Case Study on Forensic Audit

1. CASE STUDY ON FORENSIC AUDIT
Presented by Sandeep Das
Date : March 25,2016

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• What is Fraud
• Types of Fraud
• Fraud Triangle
• What is forensic audit
• What are various audit techniques
• Required skills, characteristics and subject areas of knowledge
• International practices
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SESSION OBJECTIVES

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CFE definition of Fraud:
Fraud can encompass any crime for gain that uses deception as its principal modus operandous. Fraud is defined by
Black’s Law Dictionary as:
 A knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or
her detriment. Consequently, fraud includes any intentional or deliberate act to deprive another of property or
money by deviousness, deception, or other unfair means.
Fraud under Indian Companies Act 2013
Fraud has been comprehensively explained under Section 447(1) of the Companies Act 2013 -“fraud” in relation to
affairs of a company or any body corporate, includes – any act, omission, concealment of any act or abuse of
position committed by any person or any other person with the collusion in any manner – with the intent to
deceive, to gain undue advantage from or to injure the trust of the company or its shareholders or its creditors or
any other person whether or not there is any wrongful gain or wrongful loss .
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DEFINITIONS

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Fraud against a company can be committed either internally by employees, managers, officers, or owners of the
company, or externally by customers, vendors, and other parties. Other schemes defraud individuals, rather than
organizations.
INTERNAL FRAUD
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.
EXTERNAL FRAUD
External fraud against a company covers a broad range of schemes. Dishonest vendors might engage in bid-rigging
schemes, bill the company for goods or services not provided, or demand bribes from employees. Likewise,
dishonest customers might submit bad checks or falsified account information for payment, or might attempt to
return stolen or knock-off products for a refund. In addition, organizations also face threats of security breaches and
thefts of intellectual property perpetrated by unknown third parties.
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TYPES OF FRAUD

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FRAUD BASED ON INDUSTRY
Bank frauds
Corporate frauds
Insurance frauds
Health care frauds
Cyber frauds
Securities frauds
Consumer frauds
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TYPES OF FRAUD

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FRAUD TRIANGLE
The fraud triangle is a model for explaining the factors that cause
someone to commit occupational fraud
There are three factors that must be present at the same time in order for
an ordinary person to commit fraud :
 Pressure
 Opportunity
 Rationalization
The First leg of the Fraud triangle represents Pressure. This is what
motivates the crime in the first place. The individual has some financial
problem that he / she is unable to solve through legitimate means, so he
/ she begins to consider committing an illegal act, such as stealing cash
or falsifying financial statement as a way to solve his / her problem. The
financial problem can be personal.

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FRAUD TRIANGLE Cont.
The second leg of the fraud triangle is perceived Opportunity, which
defines the method by which the crime can be committed The person
must see some way he can use (abuse) his position of trust to solve his
financial problem with a low perceived risk of getting caught. Many
people commit white – collar crimes to maintain their social status, for
example acquiring expensive cars or houses etc. Fraudster not only has
to be able to do it in such a way that he will likely not be caught and
the crime itself will not be detected.
The third leg of the fraud triangle is Rationalization. The vast majority
of fraudsters are first time offenders with no criminal past; they do not
view themselves as criminal. They see themselves as ordinary honest
people who are caught in a bad set of circumstances. Consequently, the
fraudster must justify the crime to himself in a way that makes it an
acceptable or justifiable act.

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Forensic meaning - the application of scientific methods and techniques to the investigation of crime.
What is Forensic Audit : A forensic audit is an examination and evaluation of a firm's or individual's financial
information for use as evidence in the court of law. A forensic audit can be conducted in order to prosecute a
party for fraud, embezzlement or other financial claims.
What is Forensic Accounting : Forensic accounting services generally involve the application of specialized
knowledge and investigative skills possessed by Accountants to collect, analyze, and evaluate evidential matter
and to interpret and communicate findings in the courtroom, boardroom, or other legal or administrative venue.
Difference between forensic accounting and forensic audit
In comparison, forensic accounting and audit differ in specific ways, as shown below: Forensic Accounting ● In
response to an event ● Financial investigation ● Findings used as evidence in court or to resolve disputes where
as Audit ● Mandatory ● Measures compliance with reporting standards ● Obtain reasonable assurance that
financial statements are free of material misstatement
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FORENSIC AUDIT

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FORENSIC AUDIT TECHNIQUES
Step 1
Understand business
Step 2
Identify possible fraud
exists
Step 3
Prescribed possible
fraud symptoms
Step 4
Use of technology to
collect data about
symptoms
Step 5
Analyse results
Step 8
Automate detection
procedures ( optional)
Steps 6
Investigate symptoms
Step 7
Follow ups (optional)
Analytical steps
Technology Steps
Investigative steps

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Knowledge: Abilities:
 Knowledge of Accounting standards / IFRS Interpersonal communications
 Financial Data Analysis Strong verbal and written communications
 Due Diligence Reviews Tracing illicit funds
Analytical
 Embezzlement Integrity
 Asset misappropriations Objectivity
 Contract and procurement fraud Independence
 Tax and related regulations
 Compute applications
Skills :
 Writing reports
 Interview techniques
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KNOWLEDGE, SKILLS AND ABILITIES FORENSIC AUDITOR

