BCom 3rd Year Investigation Notes Study Material
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BCom 3rd Year Investigation Notes Study Material
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BCom 3rd Year Investigation Notes Study Material
The investigation is an examination of accounts and records of a business concern with some special purpose in view. In most cases, the purpose of such an enquiry is to know as actually as possible the financial position of the concern so that an opinion can be formed and action taken accordingly. Thus, it is a sort of special audit with a particular object in view.
It is actually conducted in addition to the regular audit of accounts and is, thus, scrutiny of accounts pertaining to several years whereas an audit relates only to a particular period, more especially a financial year. This is the major point of difference between the two. But it has to be remembered that the investigation of accounts of a joint-stock company is not legally compulsory as is the case with audits.
Taylor and Perry have rightly defined investigation as given below:
“Investigation involves inquiry into facts behind the books and accounts, into the technical, financial and economic position of the business or organisation.”
AUDIT VERSUS INVESTIGATION
(DIFFERENCE BETWEEN AUDIT AND INVESTIGATION)
Investigation differs substantially from an audit assignment. The audit aims at the collection of sufficient appropriate audit evidence to enable the auditor to form a judgement and express an opinion on the financial statements or other data under examination. An investigation, on the other hand, requires a special in-depth examination of the particular records or transaction with the objective of establishing a part or happening or assessing a particular situation. The scope of the audit is broad-based and general in nature whereas the investigation is narrow and specific. (BCom 3rd Year Investigation Notes Study Material)
The approach to an investigation is different from that followed in an audit. An investigation involves a more detailed examination of the selected areas than what is required in an audit. An investigation seeks substantive and in some cases even conclusive evidence as compared to an audit which mainly relies on persuasive evidence. (BCom 3rd Year Investigation Notes Study Material)
An investigator does not accept a stated fact as correct until it is substantiated. An auditor, in the absence of suspicious circumstances, relies on stated facts or figures. An auditor has to see whether the method of valuation and other accounting policies have been properly made in the financial statements or not. An investigator, however, is not by accounting conventions, policies and disclosure requirements. An auditor does not suspect unless circumstances are there to arouse suspicion, while an investigator approaches the work with a frame of mind to suspect, verify and satisfy. (BCom 3rd Year Investigation Notes Study Material)
ESSENTIALS FOR INVESTIGATION
An investigator should keep the following points in view during the course of the investigation:
- He should keep himself free from the influence of Directors and Managers of the business.
- He should familiarise himself with all the important details about a business before the commencement of his work.
- If necessary, he should seek the assistance of technical experts during the course of his enquiry.
- He should confine to himself the purpose of investigation and keep details in regard thereto quite secret.
SCOPE OF INVESTIGATION
The scope of the investigation is quite different from that of the audit. Much depends upon the terms of the investigation. Thus, its scope may be more extensive or limited depending on the circumstances of the case. The enquiry under investigation may go beyond the books of accounts of a business concern. It may cover matters of technical and financial nature. An auditor through investigation tries to establish a relationship between the causes and the findings. Thus, investigation means an enquiry into the details so that actual facts can be analysed with causes. (BCom 3rd Year Investigation Notes Study Material)
When an investigator is appointed by his client, he should obtain in writing all the necessary instructions from him so as to decide for himself the scope of work to be performed in pursuance of a special object. If any limitations are placed on his work, he should obtain them in writing so that he may exactly determine the scope and nature of his duties. (BCom Investigation Notes Study Material)
STEPS IN INVESTIGATION (PROCESS OF INVESTIGATION)
As investigation involves a variety of situations, it is not possible to my own standardised procedure. However, usually, an investigation requires the following steps in order of sequence:
Determination of objectives and establishment of scope of investigation: At the stage of acceptance of the assignment, the investigator should be absolutely clear about what is sought to be achieved by the investigation. If instructions from the client leave matters vague and non-specific, it would be proper for the investigator to have the matters discussed and obtain clearly written instructions covering the object and the scope of investigations and the issues incidental thereto. (BCom 3rd Year Investigation Notes Study Material)
The period that the investigation should cover should be clearly specified. The results of the investigation are often seriously affected owing to changes in circumstances which have occurred since it was contemplated, e.g., devaluation, import restrictions, starting of a new division, etc. Therefore, the purpose of the investigation should be borne in mind while determining the period that an investigation should cover.
