Due Diligence, Investigation and Forensic Audit – CA Final Audit Question Bank

Due Diligence, Investigation and Forensic Audit – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Due Diligence, Investigation and Forensic Audit – CA Final Audit Question Bank

Question 1.
Write short note on: Areas in which Due Diligence can take place. [May 15 (5 Marks)]
Answer:
Areas in which Due Diligence can take place

1. Commercial/Operational due diligence: To evaluate whether proposed merger would create operational synergies,
2. Financial Due Diligence: To analyse books of account and other information pertaining to financial matters of the entity.
3. Tax Due diligence: To determine the tax effect of the merger or acquisition.
4. Information Systems due diligence: To ascertain whether information systems is providing reliable information in a timely manner.
5. Legal due diligence: To review legal aspects w.r.t. functioning of the entity and compliance with applicable laws.
6. Environmental due diligence: To study the entity’s environment, its flexibility and adaptiveness to the acquirer entity.
7. Personnel due diligence: To ascertain that the entity’s personnel policies are appropriate and suit the requirements of the restructuring.

Question 2.
Mr. Q is the proprietor of a very profitable business dealing in specialty chemicals. Due to his old age, Mr. Q wants to sell his business and has approached XYZ Pvt. Ltd., a competitor, for the same. As an advisor to XYZ Pvt. Ltd., you are appointed to do a “Due Diligence” of the business. Enumerate the points which you would look into as part of the Due diligence exercise. [Nov. 17 (6 Marks)]
Or
Mr. Clean who proposes to buy the proprietary business of Mr. Perfect, engages you as investigating accountant. Specify the areas which you will cover in your investigation.
or
An American Company engaged in the business of manufacturing and distribution of industrial gases, is interested in acquiring a listed Indian Company having a market share of more than 65% of the industrial gas business in India, request you to conduct a “Due Diligence” of this Indian Company and submit your Report. As due Diligence Auditor, what key areas you will cover in your review?
Answer:
Aspects to be covered in Financial due diligence:

1. Studying the Business History: Examine the details of establishment of company and ascertain details about the original promoters and the history of business – products, markets, suppliers, expenses and operations.
2. Significant Accounting Policies: Determine Accounting policies followed and their appropriateness.
3. Examining Profit and Loss Account: Examine extraordinary items of income or expense that might have affected the operating results. Compare the actual figures with the budgeted figures for the period under review and those of the previous accounting period.
4. Examining Net worth: Evaluate the basis upon which assets have been valued and liabilities have been recognised. The net worth of the business has to be arrived at by taking into account the impact of over/undervaluation of assets and liabilities.
5. Payment of Taxes: Check whether the business is regular in payment of taxes; both Central and State Taxes. In case taxes are in arrears; check the arrangements made to clear off the arrears.
6. Studying the Economic environment: Study the impact of economic forces at the business.
7. Cash Flow: Review historical cash flows and their pattern to determine cash generating abilities. Check whether the company is able to honour-its commitments to its creditors, to the banks, to government and other stakeholders. Examine how well does the company deploy its funds.
8. Financial Projections: Evaluate the projections for the next five years with detailed assumptions and workings and the appropriateness of assumption used in the preparation and presentation of financial projections. If assumption used by the company appears to be are unrealistic, consider its impact on the overall valuation of the company.
9. Human Resources: Examine the status of work force, staff and employees and their retention. Match the job profile of the administrative and managerial staff with the requirements of the new incumbents.
10. Statutory Compliance: Make a list of laws that are applicable to the entity as well as to make a checklist of compliance required from the company under those laws. If the company has not been regular in its legal compliance, it could lead to punitive charges under the law. The impact on such violations be quantified and assessed in respect of entity; financial status and even on its going concern status.

Question 3.
Your client is contemplating taking over a manufacturing concern and desires that in the course of due diligence review, you should look specifically for any hidden liabilities and overvalued assets. State (in brief) the major areas you would examine for the above. [Nov. 10 (5 Marks)]
Or
Z Ltd is intending to acquire A Ltd. It hires B & Co., a firm of Chartered Accountants to conduct a due diligence. B & Co., wants to reduce the risk of over valuation of assets in its due diligence exercise. Kindly guide B & Co. [May 12 (8 Marks)]
Or
M Limited is going to acquire S Limited. The purchase consideration has been decided at ₹ 4,000 Crores. M Limited is worried about hidden liabilities or overvalued assets of S Limited and ap-proached you to examine the same. List out eight important transaction/items which you would like to investigate in the Due Diligence exercise. [Nov. 13 (4 Marks)]
Or
KDK Bank Ltd., received an application from a pharmaceutical company for takeover of their outstanding term loans secured on its assets, availed from and outstanding with a nationalized bank. KDK Bank Ltd., requires you to make a due diligence audit in the areas of assets of pharmaceutical company especially with reference to valuation aspect of assets. State what may be your areas of analysis in order to ensure that the assets are not stated at overvalued amounts. [May 18 – New Syllabus (5 Marks), RTP-Nov. 20]
Or
Beta Ltd. is anticipating taking over a manufacturing concern and appoints you for due diligence review. While reviewing, it requests you to look specifically for any hidden liabilitiesand overvalued assets. State in brief the major areas you would examine for hidden liabilities and overvalued assets. [RTP-Nov. 19]
Answer:
Investigation of Hidden Liabilities:
In order to investigate hidden liabilities, the auditor should pay his attention to the following areas:

