Due Diligence, Investigation & Forensic Audit Flashcards
H Bank Ltd., received an application from a pharmaceutical company for take over of their O/s term loans secured on its assets, availed from and O/s with a nationalized bank.
H Bank Ltd., requires you to make a due diligence audit in the areas of assets of pharmaceutical company especially with reference to valuation aspect of assets.
State what may be your areas of analysis in order to ensure that the assets are not stated at overvalued amounts.
Regularly Overvalued assets: In case of due diligence, the auditor shall have to specifically examine the following areas:
- Uncollected/ Uncollectable receivables.
- Litigated assets and property.
- Intangibles having no realizable value.
- Infructuous project expenditure/ Deferred revenue expenditure, etc.
- Investment carried at cost though realizable value is much lower.
- Investment carrying a very low rate of income/ return.
- Group Company balances not reconciled.
- Underused or Obsolete P&M and their spares; asset values which have been impaired due to sudden fall in market value, etc.
- Obsolete, slow and non-moving inventories and inventories valued above NRV, huge inventories of packing materials, etc. with the name of company.
- Assets carried at much more than current MV due to capitalization of expenditure/ foreign exchange fluctuation, or capitalization of expenditure mainly in the nature of revenue.
CA R has been appointed as Forensic Auditor by B Bank Limited for one of its borrowal accounts A Ltd. CA R started the audit by first reviewing the transactions of the borrower in Bank statement as per Bank records to identify any hidden patterns in that information.
She had to review huge volume of data, as the number of transactions per day were in hundreds and the data was to be reviewed for the last three years. So, she was stuck up as to how to proceed further to identify any hidden patterns in information, if any.
Guide CA R, suggesting which technique to be used for identifying any hidden patterns in the information.
Technique to be used for identifying hidden patterns:
Detecting fraud is difficult, especially frauds involving material financial statement misstatements,
which occur only in about 2% of all financial statements. Fraud is generally concealed and often
occurs through collusion. Normally, the documents supporting omitted transactions are not kept in
company files. False documentation is often created or legitimate documents are altered to support
fictitious transactions. While fraud detection techniques will not identify all fraud, the use of sound
techniques can increase the likelihood that misstatements or defalcations will be discovered on a
timely basis.
In the given situation, CA Robo shall use the below stated data mining techniques to identify any hidden patterns of information.
• Data Mining Technique is a set of assisted techniques designed to automatically mine large
volumes of data for new, hidden or unexpected information or patterns.
• Data mining techniques are categorized in three ways: Discovery, Predictive modelling and
Deviation and Link analysis.
• It discovers the usual knowledge or patterns in data, without a predefined idea or hypothesis
about what the pattern may be, i.e. without any prior knowledge of fraud.
• It explains various affinities, association, trends and variations in the form of conditional logic.
MF. Ltd., engaged in the manufacturing of various products in its factory, is concerned with
shortage in production and there arose suspicion of inventory fraud. You are appointed by
MF Ltd. To evaluate the options for verifying the process to reveal fraud and the corrective
action to be taken. As an investigating accountant what will be your areas of verification
and the procedure to be followed for verification of defalcation of inventory?
Inventory frauds - Inventory frauds are many and varied but here we are concerned with
misappropriation of goods and their concealment.
(i) Employees may simply remove goods from the premises.
(ii) Theft of goods may be concealed by writing them off as damaged goods, etc.
(iii) Inventory records may be manipulated by employees who have committed theft
so that book quantities tally with the actual quantities of inventories in hand.
Verification Procedure for Defalcation of inventory - Such thefts usually are possible
through collusion among a number of persons. Therefore, for their detection, the entire
system of receipts, storage and despatch of all goods, etc. should be reviewed to localise
the weakness in the system.
The determination of factors which have been responsible for the theft and the
establishment of guilt would be difficult in the absence of:
(a) a system of inventory control, and existence of detailed record of the movement of
inventory, or
(b) availability of sufficient data from which such a record can be constructed.
The step in such an investigation is to establish the different items of inventory
defalcated and their quantities by checking physically the quantities in inventory he Id and
those shown by the Inventory Book.
Defalcations of inventory, sometimes, also are committed by the management, by
diverting a part of production and the consequent shortages in production being
adjusted by inflating the wastage in production; similar defalcations of inventories and
stores are covered up by inflating quantities issued for production. For detecting such
shortages, the investigating accountant should take assistance of an engineer. For that
he will be more conversant with factors which are responsible for shortage in production
and thus will be able to correctly determine the extent to which the shortage in production
has been inflated.
In this regard, guidance can also be taken from past records showing the extent of
wastage in production in the past. Similarly, he would be able to better judge whether
the material issued for production was excessive and, if so to what extent.
The per hour capacity of the machine and the time that it took to complete one cycle of
production, also would show whether the issues have been larger than those required.
BR Construction was into the business of building roads and other infrastructure facilities for
government contracts. Mr. Tiwari, one of the senior official, was looking after the procurement of
cement required at the construction sites. There was a substantial increase in the price of cement
bags bought as compared to those bought prior to the appointment of Mr. Tiwari. The management
of the company decides to get a forensic audit done for the transactions handled by Mr. Tiwari.
What points should be kept in mind by the management while appointing a forensic auditor?
A Forensic Auditor is often retained to analyze, interpret, summarize and present complex financial
and business-related issues in a manner which is both understandable and properly supported.
Forensic Accountants are trained to look beyond the numbers and deal with the business reality of
the situation. Forensic auditor needs to have an understanding on various frauds that can be
carried off and how evidence need to be collected.
While appointing a forensic auditor, the Management of BR Construction must initially consider
whether the firm has the necessary skills and experience to accept the work.
In view of above, Management of BR Construction should ensure that the forensic auditor should necessarily
possess the following characteristics and skills:
► Crafting questions to be posed.
► Responding to questions posed.
► Identifying documents to be requested and/or subpoenaed.
► Identifying individuals to be most knowledgeable of facts.
► Conducting research relevant to facts of the case.
► Identifying and preserving key evidence.
► Evaluating produced documentation and information for completeness.
► Analysing produced records and other information for facts.
► Identifying alternative means to obtain key facts and information.
► Providing questions for deposition and cross examination of fact and expert witnesses.
SN - Services rendered by Forensic Auditors
Services rendered by Forensic Auditors are:
- Crafting questions to be posed
- Responding to questions posed
- Identifying documents to be requested and/or subpoenaed
- Identifying individuals to be most knowledgeable of facts
• Conducting research relevant to facts of the case
• Identifying and preserving key evidence
• Evaluating produced documentation and information for completeness
• Analyzing produced records and other information for facts
• Identifying alternative means to obtain key facts and information
• Providing questions for deposition and cross examination of fact and expert witnesses
