All you wanted to know about forensic audit

If there is one profession that is recession- as well as pandemic-proof in India, it is that of a ‘forensic auditor’. From regulators, banks and insurance companies to police personnel and lawyers, everybody wants to retain the services of a forensic auditors these days. Forensic audit is now a key weapon in every regulator’s armoury and the moment one smells a scam or corporate wrongdoing, the brahmastra of ‘forensic audit’ is unleashed.

The RBI has mandated forensic audits for loan accounts above a particular exposure which have turned non-performing. Not to be left behind, SEBI now wants listed companies to make disclosures about initiation of forensic audit to stock exchanges. Companies will also have to disclose final forensic audit reports to bourses along with the comments of the management, if any.

Simply put, ‘forensic’ means “suitable for use in a court of law”. It is to this standard that forensic auditors need to conduct their audit of companies’ books. Forensic audit is an examination of financial records to unearth any illegal or fraudulent activity, conducted with the assumption that the findings may be used in court.

A forensic auditor would have to integrate accounting, auditing and investigative skills, besides using technology and the knowledge of the working of the legal system to establish facts and evidence in a court so that criminal acts such as siphoning of company funds, embezzlement or fraud are detected. Sometimes, forensic audits are conducted to determine negligence of those charged with fiduciary duties.

When all companies are mandated to conduct regular statutory audits, what’s the purpose of a forensic audit? Well, they’re as different as chalk and cheese. Forensic audits are commissioned in response to an event and involve financial investigations whose findings are used as evidence in court. On the other hand, financial audits are designed to measure compliance with reporting standards and verify if a company’s books represent a true and fair view of the financial position, but they are not intended to detect material frauds. The difference gets reflected in the auditor's report.

Forensic audit investigations are important as they help uncover the modus operandi of corporate misdoings such as embezzlement, bribes, extortion, fictitious transactions, kickbacks and conflict of interest. They can also help locate or identify potential fraud. They are important as India has seen a rapid rise in cases related to fraud, bribery and corruption, fuelling the need for specialists to secure and shield business stakeholders. Radical changes are required to counter white-collar crime in India and forensic audits prove handy in such efforts.

The rise of new technologies and payment methods has created new avenues for fraudsters to line their pockets. Online frauds in the Indian banking system have surged in the recent years, threatening the safety of information and assets belonging to banks and their customers. With the insolvency and bankruptcy regime taking wing in India, there is now increased use of ‘forensic audit’ by creditors to validate their actions and to scrutinise promoters.

You as a minority shareholder, owner or a manager have a lot to lose from corporate frauds. Fraud happens more often than you may think and the cost of fraud is so much more than meets the eye. The aftermath of fraud can leave a company reeling for a long while. Even the whiff of a governance issue in the stock market can cause instant value decimation, tarnishing the company's reputation in the market. Forensic audits in such cases can help the management disprove allegations or provide concrete evidence of a fraud that is useful to regulators. SEBI recently asked listed companies to make prompt stock exchange disclosures when a forensic audit is commissioned and share the full report when such audits are concluded and you must watch out for such notifications as a shareholder.

The sooner the corporate ecosystem, government, regulators and society understand the importance of forensic audit, the better it will be for all stakeholders.

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