Formulation of the investigation programme: It is not possible to draw up one programme to serve different types of investigations that a professional accountant is called upon to carry out for their scope and content have to be determined on a consideration of circumstances peculiar to each business or situation. (BCom 3rd Year Investigation Notes Study Material)
The investigation programme should be drawn up having regard to the nature of the business. of business, the instructions from the client embodying the objectives, the consequent scope and depth and the necessity to extend the investigation into books and records belonging to others. The programme should also be flexible so that knowledge gained with the progress of work can be used to extend, reduce or modify the extent and areas of checking. (BCom 3rd Year Investigation Notes Study Material)
In programming the verification, the investigator should concentrate on areas considered relevant rather than undertake a wide-ranging verification. For example, in an investigation on suspected payment of wages to ghost workers, the investigator should scan the areas having a bearing on the determination of wages and payments thereof. He should concentrate on time and job cards, appointment and termination of workers, attendance records, internal controls, internal checks, preparation of wage sheets, withdrawal of money from the bank for payment of wages and the actual disbursement of wages.
A conscious effort in investigation programming should be devoted to localise the enquiry into the relevant areas and, for that purpose, the initial wider base of inquiry should be gradually narrowed and fixed at a level that is meaningful. Matters not found to have a bearing on the subject matter of investigation should be gradually and progressively eliminated. This procedure alone will enable an in-depth examination of the matters relevant to the investigation. (BCom 3rd Year Investigation Notes Study Material)
Collection of Evidence: Through examination, the investigator would be gathering relevant evidence connected with the matters to be investigated. In the course of the examination of the documents and records, the investigator may require to obtain oral explanations from various personnel of the concerned business. In case his client is a person external to the business, it may be necessary for the investigator to get the matter formally agreed to by the business through the client.
The investigator should look for the most convincing evidence; he should seek and examine all the available evidence and by a process of elimination and corroboration, should endeavour to reach the truth of the matter. He, unlike the auditor, is not to restrict himself to prima facie evidence ordinarily available. He should examine it and if circumstances demand should try to obtain evidence that may have to be specifically procured. (BCom 3rd Year Investigation Notes Study Material)
For example, in the matter of valuation of land, he should definitely have regard to the available evidence as per records of the business and records of any bid received for the land. In addition, he should have regard to the prices at which land was sold or purchased in the neighbourhood around the same time. This may require him to obtain evidence even by going to the land registration office. He may also call for the report of experts in land valuation. (BCom 3rd Year Investigation Notes Study Material)
Analysis and Interpretation of Findings: Careful analysis and correlation of facts and figures will be necessary before the investigator can reach his conclusion. The conclusion should be well-reasoned and backed by established facts and data. He must analyse the data objectively on the basis of evidence gathered by him and should not draw conclusions according to preconceived notions. While interpreting the figures, the investigator must keep in mind various factors e.g. the political and economic considerations, the competition faced by the business, the historical pattern of the data, the nature of the business, etc.
Reporting of findings: Like all other work of an accountant, an investigation results in a report. It is submitted and addressed to the party at whose instance the investigation has been carried out. The nature of the report is governed mainly by two factors. First, the instructions given by the client as regards the special aspects of the business which are required to be investigated; and second, the findings of the investigating accountant. (BCom 3rd Year Investigation Notes Study Material)
OBJECTS OF INVESTIGATION
Investigation of accounts of a business will be advisable under the following circumstances:
- When a person intends to purchase a business.
- When a new company wishes to purchase a running business or firm.
- When a person desires to enter into a partnership firm as a new partner.
- When a person wishes to lend money to a business and wants to know its financial position.(BCom Investigation Notes Study Material)
- When a person seeks avenues of investments.
- When a person wishes to make a valuation of shares of a limited company.
- When the proprietor of a business suspects fraud.
- When it is suspected that the affairs of the company are not being properly managed (i.e., Statutory Investigation).
1. When a Person intends to Purchase Business
A person, when he intends to purchase a business, wants to know whether the business is worth buying or not. If so, he has to ascertain whether the amount of purchase consideration payable is just and proper. For this, the investigator should go through the Balance Sheets and the Profit & Loss Accounts for several years and make a search enquiry to confirm that the results disclosed by these accounts are genuine and fair. Actually, he is interested in ascertaining whether the proposal in hand will yield expected results in the form of profits in the years to come. An investigator should note the following points carefully:
(a) Earning Capacity. The investigator in such a situation should try to assess the financial position and ensure the position of assets and liabilities as shown in the Balance Sheet. The earning capacity of a business can exactly be found by going deeply into the results disclosed by the Profit & Loss Account. (BCom 3rd Year Investigation Notes Study Material)
The trend of profits earned during the past years should be enquired into. He should calculate the percentage of gross profits and other expenses to turnover and redraft the Profit & Loss Account in a tabular form. If there are any new changes, he should note them carefully. It has to be seen that an appreciation of profits is not the result of a sort of window-dressing but it is actual.