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What are the internal control weakness
 Lack of appropriate authorization for commission disbursements.
 No clearly defined lines of authority, roles, or responsibilities.
 No independent checks on performance.
 Inadequate documentation policies.
 Management override of internal controls
 A willingness among employees and third parties, and lower level employees and
management, to collude to circumvent controls.
 Insufficient written policies and procedures to direct department processing.
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CASE STUDY – S ASSOCIATES

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Lessons Learned
 When an employee exhibits lifestyle changes, it should be a red flag. Going from a modest lifestyle to a lavish one can be an
indication that the individual is stealing from the organization.
 Absent or weak internal controls are an invitation for fraud. A set of internal control procedures can help safeguard company
assets, ensure adherence to company policies, and promote efficiency and disclosure of reliable financial information. Many
internal controls are neither time-consuming nor expensive to put in place, and their benefits can be significant.
 Segregation of duties is an integral part of operational control and can deter collusion among employees. Because frauds with
collusion are more difficult to detect, companies should have whistleblower hotlines for reporting indiscretions when
employees see them.
 Lack of management review weakens detection of employee misconduct. Management should maintain documentary evidence
of its review and approval of all financial information to demonstrate that it has retained effective control over its financial
information.
 Regular disbursements, such as commissions, should not be allowed without applying regular authorization processes and
closely watching all exception cases.
 Customer control accounts should be regularly monitored and reconciled at least monthly. Any discrepancies should be
investigated adequately.
 A fraud policy gives the perception among employees that management is serious about deterring fraudulent behavior. It
should make clear that violators will be terminated and prosecuted.
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CASE STUDY – S ASSOCIATES

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Enron
Sherron Watkins blew the whistle on Enron Corp. in 2001, the energy company based in Houston was deeply
involved in fraud, insider trading, conspiracy, bank fraud, making false statements to banks and external auditors,
and securities and wire fraud. When the dust settled, 18 people pleaded guilty and three more were found guilty in
court. Enron shareholders filed a $40 billion lawsuit after the company's stock price, which achieved a high of US$
90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001
Enron Corp. whistleblower and now a Houston-based lecturer on, and advocate for, ethical leadership Sherron
Watkins is passionate about internal audit’s anti-fraud responsibilities. Enron outsourced its internal audit
department in the early 1990s to Arthur Andersen, its external auditor, she says, “so low- level staff at Arthur
Andersen conducted internal audit work.” The accounting firm went bankrupt and dissolved as a result of the Enron
meltdown. Indeed, Watkins is so adamant about the role of internal audit that she says this to interviewers: “Would
the Enron frauds have been detected earlier or prevented completely had Enron maintained an internal audit
department?” To the extent that the answer is yes, there are steps that internal audit departments can take to stay
on top of potential executive fraud. Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S.
history. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court of illegally destroying
documents relevant to the SEC investigation which voided its license to audit public companies, effectively closing
the business.
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WHAT HAPPENS WHEN EXECUTIVES GO BAD

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 Concern over conflict of interest between auditing and consulting raises the need for accounting firms to
separate their consulting activities from their auditing businesses.
 Securitization and other legitimate structured finance deals have to be disclosed with sufficient depth and detail
to adequately inform sophisticated investors.
 Management has to be free of material conflicts of interest because private investors rely on their business
judgment.
 There should be a method or basis that distinguishes between structured finance transactions that should be
allowed from those that should be restricted. This requires regulatory re-examining of structured financing
transactions. However, a long-term perspective must be taken that excessive safeguards can stifle business
innovation .
 The importance of taking corporate codes of conduct seriously and carefully thinking through their
implementation.
 There is a move considering forcing firms to routinely change auditors and for accounting firms to separate their
consulting from their auditing businesses in an attempt to prevent Enron-style collapses.
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LESSONS LEARNED FROM ENRON

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Satyam
Background
On January 7, 2009, announced confession of over Rs. 7,800 Crore financial fraud and
he resigned as chairman of Satyam. He revealed in his letter that his attempt to buy
two companies was his last attempt to “fill fictitious assets with real ones”
Promoters were booked for criminal breach of trust, cheating, criminal conspiracy and
forgery under the Indian Penal Code.
A week after Satyam founder scandalous confession, Satyam’s auditors Price
Waterhouse finally admitted that its audit report was wrong as it was based on wrong
financial statements provided by the Satyam’s management. CFO confessed to having
inflated the number of employees by 10,000 this helped in drawing around Rs 20 Crore
per month from the related but fictitious salary accounts.
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WHAT HAPPENS WHEN EXECUTIVES GO BAD

