A forensic audit is an in-depth examination and evaluation of an organization or individuals’ financial records to derive conclusive evidence that can be used in a court of law or for legal proceedings. Such an audit may be conducted to prosecute a party for fraud or other financial crimes.
Need: The need for forensic audit arises in order to uncover, or confirm various types of fraud, corruption or other illegal activities. It can also be used to unearth evidence and present the same before the court during legal proceedings. A regular audit is mandated by law; however, forensic audit is a matter of choice. Other situations when such an audit is opted for are business or employee fraud investigation, brokerage fraud, merger and acquisition, tax audit preparation, personal injury claim, shareholder and partnership conflicts, etc.
Scope: A forensic auditor is often retained to analyze, understand, summarize and present complex financial and business-related issues in a manner which is both understandable and ably supported. These accountants are trained to see beyond the numbers and deal with the present business circumstances. Forensic auditors can be employed in public practice or they could be employed by insurance companies, banks, police forces, government agencies and other similar organizations. Some of the functions carried out by these forensic auditors include fraud detection and prevention, computer forensics (developing computerized applications to aid in the recovery, analysis and presentation of financial evidence) as well as providing expert testimony.
To carry out the investigation, the auditor is expected to be familiar with legal concepts and procedures, along with expertise in the use of IT tools and techniques that facilitate data recovery and analysis.
Types:
Given the fact that a fraud committed can be of so many different types, a forensic auditor may be asked to work on any of them. These can be categorized into corruption, asset misappropriation and financial statement fraud.
Corruption: This includes extortion, conflicts of interest and bribery.
a) Extortion can be said to be a contrast to bribery as it happens when money is taken in order to secure a particular outcome.
b)Conflicts of interest – the fraudster exerts their influence to reach a personal gain which detrimentally affects the company. The fraudster may not benefit financially but instead receives an undisclosed personal benefit as a result of the situation. For examples, a senior in the team may approve the expenses of an employee who is also a personal friend in order to maintain that friendship with the knowledge that the expenses are inaccurate.
c) Bribery is the situation when money or something of value is proposed in order to manipulate a given situation.
Asset Misappropriation: This is the most common type of fraud. It refers to theft of hard currency or other assets from the company.
a) Cash theft – the stealing of physical cash, for example, petty cash, from the premises of a fellowship.
b) Fraudulent disbursements – company funds being utilized to make fraudulent payments such as billing schemes wherein payments are made to an imaginary supplier, and payroll schemes, where payments are made to imaginary employees (often known as ‘ghost employees’).
c) Inventory frauds – the theft of inventory from the society.
d) Misuse of assets – when company assets are being used by the employees for their personal interest.
Financial statement fraud: Also known as fraudulent financial reporting, it causes a material misstatement in the financial statements. It includes deliberate falsification of accounting records, omission of transactions, balances or disclosures from the financial statements, or the misapplication of financial reporting measures. This is often borne out with the intention of presenting the financial statements in a biased manner, for example, concealing liabilities in order to improve any analysis of liquidity and gearing.
Regulatory Provisions on Forensic Audit in India:
1. SEBI ACT- Regulation 11 C of the SEBI Act, 1992 empowers the SEBI to direct any person to investigate the affairs of intermediaries or brokers associated with the securities market whose transactions in securities are being dealt with in a manner detrimental to the investors or the securities market.[1]
2. Prevention of Money-Laundering Act, 2002 - Section 3 of the Act defines the offence of money laundering as the involvement of a person in any process or activity connected with the proceeds of crime and projecting it as untainted property, where the scope of integrating forensic audits can be clearly seen.[2]
3. The Companies (Auditor’s Report) Order, 2003- The Act requires the auditor to report to the effect that if a substantial part of fixed assets have been disposed of during the year, whether it has affected the going concern status.[3]
4. Companies Act, 2013[4]
a) Fraud Reporting- Section 143(12) Notwithstanding anything contained in this section, if an auditor of a company, in the course of the performance of his duties as auditor, has 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.
b) Action of Fraud Reporting in good faith- Section 143 (13) No duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter referred to in sub-section (12) if it is done in good faith.
Similar Provisions applicable to Cost Auditor and Secretarial Auditor:
Section 143 (14) the provisions of this section shall mutatis mutandis apply to-
– The Cost Accountant in practice conducting a cost audit under section 148; or
– The Company Secretary in practice conducting the secretarial audit under section 204.
Punishment for default- Section 143 (15) If any auditor, cost accountant or company secretary in practice does not comply with the provisions of sub-section (12), he shall be punishable with fine which shall not be less than 1 lakh rupees but which may extend to 25 lakh rupees.
Case Law: The Satyam Fraud – 2009
The Satyam fraud was one of the largest corporate scandals in India with regard to falsification of accounting records. Ramalinga Raju was the Chairman of Satyam and he along with ten other officials were found to be in possession of ‘unpublished price sensitive information’ and profited from sale of shares of Satyam Computer.[5]They were found guilty of an accounting fraud as per the report. In this landmark fraud case in India, forensic auditing gained tremendous importance as the market regulator even banned the auditing firm from auditing listed companies for the following two years. The non-conventional methods of auditing helped it gain such reputation post the scam.
Conclusion
Forensic auditing, has over the years proven to be a need for every large-scale company which may be more prone to financial irregularities than other. With its experienced accountants and scientific nature, this process has helped uncover numerable of controversial decisions over the years in India and since it finds its place in the various corporate legal matter, it has not faced many challenges in terms of its validity. The question of ‘need’ arises, however, it is struck down with the analysis of the scale of irregularities that are to be audited majorly. The Reserve Bank of India (RBI) in pursuance of a more transparent banking system approached banks to look into forensic auditing practices. A Serious Fraud Investigation Office (SFIO) was formed by the Ministry of Corporate Affairs[6]in order to get the help of forensic auditors. These efforts by the government and different forums will ensure that frauds are relatively exposed earlier than they used to and prevent scams of the scale such as that of Satyam.
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