• Any show cause notice, which have nof matured into demands but may be material and important,
• Contingent liabilities not shown in books
• Company may have sold some subsidiaries/businesses and may have agreed to take over and indemnify all liabilities and contingent liabilities of the same prior to the date of transfer.
• Product and warranty liabilities, product returns & discounts, liquidated damages, etc.
• Tax liability under direct and indirect taxes.
• Long pending sales tax assessment.
• Cases of custom duty where only provisional assessment has been made and final assessment is yet to completed.
• Agreement to buy back shares at a stated price.
• Future lease liabilities.
• Claims against the company including third party claims.
• Unfunded retirement benefit of employees.
• Labour claims under negotiations.

Regularly Overvalued assets: The auditor shall have to specifically examine the following areas:

• Uncollectable receivables.
• Obsolete, slow and non-moving inventories and inventories valued above net realizable value, if any.
• Obsolete and unused plant and machinery and their spares.
• Assets value which have impaired due to sudden fall in market value.
• Assets shown in books above market value due to capitalization of expenditure/foreign exchange fluctuation or capitalisation of revenue expenditure.
• Assets under litigation.
• Investment shown at cost whose market value is much lower.
• Investment carrying very low rate of return.
• Infructuous project expenditure.
• Intangibles of no value.

Question 4.
J Ltd is interested in acquiring S Ltd. The valuation of S Ltd is dependent on future maintainable sales. As the person entrusted to value S Ltd what factors would you consider in assessing the future maintainable turnover? [May 13 (4 Marks)]
Or
A Ltd. who is one of the leading manufacturer of kids clothing is interested to acquire B Ltd. B Ltd. is currently a manufacturer of women’ clothing. As a professional consultant in due diligence and valuation, A Ltd. entrusted you to value B Ltd. The valuation of B Ltd. is dependent on future maintainable sales. Discuss the factors you would consider in assessing the future maintainable turnover of B Ltd.? [MTP-March 19]
Answer:
Factors to be considered in assessing future maintainable turnover:
In assessing the turnover which the business would be able to maintain in the future, the following factor? should be taken into account:

(i) Trend: Whether in the past, sales have been increasing consistently or they have been fluctuating. A proper study of this phenomenon should be made.

(ii) Marketability: Is it possible to extend the sales into new markets or that these have been fully exploited? Product wise estimation should be made.

(iii) Political and economic considerations: Are the policies pursued by the Government likely to promote the extension of the market for goods to other countries? Whether the sales in the home market are likely to increase or decrease as a result of various emerging economic trends?

(iv) Competition: What is the likely effect on the business if other manufacturers enter the same field or if products which would sell in competition are placed on the market at cheaper price? Is the demand for competing products increasing? Is the company’s share in the total trade constant or has it been fluctuating?

Question 5.
Write a short note on – Outline the contents of a due diligence report.
Or
XYZ Limited, a company engaged in the business of manufacturing and distribution of copper rods and copper wire is interested in acquiring a listed company having a market share of 38% of Insu-lated Copper Wires. You were appointed to conduct a “Due Diligence” of the target company and you have completed review of a few key areas. List out the contents of the Due Diligence Report which you will submit to XYZ Limited. [Nov. 15 (4 Marks)]
Answer:
Contents of a Due Diligence Report

1. Executive summary.
2. Introduction.
3. Objective of due diligence.
4. Terms of reference and scope of verification.
5. Brief history of the company.
6. Summary on capital structure and group structure of company.
7. Shareholding pattern.
8. Observations on the review.
9. Assessment of Management structure.
10. Assessment of financial liabilities.
11. Assessment of valuation of assets.
12. Assessment of operating results.
13. Assessment of taxation and statutory liabilities.
14. Assessment of possible liabilities on account of litigation.
15. Assessment of net worth.
16. Any liabilities not provided for in the books.
17. SWOT analysis comments on future projections.
18. Status on charges, liens, mortgages and assets of the company.
19. Ways and means to cover unforeseen contingent liabilities.
20. Aspects to be taken care of before/after merger.
21. Interlocking investments and financial obligations with group/associate companies amounts receivable subject to litigation.

“ICAI Examiner Comments”
Presentation of the answers regarding the contents of a due diligence report was not satisfac-tory. Many examinees mentioned the types of due diligence instead of contents.

Question 6.
Ekbote Co. is currently a large organisation trading in items of office furniture. The entity wants to expand and hence are looking at acquisition of Rawat Co. which deals in items of household furniture. Ekbote Co. hires a Chartered accountant to conduct a due diligence to consider whether there is the potential for additional value to be brought out of the target company by improving its operational function and also whether there are serious operational risks about which the potential buyer should be concerned (thereby allowing the buyer to consider aborting the deal or renegotiating the price).

