FORENSIC

ACCOUNTING &
AUDITING
 Unit – 1
Fundamentals for Forensic
Accounting

By – Ms. Soumya Mohanty

Guest Faculty
P.G. Department of Commerce
Utkal University
Forensic Accounting is gathering and evaluation
of evidence by a Professional to interpret and
report findings before a Competent Authority

The overriding objective of Forensic Accounting

is to gather facts and evidence, especially in the
area of financial transactions and operational
arrangements, to help the Professional report
findings, to reach a conclusion (but not to
express an opinion) and support legal
proceedings.
Professional: A professionally qualified
accountant, carrying membership of a
professional body, such as the ICAI, who
undertakes forensic accounting and
investigation assignments using
accounting, auditing and investigative
skills
Financial forensics is the application of financial
principles and theories to facts or hypotheses at issue
in a legal dispute and consists of two primary functions:

1. Litigation advisory services, which recognizes the role

of the financial forensic professional as an expert or
consultant.

2. Investigative services, which makes use of the

financial forensic professional’s skills and may or may
not lead to courtroom testimony.
Investigation is the systematic and critical
examination of facts, records and documents
for a specific purpose

A critical examination of evidences, documents, facts

and witness statements with respect to an alleged
legal, ethical or contractual violation. The
examination would involve an evaluation of the facts
for alleged violation with an expectation that the
matter might be brought before a Competent
Authority or a Regulatory Body.
According to Investopedia, Forensic Audit is defined
as the examination and evaluation of a firm's or
individual's financial information specifically for use
as evidence in a court setting. This type of audit
may be initiated to prosecute individuals or entities
for financial crimes such as fraud or embezzlement.

Forensic Audit combines accounting, investigative, and

legal expertise to scrutinize financial information with
the goal of providing evidence that can be presented in
a court of law. It is a specialized form of audit with a
focus on uncovering financial irregularities and
supporting legal proceedings related to financial claims
or disputes.
 PARTIES APPOINTING FORENSIC
AUDITOR

[Link] Entities and Courts

[Link] and Law Enforcement
Agencies
[Link] Entities
[Link] Companies
[Link] and Financial Services
[Link]
 APPLICATIONS OF FORENSIC
ACCOUNTING & AUDITING
1. Investigation and Analysis of Financial Evidence
2. Reporting, Experts, and Testimony
3. Bankruptcy, Insolvency, and Reorganization
4. Economic Damage Calculations
5. Family Law
6. Financial Statement Misrepresentation
7. Fraud Prevention, Detection, and Response
8. Business Valuation
9. Assistance in Legal Proceedings
10. Communication of Findings
SKILLS AND EXPERTISE OF A FORENSIC ACCOUNTANT
1. Analytical Skills

