Shaheed Sukhdev College of Business Studies, University of Delhi

FORENSIC AUDIT
Rohitashwa Aggarwal (15919)
Pritom Das (15920)
Preetika Gupta (15930)
Sarthak Ahuja (15932)
FORENSIC AUDIT: DEFINITION
 Forensic audit involves examination of legalities by
blending the techniques of propriety (VFM audit),
regularity and investigative and financial audits.
 The objective is to find out whether or not true business
value has been reflected in the financial statements and
in the course of examination to find whether any fraud
has taken place.
 It encompasses two main areas:

Litigation support
Investigation
LITIGATION SUPPORT

 Is the factual presentation of economic issues related to

existing or pending litigation.

 The forensic accountant quantifies damages sustained by

parties involved in legal disputes and assists in resolving
disputes, even before they reach the courtroom.
LITIGATION SUPPORT
 Arbitration assistance
 Business valuation for divorce, stockholder disputes

 Computation of damages resulting from personal

injuries, wrongful death, breach of contract, casualty, and
fidelity losses
 Determination of lost profits due to business interruption

 Testifying as an expert witness

 Financial review of contractual obligations

 Investigative services related to fraud and other illegal

acts
INVESTIGATION

 Is the act of determining whether criminal matters such

as employee theft, securities fraud (including
falsification of financial statements), and insurance fraud
have occurred.
 Also includes searching for irregularities associated with
civil matters, such as a search for hidden assets in
divorce cases.
WHAT IS FRAUD?

 Fraud is an intentional misrepresentation of a material

point or issue on which a victim relies.
 This reliance usually results in one or more victims
suffering damages.
TYPES OF FRAUD

 Occupational
 Financial statement schemes
 Asset misappropriation (e.g., cash theft, fraudulent
disbursements, inventory theft)
 Bribery and corruption
 Intellectual property
TYPES OF FRAUD
 Other Frauds
 Financial institution
 Check and credit card fraud
 Insurance fraud
 Health care fraud
 Bankruptcy fraud
 Tax fraud
 Securities fraud
 Money laundering
 Consumer fraud
 Computer and Internet fraud
 Governmental fraud
EXAMPLES OF FRAUD

 A publicly-traded company engaged in sham transactions

for more than seven years by using several shell
companies. The money transferred to the shell
companies as payments for assets were returned as
payments on accounts receivable. The company’s assets
were inflated by as much as $80 million.
EXAMPLES OF FRAUD

Dr. X billed a patient’s insurance for the following activities:

 Knee arthroscopy with debridement $1,650
 Diagnostic knee arthroscopy 1,625
Total billed $3,275

The second procedure listed above is included in the first

procedure. Therefore, the correct amount of the bill is
$1,650.
EXAMPLES OF FRAUD

Bid was let to construct 3 buildings in the following order:

A, B, C.
Buildings
Bidder A B C Total
Avalon $510K $250K $240K $1M
St. James 375K 375K 375K 1.125M
Corinna 400K 400K 400K 1.2M
EXAMPLES OF FRAUD

 Assume the cost of janitorial services ranges from $1.50

to $2.50 per square foot (psf). BBK Company has
1,000,000 sq. ft. to be serviced. If JanServ charges 20 ¢
more psf than does an honest service, JanServ will make
an extra $200K that can be used to pay a kickback to the
employee who helps JanServ obtain the contract.
 WHO COMMITS FRAUD?

Frauds against the organisation (in %)

19%
40%
Employees
Management
Owners

41%

Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse, pp. 42-43
 WHO COMMITS FRAUD?

Frauds against organisations (in %)

0.61

Males
Females

3.2

Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse, pp. 42-43
WHY IS FRAUD COMMITTED?
The Fraud Triangle

Rationalization

Perceived
Opportunities

Perceived
Pressure
PERCEIVED PRESSURE

Employees, managers, and owners can feel

pressure to commit fraud as a result of

 Greed or preoccupation with being successful

 Living beyond means
 High personal debts
 Unexpected financial needs
 Expensive vices
 Family-imposed pressures
PERCEIVED OPPORTUNITIES

Opportunities to commit fraud exist when

levels of trust in an organization are reached
or when controls are weak.

