaged in Public Practice or employed by insurance companies, banks, police forces, government agencies and other organizations.

(i)       Criminal Investigations: Practicing forensic auditors could be called upon by the police to assist them in criminal investigations which could either relate to individuals or corporate bodies. The forensic audit would use his/her investigative skills to examine the documentary and other available evidence to give his/her expert opinion on the matter.

(ii)     Fraud Investigations: Forensic auditors might be called upon to assist in business investigations which could involve funds tracing, asset identification and recovery, forensic intelligence gathering and due diligence review. The forensic expert undertakes a detailed review of the available documentary evidence and forms his/her opinion based on the information gleaned during the course of that review.

(iii)   Professional Negligence: The forensic accountant might be to investigate whether professional negligence has taken place and to quantify the loss which has resulted from the negligence. A matter such as this could arise between any professional and their client.

(iv)    Expert Witness Cases: Forensic accountants often attend court to testify in civil and criminal court hearings, as expert witnesses. In such cases, they attend to present investigative evidence to the court so as to assist the presiding judge in deciding the outcome of the case.

(v)      Meditation and Arbitration: Some forensic accountants because of their specialist training they would have received in legal mediation and arbitration, have extended their forensic accounting practices to include providing Alternative Dispute Resolution (ADR) services to clients. This service involves the forensic accountant resolving both mediation and arbitration disputes which otherwise would have been expensive and time consuming for individuals or businesses involved in commercial disputes with a third party.

(vi)    Litigation Consultancy: Working with lawyers and their clients engaged in litigation and assisting with evidence, strategy and case preparation.

(vii)  Computer Forensics: Assisting in electronic data recovery and enforcement of IP rights etc.

III.     REPORTING ROLE OF FORENSIC ACCOUNTANTS

There is no mention of Forensic Accountants as well as their reporting mechanism in the Indian statutes so far, but there are various provisions related to Forensic Accountants/Auditors in the statutes. It can be categorized under the following heads:

(1)    INVESTIGATION AND INSPECTION: Forensic Auditors may help the Police, CBI and other investigating authorities in collecting evidences and other investigation purposes. For example section 157 Cr. P. C, 1973; section 17,18 of Prevention of Corruption Act, 1988; section 6 of The Bankers Books Evidence Act, 1891; section 78 of Information Technology Act, 2000; section 209A, 227 of the Companies Act, 1956 require the skills of Forensic Accountants while inspecting any books.

(2)    EXPERT OPINION: Forensic Accountants may see and carefully examine the accounts and balance sheets and use his skills to find out whether there is any fraud committed or any anomaly associated with it by giving his expert opinion. This finds place in for example s.45, s.118 of Indian Evidence Act, 1872; s.293 of Cr.P.C, 1973.

(3)    FORENSIC ACCOUNTING UNDER CARO (The Companies (Auditor’s Report) Order, 2003): It can be categorised under following heads:

(i)        Disposal of Fixed Assets: CARO, 2003 requires the auditor to report to the effect that if a substantial part of fixed assets have been disposed off during the year, whether it has affected the going concern status. In order to carry out the duties, the auditor has to draw a corollary and reference to the section 293 Companies Act, 1956, AS 24 ('Discontinuing Operations') and to SA 570 (Going Concern).

(ii)      Report On Frauds: If any fraud on or by the company has been noticed or reported during the year, following provisions CARO, 2003 are important in this aspect:

·         SA 260 and SA 270 guides the Auditor to obtain a management representation letter as the frauds reported and detected during the year because of the nature of the fraud and the difficulties encountered by the Auditors in detecting material misstatements in the financial statements resulting from fraud.

·         Accordingly, it is enough if the Auditor expresses his opinion on the frauds noticed and reported by the management and not expected to be a detective to approach his work with suspicion.

·         Another major issue under this clause is that it also requires reporting of frauds committed by the Company.

·         The Auditor is left with no clues and is expected to travel beyond the books to search for market information about frauds committed by the Company, which is highly illogical.

(iii)    Transactions with Related Parties: The focus of the primary reporting under this clause is to report whether transactions that need to be entered into a Register in pursuance of section 301 of the Companies Act, 1956 have been so entered. This Clause may be considered as a further step towards the investor's protection. However, the major issue here is that the audit focus has to be shifted/further intensified towards proprietary areas to find out the transactions that need to be entered (a thorough scrutiny of all entries in the books of accounts may be needed); and then to check the Register for actual recording of the same. Mere reliance on the 301 Register is not enough and the Auditor has to scrutinise Form No.24AA (Disclosure of interest by the Directors) to ascertain likely transactions that need to be entered in the 301 Register.

(4)    REPORTING & PRESENTATION

(i)        Usually, the auditee who is undergone with Forensic Audit will expect a report containing the findings of the forensic audit.

(ii)      Report usually include a summary of evidence and a conclusion. If a fraud was found then the amount of loss suffered as a result should be detailed.