Which of the due diligence review would be helpful to achieve the above objective? You are also required to briefly discuss the contents of a due diligence report.
[MTP – April 19]
Answer:
Due Diligence:
In the instant case Operational Due Diligence is required to confirm that the business plan provided is achievable with the existing facilities plus the capital expenditure outlined in the business plan.

Contents of a Due Diligence Report

1. Executive summary.
2. Introduction.
3. Objective of due diligence.
4. Terms of reference and scope of verification.
5. Brief history of the company.
6. Summary on capital structure and group structure of company.
7. Shareholding pattern.
8. Observations on the review.
9. Assessment of Management structure.
10. Assessment of financial liabilities.
11. Assessment of valuation of assets.
12. Assessment of operating results.
13. Assessment of taxation and statutory liabilities.
14. Assessment of possible liabilities on account of litigation.
15. Assessment of net worth.
16. Any liabilities not provided for in the books.
17. SWOT analysis comments on future projections.
18. Status on charges, liens, mortgages and assets of the company.
19. Ways and means to cover unforeseen contingent liabilities.
20. Aspects to be taken care of before/after merger.
21. Interlocking investments and financial obligations with group/associate companies amounts receivable subject to litigation.

Question 7.
Write a short note on – Audit and Investigation. [Nov. 18 – Old Syllabus (4 Marks)]
Or
General objective of an audit is to find out whether the financial statements show true and fair view. On the other hand, investigation implies systematic, critical and special examination of the records of a business for a specific purpose. In view of the above, you are required to brief out the difference between Audit and Investigation. [RTP-Nov. 19]
Answer:
Audit vs. Investigation:

• Auditing involves examination of financial information contained in financial statements to express an opinion whether or not the same have been prepared properly. In essence, auditing involves independent examination of financial information prepared by the management of an entity.
• Investigation implies systematic, critical and special examination of the records of a business for a specific purpose.
• Difference between audit and investigation are given below:

Basis	Audit	Investigation
Objective	To verify whether the financial state­ments display a true and fair view of the state of affairs and the working results of an entity.	It aims at establishing a fact or a happening or at assessing a particular situation.
Scope	The scope of audit is wide and is de­termined by the provisions of relevant law in case of statutory audit.	The scope of investigation may be governed by statute or it may be non- statutory.
Periodicity	The audit is carried on either quar­terly, half yearly or yearly.	The work is not limited by rigid time frame.
Nature	Involves tests checking to collect evidences for forming a judgment.	Requires a detailed study and exam­ination of facts and figures.
Inherent Lim­itations	Audit suffers from inherent limitation.	No inherent limitation owing to its nature of engagement.
Evidence	Audit is mainly concerned with prima- facie evidence.	It seeks conclusive evidence.
Observance of Accounting Principles	Is governed by compliance with gen­erally accepted accounting principles, audit procedures and disclosure requirements.	It is analytical in nature and requires a thorough mind, capable of observing, collecting and evaluating facts.
Reporting	The outcome is reported to the own­ers of the business entity.	The outcome is reported to the per­sons) on whose behalf investigation is carried out.

Investigation under the Companies Act, 2013

Question 8.
Briefly explain the investigation into the affairs of a company as envisaged under section 210 of the Companies Act, 2013.
Answer:
Investigation u/s 210 of Companies Act, 2013:
Section 210 of Companies Act, 2013 provides the following:

Central Government may order an investigation into the affairs of the company if it considers it in the following circumstances:

1. on the receipt of a report of the Registrar or inspector under section 208;
2. on intimation of a special resolution passed by a company that the affairs of the company ought to be investigated; or
3. in public interest

Central Government shall order an investigation into the affairs of that company, if an order is passed by a court or the Tribunal in any proceedings before it that the affairs of a company ought to be investigated

For the purposes of investigation, the Central Government may appoint one or more persons as inspectors to investigate into the affairs of the company and to report thereon in such manner as the Central Government may direct.

Question 9.
What will be your approach in investigation under Section 210 into the affairs of the company | registered under Companies Act, 2013? [May 14 (4 Marks)]
Or
The general approach for investigation under Sections 210 and 213 of the Companies Act, 2013 is conditioned by the legal requirements in these regards. Explain the approach/Steps for pursuing the investigation.
Answer:
General approach for Investigation:
The general approach for investigation under sections 210 and 216 of Companies Act, 2013 is conditioned by the legal requirements in these regards. The affairs of the company may include everything such as goodwill, profitand loss, contracts, investments, assets, shareholdingin subsidiaries, decision making, etc.

Investigation under sections 210 and 216 do not call for any special approach. The general approach for investigations should, therefore, be formulated having regard to the terms of reference, scope, the period, the programme and procedure of the investigation and the attending legal requirements as explained below:

1. Clarity of Terms of Reference: The inspector should ensure that the terms of reference are clear, unambiguous and in writing. If he has any doubt about any item in the terms, he should obtain clarification in writing.

2. Scope of Investigation: Inspector should determine scope of the investigation on the basis of the terms of reference. At this stage, if may be useful for the inspector to go into the history of the company and its affiliates or associates’.

3. Period for investigation: Inspector should also have regard to the period over which the investigation should stretch. The evaluation of terms of reference and the consequential determination of the scope of investigation are the twin props on which the entire investigation would rest.