 Inappropriate segregation of duties

 Ineffective supervision
 Transaction authorization not required
 Lack of physical controls
 Lack of adequate audit trail
RATIONALIZATION

Individuals usually don’t commit fraud unless

they can justify their actions in relation to
their own code of ethics.

 Feeling underpaid or overworked

 Desire to seek revenge
 Belief that taking the assets is a loan
 Belief they are helping others (family, employees)
OBJECTIVE OF FORENSIC
AUDIT
 Objective of forensic audit is to find whether or not a fraud
has taken place.
 Proper documentation is vital in substantiating the findings.
The outcome shall focus on the following, in case of
frauds:
● Proving the loss.
● Proving the responsibility for the loss.
● Proving the method/motive.
● Establishing guilty knowledge.
● Identifying other beneficiaries.
HOW DO FORENSIC ACCOUNTANTS
SEARCH FOR FRAUD?
PROACTIVE FRAUD DETECTION

 Inductive Approach: Use of data-mining software like

MS Excel, MS Access.

 Deductive Approach: Determining the kind of frauds

that can occur, and searching for symptoms of these
frauds.
DEDUCTIVE APPROACH TO
DETECTING FRAUD

Involves a 5-step process:

 Understanding the business environment.

 Understanding the kinds of fraud that can occur in this
environment.
 Determining the most likely symptoms.
 Using databases and systems to search for the fraud
symptoms.
 Following up on discoveries to determine the likelihood of
existence of fraud.
REACTIVE FRAUD DETECTION

 Fraud accountants are often engaged after someone in the

entity suspects that fraud has been committed.

 Usually the area in which fraud has been committed is

known. Often, the entire area is examined.
FRAUD DETECTION
TECHNIQUES

Critical Point Auditing aims at filtering out the symptoms of fraud from
regular and normal transactions in which they are mixed or concealed.

 Financial statements and records are analyzed mainly to find out:

(i) Trend-analysis by tabulating significant financial transactions
(ii) Unusual debits/credits in accounts normally closing to credit/debit balances
respectively.
(iii) Discrepancies in receivable or payable balances/inventory as evidenced from the
non-reconciliation between financial records and corresponding subsidiary records.
(iv) Accumulation of debit balances in loosely controlled accounts (like deferred
revenue expenditure accounts)
(v) False credits to boost sales with corresponding debits to non-existent (dummy)
personal accounts.
(vi) Cross debits and credits and inter-account transfers. 
(vii) Weaknesses/inadequacies in internal control/ check systems, like delayed/non-
preparation of bank reconciliation statements, etc.
FRAUD DETECTION
TECHNIQUES

 Propriety Audit is conducted by Supreme Audit Institutions

(SAI), like the CAG in India, to report on whether Government
accounts, i.e., all expenditure sanctioned and incurred are need-based
and all revenues due to Government have been realized in time and
credited to the government account.
 In conducting the propriety audit, “Value for Money audit” technique
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.
 The same analogy, with modifications to the principles of propriety of
public finance, applies in forensic audit to establish fraudulent
intentions if any, on the part of the management. Financial frauds are
results of wasteful, unwarranted and unfruitful expenditure or
diversion of funds by the investigated entity to another entity.
EXAMINATION METHODS

Action
Interview & Checklist
Interrogation

Test of
Reasonablene
ss

Off Balance
Sheet
Transactions

Historical
Comparisons
ACTION CHECKLIST
 Understand your risks, routes to their potential exploitation,
and the tools available to detect abuses, fraud, or wastage.
 Analyze numerical data, comparing actual costs against
expected costs.
 Investigate possible reasons for inconsistencies.

