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PRESENTATION ON FRAUD REPORTING (under Companies Act,2013)

PRESENTATION ON FRAUD REPORTING (under Companies Act,2013). BY ca Amol deshpande. AGENDA. BACKGROUND. Fraud in not a new concept introduced in Companies Act,2013 Companies Act,1956 had provisions for punishment regarding fraud. For example:

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PRESENTATION ON FRAUD REPORTING (under Companies Act,2013)

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  1. PRESENTATION ON FRAUD REPORTING (under Companies Act,2013) Ankekshan Consulting Pvt.Ltd BY ca Amol deshpande

  2. Ankekshan Consulting Pvt.Ltd AGENDA

  3. BACKGROUND • Fraud in not a new concept introduced in Companies Act,2013 • Companies Act,1956 had provisions for punishment regarding fraud. • For example: • i) 5 years imprisonment or with fine or with both for fraudulently inducing persons to invest money • ii) Reference to court when Central Government is of the opinion that any person connected to conduct and management of the company is guilty of fraud • So what changes are made in Companies Act,2013? • i) Fraud has been explicitly defined • ii) Statutory Auditor to report fraud • iii) Same punishment for all types of frauds Ankekshan Consulting Pvt.Ltd

  4. Internal fraud as defined by Association of Certified Fraud Examiners(“ACFE”): Internal fraud, also called occupational fraud, can be defined as: “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the organization’s resources or assets.” Simply stated, this type of fraud occurs when an employee, manager, or executive commits fraud against his or her employer.  Fraud is comprehensively defined u/s 447 explanation (1) as: “any act, omission, concealment of any fact or abuse of positions with an intent to deceive, to gain undue advantage from, or to injure the interests of the company or its shareholders or its creditors or any other person, whether or not there is any “wrongful gain” or “wrongful loss” Ankekshan Consulting Pvt.Ltd Fraud DEFINITION

  5. Characteristics of definition: • Wide coverage of affected parties- Company or its shareholders or its creditors or any other person • Person covers a wide range- banks, Government • Intent to deceive should be present • whether or not there is any “wrongful gain” or “wrongful loss” Ankekshan Consulting Pvt.Ltd Fraud DEFINITION (Cont’d)

  6. As per ACFE, following are the three types of occupational frauds: Ankekshan Consulting Pvt.Ltd Fraud TREE

  7. Fraud survey conducted by ACFE from October 2014 to October 2015 involving 2410 cases • across 114 counties • The total loss caused by the cases in the study exceeded $6.3 billion, with an average loss per case of $2.7 million • Asset misappropriation was by far the most common form of occupational fraud, occurring in more than 83% of cases, but causing the smallest median loss of $125,000. Financial statement fraud occurred in less than 10% of cases but causing a median loss of $975,000. Corruption cases fell in the middle, with 35.4% of cases and a median loss of $200,000 • In 94.5% of the cases in the study, the perpetrator took some efforts to conceal the fraud. The most common concealment methods were creating and altering physical documents. • The median loss suffered by small organizations (those with fewer than 100 employees) was the same as that incurred by the largest organizations (those with more than 10,000 employees). However, this type of loss is likely to have a much greater impact on smaller organizations. Ankekshan Consulting Pvt.Ltd Fraud statistics

  8. Corruption was more prevalent in large organizations while cheque tampering, skimming, • payroll frauds were more prevalent in small organizations • The most common detection method in our study was tips (39.1% of cases), but organizations that had reporting hotlines were much more likely to detect fraud through tips than organizations without hotlines (47.3% compared to 28.2%, respectively). • When fraud was uncovered through active detection methods, such as surveillance and monitoring or account reconciliation, the median loss and median duration of the schemes were lower than when the schemes were detected through passive methods, such as notification by police or by accidental discovery. • The presence of anti-fraud controls was correlated with both lower fraud losses and quicker detection. We compared organizations that had specific anti-fraud controls in place against organizations lacking those controls and found that where controls were present, fraud losses were 14.3%–54% lower and frauds were detected 33.3%–50% more quickly. Ankekshan Consulting Pvt.Ltd Fraud statistics (Cont’d)

