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A Mechanism to Check Corporate Frauds

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Date added: 17-06-26

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FORENSIC AUDIT: A MECHANISM TO CHECK CORPORATE FRAUDS ABSTRACT Satyam, Enron, Worldcom, Tyco are few of the big brands which were charged with financial frauds. Corporate are separate legal entities wherein directors and managers are supposed to act for the welfare of shareholders. Various regulators, rating agencies, auditors are part of external check system. However the financial frauds around the globe has raised several questions. The current paper focuses on the concept of forensic audit. It is now believed that the regular audit system was not successful in detecting the symptoms of fraud at correct time. Was it the negligence, incapability or willingness on part of auditors that these frauds occurred and led to collapse of big companies. This has led to emergence of a new concept- Forensic auditing. The current paper discusses about the concept of forensic auditing, its techniques and investigation procedure. Several institutes are now providing certified courses and producinf forensic auditors who will be experts in detecting the financial frauds. The rising numbers of forensic audits in India, specially banks, have created demand for forensic auditors. The accounting firms are now training their employees to meet the growing demad. The paper discusses the rising importance of forensic audit in context of India. It is recommended that there should be independent agenies conducting forensic audits to ensure that cases like Satyam do not occur again. KEYWORDS: Auditors, Forensic audit, Frauds. JEL Classification: M41, M42
Corporates scams around the world since 1990’s have highlighted various corporate governance issues. They have resulted in development of numbers of codes, standards and laws to improve the governance of companies. However, when one analyses the scams like Satyam, Enron, Worldcom, Tyco, BCCI etc., we find that failure of auditors was one of the important cause of the failure. The auditing companies came under the scanner during the corporate frauds. PWC, Arthur Anderson, KPMG, have been penalised in different cases. It is known to everyone how Arthur Anderson compromised with its auditing standards in case of Enron. The result was that Arthur Anderson, who was once among the ‘Big Five’ is no more a part of it and the world is left with ‘Big Four’. Similarly in the case of Satyam, its auditors PWC failed to detect the fake cash and bank balances. PWC was fined $6 million by the SEC for not following the code of conduct and auditing standards while performing its audit duties in the case of Satyam. The history shows that auditors have not performed their duties efficiently in case of the large scandals around the world. They failed to detect frauds in the big corporates, many of which later collapsed. Ironically the companies which failed were big corporate houses and the auditors involved were also global names. When the big names can have such frauds, it would be easier for smaller companies to do fraud and get away with it. Due to rising importance of corporate governance and increasing awareness among stakeholders, it is becoming tougher for company’s management and auditors as they are under constant scrutiny of the stakeholders and regulators. Many changes have been made over the years to improve the governance of companies, like increased disclosures; fixing accountability and responsibity of Board of Directors (BOD), management and auditors; changes in composition of BOD etc. One of the latest emerging area in fraud detection and prevention is forensic audit. Let us understand what is forensic audit all about and why is its on demand, specially in banking sector.
The paper aims to explore the rising concept of forensic auditing. Objectives are as follows:
  1. To understand the concept of forensic auditing.
  2. To understand how forensic audit is conducted.
  3. To analyse growing importance of forensic audit.
The term forensic means ‘suitable for use in a court of law’. Forensic audit refers to the examination and evaluation of the financial information of company which can be used as an evidence in the court of law. The purpose of forensic audit can be different, it may be for prosecuting a party charged of fraud, or embezzlement or for any other financial claims. We all are aware of the financial audit which involves verification of the financial statements of a legal entity, with a view to express an audit opinion. It is supposed to be an unbiased examination and evaluation of the financial statements of an organization. But the past financial scams have proved that internal and external auditors have failed to be unbiased. Forensic audit is done by an expert group. These experts are supposed to have knowledge of not only accounting standards and finance, but also skills to detect frauds. The experts are trained to investigate frauds unlike the conventional auditors at the likes of PwC who ignored the seven-year long Satyam scam. Forensic Audit is useful due to following reasons:-
  • The evidences collected serves as readymade proof from a third party in relation to any audit,
  • It gives expert comment on any fraud,
  • Forensic Audit reports can be directly placed in the court of law for prosecuting.
The forensic experts need to go beyond investigation of the financial statements and explores number of questions such as:- Figure 1: Forensic Audit: Going beyond traditions questions Types of Forensic Audit: Forensic audit can be classified into two broad categories- reactive and proactive forensic audit. They are summed up in the figure below: Figure 2: Types of Forensic Audit Forensic audit should focus on significant transactions both as reflected in financial statements and off balance sheet items. In the corporate scams some of the companies had material off-balance sheet items, which if would have highlighted at right time, would have prevented the frauds. The techniques used for forensic audit are: a. Critical Point Auditing: It aims at filtering out the symptoms of fraud from the normal transactions in which they might be mixed or concealed. In order to do it, the financial statements, records etc are analyzed in order to find out unusual trends, accounts, discrepancies, inflated sales etc. b. Propriety Audit:- It is conducted by the supreme audit institutions. It uses the “value for money audit” technique which aims at lending assurance that economy, efficiency and efficacy have been achieved in the transaction for which expenditure has been incurred or for which revenue collected.