2. Attention to Detail

3. Knowledge of Accounting and Auditing

Principles

4. Professional Skepticism

5. Legal Knowledge

6. Communication Skills

7. Ethics and Integrity

 ROLES & RESPONSIBILITIES OF A FORENSIC
ACCOUNTANT
1. Fraud Detection and Investigation:
1. Identify and investigate potential financial fraud and misconduct.
2. Use forensic accounting techniques to uncover fraudulent
activities, such as asset misappropriation, financial statement
fraud, and corruption.
3. Conduct detailed analysis of financial records to trace the origins
and destinations of funds.
2. Litigation Support:
1. Provide expert testimony in court regarding financial matters.
2. Assist legal teams in preparing cases involving financial disputes,
such as breaches of contract, shareholder disputes, and
intellectual property theft.
3. Prepare comprehensive forensic accounting reports that present
findings in a clear and concise manner for use in legal
proceedings.
 ROLES AND RESPONSIBILITIES OF A FORENSIC
ACCOUNTANT
3. Financial Analysis:
1. Analyze financial data to assess the economic impact of
alleged fraudulent activities.
2. Reconstruct financial statements and records to provide an
accurate picture of financial activities.
3. Evaluate the financial condition and performance of
businesses and individuals involved in legal disputes.
4. Asset Tracing and Recovery:
1. Trace and identify hidden or misappropriated assets in cases
of embezzlement, money laundering, or divorce settlements.
2. Work with law enforcement and legal teams to recover
stolen or misappropriated funds.
 ROLES AND RESPONSIBILITIES OF A FORENSIC
ACCOUNTANT
5. Risk Assessment and Management:
1. Conduct risk assessments to identify vulnerabilities in financial
systems and processes.
2. Develop and implement internal controls and anti-fraud measures
to prevent future occurrences of fraud.
3. Advise organizations on best practices for fraud prevention and
detection.
6. Compliance and Regulatory Investigations:
1. Ensure compliance with relevant laws, regulations, and industry
standards.
2. Investigate violations of regulatory requirements, such as anti-
money laundering (AML) laws, securities regulations, and tax laws.
3. Assist organizations in responding to regulatory inquiries and
investigations.
 ROLES AND RESPONSIBILITIES OF A FORENSIC
ACCOUNTANT
7. Digital Forensics:
1. Utilize digital forensic tools to investigate cybercrimes and
data breaches.
2. Analyze electronic data, such as emails, digital transactions,
and financial software logs, to uncover evidence of fraud.
3. Work with IT specialists to secure and preserve digital
evidence for use in legal proceedings.
8. Insurance Claims and Disputes:
1. Investigate and verify insurance claims related to property
damage, business interruption, and employee dishonesty.
2. Provide expert analysis and testimony in insurance litigation
cases.
FORENSIC AUDITOR
VS
FINANCIAL AUDITOR
 ASPECT FINANCIAL AUDITOR FORENSIC AUDITOR
Purpose To provide an To investigate specific
independent opinion on allegations or suspicions of
financial statements fraud, misconduct, or
financial irregularities
Scope General financial Detailed oriented focusing
statement review and on specific issues or
Compliance checks transactions
Nature of Work Routine, systematic, and Non-routine, often
periodic triggered by suspicion or
evidence of wrongdoing
Objective Ensure accuracy and Determine the presence of
compliance with fraud and gather evidence
accounting standards for legal proceedings
Techniques Audit Sampling, Forensic accounting
Used analytical procedures, techniques, digital forensics,
substantive testing detailed transaction analysis
 ASPECT FINANCIAL AUDITOR FORENSIC AUDITOR

Compliance Compliance with Adherence to legal standards

Focus Generally Accepted and evidentiary
Accounting Principles requirements
(GAAP) or International
Financial Reporting
Standards (IFRS)
Appointment Often appointed by legal
Typically appointed by the
by Parties entities, courts, regulatory
company's management
agencies, or parties involved
or board of directors
in disputes
Regulatory Governed by auditing May involve working with
Environment standards and regulations law enforcement and
(e.g. IAASB) regulatory bodies
OBJECTIVES OF FORENSIC ACCOUNTING
 OBJECTIVES OF FORENSIC ACCOUNTING

• Identifying financial misconduct and fraud.

• Proving financial crimes in court by offering concrete
evidence and expert testimony.
• Implementing measures and recommendations to
prevent future fraud and misconduct.
• Calculating the extent of financial losses resulting from
the financial irregularities.
• Assisting in resolving financial disputes, including
shareholder disagreements, contract disputes, or
divorce settlements, by providing financial clarity and
evidence
 PROCESS OF FORENSIC ACCOUNTING &
AUDITING

1. Planning the Investigation:

• Define the scope and objectives
• Identify stakeholders and legal context.
• Develop a detailed plan and timeline.

