Most companies in India realize they need a forensic accountant only once the damage has already been done.
Forensic accounting is frequently regarded as a complex, technical term generally reserved for specialists. On the other hand, while forensic accounting does require specialized skill sets, the foundation upon which it is built is very simple. It helps determining the actual financial condition of the firm as it relates to the events in question, as opposed to relying solely on what is written or formally reported or what the organization says is being done.
Instead of relying solely on what is written or reported by others, forensic accountants will establish an independent basis for verifying whether the facts presented are actual or otherwise.
Forensic Accounting Isn’t Just an Audit
This distinction must be made clearly right at the outset, because it’s the confusion between these two concepts that leads to major issues. An audit checks if your numbers are correct and in accordance with the laws. A forensic audit determines if anyone has been cheating you. Although these two kinds of accountants use very similar evidence and methods of investigation, they are two completely different kinds of accountants with very different purposes. While auditors audit accounts for potential errors, forensic accountants author reports and conduct investigations for the purpose of determining fraud. This is an important distinction when you consider whether what happened in your accounts was an error or whether it was a criminal act.
The word “forensic” means results that are evidence-based and can withstand analysis, whether legally, regulatorily, or by stakeholders. It is sometimes casually perceived as results that are expected to survive only judicially, but in reality, its scope goes far beyond that. One thing is for sure: this type of report is not something you will file away in a drawer.
What a Forensic Accounting Engagement Actually Looks Like
Each forensic accounting engagement will, of course, be unique. However, there are some general principles associated with most forensic accounting engagements, and that is what we will understand in this section.
- It starts with a trigger, not a plan: Forensic investigations are typically not started by a company voluntarily deciding to conduct a review. It is triggered by an event, which may involve anything from a vendor relationship that does not smell right to a whistleblower allegation or a non-performing advance that is not consistent with the borrower’s claims. The trigger point is always an emotion until proven otherwise.
- Defining Scope is crucial: Another major error often committed when embarking on a forensic review is scoping the investigation too broadly initially. It is important to identify and document the scope and the intent of the engagement and define expectations upfront. Such an approach not only increases efficiency but also mitigates potential liabilities for an organization running the investigation.
- Preservation is critical: In the context of Indian corporate fraud investigations, preservation of data is a persistent challenge. Forensic accountants rely on the help of digital forensics specialists to preserve all relevant data from accounting/financial systems, email servers, enterprise resource planning software applications, and even personally-owned devices where the business case is appropriate.
- The analysis phase is most critical: This is where the transaction pattern analysis takes place, information will be validated against the ledger, and analysts will determine the variances in the numbers to what participated in the flow of funds/goods/services.
In India, this phase often requires a reconciliation of transactions across entities. The existence and use of “shells”, “related party transactions”, and “multiple-layered subsidiaries” have become common methods for “financial manipulation” and “fraud” in India.
- The report is to be presented to several audiences: Each type of audience should be able to participate in the understanding of the findings, for example, someone from the Board of Directors, or the ones who act on those findings (legal counsel), or someone from the regulatory agencies (SEBI, RBI, Enforcement Directorate). So writing for all of these audiences simultaneously requires a unique skill set.
Why India Is a Different Beast Entirely
The context in which forensic accounting occurs in India is very specific to India’s environment. A few points about the characteristics of this environment are:
- The extensive use of “cash” as a method of conducting business (even for formally organized businesses) creates a haven for “documentation holes” to be exploited by the nefarious. The complexity of group (or conglomerate) structures (where promoters hold the same asset across multiple entities) makes it difficult to follow the flow of funds. And last, the speed with which regulations change means that the “grey” areas that existed two years ago may today constitute clearly delineated violations.
- Moreover, India has experienced a surge in related-party transaction frauds wherein money transfers between related entities that belong to the same promoter group happen through disclosures that are essentially hidden from public knowledge. SEBI’s heightened surveillance of publicly traded firms has driven such practices underground, but they remain prevalent.
- Forensic accounting has become vital to India’s efforts to recover credit from its banks’ non-performing asset problem. Forensic audits are now mandatory in India for banks to classify a debt account as being fraudulent. The RBI’s wilful defaulter framework provides a clear demand structure for forensic analysis and reports.
When Should You Actually Hire a Forensic Accountant?
This is where most firms fall flat. They seek a forensic accountant only when in trouble. Instances when hiring a forensic accountant makes sense and can be critical in saving versus losing include:
Before closing an investment or acquisition deal: Pre-acquisition forensic due diligence has become common practice in India since several notable cases where the acquirer realized after completion of the transaction that the financial statements had virtually no connection to reality. A pre-acquisition forensic audit costs a fraction of uncovering fraud after the money is transferred.
When a key individual leaves under duress: Disputes around commission, bonuses, or customer acquisition are often a smokescreen for the theft of valuable information or attempts at financial manipulation. Acting quickly in the first weeks, while logs of user activity are still available, is critical.
When the vendor partnership has become complacent: Vendor partnerships that have existed for a long time without much competition and scrutiny are almost always the basis of some kickback schemes in Indian corporates. If you’ve been working with the same vendor for eight years and no one has done any kind of commercial audit in the last three, then you need to conduct one.
When your statutory auditor raises an issue that they cannot account for: Statutory auditors are not private investigators. They raise issues that need further investigation and do not attempt to investigate these themselves. It is at this point that you should reach out to a forensic accounting firm.
When your business is under regulatory investigation: If your organization is currently being investigated by SEBI, SFIO, or ED, a forensic accounting investigation conducted by an independent agency helps show your goodwill and allows you to take control of the situation before the regulators define it for you.
Costs of Non-Intervention
The question that forensic accountants most frequently hear is: What is the cost? The question that is infrequently asked, but should be, is: What is the cost of doing nothing?
The SFIO annual reports continue to show that when fraud is formally investigated, the average value of cases prosecuted under the Companies Act is in the tens of crores range. The time period from the beginning of fraud to the time it becomes known is often three to five years.
Therefore, for three to five years, an organisation funds its own fraudulent acts. Forensic Accounting does not guarantee recovery, but it does provide a legitimate basis for further action; legally/regulatorily/commercially. Without it, you would just have a story. With it, you have proof.
IIRIS Consulting’s Forensics & Diligence practice consists of highly trained certified forensic specialists, digital forensics experts, & investigative abilities across multiple jurisdictions. If there is something unusual about your organisation’s finances, we can help you find out the reasons behind it.
