Chapter 17.2 -Investigation Page No.

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Audit v/s Investigation Important issues to be kept in mind by the investigator (c) Whether an investigator necessarily requires assistance of
while preparing his report expert
Basis Investigation Audit
• Written general consent of his client
Objective Aims at establishing a Verify whether the F.S. 1. Report to not contain anything which is not relevant to highlight • Settle the question of costs for obtaining the views and other
fact or a happening or at display a true and fair nature of investigation or final outcome thereof. related implications.
assessing a particular view of the state of 2. Every word/expression to be used properly. To minimize
(d) Investigation out of disputes and conflicting claims
situation. affairs. possibility of different meaning/interpretation.
• should remain above disputes or conflicting claims
Scope Scope of investigation Scope of audit is wide and 3. Facts & conclusions should be properly linked with evidence.
• be alert to the possibilities of the information or documents
may be governed by in case of statutory audit 4. Basis & assumptions to be explicitly stated. Should be reasonable
statute or it may be the scope of work is made available to him to be prejudiced.
& not in conflict with the objectives of investigation.
non- statutory. determined by the 5. • Should keep the interest of all the involved parties high
Report should clearly spell out nature & objective of assignment, its
provisions of relevant law scope & limitations. degree of maturity and experience.
6. Report should be made in para form with headings for paragraphs (e) Basis of opinion of an investor
Periodicity The work is not limited by The audit is carried on
rigid time frame. It may either quarterly, half- 7. Opinion of investigator in final paragraph of report. Investigator should refrain from issuing speculative opinion. He
cover several years, as yearly or yearly. Special Issues in Investigation should confine his opinion to the established facts and nothing more.
the outcome of the same
is not certain. (a) Whether an investigator is required to undertake a % verification (f) Whether an investigator can make futuristic statements
Nature Requires a detailed study Involves tests checking or approach or whether he can adopt selective verification • should refuse to be futuristic
and examination of facts sample technique to draw Safer to go by statistically recognised sampling methods than to depend (g) Whether to retain working papers or not
and figures. Investigation evidences for forming a on so-called “test checks” where circumstances permit selective • Take representation letter from the appointing authority.
is voluntary in nature. judgement and expression • To give evidence in a court of law to support his figures; for
verification.
of opinion. It is mandatory quite often the conclusions of the accountant are challenged by
Cash defalcation - examine all cash vouchers
for companies. parties.
Inherent No inherent limitation Suffers from inherent (b)Whether the investigator can put reliance on the already audited
Factors to be considered while studying Economic &
Limitations owing to its nature of limitation. statement of account –
Financial position of business:
engagement.
Evidence It seeks conclusive Audit is mainly concerned • If statements of a/c produced before investigator were not audited (i) Adequacy of fixed & working capital. Are these sufficient for
evidence. with prima- facie by a qualified accountant, then of course there arises a natural duty growth of business?
evidence. to get figures in accounts properly checked & verified (ii) What will be trend of sales & profits in future? Establishing trend
Observance It is analytical in nature Is governed by compliance of sales, product-wise & area-wise will ordinarily help in drawing a
• However, when accounts produced to investigator have been specially
of Accounting and requires a thorough with generally accepted conclusion on whether the trend will be maintained in future.
prepared by a professional accountant, who knows or ought to have
Principles mind, capable of accounting principles, (iii) Whether the profit which the business could be expected to
known that these were prepared for purposes of investigation, he
observing, collecting and audit procedures and maintain in future would yield adequate return on capital employed?
could accept them as correct relying on the principle of liability to
evaluating facts. disclosure requirements.
third parties. (iv) Whether business is operating at its 100 % capacity or
Appointing Even third party can Auditor is appointed by
improvements can be made to reach at full productivity?
Agency appoint Investigator owner/ shareholders of • Nevertheless, it would be prudent to see first that such accounts
company/ enterprise were prepared with objectivity and that no bias has crept in to give Factors while Assessing Future Maintainable Turnover
Reporting The outcome is reported The outcome is reported advantage to the person on whose behalf these were prepared.
to person(s) on whose to the owners of the
Whether the investigator can put reliance on the already audited Competition - Is demand for competitor's products increasing? Is
behalf investigation is business entity.
statement of account – If the investigation has been launched the Co's share in total trade constant or fluctuating?
carried out.
because of some doubt in the audited statement of account, no
Political & economic considerations - Are policies of govt. likely to
Steps in Investigation question of reliance on the audited statement of account arises.
extend market of goods to other countries?
1. Determination of objectives & establishment of scope of However, if the investigator has been requested to establish value
Trend - Whether in Past sales increasing consistently or
investigation. of a business or a share or the amount of goodwill payable by an
fluctuating.
2. Formulation of the Investigation programme. incoming partner, ordinarily the investigator would be entitled to put
3. Examination and study of various records by reference to reliance on audited materials made available to him unless, in the Marketability - Is it possible to extend sales to new market or they
appropriate evidence. course of his test verification, he finds the audit to have been carried have been fully exploited?
4. Analysis, processing & interpretation of findings. on very casually or unless his terms of appointment clearly require to
5. Preparation of report and drawing up of conclusions. test everything afresh"

