FORENSIC AUDIT DR. MITIL CHOKSHI CHOKSHI & CHOKSHI CHARTERED ACCOUNTANTS

1. FORENSIC AUDIT DR. MITIL CHOKSHI CHOKSHI & CHOKSHI CHARTERED ACCOUNTANTS

2. Contents • What is Forensic Audit? • Forensic Audit vs. External Audit • Statistics • Recent Frauds • What is Fraud? • Difference between Fraud & Error • Categories of frauds • Detection Techniques • Fraud Detection Methodology • Controls to avoid Fraud • Preventive Measures • Emerging Frauds • Response to Frauds • Synopsis

3. What is Forensic Audit • The term “Forensic Audit” has not been defined anywhere • Forensic Audit involves examination of legalities by blending the techniques of propriety, regularity and investigative and financial audits • “Forensic Audit” refers to specific procedures carried out in order to produce evidence for investigation and prosecution of criminal acts such as embezzlement or fraud • Findings of a forensic audit could be used in the court of law as expert opinion on financial matters • The forensic auditor should have a biased mind and negative approach and should see everything with suspicion.

4. References • Standard Practices for IFA Engagements • Managing the Business Risk of Fraud : A Practical Guide • Uniform Guidelines for Investigations endorsed by 10th Conference of International Investigators • Guidelines issued by International Financial Institutions- Anti-Corruption Task Force

5. Skills-Set • Professional Accounting Skills require the following: • an understanding of how business activity is documented, recorded, reported, managed and controlled; • the ability to identify, obtain, examine and evaluate relevant information; • the ability to quantify the financial impact of actual or expected transactions or events; • the ability to perform and interpret relevant analyses of information; • the ability to document and explain business information and the results of the financial analyses for decision-making purposes; and • the ability to render relevant and appropriate opinions and conclusions based on the findings and results of the work performed.

6. Skills-Set • Investigative Skills require the following: • an understanding of the context within which the engagement is to be conducted ; • the ability to identify, obtain, examine and assess information relevant to the engagement; • the ability to analyze and compare various types and sources of information; • an understanding of the types of information that would assist in establishing motivation, intent and bias; • an understanding of the ways in which information could be fabricated or concealed; • an understanding that information collected and the work performed, including the work and information of others, may become subject to disclosure and be tendered as evidence; and • the ability to document and present investigative findings and conclusions for decision making purposes.

7. External Audit vs. Forensic Audit

9. Statistics Percentage of companies affected by listed types of fraud Source : 2013/2014 Global Fraud Report - Kroll

10. Statistics Percentage dissuaded from investing in: Source : 2013/2014 Global Fraud Report - Kroll

11. Frauds Sector wise

12. Frauds Process wise Process perceived as most vulnerable to fraud risks (Ranks are based on total score. Rank “1” indicates most vulnerable process) PROCUREMENT 01 SALES & DISTRIBUTION 02 INVENTORY 03 FINANCE/PAYMENTS 04 ADMINISTRATION 05 TREASURY 06 HR 07

13. Statistics Percentage Recovery to Fraud Amount

15. Recent Frauds • Rajat Gupta - Insider Trading • LIBOR manipulation • CWG - Embezzlement of Funds • Adidas – Reebok - Siphoning off Funds • NSEL - Non-availability of underlying commodities • Satyam - Fudging of Financial Statements

16. Recent Frauds • Bernard Madoff - Securities Trading • Viruses and malwares - Rampant IP Fraud • Counterfeit - Counterfeiting and Piracy • Enron & AA – Payment for better accounting consequences

18. What Is Fraud ? • From an auditor’s point of view, fraud is any act : • Which results in a financial loss / reputational damage • With a malafide intention • Usually it is suppressed or camouflaged.