2. Gathering Evidence:
• Collect financial records, documents, and
digital data.
• Conduct interviews and gather witness
statements.
• Use forensic tools to analyze data
3. Analyzing Information:
Evaluate the evidence for relevance and reliability.
Identify patterns, anomalies, and potential fraud indicators.
Apply data analysis techniques to uncover hidden details.
• Substantive techniques – doing reconciliation, review of documents
• Analytical procedures – compare trends over a certain time period
or to get comparative data from different segments
• Computer-assisted audit techniques – Computer software programs
that can be used to identify fraud E.g. Helix, ACL Desktop, Ultra
Block, Password Kit Forensic.
• Understanding internal controls & testing them so as to understand
the loopholes which allowed the fraud to be perpetrated.
4. Reporting Findings:
Prepare a detailed report summarizing the findings.
Include evidence, analysis, and conclusions.
Present the report to stakeholders or legal authorities.
Example - Management wants a proactive
review to be undertaken from a forensic
accounting perspective through a
Professional on the Inventory area of the
Financial Statement. Explain the work
procedure.
❑Identify the scope and objectives of the assignment. This
may include the type of inventory, the period, the location
and the parties involved.
❑Matching the vendor invoices with payment made; to see
if the correct Goods Receipt Notes (GRNs) were submitted
by the store manager to Finance Department.
❑Check if there is any abnormal frequency of Purchase
Orders (PO) that shows signs of stock embezzlement.
❑To verify if the suspected employee has any relatives
working in the company to check for collusion, if any.
❑In the case of perishable goods and foodstuffs, look for the
date of expiry and the date of embezzlement, if any.
❑Match the quantity of goods in the invoice with the
physical quantity by performing volumetric analysis.
❑Check the invoice number of goods with the same invoice
value to find any theft/alteration.
❑Check whether intimation was made by the store manager
on the day of receipt.
❑Check the tagging of stock.
❑Get vendor confirmation of invoice received to confirm any
short deliveries highlighted in the GRN sent by store
department – this could be an attempt to cover up for any
for stock theft.
❑Check whether shifts undertaken by employees are
according to the agreement or not.
❑Review any third-party physical verification report
prepared during the closure of the financial year.
❑Collect and preserve other relevant evidence from various
sources. This may include physical inventory counts, CCTV
footage, emails, etc.
❑Analyse and reconcile the evidence to identify any
discrepancies or anomalies
 TRANSACTION CYCLE
Transaction cycles in accounting refer to the different
categories of business activities for which companies
record and process information in their accounting
systems.
These cycles encapsulate the entire process from the
initiation of a transaction to its final posting in the
financial statements.
Understanding the different transaction cycles helps in
organizing data, designing effective controls, and ensuring
that transactions are recorded and processed accurately.
Here are some primary transaction cycles in accounting:
Revenue (Sales) Cycle:
Involves all activities related to sales or services to customers.
Key processes: order taking, credit approval, shipping, billing, cash
receipt.
Purchases (Expenditure) Cycle:
Encompasses activities related to the procurement of goods or
services.
Key processes: purchase order issuance, receiving goods or
services, invoice processing, cash disbursement.
Payroll (Personnel) Cycle:
Deals with all activities related to employee compensation.
Key processes: timekeeping, wage rate determination, payroll
computation, payroll disbursement, tax and other deductions.
Production Cycle:
Relevant for manufacturing entities.
Involves activities related to the conversion of materials into
finished goods.
Key processes: raw material requisition, production
scheduling, production, storage.
Finance and Investment Cycle:
Focuses on activities related to raising capital, managing
investments, and other financing activities.
Key processes: issuing bonds or shares, dividend distribution,
buying or selling investments.
Fixed Assets (Property, Plant, and Equipment) Cycle:
Deals with activities related to tangible long-term assets used
in the business.
Key processes: acquisition, depreciation, maintenance,
disposal.
Novel Books Inc. – Revenue (Sales) Cycle:
1. Order Taking:
A customer browses Novel Books’ online store and decides to order three
books.
2. Credit Approval (Payment):
For customers purchasing on credit (like through a credit card with payment
due after a month), Novel Books will check the creditworthiness of the
customer, perhaps by using third-party credit-checking services.
3. Shipping:
Once the order is confirmed and credit (if applicable) is approved, the books
are packed and dispatched to the customer’s address.
4. Billing:
An invoice is generated. For direct online payments, the invoice is usually
marked as paid. For credit purchases, the invoice would indicate the due date
for payment.
5. Cash Receipt:
When the payment is made by the customer, especially for those on credit
terms, the cash receipt is recorded. For online payments, this might be
instantaneous.
Internal Controls in this Cycle:
• Novel Books may have a system in place to authenticate the
validity of each order (e.g., CAPTCHA, verification emails).
• For credit approvals, there might be a defined threshold. If a
customer’s order exceeds this threshold, additional
verification might be required.
• Shipping can have controls like tracking numbers to ensure
that the goods reach the intended recipient.
• For billing, an automated system might be in place to cross-
check the price of the books ordered with the amount on the
invoice.
• With cash receipts, reconciliation processes can be
implemented where the amounts recorded as received in the
accounting system are regularly matched with bank statement
amounts.
 Internal Control