 Consider whether covert detection techniques might be

more appropriate when investigating cases of possible
fraud.
 External auditing specialists with extensive experience of
complex forensic audits can offer industry specific
experience, auditing management expertise, and advanced
interviewing techniques.
TEST OF REASONABLENESS

 Check weaknesses in internal controls.

 Identify questionable transactions – indicating wide
fluctuations from the normal ones and not, in general,
related to main objectives. 
 Review questionable transaction documents for
peculiarities, like improper account, classifications,
pricing, invoicing, or claims, etc.
HISTORICAL COMPARISONS
 Develop a profile of the entity under investigation, its
personnel and beneficiaries, using available information.
 Identify questionable accounts, account balances, and
relationships between accounts, for finding out variances
from current expectations and past relationships. 
 Gather and preserve evidence corroborating asset losses,
fraudulent transactions, and financial misstatements.
OFF BALANCE SHEET
TRANSACTIONS
These may encompass:
 Significant purchases/sales of raw materials and/or finished goods with
only a particular dealer or group companies of such vendor.
 Pattern of consumption of major raw materials/components.

 Over/under-invoicing for capital goods, raw materials/ components,

services, etc.
 Alteration of contractual terms, to pass on otherwise accrued benefit, to
holding/group companies.
 Diversion of funds through group companies and setting off such debits
as expenditure.
 Cost over–runs in major capital expenditure without corresponding
benefit or convincing reasons.
 Justifications for non-maintenance of certain basic records, on technical
grounds, but with intention to defraud.
INTERVIEW & INTERROGATION
 Interview and interrogation as evidence-gathering
techniques involve asking people questions.
 The basic difference is that interrogation is confrontational
while interviewing is not. In either case, the interviewer
records both the answers to the questions and physical
behaviors.
 Key information to gather centers on the suspect’s
pressures: Being deep in debt; perceived opportunities such
as having access to the organization’s assets; and
rationalization due to being passed over for a promotion.
FORENSIC ACCOUNTANTS AND
SKILLS FOR FORENSIC AUDIT
 Forensic accountants are viewed as a combination of an auditor and
private investigator.
 Knowledge and skills include the following: investigation skills, research,
law, quantitative methods, finance, auditing, accounting and law
enforcement officer insights.
 They possess skills such as:
(a) Knowledge of entity’s business and legal environment.
(b) Awareness of computer assisted audit procedures.
(c) Innovative approach and skeptic of routine audit practices.
FORENSIC ACCOUNTANTS AND
SKILLS FOR FORENSIC AUDIT
 Forensic accountants have been employed by the FBI, CIA,
Internal Revenue Service (IRS), Federal Trade Commission
(FTC), Homeland Security, Bureau of Alcohol, Tobacco and
Firearms, Governmental Accountability Office (GAO) in the USA;
the Crime Branch of India (CBI), the Income Tax Department, and
the Comptroller and Auditor General (CAG) in India.
 Other employers of forensic accountants include financial
intermediaries such as banks and insurance organizations plus
divorce attorneys.
 Forensic accountants often testify in civil and criminal court
hearings. In this capacity, they are serving as expert witnesses.
They do not testify as to whether fraud has occurred. This is the
court’s decision. The expert witness presents evidence.
APPLICATION
 Forensic Accounting and Audit may be applied in the
following areas besides fraud detection:
(a) Conducting due-diligence (especially for segment wise
profitability analysis)
(b) Business valuation
(c) Management auditing 
(d) Assessing loss before settling insurance claims.
DISTINCTION BETWEEN
STATUTORY AUDIT AND
FORENSIC AUDIT
ADVANTAGES OF FORENSIC
AUDIT
 It strengthens control mechanisms.
 It plays an important role for companies under review by
regulatory authorities.
 It provides a sound base of factual information that can be used
to help resolve disputes.
 It can improve efficiency by identifying areas of waste.

