Forensic Accounting & Fraud Prevention
- Fraud is intentional deception made for personal gain or to damage another individual. Defrauding people or entities of money or valuables is a common purpose of fraud.
- The term ‘forensic ‘has usually attracted an unfortunate connotation with the morbid world of forensic medicine. Forensic accounting shares only one thread common with forensic pathology. That common denominator is the pursuit of evidence that will stand the rigorous scrutiny that the rules of evidence and procedure demand for its admission as evidence before the courts.
The integration of accounting, auditing and investigative skills yields the specialty known as Forensic Accounting. It is the application of accounting methods to the tracking and collection of forensic evidence, usually for investigation and prosecution of criminal acts such as embezzlement or fraud. Forensic Accounting can sometimes be referred to as Forensic Auditing.
- Forensic Audit can be broadly classified into two categories:-
- Encompassing litigation support &
- Investigative accounting.
- Other support services that traditionally come within the sphere of investigative services revolve – including corporate intelligence and fraud investigation services.
Difference between Forensic Audit and other Audits
The procedures for financial audits are designed to detect material misstatements, not immaterial frauds. The vast majority of frauds could not be detected with the use of financial audits. Reasons include the dependence of financial auditors on a sample & the auditor’s reliance on examining the audit trail versus examining the events and the activities behind the documents. The latter is simply resource prohibitive in terms of costs and time.
Advantages of Forensic Audit
Forensic audit involves examination of legalities by blending the techniques of propriety (Value for Money audit), regularity and investigative and financial audits.
Use of Forensic Auditing:
The services rendered by the forensic auditors are in great demand in the following areas:
- Fraud detection where employees commit Fraud
- Criminal Investigation: Matters relating to financial implications the services of the forensic accountants are availed of.
- Cases relating to professional negligence
- Arbitration Service
- Settlement of Insurance Claims
- Dispute Settlements
engage a Forensic Auditor?
Engaging an external party other than internal auditor & management team can have distinct advantages from conducting an internal investigation.
- Objectivity & Credibility: An external party would be far more independent and objective than an internal auditor or company accountant as well as an established firm of forensic accountants would also have credibility stemming from the firm’s reputation, network and track record.
- Accounting expertise and industry knowledge
- Provision of valuable manpower resources
Enhanced effectiveness and efficiency
Forensic Accounting Concepts
The fraud triangle developed by Donald Cressey, is a model for explaining the factors that cause someone to commit occupational fraud. It consists of 3 components which, together, lead to fraudulent behavior:
- Perceived pressure
- Perceived opportunity
Certain risk factors are usefully considered in the evaluation of whether or not the organization is at a greater or lesser degree of risk, owing to incentives or pressures that could potentially lead to material misstatements.
- Financial stability is threatened by economic, industry, or entity operating conditions.
- Excessive pressure exists for management to meet debt requirements
- Personal net worth is materially threatened
Fundamentally, rationalization and attitude are functions of the culture of an organization, the psychology of those who work in it, and the interaction between the two. Hard times in an industry or in overall economy may make it easier for some individuals to rationalize fraud.
- A history of violations of laws is known
- Little communication and support of the entity’s core values is evident.
- Management has a practice of making overly aggressive or unrealistic forecasts.
- Personal financial obligations create pressure to misappropriate assets.
- Adverse relationship between management and employees motivate employees to misappropriate assets.
- Disregard for the need to monitor or reduce risk of misappropriating assets exists.
- There is a disregard for internal controls.
An opportunity must exist to commit fraud. Opportunities may also be inherent in the nature, size, or structure of the business. Certain types of transactions lead themselves more than other to falsification or manipulation, as do certain kinds of balances or accounts.
- There is presence of large amounts of cash on hand or inventory items.
- There is an inadequate internal control over assets.
Occupational Fraud has been defined under 3 branches:
- Fraudulent Statements
- Asset Misappropriation
Occupational frauds are:
- Frauds that are done quickly and easily within the company
- Are internal in nature, which means that they are perpetuated by employees
- Include things like check fraud , revenue skimming , and false invoicing
Digital forensics has been defined as the use of scientifically derived and proven methods towards the preservation, collection, validation, identification, analysis, interpretation and presentation of digital evidence derived from digital sources for the purpose of facilitating or furthering the reconstruction of events found to be criminal or helping to anticipate the unauthorized actions shown to be disruptive to planned operations. It is the application of proven scientific methods and techniques in order to recover data from electronic/ digital media.
