Additional methods for detection of fraud in the financial statement

The corporate world has witnessed an increasing amount of corporate fraud or White-Collar crimes recently. With large number of frauds being unearthing on almost daily basis, the auditors who audits the financial statement of such corporates have to take the blame. The expectation of auditors has thus increased manifolds and auditors are expected to behave like blood-hound instead of watch dogs.

The auditors who audit the financial statements, cannot be expected to use the conventional methods as the transactions have become voluminous and complex in nature. The new way of conducting the business has forced auditors to adopt new thinking, new multi-dimensional approach and new tools to conduct the audit of financial statement.

This article describes some of the unconventional techniques to detect fraud in the financial statement

Following section describes the various tests in detailed manner

Tiger Team Test

Tiger team test or penetration test are the walk-through of the established procedures which includes the internal control testing of the organisation. This method includes trying to overrule the existing procedure through penetration and see whether the controls established is able to distinguish such transactions. In an electronic environment to check the controls, permission of the management is taken to penetrate the networks or firewalls. Another term used for such penetration is called “Ethical hacking”. Ethical hacking is a part of the Tiger Team Test.

Benford’s Law

This law has been used as a method of spotting fraudulent accounting data by looking at the first significant digit of each data entry and by comparing the actual frequency of occurrence with the predicted frequency. Generally, the fraud perpetrators are not aware of this law and will tend to use each digit about 10% of the time for the first significant digit in a number. This method is generally used in voluminous data. This method cannot be used for random numbers generated through random number generator or the numbers controlled through a specific value.

It helps in detecting too many vouchers below a certain limit, regularly duplicated or replicated amount, data entry errors etc.

Barium Test

It is a method where the dummy data or the data containing predetermined error is passed through an application to test the built-in controls and check of any significant blockages. While adopting for the barium test, consent of management is extremely essential. Due to the unique nature of the test designing adequate audit procedure and documentation is extremely important.

Birbal Tricks and Traps

This method is generally used by creating situations which induce greed, fear, or even anger in the minds of suspect or the fraudster. Such situation is created with the objective of admission of the guilt and disclosing the method of doing such fraudulent activities. Before adopting the method, it is important to ensure that this exercise is undertaken only when there is an allegation or sufficient reason to believe that some kind of wrong doing has been done and there is likely material impact on the financial statement. Body language and the environmental influence has to be considered while adopting this test. The test has to be corroborated with additional evidences. This test is highly subjective in nature and management and legal clearance has to be considered and discussed.

Inverse Logic Test

Inverse logic test can be applied in situations where information is missing, incomplete or perhaps deliberately modified. The process involves searching for fallacies, or non-feasibility in the evidence or the information that is made available to the auditor. This test will result to the point that if the auditor cannot find the truth, he can at least prove the falsity of the financial statement submitted for audit. The approach to inverse logic essentially comes from experience of the auditor and it does not have a standardized form or content. In this test, the auditor can also apply test of reasonableness and test for detecting absurdities. The difference between the test of reasonableness and absurdities is that in the former the situation is just not possible whereas in the absurdities the situation is possible but not probable.

Space and time dimension test

Conventionally, the auditors while auditing the financial statements concentrate on the financial aspects and apply the test on the financial figures. However, it often happens that they miss errors or frauds which could have been spotted if the tests were applied on the non-financial aspects. In this context, the space and time dimension test could provide additional insight to arrive at a conclusion. In certain cases, the nature of the business can be so complex that for an auditor, it is not possible to grasp and understand the process unless he adopts multi-dimensional approach.

Space dimensions could be examining the space available in the transportation vehicle and compute the volumes of quantities received or despatched at different time during the year and find the anomalies. Another example could be comparing the installed production capacities with daily production report.

Time dimension could be credit -notes or vouchers entered in the system after the working hours, delivery of the goods after the office hours, approval of transactions just before the departure of senior employees, data entry time taken at various terminals can be indicator of fraud.

Inventories, fixed assets, sales dispatches, purchase receipts or returns would be appropriate for the space dimension test. Time dimension would be appropriate for every audit test.

Surprise repetition in the Audit test

The chances of detecting any abnormalities by regular, well-defined and relatively predictable procedures becomes slim in certain situations where the auditee is fully conversant with the timing and nature of audit procedures. Repetitive use of certain audit tests using different timings with an intent of surprise, is one of the methods which could phenomenally increase the effectiveness of any audit. The objective of applying surprise repetition is two folds. On one hand it tests the controls on two different occasions resulting in increase in the level of assurance and on the other hand, it brings in greater element of unpredictability and surprise which is important for fair evaluation of controls.

Situations where the surprise repetition can be useful are

1. Verification of inventory, cash, fixed assets, investment and third-party stocks
2. Compliance test of internal controls
3. Process audits, internal audits, compliance audits, loan document verification during bank audits etc.

Source: Study on Unconventional method in Special Audits and Investigations published by Institute of Chartered Accountants of India.