 It can help with the detection and recording of potential

conflicts of interest for executives by improving transparency
and probity in the way resources are used.
DISADVANTAGES OF FORENSIC
AUDIT

 A poorly managed forensic audit could consume excessive

amounts of management time. 
 The scope of the audit may need to be extended, with a
corresponding increase in the budget. 
 Some employees can interpret a proactive forensic audit as a
slight on their integrity.
 CASE STUDY:
VIVITA LTD.
 Vivita Limited is an agriculture
products processing,
manufacturing company based
in Pune.
FACTS OF THE CASE
 Based on Balance Sheet as on 30th June 2002, showing erosion in net
worth, Vivita Ltd. filed a reference U/S 15(1) of Sick Industrial
Companies (Special Provisions) Act, 1985.

 Secured creditors objected on the grounds, amongst others, that:

(a) Requisite number of directors did not attend the meeting of Board
of Directors of the company held to decide on reference to BIFR.
(b) Company indulged in the following:-
i. Gave a huge discount of Rs.6.48 crore without any
explanation/justification.
ii. Company devalued its investments by 90% without explaining
reasons for such a devaluation. 
iii. Company had written off Rs. 3.97 crore on account of foreign
exchange fluctuations.
iv. Loans and advances had increased by Rs.39.64 crore without
any proper/cogent explanation. It was suspected that these
funds had been diverted/siphoned off to one of the related/or
group companies.
v. Addition to gross block included Rs.26 lakhs as land
development expenses, actually not incurred, as per inspection
carried out by banks.
vi. Depreciation increased by Rs.1.84 crore despite a fall in fixed
assets.
vii. Steep reduction in the sundry debtors during 2001- 02 without
any cogent explanation.
viii. Availed unsecured, secured loans, and increased drawings from
cash credit account, all together to the extent of Rs 43 crore.
ix. Profit earned (operating profit) during the previous year was
Rs.12.24 crore on a sale of Rs.96 crore. However, the company
reported a huge loss of Rs.40 crore on a marginal fall in sales
during 2001- 02 to Rs.87 crore.
FACTS OF THE CASE
 BIFR observed that the group companies (to which Vivita
belonged) referred to BIFR, though engaged in different
activities, adopted the pattern of reporting huge losses on
slight fall in sales. Marginal fall in the sales and huge
losses accompanied with large discounts in a single
financial year was common to all the companies.
VIVITA’S REPRESENTATIONS
AND DECISION OF BIFR
 Vivita stated huge discounts were offered to liquidate stock, as it
feared trademark infringement proceedings by another company.
BIFR did not accept this as sufficient evidence was not made
available and hence heavy increase in discounts and losses were
not allowed.
 
 Devaluation of investments not admitted as Vivita Ltd failed to
submit copy of B.O.D. resolution to ascertain whether it was
long-term or short-term investment.
 
 Accounting jugglery has been committed, in respect of
accounting for foreign exchange fluctuation on P&M, only to
make its net-worth negative. Hence not allowed.
 Increase in loans and advances, on the one hand and sundry
creditors/other liabilities, on the other, could mean a diversion of
funds of the company and increase in losses by providing interest
on borrowed funds. For want of complete details, this issue was
kept open.
 
 Explanation of Vivita Ltd as for increase in depreciation was
acceptable.
 
 Considering the market practice in the industry of taking advance
from buyers and passing the same to the suppliers, BIFR noted that
selling prices and the procurement prices are fixed in advance.
BIFR set aside Vivita Ltd’s contention of losses in trading activities
and ruled that losses of the company were overstated by Rs. 34.61
crore on account of increase in raw material consumption.
 
 Reduction in sundry debtors could mean diversion of cash
flow as the company did not submit explanation.
 
 As to increase in loans, details were not available, but in
case of unsecured loans, BIFR observed that Vivita Ltd.
had given preferential treatment in the payment of
unsecured loans at the cost of secured loans.

 Regarding loss of Rs.40 crore on a marginal fall in the

sales, Vivita has not submitted any explanation.
JUDGMENT

 BIFR, re-worked, based on above rulings, the net-worth

to be positive and hence rejected the reference u/s 15(1).