Internal control, is a process implemented by

those charged with governance,
management, and other personnel to ensure
the achievement of entity’s objective, reliable
financial reporting, effective operations, asset
protection, and compliance with laws and
regulations.
 Objectives of Internal Control
To encourage adherence to prescribed policies

To avoid frauds and errors

To promote operational efficiency

To safeguard asset and records

To provide accurate and reliable data

To assist in timely preparation of Financial

Statements
Components of Internal Control

Control
Monitoring Environment

Control Entity’s Risk

Activities Assessment

Information
system &
communication
 Segregation
of Duties

Processing of
Information
Control
Internal
Control
Techniques

Review Authorization
Legal Fundamentals
 BASIS CIVIL LAW CRIMINAL LAW
Purpose Resolve disputes Punish and deter wrongful
between individuals or conduct
entities.
Parties Prosecution
Involved Plaintiff vs. Defendant (State/Government) vs.
Defendant
Type of Wrong/ Private wrongs (e.g., Public wrongs (e.g., theft,
Default breaches of contract, assault, murder)
torts)
Outcome Compensation or specific Punishment (e.g.,
relief imprisonment, fines,
probation)
Examples Property disputes, Theft, assault, murder
contract breaches,
personal injury claims
 CIVIL PROCESS CRIMINAL PROCESS
Initiating a Civil Claim Initial Investigation

Evidence Collection Evidence Collection

Asset Tracing and Filing of Charges

Recovery

Legal Proceedings Trial and Prosecution

Judgment and Verdict and Sentencing

Enforcement
 Financial Crime

Financial crime refers to illegal acts committed by an individual or a

group to obtain a financial or professional advantage. These crimes
typically involve deceit, fraud, and manipulation of financial systems
for personal gain. Financial crimes can severely impact individuals,
businesses, economies, and governments.

Key Characteristics:
[Link] and Fraud
[Link]
[Link] Financial Gain
Types of Financial Crimes:
[Link]: Deceiving others to gain money, such as through Ponzi
schemes or false insurance claims.
[Link] Laundering: Concealing the origins of illegally obtained
money, often by means of transfers involving foreign banks or
legitimate businesses.
[Link] Trading: Trading stocks or other securities based on
confidential information not available to the public.
[Link] and Corruption: Offering, giving, receiving, or soliciting
something of value to influence the actions of an official or other
person in charge of a public or legal duty.
[Link] Evasion: Illegally avoiding paying taxes owed.
[Link]: Misappropriation of funds placed in one's trust or
belonging to one's employee
[Link] Espionage : stealing proprietary information, trade
secrets/intellectual property from a business and using it to gain
competitive advantage.
 CORPORATE FRAUD?
In the context of a company's affairs, "fraud" under the Companies Act 2013
encompasses any act, omission, concealment of a fact, or abuse of position
done by a person with the intention to deceive, gain an undue advantage, or
harm the interests of the company, its shareholders, creditors, or any other
person. This applies regardless of whether there is any actual wrongful gain or
loss.

• Dishonest Misappropriation of Property

This involves a person dishonestly taking or converting any movable property
for their own use.
• Forgery
Forgery occurs when someone creates false documents (or electronic records)
with the intent to cause harm or injury to the public or any individual, support
any claim or title, induce someone to part with property, or enter into any
contract, whether explicitly or implicitly, with the intention of committing
fraud or facilitating fraud.
 The Indian Penal Code, 1860
Indian Penal Code recognizes the following acts as fraud:
a) Impersonation
b) Counterfeiting
c) Wrong weighing and measurement
d) Misappropriation
e) Criminal breach of trust
f) Cheating
g) Dishonest dealing in property
h) Mischief
i) Forgery
j) Falsification
k) Possessing stolen property
l) Concealment
 LAWS & REGULATIONS RELEVANT TO FORENSIC
ACCOUNTING AND AUDITING

1. Companies Act 2013

•Governs the incorporation, responsibilities, and functioning
of companies in India.
•Provides the legal framework for corporate governance,
financial reporting, and auditor responsibilities.
•Includes provisions for preventing and addressing fraud and
misconduct within companies.
•National Company Law Tribunal (NCLT)

