Forensic Audit - A Modern Day Thrust and Thirst

Introduction:

In the recent past, more so in the previous decade, accounting and auditing community witnessed and in fact, confronted and gone through scandals emanating from fraudulent and manipulative devious and dubious accounts. These shames outraged not only the auditing community but the public at large. What is noticed in all these cases is the methods deployed are tailored to suit the deceitful purpose of manipulations in financial statements. Enron episodes and other companies’ incidences made the accounting and audit community to sit erect and ponder over a stratagem to come out of that rut—the result is the birth of forensic accounting.

Part played by CARO:

Companies (Auditors’ Report) Order, 2003 was also an attempt to target specific areas to plug the loopholes so as to arrest the untoward in the horizon.   CARO clauses call for straight answers to the queries depicting the correct positions prevailing in the setup for the period under audit. One of the clauses requires auditors to report, amongst other things, “whether any fraud on or by the company has been noticed or reported during the year; If yes, the nature and the amount involved are to be indicated”. The CARO 2016 in clause 3 (x) has further enlarged the scope of   the clause to spell out and extract as to “whether any fraud by the company or officers or employees has been noticed the nature and the amount involved is any fraud on the Company by its or reported during the year; If yes, to be indicated”. Nonetheless, even in the present avatar of CARO, auditors’ responsibility is limited to report under this clause when these frauds are noticed during audit, either in internal reporting of the management or otherwise.

Auditors added Responsibility under the provisions of the Companies Act 2013:

The responsibility of the auditors has been well enlarged as clearly spelt out in Section 143, especially with reference to Internal Financial Controls-- “Whether the company has adequate internal financial controls in place and operating effectiveness of such controls?”(143(3)(i) of the Act). Thanks to this heightened responsibility in the main audit report, CARO, 2016  has dispensed with the clause on Financial controls in three vital areas, that is, for the purchase of inventory and fixed assets and for the sale of goods? Whether there is a continuing failure to correct major weaknesses in internal control”.

The responsibility of an auditor(s) is to express an opinion on the financial statements based on his or  their audit after taking into account the provisions of the Companies Act, 2013( the Act) and the Rules made there under and  also the provisions of other applicable Acts,  the  accounting  and  auditing  standards ( Refer Section 143(10) of the Act) and matters which are necessary .Those Standards require that the auditors comply with ethical requirements and plan and perform the audit  to  obtain  reasonable  assurance  about  whether  the  financial  statements  are  free  from material misstatement. SA 240 on THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT OF FINANCIAL STATEMENTS.

In other words, an  audit  involves  performing  procedures  to  obtain  audit  evidence  about  the  amounts  and the disclosures  in  the  financial statements.  The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal financial control relevant to the Company’s preparation of the financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of the accounting policies used and the reasonableness of the accounting estimates made  by the Company’s  Directors,  as well  as  evaluating  the  overall  presentation  of  the  financial statements

 As per Section 143(12) if the auditors of a company have reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed.

In other words, the audit report gives  an opinion  as  to  the best  of their   information  and  according  to  the  explanations  given  to  them, the financial  statements  give  the  information  required  by  the Act in  the  manner  so required and give a true and fair view in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as on a date .  From this it is clear, a financial statement audit does not scrutinize or investigate every transaction or look for fraud particularly. While a properly planned financial statement audit may uncover fraud, the focus is not on uncovering likely fraudulent acts.

Forensic Audit:

Forensic Audit, on the other hand, is a different ball game altogether. No doubt, forensic auditors start on the basis of audited accounts and the auditors’ Report. But, their ball game is different based on the specific domain. In cricket, the ball that is hit over the ground beyond the boundary line is “six’ that is ‘sexy’ for the audience. If it is hit through the ground to periphery, it is four that never bores. But, in tennis it is out, whence it crosses border. But, in football, if it crosses into the goal space, it is a ‘goal’ for any player in the team to esteem. What does it covey? As different rules are played out in different games for assessing the boundaries, different procedures have to be deployed for different forensic assignments as they warrant. Why?

Each forensic project is unique by itself and calls for different approach to unravel the mystery behind.  Therefore, a standard approach cannot decipher the issue on hand. How to go about is ingenuity – an initiative that tries to unknot the unknown hidden. Consequently, the forensic/accountants and auditors may have to necessarily develop an audit program for the specific objective of the individual engagement with necessary backup of Legal team including criminal lawyer &police without sticks so as to testify as an expert in a court of law. “Accountants look at the numbers. Forensic accountants look behind the numbers” Therefore, it will be appreciated it is more of investigative work of talking with involved officials for extracting the correct position that may involve cross examinations with the each other as a valve  to decipher the issue on hand.