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 Chapter 17.2 -Investigation Page No. - 2
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Investigation on behalf of an Incoming Partner Investigation on behalf of a Bank/ Financial Institution Investigation on behalf of an Individual or Firm
Proposing to Advance/Loan to a Company Proposing to Buy a Business
Ascertainment of history of the inception and growth of the firm.
Study of provisions of deed of partnership - composition of 1. Purpose for which the loan is required and the manner in which the (A) In case of proprietary concerns or partnerships -
partners, their capital contribution, drawing rights, etc. borrower proposes to invest the amount of the loan (i) Reasons for sale of business & effect on turnover and profits.
Scrutiny of record of profitability of firm’s business over a suitable 2. Financial standing and reputation for business integrity enjoyed (ii) Length of lease under which premises are held, prospects of its
No. of years, with usual adjustments that are necessary in
by directors and officers of the company. renewal or extension.
ascertaining true record of business profits.
3. History of growth and development of the company & its (iii) Unexpired period of any patents.
Examination of asset and liability position to determine tangible asset
performance during the past 5 years (iv) Age of present managerial staff & prospects of continuing in
backing for the partner’s investment, appraisal of the value of
4. Schedule of repayment of loan submitted by the borrower service under new proprietorship & possible liability, not already
intangibles like goodwill, know how, patents, etc.
In case of firms rendering services, question of tangible asset 5. Whether the company is authorised by the MOA or AOA to provided for- Gratuity, Retrenchment compensation.
backing usually is not important. borrow money for the purpose for which the loan will be used. (v) If bulk of sales are made to customers whose number is small,
Reasons for offer of admission to new partner & whether any senior 6. Whether any loan application to any other Bank or Financial profitability of business would be greatly shaken on withdrawing
partner is retiring at same time. Institution was made, & if so, the reasons for rejection thereof. their support. This should be investigated as it might affect
7. How the economic position of the company would be affected by future profitability.
Various important contractual and legal obligations should be
ascertained and their nature studied. It may be the case that the
economic, political and social changes that are likely to take place (B) If the business belongs to a limited company
firm has standing agreement with the employees as regards salary during the period of loan. (i) Authorised & issued capital of Co.
and wages, bonus, gratuity and other incidental benefits. Full impact of (ii) Uncalled liability on shares.
To investigate the profitability of the business for judging the
such standing agreements be considered. (iii) If capital is divided into different classes of shares - Rights
accuracy of the schedule of repayment furnished by the borrower,
Study composition and quality of key personnel employed by the firm attached to each class.
as well as the value of the security in the form of assets of the
and any likelihood of their leaving the organisation in near future. (iv) Particulars of dividends paid in past & amounts thereof which
business already possessed and those which will be created out of the
are in arrear (on cumulative preference shares).
loan, the investigating accountant should take the under-mentioned
Investigation in Valuation of shares of Pvt. Co. (v) Mortgages/ charge created on assets in company’s books. Inspect
steps:
Register of Charges.
In respect of equity shares, there are two main methods of valuation (a) Prepare a condensed income statement from the Statement of (vi) Price at which shares are being offered.
Profit and Loss for the previous 5 years, showing separately a. Public co – Quoted Price
First Method: Net Worth
therein various items of income and expenses b. Pvt co – valuation
• Value per Share =Amount of net worth / No. of shares of ESC. (b) Compute the under-mentioned ratios separately and then include
• Goodwill of business, & non-trading assets (like investments) based them in the statement to show the trend as well as changes that Investigation in connection with review of
on estimated future maintainable profit, is included among the assets have taken place in the financial position of the company: Profit/Financial Forecasts
to arrive at amount of net worth. 1) Current Assets to Current Liabilities
(i) Each asset should be revalued on Going Concern assumption. 2) Quick Assets to Quick Liabilities There are many investigations which involve an examination of future
3) Equity to Long Term Loans profits like,
(ii) Value of goodwill of a business is primarily dependent on its
capacity to earn super- profit & period over which these are 4) Sales to Book Debts 1) Profit reports - can be required as part of a general
expected to arise 5) Return on Capital Employed investigation into the purchase of a business or,
6) Sales to Average Inventories held
Second method: Yield basis 2) By banks and financial institutions with regard to project
7) Sales to Fixed Assets
cash flow and profitability statements for appraisal of
• Avg. profit earned by business during preceding 5 to 7 years is 8) Equity to Fixed Assets
(c) Enter in a separate part of the statement the break-up of annual loan applications submitted by the intending borrowers.
computed.
• On the assumption that same would continue to be earned in sales product-wise to show their trend. All forecasts depend, to a large extent, on the nature of the
future, value of business is calculated by capitalising it at a business with its numerous and substantial uncertainties.
reasonable rate of interest.
Steps involved in verification of assets & liabilities included in B/S Therefore, such forecasts are not capable of verification by the
High Rate of Interest -> Smaller Value of Business of borrower company which has been furnished to Bank accountants in the same way as financial statements which present
Low Rate of Interest -> Higher Value of Business the results of a completed accounting period.
Next page
Normally, such situations involve special review as these depart
from the auditor’s role of expressing an opinion in relation to past
events.

