Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal.

Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal

Thank you to Vadodara Branch and members of ICAI From Chetan Dalal

All case studies / exhibits / example are adaptations of real life situations, and any resemblance or use of any name, logo or symbol of any entity is purely for academic purposes and to facilitate better understanding. Case studies discussed in the seminar are imaginery and at no point is there any direct or indirect implication of fraud in or by any entity referred to anywhere.

1. Forensic Audit: introduction and traits of a forensic accountant and forensic accounting and examples of some unusual frauds in business world 2. Fraud and manipulations in excel reports 3. Simple forensic tests which can be conveniently used to detect fraud 4. Red flags and early warning bells of possible fraud 5. Unusual methods of investigating

1. F ORENSIC A UDIT : WHAT IT MEANS AND W HAT ARE THE TRAITS OF A GOOD FORENSIC ACCOUNTANT OR AUDITOR ?

Forensic accounting is the specialty practice area of accountancy that describes engagements that result from actual or anticipated disputes or litigation. "Forensic" means "suitable for use in a court of law", and it is to that standard and potential outcome that forensic accountants generally have to work. accountancylitigation Forensic accountants, also referred to as forensic auditors or investigative auditors, often have to give expert evidence at the eventual trial. Forensic Audit- Technical definition-Wikipedia, the free encyclopedia

- Accounting - Auditing - Investigating

Forensic audit is issue based or related to a specific problem It has several components and could include any or all of the following: - Financial and accounting review - Digital forensic analysis - Field investigations - Data mining at an advanced level - Application of Interviewing skills - Technical assistance such as handwriting, specimen signatires, QC evaluation etc Audit relies on documentary evidence, whereas a forensic audit actually examines the reliability of documentary evidence itself Forensic accounting emphasizes the need to look for other evidence available as well.

Distrust the Obvious Think differently and Develop an open mind Look from different angles and all sides. You will get a different revelation

Laxman was sent by Ram when Ravana was dying to get advise and some learnings: He got the following tips - Never underestimate your adversary- he made this mistake with Hanuman - Trust only those advisors who have the courage to criticize you. - Treat your servants, driver (charioteer), close family members with discretion and keep your secrets close to you. They can harm you. - You cannot win always, sometimes you may think that you may be winning, but you may not be.

1. Fraudsters/ deceivers are Intelligent 2. Technology 3. Stale procedures syndrome 4. Lack of perseverance

Use of desktop internet investigation (useful in audit too) Use of the theory of impossibility and absurdity to detect fraud. If an investigator habitually applies these his success rate will increase phenomenally.

This is a technique you must use to conduct verifications, research and information regarding vendors, products, third parties, and almost anything you are auditing or investigating Do this as frequently as possible to spot forgeries or establish the authenticity of third parties, entities, documents such as invoices, letters, agreements, wills, old records, title deeds, letters of guarantee, LCs, and on rare occasions forgeries in passports, treasury bonds, fixed deposit receipts from banks etc

When you identify what is not possible or very unlikely, the fallacy or deceit in given submissions will be exposed. Also, in investigations evidence is often destroyed or changed or altered or hidden. To find the supporting evidence is therefore practically difficult. Make it a habit to think of what is not possible or impossible or unreasonable

2. M ANIPULATIONS AND FRAUD IN SPREADSHEETS Example using Excel Sheets

Consider a spreadsheet containing some data of two years comparisons The CEO wanted to show a good performance.Excel-Book1_cd.xlsxExcel-Book1_cd.xlsx Excel Forensic.xls Excel Forensic.xls Star-Contest-Result.xlsx Star-Contest-Result.xlsx

3. S OME SIMPLE FORENSIC TESTS - Juxtaposition test for testing authenticity of documents format and content - Test of reasonableness or absurdity - Test of replication of content - Test of impossibility - Scrutiny of suspicious documents particularly those having alterations

For example: Can be applied on volume of stocks in a warehouse or production with actual machine capacity

Forensic study of alterations try and discern consistency of cancellations, smudges, spaces and overwritings

