Detection and Reporting of Fraud by Secretarial Auditor

DETECTION OF FRAUD

The Auditor shall exercise professional judgment and maintain professional scepticism throughout the planning and performance of the audit to detect and report the fraud envisaged under the provisions of Section 143(12) of the Companies Act, 2013 read with Companies (Audit and Auditors) Rules, 2014.

Here, professional scepticism means, an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

PROFESSIONAL SCEPTICISM includes being alert to, for example:

Audit evidence that contradicts other audit evidence obtained.

Information that brings into question the reliability of documents and inquiries to be used as audit evidence.

Conditions that may indicate possible fraud.

Many factors influence the level of professional scepticism shown by auditors which include the following:

a) personal attitudes and ethical values.

b) levels of education, training and experience, and therefore overall competence.

c) the actions of the firm's leadership and the engagement partner.

d) the culture, incentives and business environment of the audit firm.

Following are the factors that re-enforce the professional scepticism:

• • Have the self-confidence and strength of character to maintain an enquiring mind.
• • Suspend trust: rationally and logically consider all the likely options, not just the one that is being put in front of you.
• • Resist the temptation to just accept the easy answer.

Go beyond simply providing evidence to support disclosures. Consider alternative disclosures or viewpoints as well.

PROFESSIONAL JUDGEMENT MEANS

The application of the accumulated knowledge and experience gained through a relevant accounting or auditing training, by making use of the ethical standards, resulting in making informed decisions about the courses of action that are appropriate in specific circumstances.

1). During the course of the audit, if the Auditor suspects commission of any fraud, he shall endeavour to collect further evidence for the same. The suspicion may arise on perusal of internal control systems, complaint under whistle blower mechanism and reports of the other auditors, etc.

2). The Auditor shall ensure to collect sufficient evidence which substantiates his suspicion of the commission of the fraud against the Auditee by its employees and officers. Here 'Suspicion' is a state of mind more definite than speculation but falls short of knowledge based on evidence. It must be based on some evidence, even if that evidence is tentative - simple speculation that a person may be engaged in fraud is not sufficient grounds to form a suspicion.

SUSPICION is a slight opinion but without sufficient evidence.

• • Examples of information which could be classified as suspicion are provided below: Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth.
• • The practice by management in maintaining or increasing the entity's stock price or earnings trend.
• • Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult "substance over form" questions.

* Significant related party transactions which appear to be not in the ordinary course of business or with related entities not audited or over which the Auditor does not have information.

If suspicion of fraudulent activity arises during the audit, the Auditor notifies the appropriate levels of management and those charged with governance, where appropriate, unless they may be implicated.

If Auditor has received report of other Auditor and it indicates a fraud, then that will be considered by the Auditor as a basis of his suspicion of the fraud. Pursuant to the reply of the Auditee disagreeing with the initial belief of the Auditor that a suspected offence involving fraud is being or has been committed, if the auditor is convinced that his initial suspicion was incorrect, the need for reporting the matter to the Central Government would not be applicable.

This situation would arise only if the Auditor did not have the evidence or information that is now provided as part of the reply or additional information has now been provided to the Auditor and there is persuasive evidence now available to convince the Auditor that the suspected offence involving fraud does not exist.

REPORTING OF FRAUD

1). If the Auditor has sufficient reason to believe that there is commission of fraud and have justifiable grounds for the same, he shall report to Audit Committee/ Board/ Central Government as per the process laid down under the Companies Act, 2013 and include the same in Secretarial Audit Report.

2). The Auditor shall verify whether the Audit Committee/ Board has given any comments on the fraud reported by the auditors in their report in terms of the provisions of the Companies Act, 2013.

3). The Auditor shall verify if the fraud detected by other Auditor has been reported to the Audit Committee/ Central Government and report the same in the Secretarial Audit Report.

Auditor will take note of and mention the fact about reporting of fraud by the other Auditor for example, Statutory Auditor under Companies (Auditor's Report) Order ["CARO"], or by Cost Auditor or Internal Auditor.

While the reporting responsibility under Section 143(12) is to the Audit Committee or the Board of Directors of the Company and/ or to the Central Government, the Auditor would also need to consider whether such matter also needs to be disclosed in the Auditor's Report under Section 143(3)(f) which requires the auditor to state his/her observations on financial transactions/ matters, which have any adverse effect on the functioning of the company to the extent it relates to the non-compliance of applicable laws, act, rules, regulations and guidelines covered under MR-3.

IT MAY BE NOTED THAT SECTION 143(12) includes only fraud by officers or employees of the company and does not include fraud by third parties such as vendors and customers.

IDENTIFICATION AND REPORTING OF THE EVENTS/ ACTIONS HAVING MAJOR BEARING ON AUDITEE'S AFFAIRS

1) It shall be the duty of the Auditor to identify and report in the Secretarial Audit Report all events/ actions having major bearing on the Auditee's affairs in pursuance of the applicable laws, act, rules, regulations, guidelines, standards, etc.

2) An event/ action shall be considered as having major bearing on Auditee's affairs if it affects its going concern or alters the charter or capital structure or management or business operation or control, etc.

EVENTS HAVING A MAJOR BEARING ON AUDITEE'S AFFAIRS

1) The Auditor shall assess and identify the material action or events having bearing on the Auditee's affairs in pursuance of the applicable laws, act, rules, regulations, guidelines, standards, etc. and report accordingly.

2) The identification of the corporate actions or events having bearing on the Auditee's affairs in terms of applicable laws, act, rules, regulations, guidelines, standards, etc. is a subjective matter and needs to be concluded keeping in mind various parameters.

SUCH PARAMETERS MAY INCLUDE THE FOLLOWING

a) The consideration involved in the transaction as a percentage of the consolidated turnover, net worth or profit;

b) The transaction whether or not in the ordinary course of business;

c) The transaction representing a significant shift from the company's strategy;

d) The omission of an event or information is likely to result in significant market reaction if the said omission came to light at a later date.

3. FURTHER, FOLLOWING ARE INDICATIVE ACTIONS AND/OR EVENTS MAY BE CONSIDERED TO HAVE A BEARING ON THE AUDITEE'S AFFAIRS:

a) Future plans of Merger or Amalgamation.

b) Revision in Rating(s).

c) Fraud/ defaults by promoter or key managerial personnel or by listed entity or arrest of key managerial personnel or promoter.

d) Agreements [viz. shareholder agreement(s), joint venture agreement(s), family settlement agreement(s) (to the extent that it impacts management and control of the listed entity), agreement(s)/ contract(s) with media companies)], which are binding and not in normal course of business, revision(s) or amendment(s) and termination(s) thereof.

e) Corporate Debt Restructuring.

4. The Auditor shall disclose the material non-compliances and transactions as observed during the course of Audit.

DISCLAIMER: The article presented here is only for sharing information with readers. In case of necessity do consult with professionals.

REFERENCE: Guidance Notes on Secretarial Auditing Practices.