Profit can be inflated as a result of inflation of sales, suppression of purchases, omission of expenses or capitalization of revenue expenditure, less or no provision for depreciation or bad debts, etc., over-valuation of stock or addition of fictitious items of income. He should carefully go through all these details and ensure that capital profits are distinctly dealt with and are not mixed with the revenue profits. Such a procedure can bring to light the real earning capacity of the business which is being purchased. (BCom Investigation Notes Study Material)
(b) Financial Stability. Next, he should go through the details of assets and liabilities as shown in the Balance Sheet. He should ascertain that the assets have been properly valued and depreciation has been adequately provided for. Similarly, regarding the liabilities, the position is also real and not artificial. These are the simple things which an investigator should keep in mind.
He should confirm that the working capital is adequate. It is to be ensured that there is not much gap between the paid-up capital and Block Account. The position of availability of working capital has to be thoroughly enquired into.
(c) Valuation of Goodwill. He should enquire into the method of valuation of goodwill. The bases of the valuation of goodwill may be either past profits or turnover. The price demanded by the vendor for goodwill should be verified with reference to the trend of past profits and other factors, e.g., its dependence upon the personality and relations of the proprietor, etc.
It has to be remembered that if the basis of calculation is the past profit, necessary adjustments for extraordinary profits or losses, capital profits or losses and similar items will have to be made. If, on the other hand, the goodwill is calculated on the basis of turnover, it should be carefully scrutinized. If goodwill is attached to a particular place where the business is being carried on, it should be seen how far the change in proprietorship will affect it favourably or adversely. (BCom 3rd Year Investigation Notes Study Material)
(d) General Considerations. The investigator should also pay attention to the following factors:
(i) It should be enquired into whether the business enjoys State protection. If so, how long will it continue? This is important as the expansion and further improvement in the affairs of a business depend to a large extent on the protection granted by the Government.
(ii) Another point to be considered is the term of credit given and received. It is true that the term of credit affects the volume of working capital and also the amount of goodwill. (BCom 3rd Year Investigation Notes Study Material)
(iii) It is to be seen how far the success of the business is dependent upon the qualities and character of the vendor. It is to be confirmed whether the business will enjoy similar benefits or extra gains under the new proprietorship.
(iv) Next, he should examine the possibilities of competition. This may be ascertained by reference to the terms of sale imposing any restrictions on the vendor to start another business in competition. (BCom 3rd Year Investigation Notes Study Material)
(v) He should also enquire into the nature of customers. It should be seen it change In the proprietorship is to affect adversely their attitude,
(vi) The attitude of employees is another important factor to be taken into account. The investigator should ensure whether they would like to continue in employment when there is a change in ownership. (BCom 3rd Year Investigation Notes Study Material)
(vii) The closing stock should be properly verified. This is an important item to be Judiciously examined.
The investigator should submit his report to the client in clear terms indicating therein the period covered. It is expected from him that he will disclose all matters which are likely to affect the future of the business to be purchased.
- When a New Company wishes to Purchase a Running Business Concern
A newly incorporated company, wishing to purchase a running firm, intends to get its accounts investigated because it desires to appraise the prospective shareholders of its real position. An investigator so appointed should take into account the following points:
(i) The Profit & Loss Account pertaining to previous years should be redrafted in a tabular form and each item therein should be compared on the basis of the calculated percentage. He should ensure that the profits have not been inflated as a result of some manipulation in the accounting records. (BCom 3rd Year Investigation Notes Study Material)
(ii) He should throw light on all the matters about the business which may influence the earning capacity of the business in future.
(iii) Correct profits should be arrived at. Even if correct profits are calculated, it would be necessary to make certain adjustments in their figures in order to arrive at the profits that the purchaser will be in a position to earn after the business has been actually purchased.