4. Framing of Programme: The next step is the investigator/inspector should frame his programme for investigation in a systematic manner. He should keep adequate working notes and papers with references and cross references in a proper and methodical way to aid him in the preparation of the report.

5. Using the work of Experts: He should also consider whether assistance of other experts like engineers, lawyers, etc., is necessary in the interest of a comprehensive and full proof examination of the documents and information.

6. Legal requirements and investigation Report: After completion of steps in the investigation programme and collection of all the information that he needed, report should be prepared. However, an interim report may be made if required. The findings should be completed and exhaustive.

Before he makes his final report, he should obtain and keep on record the evidences relied upon by him. By the nature of things, such evidence should be as conclusive as possible depending on circumstances of the case. He should make his report in accordance with the provisions of the Companies Act, 2013.

Question 10.
The Central Government is of the view that there are certain interested members and companies who are financially interested in the success or failure of the company or who have been able to control or to materially influence the policy of the company.
Hence the Central Government wants to investigate the ownership of the company.
Describe the scope and extent of investigation by an Investigator/Chartered Accountant on behalf of Central Government under Companies Act, 2013. [Nov. 16 (4 Marks)]
Answer:
Scope and Extent of Investigation under Companies Act, 2013:

• When a CA is appointed to carry out an investigation under section 210,213 or 216 of Companies Act, 2013, the scope and extent of enquiry, the objective of the investigation and other matters asked for investigation are specified in the order of investigation issued by the appointing authority.
• On the basis of terms of investigation, the investigating accountant should determine the areas of accounts to be investigated and the extent to which the enquiry is to be made.
• In case of a company having subsidiaries or where one or more directors are interested in one or more entities, all the dealings with these entities should be examined.
• Any breach of duty for purposes of investigation would be material only if it has resulted in a loss to the company. In such a case, the factors responsible for the losses, besides the amount thereof, shall have to be investigated. Negligence would be culpable only if it was in relation to a duty cast by the Act, Articles of Association or by a resolution of the shareholders or that of the Board of Directors.
• Any negligence in the discharge of duty of a director or any other managerial personnel must be construed very broadly. As such, it is their duty to safeguard the property of the company and protect the interest of the shareholders.
• An investigator may interrogate directors, officers, agents, and others concerned with matters under his enquiry, if appears necessary.
• If the Investigating accountant is required to report on the efficiency of the management, he should be discreet in expressing his opinion.
• The inspector must ensure that the persons who figure in the investigation get the fullest opportunity to explain their action and conduct.

Question 11.
What are the important steps involved while conducting Investigation on behalf of an Incoming Partner? IMTP-April 18]
Or
Lamba, Malhotra and Khandeiwal are partners in a firm sharing profits and losses in the ratio 2:2:1. The partners have agreed to take Mr. Jain as a partner with effect from 1st April, 2021 as 1/4th partner. What are the important steps involved while conducting investigation on behalf of Mr. Mistri, the incoming partner? [MTP-May 20]
Answer:
Investigation on behalf of incoming partner:
Investigation on behalf of incoming partner is carried out so as to ascertain whether the terms offered to him are reasonable having regard to the nature of the business, profit records, capital distribution, personal capability of existing partners, etc. Steps involved in investigation includes the following:

(a) Ascertaining the history of the firm since inception and growth of the firm.
(b) Studies of the provisions of the Deed of Partnership, particularly for composition of partners, their capital contribution, drawing rights, retirement benefits, job allocation, etc.
(c) Scrutiny of the record of profitability of the firm’s business over a suitable number of years
(d) Examination of the asset and liability position to determine the tangible asset, investment, appraisal of the value of intangibles like goodwill, know-how, patents, etc. including contingent liabilities and those for pending tax assessment.
(e) Assess position of order at hand and the range and quality of clientele should be thoroughly examined under which the firm is presently operating.
(f) Scrutinize terms of loan finance to assess its usefulness and the implication for the overall financial position.
(g) Study important contractual and legal obligations. It may be the case that the firm has standing agreement with the employees as regards salary and wages, bonus, gratuity and other incidental benefits.
(h) Study the composition and quality of key personnel employed by the firm and any likelihood of their leaving the organisation.
(i) Ascertain reasons for the offer of admission to a new partner and it should be determined whether the same synchronizes with the retirement of any senior partner whose association may have had considerable impact having on the firm’s successes.
(j) Appraisal of the record of capital employed and the rate of returns. It is necessary to have a comparison with alternative business avenues for investments.
(k) Ascertain manner of computation of goodwill on admission as also on retirement, if any.
(l) Examine whether any special clause exist in the Deed of Partnership to allow admission in future a new partner.