2. Indian Penal Code (IPC) 1860

The primary criminal code in India, covering various offenses,
including fraud, forgery, and criminal breach of trust.
3. SEBI (Prohibition of Fraudulent and Unfair Trade
Practices) Regulations, 2003
•Issued by the Securities and Exchange Board of India
(SEBI) to prohibit fraudulent and unfair trade practices
in securities markets.
•Relevant for investigating securities fraud, insider
trading, and market manipulation

4. SEBI (Listing Obligations and Disclosure

Requirements) Regulations, 2015
•Mandates disclosure requirements for companies
listed on stock exchanges.
•Ensures transparency and accountability in financial
reporting.
5. RBI Fraud Classification and Reporting by
Commercial Banks and Financial Institutions
Directions, 2016
• Guidelines issued by the Reserve Bank of India (RBI)
for classifying and reporting frauds in banks and
financial institutions.

6. Income Tax Act, 1961

• Governs the taxation of income in India.
• Relevant sections include those related to income
from undisclosed sources and penalties for evasion.
7. Central Goods and Services Tax (CGST) Act, 2017
• Regulates the levy and collection of goods and
services tax (GST) in India.

8. Insolvency and Bankruptcy Code (IBC), 2016

• Provides a framework for insolvency resolution and
bankruptcy proceedings for companies and individuals

9. Indian Contract Act, 1872

• Governs contracts and agreements in India.

10. Others
 LIST OF INSTITUTIONAL FRAMEWORK TO COMBAT FRAUD IN
INDIA
i. Serious Fraud Investigation Office (SFIO) - This is a multi-
disciplinary organization constituted under the CA 2013. The SFIO is
responsible for investigating and prosecuting cases of white-collar
crimes/frauds.

ii. Public Accounts Committee - examines the appropriateness of the

expenditure incurred by the government as presented in the
accounts, the reported cases of losses, financial irregularities in the
government, and so on.

iii. Comptroller and Auditor-General - the constitutional authority

charged with the responsibility of auditing all receipts and
expenditure of the Union Government and that of the States and
Union Territories and agencies under them.
 LIST OF INSTITUTIONAL FRAMEWORK IN INDIA TO COMBAT
FRAUD IN INDIA
iv. Central Bureau of Investigation (CBI). The CBI is the premier
investigation agency in India. The CBI was originally set up to investigate
corruption cases but also conducts investigations into economic
offences and other high-profile cases.
vii. Central Vigilance Commission - This is an autonomous body free
from executive control. It exercises superintendence over and gives
directions regarding the functioning of other investigating agencies if
these relate to the investigation of offences alleged under the PCA
viii. Lokpal & Lokayuktha - These were established under the Lokpal
and Lokayuktas Act 2013. The Lokpal (the central agency) and
Lokayuktas (state specific agencies) deal with matters relating to
allegations of corruption by various public functionaries (such as the
Prime Minister, Minister of the Union, any member of House of
Parliament, or any officer/employee of any corporation ).
 REGULATIONS RELATED TO THE CASES OF BRIBERY
AND CORRUPTION
The main regulatory provisions and legislation governing bribery and
corruption is the Prevention of Corruption Act 1988 (PCA). This is the primary
law relevant to bribery and corruption offences in India.
• The provisions of the IPC and CA 2013 can also be interpreted to cover
bribery, including bribery committed in the private sector.
Other laws relevant to bribery and corruption includes -
•Central Civil Services (Conduct) Rules 1964.
•All India Services (Conduct) Rules 1968.
•Foreign Contribution Regulation Act 2010.
•Lokpal and Lokayuktas Act 2013.
•SEBI LODR Regulations.
•Prohibition of Benami Property Transaction Act,1988
•Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax
Act 2015.
•Prevention of Money Laundering Act 2002 (PMLA)
 AUTHORITIES TO INVESTIGATE AND REGULATE
BRIBERY AND CORRUPTION
•CBI - This is the premier investigation agency for corruption cases. The
CBI's jurisdiction covers central government and union territories
(extendable to states, on special order from the government).
•Anti-Corruption Bureau. The Anti-Corruption Bureau operates as a
state-specific agency responsible for the detection, investigation and
prosecution of cases of corruption that fall within the jurisdiction of the
respective Indian states.
•Police
•Central Vigilance Commission (CVC)
•Lokpal and Lokayuktas.
•Comptroller and Auditor General (CAG).
•Special judges : The PCA provides for the appointment of special judges
to try offences under the PCA (or any other offence the accused is being
charged with at the same trial).
 REGULATORY BODY TO CHECK ON FRAUDULENT
ACTIVITIES RELATED TO STOCK MARKET

• The securities market in India is regulated by the SEBI.