More extensive corroboration: Naturally, keeping the above back drop, it may call for working with a legal team, under   distinctive  and instinctive assumption that he or she will have to testify as an expert in a court proceeding. The qualifications and expertise of the engagement team is paramount as the documents created during the forensic audit may be needed in civil and criminal proceedings, by law enforcement, government agencies, or confidential investigations. Therefore, besides performing all that are required of financial statement auditors, a forensic accountant will often require more extensive corroboration, since it demands of expertise with practical tinge that focus on a dedicated line of attack designed to spot out financial fraud.

Skills expected: Forensic accountants/fraud auditors are generally accountants or auditors who by virtue of their aptitudes and attitudes, talents and abilities, skills and dexterities, knowledge and practical experience are bona fide authentic experts and specialists in sensing and detecting frauds in accounting and financial transactions so as to document fraud losses for criminal and civil purposes. They should have developed the art of interviewing third party witnesses so as to testify as an expert witness.“Investigative mentality” and “professional skepticism” is the core and chore of forensic audit.  A forensic accountant may have to focus more on seemingly immaterial transactions to look for indications of fraud that are not subject to the scope of a financial statement audit.  

1. Theft and Squandering of money: 

It relates to any fraud by the company (management) or officers or employees of   the company. Under CARO, it is whence noticed. But, under forensic audit, it is to be examined in detail, in deep and mostly through well-defined investigative process. Auditors may have to give goodbye to ‘sample checks’ in forensic audit but should be in ‘ample ‘as warranted by the situation and projects under investigation.

2. Manipulation of Accounts and Financial Statements:

Fraudulent financial reporting means deliberate misstatements so as to trick others by unfair means to unjust gains. This is normally attempted where management is ostensibly under pressure, to achieve a target that is seemingly unrealistic, where consequences of failure are significant. More often than not, it is attempted to maintain or increase the earning trends to float well in the share market especially in a year when it is going for public subscription. Accounts are also at times scripted to take some tax advantage. This can be attempted through various dubious means- by intentional falsification or alteration of records; by applying wrong estimates with intent to window dress; calculated omission in financial stamens and on the top misapplication of the principles of accounts as to recognition, measurement, presentation and disclosure requirements of various mandated standards.

3. Noncompliance of Statutory and other regulatory Requirements:

The world has been reduced to a global village. What is happening right in the morning in Japan affects the rest of the world as time zone advances! Today, shareholders and other stakeholders are spread across the globe. When there is cold in America, we sneeze it here. As a result, laws and regulatory requirements are periodically updated to suit the dictates of times. There are various international agreements that warrant compliances from the signatory countries. Accounting and auditing standards are becoming monolithic so as to understand in the same wave length. Therefore, very often, it is possible, different agencies may call for compliance certificate that may warrant forensic audit in specific circumstances where investigation is sine quo non. The court, various tax departments and various regulatory authorities may also ask for and rely for substantive evidence.

4. Computer Forensics – assisting and helping in electronic data recovery and enforcement of IP rights etc. This may call for specialist service with high computer background.

5. Others: Besides, forensic may cover and include within its scope conducting due-diligence  that is also unique for ease assignment; Business valuation; specific management auditing; and Evaluating loss before settling insurance claims. These may further include plethora of cases like calculating and quantifying losses and economic damages, whether suffered through wrongdoing or breach of contract; disagreements relating to company acquisitions, breaches of warranties and what not.   These may be eengagements relating to civil disputes/settlements.

Difference between statutory audit and Forensic Audit.

Conclusion:

Though forensic auditors start their assignments on the basis of audited accounts and the auditors’ Report as pointed out earlier, each forensic project is unique by itself and calls for different approach to unravel the unknown behind.  Therefore, a standard approach cannot decipher the issue on hand. How to go about is already dealt with earlier in the article. When the size of business has enlarged  by leaps and bounds over the periods and audit is  necessarily to be completed within the appointed time, opinion expressed on audit report is basically to give  an opinion  as  to  the best  of their   information  and  according  to  the  explanations  given  to  them, the financial  statements  give  the  information  required  by  the Act in  the  manner  so required and give a true and fair view in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as on a date except where it is qualified .

From this, it is crystal clear, a financial statement audit does not scrutinize or investigate every transaction or look for fraud particularly. While a properly planned financial statement audit may uncover fraud, the focus is not on unearthing fraud that could be a hard nut to crack under statutory audit not only because of the time constrain but also because of the scope of the audit. Besides, forensic audit demand different skills and wherewithal’s, time and energy to uncover the fraud hidden in the transactions, it is a different ball game altogether as explained earlier copiously.

As on date, there is no articulated Guidance Note nor any dependable check lists for reason that each assignment is unique and distinctive; and as a result, different routes to be used to go to the roots; - as seas can be used for navigation, roads for road traffic, planes by air- again different types of vehicles are used on the same routes depending of the size and level of passengers and quantum, size and quality of the materials. Therefore, most important in forensic audit is to decide the effective modus- operandi -technique, style procedure, approach, course of action and articulated methodology so as to successfully handle and deliver the correct result of the assignment so as to fix the fraud in all its manifestation.