Question 12.
A nationalized bank received an application from an export company seeking sanction of a term loan to expand the existing sea food processing plant. In this connection, the General Manager, who is in charge of Advances, approaches you to conduct a thorough investigation of this limited company and submit a confidential report based on which he will decide whether to sanction this loan or not. List out the points you will cover in your investigation before submitting your report to the General Manager. ‘ [RTP-Nov. 18]
Or
M/s ISBN Bank Ltd. appoints you to investigate on behalf of them for advancing loan to M/s Dust Ltd. As an investigating accountant, what information and factors you will enquire into? [May 18 – Old Syllabus (4 Marks)]
Answer:
Points to be covered in an investigation on behalf of bank:

1. Collection of Information: Investigator is required to collect the information w.r.t.
(a) Purpose for which the loan is required
(b) Manner in which the borrower proposed to invest the amount of the loan.
(c) Schedule of repayment of loan submitted by the borrower, particularly, the assumptions made therein as regards amounts of profits that will be earned in cash and the amount of cash that would be available for the repayment of loan to confirm that they are reasonable and valid in the circumstances of the case.
(d) Financial standing and reputation for business integrity enjoyed by the directors and officers of the company.
(e) Authorisation under Memorandum or the Articles of Association to borrow money for the purpose for which the loan will be used.
(f) History of growth and development of the company and its performance during the past five years.

2. Examination of Financial Statements: It will cover the followings:
(a) Preparation of a condensed income statement: It will be prepared from statement of profit & Loss for the previous five years, showing separately therein various items of income and expenses, the amounts of gross and net profits earned and taxes paid annually during each of the five years. Purpose of condensed income statement is to ascertain strengths of profitability.

(b) Computation of Relevant Ratios:

• Sales to Average Stocks held.
• Sales to Fixed Assets.
• Equity to Fixed Assets.
• Current Assets to Current Liabilities.
• Quick Assets to Quick Liabilities.
• Equity to Long Term Loans.
• Sales to Book Debts.
• Return on Capital Employed.

(c) Break-up of annual sales: Product-wise to show their trend.

(d) Schedule of assets and liabilities: Schedule of assets is to be prepared to ensure their existence, ownership and proper valuation and to examine whether assets have been adequately insured. Schedule of liabilities will assist in determining present and future obligations and ensure completeness of recording.

Question 13.
A nationalized bank received an application from a Limited company seeking sanction of a term loan to expand its existing business. In this connection, the Loan Manager of the Bank approaches you to conduct a thorough investigation of the items of the Balance Sheet of this Limited company and submit a confidential report based on which he will decide whether to sanction this loan or not. List out the major steps an investigating accountant would keep in mind while verifying assets and liabilities included in the Balance Sheet of the borrower company which has been furnished to the Bank. [MTP-Oct. 20]
Answer:
Steps involved in the verification of assets and liabilities included in the Balance Sheet:
(1) Fixed assets:

• The investigating accountant should prepare schedules of full description of each item, its gross value, the rate at which depreciation has been charged and the total depreciation written off.
• In case the rate at which depreciation has been adjusted is inadequate, the fact should be stated.
• In case any asset is encumbered, the amount of the charge and its nature should be disclosed.
• In case an asset has been revalued recently, the amount by which the value of the asset has been decreased or increased on revaluation should be stated along with the date of revaluation.

(2) Inventory:

• The investigating accountant should prepare schedules of the value of different types of inventories held (raw materials, work-in-progress and finished goods) and the basis on which these have been valued.
• Details as regards the nature and composition of finished goods should be disclosed.
• Slow-moving or obsolete items should be separately stated along with the amounts of allowances, if any, made in their valuation. For assessing redundancy, the changes that have occurred in important items of inventory subsequent to the date of the Balance Sheet, either due to conversion into finished goods or sale, should be considered.
• If any inventory has been pledged as a security for a loan the amount of loan should be disclosed.

(3) Trade Receivables, including bills receivable:
Composition of trade receivables should be disclosed to indicate the nature of different types of debts that are outstanding for recovery; also whether the debts were being collected within the period of credit as well as the fact whether any debts are considered bad or doubtful and the provision if any, that has been made against them.

(4) Investments:
Investigating accountant should prepare schedule of investments which disclose the date of purchase, costand the nominal and market value of each investment. If any investment is pledged as security for a loan, full particulars of the loan should be given.

(5) Secured Loans:

• Investigating accountant is required to include debentures and other loans together in a separate schedule.
• Against the debentures and each secured loan, the amounts outstanding for payments along with due dates of payment should be shown.
• In case any debentures have been issued as a collateral security, the fact should be stated. Particulars of assets pledged or those on which a charge has been created for re-payment of a liability should be disclosed.

(6) Provision of Taxation:

• Investigating accountant should ascertain the period up to which taxes have been assessed.
• If provision for taxes not assessed appears in be inadequate, the fact should be stated along with the extent of the shortfall.

(7) Other Liabilities:
Investigating accountant should state whether all the liabilities, actual and contingent, are correctly disclosed.

(8) Insurance:

• Investigating accountant should prepare schedule of insurance policies giving details of risks covered, the date of payment of last premiums and the sum assured.
• He should also make a report as to whether or not the insurance-cover appears to be adequate, having regard to the value of assets.

(9) Contingent Liabilities:

• Investigating accountant should ascertain particulars of any contingent liabilities which have not been disclosed.
• For this purpose, he may conduct direct enquiries from the borrower company and members of its staff.