In simple words it means placing side by side for comparison and spotting differences, where there should be none. This can be very effective in spotting manipulations

Document comparisons: Contracts agreements copies lying with different departments Vendor letterheads, bills and letter formats- all bidderss documents and search for common addresses, telephone numbers, fax numbers, fax/tel numbers, email addresses? HR frauds- Juxtapose degree certificates, signatures on certificates, multiple reference letters, etc Fictitious Expense or purchase bills. Juxtapose bills from large volume vendors Documents lying in multiple departments- eg copies of minutes of meetings or letters or memoes issued to different departments Signatures on important documents

Think of events which may be possible but not probable. Can a person arrive and depart at exactly the same time every day ? If smart/swipe card analysis shows such a pattern it is likely to be a phantom employee

4. E ARLY WARNING BELLS AND RED FLAGS Close nexus with suppliers, customers and third parties Missing records, details, etc Discrepancies in inventories, cash, and assets Behavioural indicators- chronic late sitting, arrogance and known bad habits like gambling, alcoholic traits etc Too much of power and authority in one or few individuals Mismatch between standard of living and known sources of income Arrears and sloppiness in bookkeeping, reconciliations etc

Cash Contras Stock in transit Accounting favours to debtors Non reversal of stale cheques to create secret reserves Not redepositing unpaid cash expenses such as wages, reimbursements etc Recycling of petty cash advances or IOUs

Bombay BrDelhi BrKolkattaChennaiBOM-serLucknowPune Purchases2076689142728610419191972854101757817236521993621 Staff Recruitment & Training576109501215365887547304282293.4553065 Travelling Exp - Foreign493068428969313147468415241603.3409246473345 Repairs & Maint437968381032278153875936214604.3363513420449 Printing & Stationery379100329817240766360145185759314653363936 Travelling Exps301765262536191651286677147864.9250465289694 Tel / Mobile / Internet11695410175074277.511110657307.4697071.8112276 Electricity Charges120000104400762121140005880099600115200 Communication - FBT10695393049.167925.910160552406.9788771102675 Discounts given10587392109.567239.910057910902387874.6101638 Discounts on sales206902180005131403196557101382171729198626 Vehicle Running & Main - R249529217090158476237053122269.2239548 Subscription Charges14339912475791072.713622970265.51119021137663 Funds transferred- Kolkatta250000 Funds transferred- Pune50000 Funds transferred- Chennai125000 Funds transferred- Delhi1437477 Stock in transit to Kolkatta500000 Security Charges13954312140288623.813256668376.07115821133961 stocks in transit209488182255133046199014102649.1173875201108 Stock in transit to Bom_ser800000696000508080760000392000768000 Postage / Telegram273491237937173694259816134010.6226998262551 Membership Fees17408615145511056216538285302.14144491167123 Insurance Prem - FBT18752416314611909617814891886.76155645180023 Insurance Prem - Clinical Trials214218186369136050203507104966.6205649 Housekeeping Services15919113849610110215123178003.59132129152823 Facility Management17504415228811117016629285771.5145286168042 Conference/Seminar Fees499233434333317063474271244624.2414363479264 Computer Maint AMC Others Sales142728612417399064691355922699370.211846471370195 HO account901195784040572349856135441585.6747992865147 Funds transferred from Bom250000 Funds transferredfrom Delhi Funds transferred from chennai125000 Funds transferred from Pune1437477 Stocks in transit from Bom800000 Stocks in transit from Bom500000

5. U NUSUAL M ETHODS OF INVESTIGATING

1. Secret reserve search 2. Mirror image evaluation approach to find inconsistent results 3. Relative Size Factor in stocks, debtors, creditors to detect error or manipulation 4. Illogical events- loans taken when huge liquid assets are available such as fixed deposits 5. Impossibility of certain results based on events known 6. Duplicate Numbers- could stem from error or fraud 7. Cash /stock shortages indicated by illogical withdrawing/purchasing 8. Negative asset / expense balances could be errors or fraud 9. Ghost workers search 10. Use Test Packs to check software bugs where audit train is invisible 11. Benfords theorem test results 12. Spreadsheet forensics and Ratio Analysis for trends 13. Physical verifications of assets, processes, and walk through tests, including tiger team tests