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Satyam Cont..
According to SFIO report, Satyam founders , CFO and vice-president (finance) together hatched a conspiracy to
artificially increase the revenues and profits in the books. The report highlights that the falsification was done by
deliberately leaving loopholes in the Computerized Accounting System which uses ERP modules. The high-level
application landscape of Satyam internal applications has many links between various systems where either there
was no integration or there was weak integration. These loopholes were deliberately left to insert fictitious
invoices and fictitious bank statements to balance them without being detected. Very smartly fictitious invoices
were created in the invoice management system using regular login ids, falsely intimating that any of the
employees could be involved in this. In order to cover up these fictitious entries, the receipts were first accounted
with Bank of Baroda, New York branch, (account no- 120559) and they then were relocated as fixed deposits in
other accounts. With such artificial entries started giving a blooming picture of the company, the management
decided to put the surging profits in better investments.
The SFIO probe also takes a call on the account statements of the company with the Bank of Baroda highlighting
jacking up of the books ever since 2001-02. The report also clarifies that the company had booked false fixed
deposits and interests in five banks namely, ICICI, HSBC, HDFC, BNP Paribas and Citi Bank. On the reconciliation of
these statements the company books showed major gaps with the actual existing deposits.
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WHAT HAPPENS WHEN EXECUTIVES GO BAD

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Satyam Cont...
The investigation also throws light on the company's paying excess taxes on the non-existing assets and also
indulging in forging current account balance statements. This helped the company forge quarterly details of
outstanding balances of fixed deposits and interest earned on them. The report says that by showing a rosy picture
of the company, the promoters were jacking up the share price and simultaneously selling off their holdings raking
in handsome money. The company, apart from this, is also believed to have issued American Depository Shares
worth $ 15.2 crore out of which only $ 5.25 crore were brought in to the country. The SFIO investigations also throws
light on the company's desperate attempt to acquire Maytas Infrastructure (MIL) and Maytas Properties (MPL), an
act done under the pressure from external investors who were pressing for better use of liquid asset shown in the
balance sheet. The report states that the promoters and the CFO were fully aware of the precarious financial
position of the company and the large number of fake fixed deposit and fake bank balances created in the books
since 2000-2001 onwards.
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WHAT HAPPENS WHEN EXECUTIVES GO BAD

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Following are the common governance problems, which have been noticed in the collapse of
Satyam:
 Unethical conduct - Founders wanted to make money by avoiding paying taxes, cooking books, and pay offs;
revealed some alarming truths that he was concealing for a long period by confessing to a fraud of Rs 7,800 crores
($1.47 billion) on Satyam’s balance sheet.
 A case of false books and bogus accounting-These figures of accrued interest were shown in balance sheets in
order to suppress the detection of such non-existent fixed deposits on account of inflated profits. The investigations
also detailed that the company had deliberately paid taxes of about 186.91 crores on account of the non-existent
accrued interests of Rs 376 crores, which was a considerable loss for the company.
 Unconvinced role of independent Directors -The Satyam episode has brought out the failure of the present
corporate governance structure that hinges on the independent directors,53 who are supposed to bring objectivity
to the oversight function of the board and improve its effectiveness. They serve as watchdogs over management,
which involves keeping their eyes and ears open at Board deliberations with critical eye raising queries when
decisions scent wrong
 Questionable role of Audit Committee -The true role of audit committee in précis is to ensure transparency in the
company, that financial disclosures and financial statements provide a correct, sufficient and creditable picture and
that, cases of frauds, irregularities, failure of internal control system within the organization, were minimized, which
the committee failed to carry out18
WHAT HAPPENS WHEN EXECUTIVES GO BAD

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Following are the common governance problems, which have been noticed in the collapse of
Satyam:
 Dubious role of rating agencies - Credit rating agencies have been consistently accused of their lax attitude in
assessing issuers and giving misleading ratings without thorough analysis they failed to warn market participants
about the deteriorating condition of company.
 Questionable role of banks - While sanctioning short term loans why not the banks posed any question as to
why the company which was supposedly cash rich as per the financial statements was taking loans from them.
 Fake audit - PricewaterhouseCoopers (PwC)’s audit firm, Price Waterhouse, was in the auditor for Satyam and
have been auditing their accounts since 2000-01. The fraudulent role played by the PricewaterhouseCoopers
(PwC) in the failure of Satyam matches the role played by Arthur Anderson in the collapse of Enron.
Partners of PwC according to the SFIO findings, had admitted they did not come across any case or instance of fraud
by the company. However, founder admission of having fudged the accounts for several years put the role of these
statutory auditors on the dock.
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WHAT HAPPENS WHEN EXECUTIVES GO BAD

20.  -FC
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INTERNATIONAL PRACTICES
The Foreign Corrupt Practices Act of 1977 (FCPA) is a United States Federal Law known primarily for
two of its main provisions, one that addresses accounting transparency requirements under the
Securities Exchange Act of 1934 and another concerning bribery of foreign officials. The act was
amended in 1988 and in 1998.
United Kingdom (UK) Bribery Act 2010, The Act is concerned with bribery. Very generally, this is defined
as giving someone a financial or other advantage to encourage that person to perform their functions
or activities improperly or to reward that person for having already done so

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