Question 14.
In a company, it is suspected that there has been embezzlement in cash receipts. As an investigator, guide the company the areas where embezzlement is possible?
Or
In cases like holding back cash sales, collections by travelling salesmen, V.P.P receipts, or casual receipts, e.g., sales of scrap, recoveries out of debts written off earlier, etc., the amount or amounts of receipts embezzled may be subsequently covered up by the perpetrator adopting certain meth-ods. In a company, it is suspected that there has been embezzlement in cash receipts. The company appoints you as an investigator. What are the areas you would verify?
Answer:
Areas of embezzlement of cash receipts:

1. Issuing a receipt for full amount collected, entering lesser amount on the counterfoil.
2. Showing a larger cash discount than actually allowed.
3. Adjusting a fictitious credit in the account of a customer for goods returned.
4. Cash sales entered as credit sales with debit to customer.
5. Writing off a good debt as bad & irrecoverable to cover up misappropriation of amount collected.
6. Short-debiting customer’s ledger account and withdrawing the difference on collection of full amount.
7. Under-casting the receipts side of cash book.
8. Over-casting the payment side of the cash book.

Question 15.
You have been appointed to investigate a suspected embezzlement of cash receipts in a departmanental store. What are the steps you would take in this regard? [Nov. 12 (6 Marks)]
What steps needs to be taken to investigate frauds of Cash Receipts. [Nov. 15 (4 Marks)]
Answer:
Steps to investigate frauds of cash receipts:

1. Ascertain nature of duties of person who is suspected to have committed a fraud.
2. Examine line of responsibility among the various members of the staff.
3. Income received from different sources should be scrutinized. –
4. Carbon copies of receipts marked ‘duplicate’ should be scrutinized.
5. Examining record of small or negligible sources of income such as sales of scrap or sale of waste paper.
6. Review of recoveries from customers and sundry parties along with deductions on account of cash discounts.
7. Examine that receipts are serially numbered and all receipts have been accounted for.
8. In case of cancelled receipt, its original copy should be examined and verified.
9. Enquiries should be made for unreasonable cash discount.

“ICAI Examiner Comments”
Instead of explaining about steps to be taken to investigate frauds of cash receipts, examinees wrote about verification of cash balance and cash payments.

Question 16.
Write short note on: Frauds through suppliers Ledger. [Nov. 08, May 11 (4 Marks)]
Answer:
Frauds through Supplier’s Ledger:
Frauds through supplier’s ledger may be committed in following ways:

1. Adjusting fictitious or duplicate invoices as purchases in the accounts of suppliers and subsequently misappropriating the amounts when payments are made to the suppliers in respect of these invoices.
2. Suppressing the Credit Notes issued by suppliers and withdrawing the corresponding amounts not claimed by them.
3. Withdrawing amounts unclaimed by suppliers, for one reason or another by showing that the same have been paid to them.
4. Accepting purchase invoices at prices considerably higher than their market prices and collecting the excess amount, paid in cash, from the suppliers.

Question 17.
State the points in an investigation of frauds through suppliers’ ledger.
Or
In a Public Limited Company, it is suspected by the Management that there has been embezzlement in supplier’s ledger. As an auditor of the Company, you have been asked to investigate the matter. What are the major areas that you would verify in this regard? [Nov. 19 – Old Syllabus (4 Marks)]
Answer:
Investigation of frauds through supplier’s ledger:

1. Verify the adjustments in fictitious or duplicate invoices as purchases in the accounts of suppliers and subsequently misappropriating the amounts when payments are made to the suppliers in respect of these invoices.
2. Check whether any Credit Notes issued by suppliers are being suppressed and the corresponding amounts not claimed by them is subsequently withdrawn.
3. Check whether any amount unclaimed by suppliers, for one reason or another is being withdrawn by showing that the same have been paid to suppliers.
4. Verify whether purchase invoices are accepted at prices considerably higher than their market prices.
5. Verify the bought journal with reference to entries in the Goods Inward Book and the suppliers’ invoices to confirm that amounts credited to the accounts of suppliers were in respect of goods, which were duly received, and the suppliers’ accounts had been credited correctly.
6. Request all the suppliers to furnish statements of their accounts to see whether or not any balance is outstanding or due so as to confirm that allowances and rebates given by them have been correctly adjusted.

Question 18.
A company engaged in manufacturing of chemicals is consistently recording higher sales turnover, but declining net profits since the last 5 years. As an investigator appointed to find out the reasons for the same, what are the points you would verify?
Answer:
Decline in Net Profits Despite Increasing Sales:
As per the facts that there has been consistently high turnover but declining net profits is an anomalous
situation. It may be attributed to one or more following reasons requiring further investigation:

(i) Unfavourable Sales mix: Where the company sells different chemical products with different product margins, the product with the maximum PV ratio/margin should have a higher share in the total sales. If due to revision of sales mix, more quantities of unprofitable products are sold, profits will be reduced in spite of an increase in sales.

(ii) Negative Impact of Financial Leverage: Where the company does not have sufficient own funds (equity) but has a higher debt-equity ratio, the interest commitments will be higher. As the volume of its operation increases, higher debt and interest charges would result in lower profits.