19. Difference Between Fraud & Error

20. Categories Of Fraud

21. Typical Business Frauds • Achilles Heel Frauds Piggyback Fraud • Red Herring Frauds Duplicate Purchases/ Expenses • Trojan Horse Frauds Disaster Frauds

22. Fraud Triangle

23. General Susceptibility People most susceptible to commit fraud (Ranks are based on total score. Rank “1” indicates most vulnerable process) VENDORS/AGENTS 01 MANAGEMENT EMPLOYEES 02 NON MANAGEMENT EMPLOYEES 03 BUSINESS ASSOCIATE 04 CUSTOMER 05

24. VIDEO CLIP

25. Detection Techniques CRITICAL POINT AUDITING FORENSIC AUDIT Aims at filtering out the symptoms of fraud from regular and normal transactions in which they are mixed or concealed PROPRIETY AUDIT Aims at lending assurance that economy, efficiency and efficacy have been achieved in the transactions for which expenditure has been incurred or revenue collected is usually applied

27. Fraud Detection Methodology • Management Interviews: • Interview of current as well as ex employees • Minutes of the organization to be critically reviewed • Preparation of a detailed questionnaire to extract constitutive information • Questions so intended that they draw out the best possible information from the interviewee

28. Fraud Detection Methodology Fraud Detection Methodology • Verification of Applications: • Confirming data not recreated/ modified • Checking the control structure • Checking Integrity and Reliability of data. • Verifying size and version of data.

29. Fraud Detection Methodology Fraud Detection Methodology • Preliminary steps for Review :

30. Fraud Detection Methodology Fraud Detection Methodology • Verification of authenticity of Legal Documents like minutes, statutory registers, contracts: • Examples – • Signature Analysis – Consistency and genuineness of signatures on all documents. • Testing the senility of the papers to verify if the documents have been created in order to make justifications available to the auditors.

31. Fraud Detection Methodology Fraud Detection Methodology • Theory of Inverse Logic: • Process of proving the truth in the reverse order • Determining what is fallacious and eliminating it • Two useful methods of determining the truth: • The Mathematical or axiomatic approach • Clues don’t fit or the reductioad absurdum approach

32. Fraud Detection Methodology Fraud Detection Methodology • Axioms/ Theories / Mathematical tools/ etc. • Benford’s Law of appearance of digits

33. Fraud Detection Methodology Fraud Detection Methodology Pattern of naturally occurring numbers – Benford’s Law • Relative Size Factor • Statistical measures such as regression which indicate the dependence of one variable upon another

34. Fraud Detection Methodology Fraud Detection Methodology • Related Parties: • Identifying Related Parties and transactions • Investigating favors given for any hidden considerations • Verification Of Movement Of Funds: • Tracing the movement of funds to identify the ultimate source of funds and the ultimate beneficiary • Checking if there exists funneling of cash or other funds from illegal activities through legitimate financial institutions and businesses to conceal the source of the funds

35. Fraud Detection Methodology Fraud Detection Methodology • Exit Interviews: • Evaluation of the Exit interviews that were conducted with departing employees • The primary aim of the exit interview is to understand the rationale behind the person's departure • Verification of the Internal and External communicationsthrough all modes

37. Documentation • The following documents or summaries should be retained on file: • Research; • Accounting, banking and other business records, and agreements; • Pleadings, criminal or regulatory charges, and other legal claims; • Affidavits and discovery transcripts; • Engagement letters and other correspondence; • Reports issued; • Schedules and calculations, including all necessary explanations;

38. Documentation • The following documents or summaries should be retained on file: • Notes and other recordings of interviews, meetings and discussions; • Documentation of key issues considered and key assumptions made; • The approach(es) taken and specific techniques used; • A record of the nature, extent and timing of procedures performed and the results of such procedures; • A record of the identities of the individual(s) performing the IFA engagement and a record that the work performed by assistants was supervised and reviewed; • Where the work of others is relied upon, their findings and conclusions.

39. Reporting • Auditors may communicate their findings and conclusions in a number of different forms: • written, oral or visual; • draft, interim or final; • point-form or narrative; and • formal, affidavit or letter form.

41. Fraud: Red Flags • Large amount of cash in hand • Lack of segregation of duties • Lack of mandatory time off for employees performing key control functions • Resource Constraints • External pressure on employees • Changes in employees behavior

42. Fraud: Preventive Measures • Ethics Statement/ Employees Code of Conduct • Training & Communication • Written Policies & Procedures • Segregation of Duties • Access Controls • Monitoring lifestyle of Employees • Employee Background Screening

43. Controls to avoid Frauds Detection & Deterrence

45. Emerging Frauds

46. Response to Fraud

47. To sum up…. • Forensic Audit is an exception to the clause: • ‘Auditors can be watchdogs and not blood- hounds’.