(i) Items to be Added to the Profits of the Vendors:
- Interest on Partners’ Capital and Current Accounts:
- Capital Losses:
- Rent of the land not owned by the vendor for which he was paying rent regularly;
- Interest on loans, bank overdrafts, etc.;
- Capital expenditure treated as revenue expenditure;
- Excessive provision for depreciation or reserve for bad debts;
- Exceptional losses;
- Discount on purchases, etc.
(ii) Items to be Deducted from the Profits:
- Capital Profit;
- Profits not earned in the ordinary course of business;
- Expenditure, if any, to be incurred after the purchase;
- Interest from investments not to be taken over by the purchasing company:
- Exceptional profits:
- Interest on Partners’ drawings credited to the Profit and Loss Account by the Vendor, etc.
The investigator should submit his report in clear and unambiguous terms so that it may reveal the true picture of the business purchased. He should be very careful in this matter. Nevertheless, he must not express any opinion about the future earning capacity of the business.
- When a Person Desires to Enter a Partnership Firm as a New Partner
The Investigator will, first of all, like to know in detail the true state of affairs of the firm and the prospects for profits in future. He should proceed in a manner similar to that which he could have adopted if his client would have been an intending purchaser. He should take the following points into consideration:
- He should enquire about the reasons why a new Partner is being taken in by the existing partners.
- If the new partner is taking the place of a deceased or retiring partner, he should ascertain whether the firm will be put to some loss by the absence of such a partner. It should also be seen if the loss so caused will be made good by the availability of skill and experience of the new partner. (BCom 3rd Year Investigation Notes Study Material)
- He should locate the use to which the capital to be introduced by the new partner will be put. Such capital may be utilized for paying off any liability or paying back the capital balance of the retiring or deceased partner or for providing additional working capital. In the latter case, it should be seen whether this amount of capital will be sufficient for the purposeful expansion of the business.
- He should compare the capital of different partners with their proportion of shares in the profit or loss of the firm.
- He should have a thorough peep into the financial position of the business. If it is under a heavy financial strain, it should be carefully diagnosed whether such a situation will adversely affect the interests of the new partner.
- He should study the Balance Sheet to ensure that assets and liabilities have been correctly shown therein.
- He should make a careful scrutiny of the Partnership Deed, specially the clauses which are connected with the entry of the new partner.
- He should carefully enquire whether the amount of goodwill to be paid by his client is a reasonable one. Ordinarily, a new partner is asked to bring in a specific amount of goodwill. It has to be seen as to how this amount is to be shared by the existing partners.
- He should pay special attention to the earning capacity of the business so that he may be in a position to make an idea of the future prospects of the business. (BCom 3rd Year Investigation Notes Study Material)
- He should enquire whether any specialized technical knowledge is necessary for the successful conduct of the business, and, if so, how far the new partner will be in a position to fill up the gap. (BCom 3rd Year Investigation Notes Study Material)
He should submit his report to his client and deal with all these matters freely and clearly in his report.
- When a Person Wishes to Lend Money to Business
When a banker is approached by its customer to advance a sum of money as loan it is quite natural that he should familiarize himself with the trend of the business. The attention of the investigator should be directed towards the following points in such a case :
- He should know about the nature and circumstances of the business to which the money is to be lent and specially enquire about the skill, qualification and experience of the managing personnel who are responsible for its management.
- He should make a survey of the earning capacity and for this, he should redraft the Profit & Loss Accounts of previous years in a tabular form.
- He should go through the Balance Sheet of the business and study its financial position. It should be seen whether adequate security can be made available if loan is advanced to the business. (BCom 3rd Year Investigation Notes Study Material)
- He should compare the amount of current liabilities with the liquid resources of the business and specially note down the ratio between the two.
- He should estimate the security offered for the loan and see if it has already a prior charge on it. If so, what is the value of the charge?
- It should be seen whether the liabilities are being paid off regularly and in time.
- He should study the purpose of loan. If it is meant for expanding the business, he should examine thoroughly the possibilities of expansion of the business.
- He should enquire into the nature of the product manufactured by the business and also the position of the stock of raw materials.
- He should examine the investments of the business and ascertain income received therefrom.
- He should check the bills receivable and bills payable.
- It should be enquired whether the loan has been sought from any other source and if so, why has it been refused?