(iii) Other Items Included in Sales: The figure of sales as per Profit and Loss Account may include incidental revenues, e.g., freight, excise duty, sales-tax, etc. where the amount of excise duty goes up considerably the total sales may show an increase which is not represented by a real increase in sales quantity/value.

(iv) High Administrative and Selling Expenses : Administrative and selling costs are generally period costs which are fixed in nature. Their increase is generally not proportional to sale increase. However, a reduction in profit could also be due to increase in administrative overheads and sales overheads at a rate higher than the rate of increase in sales.

(v) Cost-Price Relationship: If the increases in cost of raw materials and labour has not been compensated by a corresponding increase in the sales price this would also result in higher sales and declining profits. In spite of same sales quantity, for the increasing cost of raw materials and other services, per unit values of the product has been increased which is however unmatched by the increase in cost.

(vi) Competitive Price: Where sales have been made at cut-throat prices in order to eliminate competition from the market, the profits would be in the declining trend in the short-run.

(vii) Additions to Fixed Assets: Where there are heavy additions to fixed assets and consequent depreciation charges in the initial years of additions, there may be reduction in profits in spite of increased sales.

Question 19.
Mr Sharma is reviewing the anti-fraud controls for a construction company. The company has witnessed a few frauds in the past mainly in the nature of material stolen from the sites and fake expense vouchers.
Mr. Sharma is evaluating options for verifying the process to reveal fraud and the corrective action to be taken in such cases. As an expert, you are required to brief Mr. Sharma about the inventory fraud and verification procedure with respect to defalcation of inventory? [RTP-May 19, MTP-Oct. 19]
Or
MF Ltd., engaged in the manufacturing of various products in its factory, is concerned with shortage in production and there arose suspicion of inventory fraud. You are appointed by MF Ltd. to evaluate the options for verifying the process to reveal fraud and the corrective action to be taken. As an investigating accountant what will be your areas of verification and the procedure to be followed for verification of defalcation of inventory? [Nov. 19 – New Syllabus (4 Marks)]
Answer:
Ways of Committing Inventory Frauds:

1. Employees may simply remove goods from the premises.
2. Theft of goods may be concealed by writing them off as damaged goods, etc.
3. Stock records may be manipulated by employees who have committed theft so that book quantities tally with the actual quantities of stocks in hand.

Verification procedure:

1. The first step towards verification is to establish the different items of inventory defalcated and their quantities by checking physically the quantities in inventory held and those shown by the Inventory Book.

2. Next step will be to verify all the receipts and issues of inventory recorded in the Inventory Book by reference to entries in the Goods Inward and Outward Registers and the documentary evidence as regards purchases and sales. This would reveal the particulars of inventory not received but paid for as well as that issued but not charged to customers.
In addition, entries in respect of returns, both inward and outward, recorded in the financial books should be checked with corresponding entries in the Inventory Book.

3. Afterwards, the shortages observed on physical verification of inventory should be reconciled with the discrepancies observed on checking the books in the manner mentioned above.

4. Defalcations of inventory, sometimes, also are committed by the management, by diverting a part of production and the consequent shortages in production being adjusted by inflating the wastage in production; similar defalcations of inventories and stores are covered up by inflating quantities issued for production.

For detecting such shortages, the investigating accountant should take assistance of an engineer. For that he will be more conversant with factors which are responsible for shortage in production and thus will be able to correctly determine the extent to which the shortage in production has been inflated. In this regard, guidance can also be taken from past records showing the extent of wastage in production in the past.

Question 20.
Explain how a Frensic Audit differs from an Assurance Engagement. [May 18 (4 Marks)]
Answer:
Forensic Audit vs Financial Audit:

Basis	Forensic Audit	Assurance Engagements (Finan­cial Audit)
Meaning	Examination of evidence regarding an assertion to determine its corre­spondence to established criteria carried out in a manner suitable to the court.	Examination of Financial Information so as to express an opinion on true and fair view of state of affairs and financial results.
Objective	To determine whether fraud has taken place.	To express an opinion on true and fair view.
Frequency	No specific period.	Generally parried out for a financial year.
Techniques	Investigative and substantive	Risk based with the help of compliance & substantive procedures.
Extent	In-depth checking.	Test Checking based
Verification of As­set and liabilities	Verification of suspected/selected items is done where misappropria­tion is suspected.	All assets & liabilities are verified with the help of audit procedures or man­agement certificate/representation.

Question 21.
Forensic Auditors can be engaged in public practice or employed by insurance companies, banks, police forces, government agencies and other organizations. Briefly mentioned the areas in which forensic auditor can render the services.
Answer:
Areas in which forensic auditor can render the service:
Forensic Auditor is generally involved in the below mentioned areas of work:

(a) Fraud Detection: Area of Fraud detection comprises of:

• Investigating and analyzing financial evidence.
• Detecting financial frauds
• Tracing misappropriated funds.

(b) Fraud prevention: Area of fraud prevention comprises of:

• Reviewing internal controls to verify their adequacy
• Providing consultation in the development and implementation of an internal control framework aligned to an organization’s risk profile

(c) Computer Forensics: Area of Computer forensics comprises of developing computerized applications to assist in the recovery, analysis and presentation of financial evidence.