(iii)    Also, how the fraud was set up and which controls were circumvented are the additional disclosures along with this reporting strategy.

IV.     REPORTING TECHNIQUES OF FORENSIC ACCOUNTING

The conventional accounting and auditing with the help of different accounting tools like ratio technique, cash flow technique, a standard statistical tool examination of evidences are all part of forensic accounting. In cases involving significant amounts of data, the present-day forensic accountant has technology available to obtain or source data, sort and analyze data and even quantify and stratify results through computer audit and various other techniques. Some of the techniques involved in Forensic Accounting to examine and report frauds are:

(i)            BENFORD’S LAW: It is a mathematical tool, and is one of the various ways to determine whether variable under study is a case of unintentional errors (mistakes) or fraud. On detecting any such phenomenon, the variable under study is subjected to a detailed scrutiny.

(ii)          THEORY OF RELATIVE SIZE FACTOR (RSF): It highlights all unusual fluctuations, which may be routed from fraud or genuine errors. RSF is measured as the ratio of the largest number to the second largest number of the given set. Usually, there exist certain limits (e.g. financial) for each entity such as vendor, customer, employee, etc.; these limits may be defined or analyzed from the available data.

(iii)        COMPUTER ASSISTED AUDITING TOOLS (CAATs): CAATs are computer programs that the auditor use as part of the audit procedures to process data of audit significance contained in a client's information systems, without depending on him. CAAT helps auditors to perform various auditing procedures such as:

a)        Testing details of transactions and balances,

b)        Identifying inconsistencies or significant fluctuations,

c)        Testing general as well as application control of computer systems.

d)        Sampling programs to extract data for audit testing, and

e)        Redoing calculations performed by accounting systems.

(iv)         DATA MINING TECHNIQUES: It is a set of assisted techniques designed to automatically mine large volumes of data for new, hidden or unexpected information or patterns. Data mining techniques are categorized in three ways: Discovery, Predictive Modelling and Deviation and Link analysis. In Deviation analysis the norm is found first, and then those items are detected that deviate from the usual within a given threshold. Link discovery has emerged recently for detecting a suspicious pattern.

(v)           RATIO ANALYSIS: Another useful fraud detection technique is the calculation of data analysis ratios for key numeric fields. Like financial ratios that give indications of the financial health of a company, data analysis ratios report on the fraud health by identifying possible symptoms of fraud.

V.     TYPES OF REPORTS

1)        Expert Witness Report

¡  Basis for the expert witness opinions: In combination with work performed, a description of the fundamental principles used completes the requirement to report the basis and reasons for the expert witness’s opinions.

¡  Opinions of the expert witness: The practitioner reports the opinions to be expressed by testimony at the trial.

¡  Data or other information considered: Disclose materials considered by the practitioner in reaching opinions and preparing the expert report. This includes documents and data produced by the parties during the litigation, as well as research and other materials independently prepared by the practitioner.

¡  Exhibits to be used by the expert witness: The expert witness includes exhibits expected to be used during the trial to summarize, support, or explain the expert witness’s opinions.

¡  Qualifications of the expert witness: Describes the expert witness’s scientific, technical, or other specialized knowledge believed to be able to assist the trier of fact to understand the evidence or determine a fact in issue.

2)        Consulting Service Report

¡  A Consulting Service Report provides advice about the facts, issues, and strategy of a matter. The consultant does not testify as an expert witness unless the consultant’s role subsequently changes to that of an expert witness

   A Format Consulting Services Report

I.    INTRODUCTION

§  Why we were retained (example: perform a proof of cash)

§  A statement: Procedures do not constitute an audit

II.  OVERVIEW

§  Brief Company Background

III. PROCEDURES PERFORMED

§   Objectives of Analyses (account for all funds received and disbursed)

§  Scope of Analysis (for period x to y)

IV. OBSERVATIONS (FINDINGS)

§  Certain funds were not properly accounted for (theft of cash)

§  Possible additional work suggested (Internal Control is weak)

§  Scope Limitations (not allowed to see some stuff we want)

V.  EXHIBITS

3)        Fraud Examination Report

Section I. Background

¡  The background section is about two paragraphs very succinctly stating why the fraud examination was conducted.

Section II. Executive Summary

¡  The executive summary is no more than five or six paragraphs.

¡  This summarize what actions you performed during the fraud examination

Section III. Scope

Section IV. Approach

¡  This section gives a brief description of the following items:

¡  Team members

¡   Procedures Individuals interviewed

¡  This section simply answers the five 'Wh' questions of the Audit.

Section V. Findings

¡  This section contains the details of the fraud examination. It will generally consist of several pages.

¡  The information is presented either chronologically or by topic.

Section VI. Summary

Section VII. Recommendations

¡  This section is optional. There may be instances where you wish to discuss remedial measures or specific recommendations in a separate document.

This article has been shared by S. Omkhar. He is CA Final Student.

SRO 0292620

CA Final