5. When a Person Seeks Avenues of Investments
The major point to be considered by the investigator is to know exactly the nature of business in which he has to invest his money so that he may ascertain whether the investment will be profitable or not. He should keep the following points in view:
- If the investment is proposed to be made in a private concern or in a partnership firm, the investigator should go through the terms of investment to ensure whether they are favourable or not. (BCom 3rd Year Investigation Notes Study Material)
- If he finds that some of the terms of investments are against the interest of the client, he should make a report to that effect to his client.
- If the investment is proposed to be made by way of purchase of shares or debentures in a joint-stock company, he should examine the Memorandum and Articles of Association with the object of determining the rights and liabilities of various classes of shareholders.
- He should thoroughly examine the Balance Sheets and Profit & Loss Accounts of past years so as to be familiar with the earning capacity and financial position of the business in which the investment is proposed to be made.
- He should try to determine the effective capital employed in the business and for this purpose, he should ascertain the correctness of the valuation of assets after deducting therefrom the existing liabilities. (BCom 3rd Year Investigation Notes Study Material)
- Lastly, he should think of the proposed investment to be safe and report to client accordingly.
6. When a Person Wishes to make a Valuation of Shares of a Limited Company
There are two bases of valuation of shares of a company:
(i) ‘Assets’ basis method, i.e., the extent to which the share capital of a company is represented by its tangible assets.
(ii) ‘Yield’ basis method, i.e., the yield or return on capital in the form of dividends paid by the company during the past years. Such a return can well be compared with the return available on similar investments in the market.
Under the ‘Assets’ basis method, the total value of liabilities (including the prior claims of other classes of shareholders) is deducted out of the total value of assets (including goodwill). The net amount so derived is divided by the number of shares and the value of each share can thus be ascertained. (BCom 3rd Year Investigation Notes Study Material)
- When the Proprietor of a Business Suspects Fraud
When a proprietor of a business suspects fraud, an investigator is appointed to investigate into it. The investigator so appointed should go through the duties of the persons suspected of fraud and the books of accounts dealt with by them.
The investigator should know at the very outset whether the fraud involves misappropriation of cash or goods. Ordinarily, the defalcation of goods is the result of collusion between two or more persons. He should examine the system of supplying and receiving goods and check the sales thoroughly. He should also scrutinize the system of purchases returns and sales returns. Besides, he should check the Debtors’ Accounts, doubtful debts, etc., very carefully. (BCom 3rd Year Investigation Notes Study Material)
If cash has been misappropriated, the investigator should note the following:
- He should be familiar with the nature of business and of the fraud suspected.
- He should check the Cash Book thoroughly. In doing so, he should take the following steps:
(i) He should check up the balances and totals of the Cash Book carefully.
(ii) The balances of Cash Book should will be compared with those of the Bank Pass Book.
(iii) The counterfoils of Pay-in-Slip Book should be compared with the Schedules received from the Bank.
(iv) Cash sales should be checked with reference to the original contracts and documents.
(v) Items of expenditure should be verified.
(vi) Discount received or allowed should be vouched.
- He should carefully examine the Purchases Book and Sales Book.
- He should examine the Petty Cash Book.
After taking the steps stated above, he should submit the report to his client.
- When it is Suspected that the Affairs of the Company are not being properly Managed (i.e., Statutory Investigation)
There is a provision for investigation in Sections 210 to 229 of the Companies Act, 2013.
The Central Government has the power to order an investigation into the affairs of the company either on the report of the Registrar or on special resolution passed by a company. It can be ordered by the government in public interest also. The Courts or the Tribunal can also order that the affairs of the company aught to be investigated. The Central Government has the power to appoint inspectors and seek report from them. (BCom 3rd Year Investigation Notes Study Material)
Establishment of Serious Fraud Investigation Office
The Central Government shall, by notification, establish an office to be called the Serious Fraud Investigation Office to investigate frauds relating to a company.
The Serious Fraud Investigation Office shall be headed by a Director and consist of such number of experts from the following fields to be appointed by the Central Government from amongst persons of ability, integrity and experience in : banking, corporate affairs, taxation, forensic audit, capital market, information technology, law, or such other fields as may be prescribed.
Serious fraud investigation can be ordered by the Central Government on receipt of a report of the Registrar or Inspector, on intimation of a special resolution passed by a company that its affairs are required to be investigated, in the public interest or, on request from any department of the Central Government or a State Government. (BCom Investigation in Auditing Notes Study Material)
Where the investigation into the affairs of a company has been assigned by the Central Government to Serious Fraud Investigation Office, it shall conduct the investigation in the prescribed manner and follow the prescribed procedure and submit its report to the Central Government within such period as may be specified in the order. (BCom 3rd Year Investigation Notes Study Material)
If the Director, Additional Director or Assistant Director of Serious Frauds Investigation Office has reason to believe that any person has been guilty of any offence punishable under sections he may arrest such person.