The process of conducting a forensic investigation is similar to the process of conducting a financial audit with some additional considerations. The various stages are summarized in figure 3. Figure 3: Procedure of Forensic Auditing
If we go back two years, India had only about 30 forensic auditing experts. Today the number stands at 300 that means it has multiplied 100 times! KPMG's forensic audit team conducted 220 inquiries in India in the nine months through December 2013 compared with 77 in the full fiscal year 2010-11. The rising demand is due to several reasons. The investors and stakeholders are pressurising companies to have mechanisms to identify and mitigate risk of fraud. Finaincial scams of the past has also increased the pressure on Board to seek third party investigation as a precautionary measure. After the NSEL crisis, promoters are ordering forensic audits of their firms to ensure there is no such employee fraud. Independent directors who are now considered as watchdogs, also prefer forensic audits. Also to comply with the Foreign Corrupt Practices Act, foreign companies might go for forensic audit of the books of their Indian arms or firms they intend to invest in. Countries such as the UK and US have tightened their anti-bribery and corruption laws in the past few years. Many other countries are also enacting similar laws that companies must follow to do business. NSEL scam has brought forensic audit into public discussion. The Forward Markets Commission had ordered forensic audits of NSEL and one special audit of Multi Commodity Exchange. The forensic audits are also catching up in banks. Banks are opting for forensic audits themselves as well as RBI is also ordering the same in order to investigate money laundering, fraud etc. For example, KPMG has been hored by Axis Bank to conduct forensic audit. This was due to a sting operation done by Cobrapost that alleged executives of the bank had indulged in money laundering. KPMG has also been appointed to conduct forensic audit of Universal Commodity Exchange(UCX) after it found that its promoter allegedly siphoned off funds from the exchange. UCX is the country's sixth national level commodity bourse. RBI has instructed banks to include forensic auditing practices. A clean and transparent banking system is the key to detect and fight accounting frauds and other white-collar crimes like that of money laundering. RBI’s circular dated 16 September 2009, titled “Fraud Risk Management System in banks – Role of Chairmen / Chief Executive Officers”, have urged the banks to identify and train staff in forensic auditing to investigate “large value frauds” or scams involving more than 1 crore rupees. In 2013 October, RBI has mandated forensic audit of all loans of Rs 1,000 crore or more where the bank plans to move them for corporate debt restructuring. For smaller loans too, banks are advised to take the help of these auditors. The Ministry of Corporate Affairs has also established the Serious Fraud Investigation Office (SFIO), which seeks the help of forensic auditors.
Forensic audit appears to be the need of the hour to detect and prevent white collar financial frauds in corporates. The forensic audit market is at nascent stage in India. Changes have started at national level. The introduction of the Companies Act, 2013 has a significant impact on fighting and preventing frauds.Setting up of NFRA, definition of ‘ fraud’, enhanced responsibility of auditors and directors aim to keep a check on the frauds. National Financial Reporting Authority (NFRA) have been set up by Central Government which will have wide powers to recommended, enforce and monitor the compliance of accounting and auditing standards. The auditors' role has come under scrutiny as they will be regulated by the NFRA and heavy penalties have been prescribed for auditorsin case of failure. As per section 245 (1g) the depositors and members of a company can claim damages from auditors, management and other consultants for the wrongdoings by the company and its management. Many consultants and senior executives are expected to become part of the certified community. Due to increased demand, there is new career area for the young auditors. As already mentioned, a forensic investigation requires highly skilled team members who have experience not only in accounting and auditing techniques, but also of the relevant legal framework. It is believed that personnel having such skills would be in great demand and would be valuable assets to a bank for their fraud risk management activities. ICAI and ACCA are providing courses on forensic auditing that will prepare individuals to act as watchdogs in companies. Youngsters can look upto this avenue and pursue to become forensic auditor who are going to be in great demand in near future. They will be skilled and have distinct identity from regular auditors as they will be trained in muti-disciplines and relevant regulations so that they can detect and prevent frauds. However on must pay attention to the fact that the big auditing firms who were involved in frauds themselves, will be able to detect frauds with help of forensic techniques or will it be better to have separate forensic auditing institutes who would be independent agencies and conduct independent investigations which would be complementary to the regular auditing function of the company. REFERENCES
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