A red flag is a set of circumstances that are unusual in nature or vary from the normal activity. It is a signal that something is out of the ordinary and may need to be investigated further.
Forensic Audit Process
Broad stages of Forensic Audit:
- Accepting the investigation:
- Forensic Auditors must ensure whether their firm has necessary skills and experience to accept the work.
- Ideally statutory Auditors should not accept forensic auditing assignments of the same concern.
- Planning or Objectives of the investigation:
- Identity type of fraud & Fraudsters
- Quantify the loss
- Gather Evidence
- Provide advice to prevent the reoccurrence
- Gathering Evidence or Technique :
- Testing internal controls
- Use analytical procedures
- Apply CAAT
- Discussion and interviews with employees
- Substantive techniques such as Reconciliation, Cash counts and Review of stocks.
- Reporting: Report contains-
- Findings/ observation
- Summary of evidences
- Amount of loss
- How fraudsters set up fraud scheme and which controls were circumvented
- Recommend improvements of control
- Court Proceedings:
- Members of investigation team are involved
- Evidence gathering is presented
- Simplify technical teams
Forensic Accountants do not testify that fraud has occurred but only present evidence.
Forensic Audit tools & Techniques
The seven recognized Investigative Tools and Techniques used by Forensic Specialist/ Fraud Examiners
- Public Document Reviews and Background investigations – Public Databases, MCA Website, Corporate Records, internet etc.
- Interviews of Knowledgeable Persons
- Confidential Sources- Hotlines, E-mail, Letters, Current & Former Vendor, Customers & Employees.
- Laboratory analysis of Physical and Electronic Evidence- physical examination, fingerprint analysis, forgeries, ink sampling , document dating, Computer Forensics
- Hard disk Imaging
- E-mail analysis
- Search for erased files
- Analyze use & possible misuse
- Computer software to analyze data
- Physical and Electronic Surveillance
- Undercover operations
- Analysis of Financial Transactions
Some of the Techniques that a Forensic Auditor may use are listed below:
- General Audit Techniques
- Testing Defenses
Most businesses and other organizations have procedures and defenses set up to prevent the occurrence of fraud. A good initial forensic audit technique is to attempt to circumvent these defenses yourself.
- Statistical & Mathematical Techniques
- Trend Analysis
- Ratio Analysis
- Technology Based / Digital Forensics Techniques:
- Cross- drive analysis
- Live analysis
- Deleted files
- Stochastic forensics
- Tracking Log Files
- PC System Log
- Free Log Tools
- Computer Assisted Auditing Techniques (CAATs) / Computer Assisted Audit Techniques & Tools(CAATT)
Computer- assisted audit techniques (CAATs) or computer-assisted audit tools & techniques (CAATTs) are computer programs that the auditors use as part of audit procedures to process data of audit significance contained in a client’s information systems, without depending on him. CAAT help auditors to perform various auditing procedure such as:
- Testing details of transactions and balances
- Identifying inconsistencies or significant fluctuations
- Testing general as well as application control of computer systems
- Sampling programs to extract data for audit testing, and
- Redoing calculations performed by accounting systems.
Computer Aided Audit Tools or CAATs cab be broadly divided into
- Generalized Audit Software’s (GAS) or
- Common Software Tools (CST)
As a part of computer- aided audit, an auditor needs to do one or more of the following.
- Check Missings
- Check Duplicates
- Round numbers
- Repetitive Odd-Numbers
- Single Transactions
- Isolated Outliers
- Data Mining Techniques
It is a set of assisted technique designed to automatically mine large volumes of data for new, hidden or unexpected information or patterns.
Data mining commonly involves four classes of task:
- Classification- Arranges the data into predefined groups with the help of algorithms.
- Clustering- Is like classification but the groups are not predefined, so the algorithm will try to group similar items together
- Regression- Attempts to find a function which models the data with the least error. A common method is to use Genetic programming
Association rule learning- Searches for relationships between variables.