On completion of the investigation, the Serious Fraud Investigation Office shall submit the investigation report to the Central Government.
On receipt of the investigation report, the Central Government may direct the Serious Fraud Investigation Office to initiate prosecution against the company and its officers or employees. (BCom 3rd Year Investigation Notes Study Material)
Investigation into Company’s Affairs in Other Cases
The Tribunal can order investigation:
(a) on an application of not less than one hundred members or members holding not less than one-tenth of the total voting power, in the case of a company having a share capital: or not less than one-fifth of the persons on the company’s register of members,` in the case of a company having no share capital,
(b) on an application made to it by any other person or otherwise, if it is satisfied that there are circumstances suggesting that :
(i) the business of the company is being conducted with intent to defraud its creditors, members or any other person or otherwise for a fraudulent or unlawful purpose, or in a manner oppressive to any of its members or that the company was formed for any fraudulent or unlawful purpose;
(ii) persons concerned in the formation of the company or the management of its affairs, have in connection therewith been guilty of fraud, misfeasance or other misconduct towards the company or towards any of its members; or
(iii) the members of the company have not been given all the information with respect to its affairs which they might reasonably expect, including information relating to the calculation of the commission payable to a managing or other director, or the manager, of the company.
Protection to employees during investigation. If a company during the pendency of any investigation into the affairs of the company or during the pendency of any proceeding against the company, proposes to discharge or suspend, terminate, change the terms of employment, dismiss or reduce in rank any employee, it shall send by post to the Tribunal previous intimation in writing of the action proposed to be taken against the concerned employee. If the Tribunal has any objection to the proposed action then it may give notice to the company.
Punishment. The company law now provides for punishment for furnishing false statements, mutilation or destruction, concealment, tampering or unauthorized removal of documents during the course of inspection or investigation.
The investigator should take note of the following points:
(i) It should be confirmed that the books of the company have been kept in accordance with the provisions of the Companies Act, 2013.
(ii) It should be ascertained that the directors of the company are not making improper use of the company’s money directly or indirectly.
(iii) He should compare the profits of the company with those actually distributed amongst shareholders by way of dividends.
(iv) He should examine carefully the share capital, investments, debentures, etc., and verify the income received from the investments.
(v) He should ensure that the authorities of the company are not misusing or abusing the powers conferred upon them by the company.
(vi) He should compare and contrast the reserve fund with similar funds for the past I secret reserve is created, its genuineness should be thoroughly enquired into. (BCom 3rd Year Investigation Notes Study Material)
(vii) He should specially check the capital and revenue expenditure and ensure that proper allocation has been made between the two.
After making an exhaustive enquiry into the company’s affairs, the investigator should make a report to the Central Government with all the material facts at his disposal. (BCom 3rd Year Investigation Notes Study Material)
Forensic means pertaining to or connected with or used in courts of law.
Definition of forensic audit, “An examination and evaluation of a firm’s or individual’s financial information for use as evidence in court. Forensic audit can be conducted prosecute a party for fraud, embezzlement or other financial claims.”
Object. Forensic audit is conducted in order to prosecute a party for fraud embezzlement or financial claims. Forensic auditors investigate crimes such as fraud and give expert testimony in court trails. They also perform work related to civil disputes, Forensic auditors are also called fraud investigative accountants or investigators. (BCom 3rd Year Investigation Notes Study Material)
Frequency, volume and the gravity of instance of fraud across various sector particularly in financial sector has gone up tremendously over the past few years, Indian is ranked as the 88th most corrupt nation. India has witnessed a spate of fraudulent activities in the corporate sector over the last two decades in the form of Satyam, Reebok Adidas etc. Forensic auditors have been used to find black money trails, sources of finance of terrorist activities. (BCom 3rd Year Investigation Notes Study Material)
Forensic audit is the examination of documents and interviewing of people to extract evidence. Forensic auditors examine individual and financial records to investigate frauds and find evidence suitable for use in litigation. They assist in legal proceedings including testifying in courts as experts witnesses and prepare visual aids to support evidence. (BCom 3rd Year Investigation Notes Study Material)
Fraud auditors i.e., forensic auditors go outside the books of accounts to find fraudulent transactions. This may include reviewing receipts not only of the company but of customers as well. Forensic auditors interview employees, customers and sometimes, clients to find out if a fraud has taken place. (BCom 3rd Year Investigation Notes Study Material)
Who employs forensic auditoes? Generally, lawyers, police departments, insurance companies, government regulatory bodies and agencies, banks, courts and business employ forensic auditors.