The excel UFSRD method U- unhide F- font coloration S-Show Formula R- rectify and replace D-duplication check..\collections\financialsA.xls..\collections\financialsA.xls

BOTH SPACE AND TIME OFFER TESTING YARDSTICKS FOR AUDIT PURPOSES. e.g. How much quantity can be stored in a warehouse, container, truck, box can be very useful for corroborative tests of inventory, sales, purchases. Time can be used in several ways, time of transaction, time taken for the transaction, time difference between two events etc. Case Study

A robbery took place in a mall in January 2006 Thieves broke in through the door They stole case worth more than Rs. 40 lacs Police complaint lodged Police made inquiries with staff, neighbourhood

Findings of the Police They concluded that this was the work of a local gang of thieves operating in the area and this mall was the latest victim They suspected that some employee may have helped but could not get specific clues against anyone They recommended better locks and greater security. Case virtually closed

Management appointed auditors who were specialised investigators more for studying controls and recommending preventive measures

Auditors spot red flags The time element indicated that the thieves had only 20 minutes to complete the robbery while the patrolling guards were circling the mall. How could they throw about all contents of all drawers? Where did they have time to steal a few cell phone handsets which were on a different floor? The alarm had been switch off. Therefore it was certain that someone had helped them The door that was broken was done with crude tools- not the work of a professional gang Out of two safes only one was broken into and robbed. The second was left untouched?

Findings good but inadequate to point out any means of recovery

Auditors try a new approach The use the space time dimension approach IDEA_DATA.xls Amazing findings- Late night sales

The log in id was traced the store manager. On being questioned he confessed There was no robbery- it was a stage managed robbery to cover up stock shortages The shortages were built up over a period of time. The store manager panicked when he was told that a stock taking was to take place He converted the stock shortages into artificial sales by entering sales at midnight along with his accomplice the head cashier during the previous two nights. This resulted into stock shortages being converted into cash shortages. This shortage was then palmed off as robbery by breaking open the door and throwing papers and documents in the cash room to make it look like a robbery

Relative Size Factor (RSF) Use of mathematical tools 39

Relevance Scrutiny of individual parties account is humanly ineffective. It highlights all unusual fluctuations which may be stemming from frauds or errors 40

What is RSF ? RSF is the ratio of Largest Number to the Second Largest Number of a relevant set. RSF = Largest Number Second Largest Number 41

RSF- Relative Size Factor RSF= highest value divided by the second highest value in a ledger account of debtors, or creditors Even a comparison of prices, quantities or values in an inventory If the RSF > 10, chances of error or fraud are great

How does RSF Work ? Any set of transactions take place in certain range. E.g. A vendor XYZ may have normal pattern of bill value range of Rs. 13k to 50k. If there is any stray instance of single transaction which is way beyond the normal range than that ought to be looked into. E.g. in above case, if there is bill of Rs. 5 lacs. RSF is above case will give a ratio of 10 (I.e. ratio of Rs. 5lac to Rs. 0.50 lacs) These single instances could be cases where there is some foul play. 45

Types of frauds that RSF can unearth Data entry mistakes Alterations in decimals Wrong coding with masters (vendors, customers, employees, etc.) Revenue items charged to capital accounts and vice versa Excess payments in payroll

Luhns algorithm For verifying correctness of credit cards and other cards which have been generated using the check sum digit

Tests used to assess the robustness of a system by actually carrying out penetration tests or walk through tests of processes as in ethical hacking for IT process testing

Surprise tests lose their sting when an auditee can predict an auditors plan Timing is very effective: one way to throw a suspected auditee completely off guard is to repeat a test in quick succession. Complacency, cover-ups and even frauds are likely to be exposed in the repeat test.

Tests of processes, operations and controls across similar units Anomalies should be explained, else something is amiss: - Case of discounts in chocolate shops - Case of repairs to moulds in two identical processing units

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Forensic Audit Case studies ICAI Vadodara 2013 Chetan Dalal.

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