  9. While the implementation rates of anti-fraud controls varied by geographical region, several controls—external audits of the financial statements, code of conduct, and management certification of the financial statements—were consistently among the most commonly implemented across organizations in all locations. • The most prominent organizational weakness that contributed to the frauds in the study was a lack of internal controls, which was cited in 29.3% of cases, followed by an override of existing internal controls, which contributed to just over 20% of cases. • More occupational frauds originated in the accounting department (16.6%) than in any other business unit. Of the frauds we analysed, more than three-fourths were committed by individuals working in seven key departments: accounting, operations, sales, executive/upper management, customer service, purchasing and finance. Ankekshan Consulting Pvt.Ltd Fraud statistics (Cont’d)

  10. While the implementation rates of anti-fraud controls varied by geographical region, several controls—external audits of the financial statements, code of conduct, and management certification of the financial statements—were consistently among the most commonly implemented across organizations in all locations. • The most prominent organizational weakness that contributed to the frauds in the study was a lack of internal controls, which was cited in 29.3% of cases, followed by an override of existing internal controls, which contributed to just over 20% of cases. • More occupational frauds originated in the accounting department (16.6%) than in any other business unit. Of the frauds we analysed, more than three-fourths were committed by individuals working in seven key departments: accounting, operations, sales, executive/upper management, customer service, purchasing and finance. Ankekshan Consulting Pvt.Ltd Fraud statistics (Cont’d)

  11. Fraud perpetrators tended to display behavioural warning signs when they were engaged in their crimes. The most common red flags were living beyond means, financial difficulties, unusually close association with a vendor or customer, excessive control issues, a general “wheeler-dealer” attitude involving unscrupulous behaviour, and recent divorce or family problems. At least one of these red flags was exhibited during the fraud in 78.9% of cases. • Most occupational fraudsters are first-time offenders. Only 5.2% of perpetrators in this study had previously been convicted of a fraud-related offense, and only 8.3% had previously been fired by an employer for fraud-related conduct • In 40.7% of cases, the victim organizations decided not to refer their fraud cases to law enforcement, with fear of bad publicity being the most-cited reason. Of the cases in the study, 23.1% resulted in a civil suit, and 80.8% of such completed suits led to either a judgment for the victim or a settlement Ankekshan Consulting Pvt.Ltd Fraud statistics (Cont’d)

  12. The fraud triangle is a model advocated by Donald Cressy for explaining the factors that cause someone to commit occupational fraud. It consists of three components which, together, lead to fraudulent behaviour: Pressure Financial or emotional FRAUD Ankekshan Consulting Pvt.Ltd Fraud Triangle Opportunity Ability to execute plan without being caught Rationalization Justification of dishonest actions