Types of Frauds
Fraud or forensic auditing is done to investigate six types of frauds, these are: embezzling, bribes, stealing, exortion, fictitious transactions, kickbacks and conflict of interest situations. If frauds are classified on the basis of industry, these are:
(i) Bank frauds. (relating to bank deposits, inter-branch accounting and inter-branch transactions). Banks have also to face electronic frauds relating to credit and debit cards and cheques. (BCom 3rd Year Investigation Notes Study Material)
(ii) Corporate frauds. Corporate frauds take place when accounts of companies are manipulated. For example, B. Ramalingam of Satyam Computers was found to have inflated company’s profits and jacked up the company’s Balance Sheet by more than one billion dollars.
(iii) Insurance frauds. These are committed to obtain fraudulent gains from insurance process like false insurance claims, premium diversion or deliberately causing accidents or damage (like fire to stock) to claim insured money.
(iv) Cyber crimes. Cyber crimes include any criminal act dealing with comp network (called hacking). Examples of cyber crimes are: telemarketing and internet frauds, identity theft and misuse of credit and debit cards. Cyber crimes are considered to have taken place when illegal activities are committed through the use of computers and the internet.
(v) Securities fraud. These are concerned with securities market manipulations done through cyber-intrusions. Recent cases is of commodity exchange unjustifiably increasing the value of stored commodities which were never purchased. Other examples are ponzischemes and foreign based reverse merger schemes etc. (BCom 3rd Year Investigation Notes Study Material)
(vi) Consumer frauds. Consumer frauds means defrauding consumers, for example by selling bogus ayurvedic medicines through television or selling products which do not perform as advertised. These types of schemes take the form of misleading advertising, offering, unfair terms of transactions and services and charging unfair prices etc. (BCom 3rd Year Investigation Notes Study Material)
Report of Forensic Audit
Issuing a report is the final step of forensic audit. The client will expect a report containing the findings of the investigation, including a summary of evidence and a conclusion as to the amount of loss suffered as a result of fraud. It is also likely that the investigative auditor may recommend improvements, to prevent such frauds occurring in future. (BCom 3rd Year Investigation Notes Study Material)
Forensic investigations are likely to lead to legal proceedings against suspects and the investigators may be involved in court proceedings. Evidence gathered during forensic audit will be presented to the court and the forensic team may be summoned by the court to describe evidences they have gathered. They may be asked to explain how the suspect was identified.
INVESTIGATION AND DUE DILIGENCE
‘Due Diligence’ is a term that is often heard in the corporate world these days in relation to corporate restructuring. The term ‘corporate restructuring normally includes internal reconstruction, amalgamations, spin-offs, divestiture, mergers, joint ventures, split-off, etc. Certain corporate restructuring exercises are not within the group (also known as external corporate restructuring exercises), for example, a joint venture between two parties where one party hives off an existing unit or division into another company into which the joint venture partner then acquires an interest or has acquired an interest. (BCom 3rd Year Investigation Notes Study Material)
These are all corporate restructuring exercises that involve more than one party. For such a corporate restructuring exercise to succeed, it must be planned properly. A key element in such an exercise, where it involves the acquisition of another entity, unit or assets of an entity, is the performance of a “due diligence” review. (BCom 3rd Year Investigation Notes Study Material)
Due Diligence may also required to be performed in cases of venture capital financing, lending, leveraged buyouts, public offerings, disinvestment, corporatisation, etc. Sometimes, in a restructuring exercise, while the unit may remain within a group, it may pass from under the charge of one management team to that of another team. This situation also gives rise to the need for a due diligence review.
Purpose of Due Diligence
The purpose of due diligence is to assist the purchaser or the investor in finding out all the reasons can about the business he is acquiring or investing in prior to completion of the transaction including its critical success factors as well as its strength and weaknesses.
In addition, it may expose problems or potential problems that can be addressed in the price negotiations or by dealing with suitable clauses in the contractual documentation, in particular, warranty and or indemnity provisions.
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