• The SEBI regulates insider trading and market abuse
through the SEBI Act 1992 (SEBI Act) and regulations
framed in accordance with the SEBI Act.
• The SEBI (Prohibition of Insider Trading) Regulations 2015
(Insider Trading Regulations) issued under the SEBI Act
sets out the legal regime for insider trading.
• The PFUTP Regulations contains the provisions prohibiting
fraudulent and unfair trade practices in the securities
market in India
LAWS & REGULATIONS RELEVANT TO MONEY LAUNDERING
AND TERRORIST FINANCING

• The primary legislation for money laundering is the PMLA,2002.

The PMLA was enacted to prevent, control and criminalize money
laundering.
• In addition, regulators such as the Reserve Bank of India (RBI), the
SEBI and the Insurance Regulatory and the Development Authority
of India (IRDA) have issued regulations regarding money
laundering.
• As banking channels can be used for money laundering activities,
the Indian Banks Association has taken a lead role in evolving a
self-regulatory code to combat money laundering activities in the
banking industry. Standards set by international financial
institutions and other such bodies are generally accepted as good
principles, practices and guidelines for the relevant areas.
 LAWS & REGULATIONS RELEVANT TO MONEY LAUNDERING AND
TERRORIST FINANCING

TERRORIST FINANCING
The Unlawful Activities (Prevention) Act, 1967 (UAPA) deals with combating
terrorism in all its facets, which includes terrorist financing.
Furthermore, the National Investigation Agency Act 2008 (NIA Act) deals with
investigations and prosecutions of offences under the UAPA and certain other
scheduled offences.
FINANCIAL/TRADE SANCTIONS
Financial/trade sanctions can be imposed by the:
•Ministry of Commerce and Industry under the framework of the Foreign
Trade Policy (FTP) read with Foreign Trade (Development and Regulation) Act
1992 (FTDRA).
•Ministry of Finance (MoF) under the Customs Tariff Act 1975 (CTA) and the
exchange control framework set out under the Foreign Exchange Management
Act 1999 (FEMA).
• Sanctions can be issued against specific individuals, organizations as well as
countries (including specific notifications in times of war or conflict).
 CASE STUDY – SCAM 1992 HARSHAD MEHTA STORY
Background: The Scam 1992 refers to a massive financial scandal in
India involving stockbroker Harshad Mehta, who manipulated the stock
market and banking system to artificially inflate stock prices, creating a
market bubble.
Impact:
•Market Impact: The scam led to a significant stock market crash in
1992, wiping out many investors' savings.
•Banking System: Several banks faced severe liquidity issues due to their
involvement in the fraudulent BR transactions.
•Legal Repercussions: Harshad Mehta was arrested, and the scandal led
to stricter regulations in the banking and stock market sectors.
Regulatory Changes Post Scam:
•SEBI: Strengthening the role of the Securities and Exchange Board of
India (SEBI) to monitor and regulate the stock market.
•Banking Reforms: Implementation of stricter banking regulations to
prevent the misuse of BRs and other financial instruments.
 CASE STUDY – SCAM 1992 HARSHAD MEHTA STORY
Mechanism of the Scam:
[Link] Market Manipulation:
• Buying Shares
• Creating Hype
[Link] Receipts (BRs):
• BRs are documents acknowledging a short-term loan that a bank gives
to another bank. Mehta used fake BRs to obtain loans from banks. He
convinced banks to issue BRs without underlying government securities.
He used the money obtained through BRs to buy stocks, further
inflating their prices.
[Link] Forward Deals (RFDs):
• RFDs are essentially short-term loans where securities are sold with an
agreement to repurchase them at a later date.
• Mehta manipulated RFDs by borrowing money from banks against
securities and then using those funds to manipulate stock prices. Often,
the securities involved did not exist, making the transactions fraudulent.
He created a cycle where he used the inflated stock prices to pay back
loans and acquire more funds, perpetuating the scam.