  13. Sections 143(12) to 143(15) of the 2013 Act states the provisions of the 2013 Act with • regard to auditor’s reporting on fraud. • Rule 13 of the Companies (Audit and Auditors) Rules, 2014, as amended by the Companies (Audit and Auditors) Amendment Rules, 2015, provides the timeline and manner in which the auditor should report on fraud. • Sec 143 (12) - Notwithstanding anything contained in this section, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees of the company, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. (emphasis added) • Provided that in case of fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed: • Provided further that the companies, whose auditors have reported frauds under this sub-section to the audit committee or the Board but not reported to the Central Government, shall disclose the details about such frauds in the Board’s report in such • manner as may be prescribed Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  14. As per Rule 13: • The fraud, he has a reason to believe is being committed which is individually amounting to Rs One Crore or above is to be reported to the Central Government. • The manner of reporting is: • The auditor should report immediately or within 2 days of his knowledge of fraud to the Audit Committee or the Board of Directors (“Board”) • The auditor to seek the reply of Audit Committee or Board within 45 days • On receipt of the reply, the auditor has to submit his report along with the Audit Committee’s reply and his comments on the reply to the Central Government within 15 days of receipt of reply. • In case the reply is not received within 45 days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier • forwarded to the Board or the Audit Committee for which he has not received any reply or observations Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  15. As per Rule 13: • Report to be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed post followed by • an e-mail in confirmation of the same • The report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his membership number • The report should be submitted in form AD-4 • In case of frauds involving amounts lesser than Rs One Crore, the auditor shall submit report to the Audit Committee or Board giving details of Nature of fraud with description, approximate amount and Parties involved • The Board has to report frauds reported to it in the Board’s report- Nature of Fraud, Approximate value, Parties involved, if remedial action not taken and remedial action taken Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  16. Trigger Point of reporting: • Sec 143 (12) requires the Auditor to report fraud if he has “ reasons to believe”, Rule 13 uses the terms- “ reasons to believe” and “knowledge” while form ADT-4 uses the term- “ suspected offence involving fraud” • Suspicion is a state of mind but is not conclusive about the existence of fraud • “ Reason to believe” is the state where the Auditor, based on the evidences and information • “knowledge” means confirming the existence of fraud with more evidences and analytical procedures he has performed • Based on the homogeneous reading of these, fraud is to be reported only when the auditor has reason to believe and has knowledge that a fraud has occurred or is occurring i.e., when the auditor has evidence that a fraud exists Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  17. Persons covered under sec 143(12): • Statutory Auditors • Cost Auditors • Branch auditor appointed u/s 139 • Section 143(12) not applicable to: • Other Professionals rendering services to the Company e.g. Internal Auditor • Frauds committed by vendors, customers, outsiders, sub contractor’s staff • Auditor not guilty of professional misconduct: Auditor is not guilty of professional misconduct if he discloses information as required u/s 143(12) • Fine for non compliance: Auditor shall be punishable with a fine of at least Rs 1 lakh which may extend to Rs 25 lakhs for failing to comply with provisions of section 143 (12)- sec 143(15) Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  18. Compliance with Standards on Auditing: • As per sections 143(9) and 143 (10), Statutory Audit is to be conducted in accordance with accounting standards i.e. Standards on Auditing (“SA”). And as per sec 143(2), report is to be issued considering the SA. • As such, SA 240 – ‘The Auditors responsibility relating to Fraud in in an audit of Financial Statements’ should be considered while performing the Statutory Audit • Paragraph 5 of SA 240 states that - ‘An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error’. • Paragraph 40 states that the Auditor has to communicate fraud to appropriate level of management if he has identified or has obtained information about fraud Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  19. Compliance with Standards on Auditing: • Paragraph 10 of SA 240 requires an auditor to obtain sufficient appropriate evidence about the assessed risk of material misstatement due to fraud • SA 250- “Consideration of Laws and Regulations in an Audit of Financial Statements”- Paragraphs 22 and 23- require auditor to communicate to Audit Committee or Board non –compliance with laws and regulations, that come to auditor’s notice • Paragraph 27 of SA 315- “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment”, requires the auditor to consider the risk of fraud in determining which risks are significant risks • SA 230 - Audit Documentation • SA 315- Identifying and Assessing the Risk of Material Misstatement Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  20. Other Reporting Considerations: • Frauds noticed during bank audits- The RBI issued Circular No. DBS.FGV.(F).No. • BC/23.08.001/2001-02 dated May 3, 2002 requires auditing professional to report any fraud to the RBI. However, as per Chartered Accountants Act,1949 prohibits a member to disclose any information to any person other than the Client. However, he can do so if the circular is included in the appointment letter. RBI has issued a Master Circular no.DBS.CO.CFMC.BC.No. 1/23.04.001/2015-16 dated July 1,2015 on “Frauds–Classification and Reporting” on the matters relating to classification and reporting of frauds and laying down a suitable reporting system. As such, auditor has to report the frauds to the RBI in addition to the Chairman/ Managing Director of the concerned Bank. Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  21. Other Reporting Considerations : • Frauds noticed during limited review/ interim review/other attest/non attest functions: Provisions of sec 143(12) are applicable whenever auditor performs attest functions even under other Act- regulation 33 of SEBI (Listing Obligations and Disclosure Requiremnets,2015. If the auditor uses or intends to use the same in performing the statutory audit and the amount is above Rs 1 Crore, he has to report to the Central Government. • Frauds detected by the Management: Provisions of section 143(12) are applicable only if he is the first person to identify the fraud Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  22. Other Reporting Considerations : • Reporting on frauds in Consolidated Statements: • Not applicable for foreign corporate component • Not applicable for if a component is not a Company • Can use work of other auditors but has to state the work division in his report • Has to report fraud if such fraud is being committed by employees or officers of the parent Company and is committed against the parent company • Reporting of frauds relating to years to which Companies Act 1956 applies: Auditor has to report such cases if identified during the audit for financial years beginning on or after 01-04-2014 and was not dealt in Financial Statements or Auditor’s Report or Board’s Report. • Consideration of Materiality: As per SA 450, materiality should be considered by the Auditor for misstatements arising out of fraud Ankekshan Consulting Pvt.Ltd Fraud reporting (under companies act 2013)