(d) Expert Testimony: Area of Expert testimony comprises of

• Assisting in legal proceedings,
• Testifying in court as an expert witness
• Preparing visual aids to support trial evidence.

Question 22.
Enumerate the steps to be undertaken in case of forensic audit process.
Or
PQR Ltd. is a listed company having turnover of Rs. 50 crores & plans expansion by installation of new machines at new building-having total additional project cost of Rs. 20 crore.

Rupees (In crore)	Purpose
10.0	for Building
8.50	for Machinery
1.50	for Working Capital
20.00

Project gets implemented in 2019-20 and one of the accountants points out to Managing Director that something wrong has happened in the purchase of building material.
On hearing this, the management is planning to appoint Forensic Auditor. Advise the Forensic Auditor about the steps to be undertaken in case of forensic audit process. [MTP-Aug. 18J
Answer:
Steps to be undertaken in Forensic Audit:

Step 1 – Initialisation

• Meeting with the client and accepting the engagement: In order to understand important facts, players and issues etc., the investigator must meet the client. It is to be considered initially that whether his firm has the necessary skills and experience to accept the work.
• Performing conflict check: In order to achieve objectivity, a conflict of interest check should be carried out as soon as the relevant parties are established.
• Performing initial investigation: It is generally desired to perform an initial action plan prior to developing a detailed plan. Such initial action plan will help to formulate subsequent planning to be based upon more complete and comprehensive understanding of the situation.

Step 2 – Planning the audit

• This is to be developed based on the meeting with the client and carrying out the initial investigation scanner on the subjects to be investigated.
• This action plan will set out the objectives to be achieved and the methodologies to be adopted. The investigation team must carefully take into consideration the objectives to be achieved and plan their work accordingly.

Step 3 – Collection of Evidences

• It involves obtaining relevant documents, economic information, tracing different assets/persons/unaccounted records, meeting with other experts, statutory and internal auditors of the client.
• The evidences gathered should be sufficient to ultimately identify and prove the fraudster(s) and the mechanism adopted for such frauds.

Step 4 – Performing Analysis
The actual analysis to be performed will solely depend upon the nature of the assignment. This may include:

• Summarisation of a large number of transactions.
• Performing robust procedures to trace unidentified assets.
• Calculating the economic damages and if required, the loss of goodwill.
• Estimating the present value of the financial losses or frauds involved in case such irregularities or frauds took place for a long period of time.
• Performing the statistical regression or sensitivity analysis of the frauds etc.
• Using various computerized application software and graphs etc. to explain and analyse the frauds.

Step 5 – Reporting
The report generally includes various sections describing the nature of the assignment, scope, approaches utilized, findings, opinions and limitations.
Report is generally submitted to the appointing authority.

Step 6 – Court Proceedings

• The investigation is likely to lead to legal proceedings against the suspect.
• The evidence gathered during the investigation will need to be presented at court, and team members may be called to court to describe the evidence they have gathered and to explain how the suspect was identified.

Question 23.
Briefly describe the techniques that a forensic auditor may use.
Answer:
Techniques of Forensic Audit:

(i) Benchmarking: Comparing one financial period with another or the performance of one cost centre, or business unit, with another, overall business performance with its standards defined.

(ii) Analytical Tools: Trend Analysis and Ratio Analysis may be used to identify any abnormal trends and changes.

(iii) Digital Techniques: Digital investigations are complex techniques and require support from trained digital investigators. Digital techniques comprise of close scrutiny of relevant emails, accounting records, phone logs and before applying digital techniques like obtaining data from email etc. the forensic auditor should take appropriate legal advice so that it doesn’t amount to invasion of privacy.

(iv) CAATs: CAATs known as Computer-assisted audit techniques are computer programs that the auditors use as part of the audit procedures to process data of audit significance contained in a client’s information systems, without depending on him.

(v) System analysis: To examine the systems in place and identifying any weaknesses that could be opportunities for the fraudsters.

(vi) Common Software Tool: Common Software Tools like spreadsheets (MS Excel), RDBMS (MS Access) and Report writers (Crystal reports) are widely accepted due to their instant availability and lower costs.

(vii) Data Mining Techniques: It is a set of assisted techniques designed to automatically mine large volumes of data for new, hidden or unexpected information or patterns.

Question 24.
You have been appointed as a forensic accountant in M/s Secure Ltd. to carryout various analysis as part of your assignment to arrive at a particular result. Specify the various analysis which might have to be carried out by you to arrive at your result. [May 19 – New syllabus (5 Marks)]
Answer:
Analysis to be carried out in process of forensic audit:
The actual analysis to be performed will solely depend upon the nature of the assignment. Various analysis that can be performed are listed below:

1. Summarisation of a large number of transactions.
2. Performing robust procedures to trace unidentified assets.
3. Calculating the economic damages and if required, the loss of goodwill.
4. Estimating the present value of the financial losses or frauds involved in case such irregularities or frauds took place for a long period of time.
5. Performing the statistical regression or sensitivity analysis of the frauds etc.
6. Using various computerized application softwares and graphs etc. to explain and analyse the frauds.