  23. Changes in Engagement letter- Modifications are required in the Engagement Letter with regard to Auditor’s responsibility and Management’s Responsibility for reporting u/s 143(12) • Consider the impact of fraud on Financial Statements and Internal Financial Controls • Obtain Management Representations confirming that they have disclosed to the auditor the results of Management’s assessment of risk that financial statements may be materially misstated due to fraud and their knowledge about fraud Ankekshan Consulting Pvt.Ltd Matters to be kept in mind

  24. Gain knowledge of the client’s business- Assess potential high risk areas • Modify audit procedures: • Performing analytical procedures • verifying inventory near the period close instead of at period close • visiting locations not earlier visited etc. • Incorporate surprise element in audit procedures • Performing Ratio analysis • Apply test of reasonableness and test of absurdity • Compare mutually exclusive things- Sales and Production, Production with Machine capacity • Juxtaposition – can be used in contracts, signatures, invoices • Review of IT Security Ankekshan Consulting Pvt.Ltd Some Audit procedures for sa 240 compliance

  25. Observe Red Flags: • Non availability of records • Consistent losses in an otherwise thriving industry • Sudden Profits • Too many cancellations/reversals • Chaotic sate of affairs ,bookkeeping mess, unreconciled accounts • Close nexus of employee and vendor / customer • Selling flagship assets • Dwindling cash and mounting losses • Increase in debts Ankekshan Consulting Pvt.Ltd Some Audit procedures for sa 240 compliance

  26. Observe Green Flags:- • One way mistakes- cash-always in excess • Employee does not take travel advance • Very friendly or very harsh • Too Good to be True • Observe Behavioral Aspects • Living beyond means • Divorce • Addiction • Significant debt and personal problems • Not taken leave for a long period Ankekshan Consulting Pvt.Ltd Some Audit procedures for sa 240 compliance

  27. Some novel Methods of audit: • Use of Benford’s Law –good for sampling • Use of CAATS or Excel for data analysis • Relative Size Factor –Largest number/Second Largest number .If this ratio is 10, largest transaction needs to be investigated • Check Missing numbers in- invoices, cheques • Check Duplicates Ankekshan Consulting Pvt.Ltd Some Audit procedures for sa 240 compliance

  28. Auditor’s will face challenges in reporting the following frauds: • Frauds not in books- e.g. accepting bribe to favour a vendor • Frauds involving theft of code, drawings Ankekshan Consulting Pvt.Ltd Challenges in fraud reporting

  29. Ankekshan Consulting Pvt.Ltd THANKYOU

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