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 Chapter 17.2 -Investigation Page No. - 3
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Investigation of Frauds Fraud Diamond Steps involved in verification of assets & liabilities included in B/S
of borrower company which has been furnished to Bank
Fraud at Operational Level Employees Four Elements of Fraud:
a) Fixed assets:
1) Cash Misappropriation: Cash is misappropriated after the 1. Incentive: I want to, or have a need to, commit fraud.
a) A full description of each asset, its gross value, rate of
accounting entries are already passed in the books 2. Opportunity: There is a weakness in the system that the right
depreciation, Revaluation.
person could exploit. Fraud is possible.
2) Teeming and Lading: b) In case any asset is encumbered, the amount of the charge &
3. Rationalization: I have convinced myself that this fraudulent
3) Fraudulent Disbursements: Issuing or submission of false bills, its nature should be disclosed
behaviour is worth the risks.
or personal expense bills being converted into official expenses b) Inventory: value & basis of valuation
4. Capability: I have the necessary traits and abilities to be the right
bills. c) Trade Receivables, including bills receivable: Their composition
person to pull it off. I have recognized this particular fraud
should be disclosed, whether any debts are considered bad or
4) Expense Reimbursement Schemes: Employees may get opportunity and can turn it into reality.
doubtful.
reimbursed by third parties (such as distributors) as well as by
Auditor’s ability to detect fraud depends on such Factors d) Investments: schedule of investments - date of purchase, cost
claiming these expenses from the company. Multiple expense
and the nominal and market value
claims based on duplicate bills or photostat copies. ➢ Skilfulness of the perpetrator e) Secured & Unsecured Loans: the amounts outstanding for
5) Payroll Fraud: Payment to non-existent employees or in a ➢ Frequency & extent of manipulation payments along with due dates of payment.
contractual arrangement inflating of the manpower resources ➢ Degree of collusion involved f) Provision of Taxation: P.Y. up to which taxes have been assessed
than those actually deployed while billing the client. ➢ Relative size of Individual amounts manipulated; and or assessment order received should be ascertained
➢ Seniority of those individuals involved. g) Other Liabilities: All the liabilities, actual & contingent, are
6) Commission Schemes: salesman exaggerates the sales through
fictitious billings to earn higher commission or alter the sales correctly disclosed
prices of the products sold from those stipulated by the h) Contingent Liabilities: Proper disclosed.
company
7) Tampering of Cheques/Drafts/On-line payments/receipts:
Tampering of cheques, payee name being altered, or preparation
of cheques without the same being issued to payee, etc., are
methods that may also lead to falsification of accounts.
8) Off Book Frauds: Fraud perpetrator misappropriates the cash
before these are recorded in the books or before the sale is
recorded in the books.
Indicators of Fraud

(i) Discrepancies in Accounting Records including non-recording or

partial recording or incorrect recording or delayed recording of
amounts, misclassifications, etc.
(ii) Conflicting or missing evidence including missing documents,
altered documents, significant unexplained items in reconciliations,
discrepancies between entity’s records and confirmations received
etc.
(iii) Unacceptable management responses such as – denial of access to
records/facilities/employees, undue time pressure to resolve
complex issues, unusual delays in providing requested information,
denial for use of Computer Assisted Audit Techniques,
unwillingness to address identified deficiencies in internal control
etc.
(iv) Other indications such as – Accounting Policies in variance with
Industry Norms, Frequent changes in accounting estimates etc.

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 Chapter 17.2 -Investigation Page No. - 4
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Ways of Committing Fraud Investigation Procedure Ways of Committing Fraud Investigation Procedure
Cash Receipt Supplier Legder
1. Showing a larger cash discount than actually 1. Cash sales should be vouched in detail. 1. Adjusting fictitious or duplicate invoices as 1. Purchase Journal should be vouched by
allowed 2. Recoveries from customers and sundry parties purchases in the accounts of suppliers and Goods Inward Book and suppliers invoices.
2. Adjusting a fictitious credit in the account of should be checked with the copies of receipts subsequently misappropriating the amounts when 2. All suppliers should be requested to furnish
a customer for the value of goods returned issued to them payments are made to the suppliers in respect of statements of their accounts to see
by him. 3. Paying-in-slips from the bank the details of cash these invoices. whether or not any balance is outstanding
3. Adjusting a cash sale as a credit sale, and deposited on each day should be compared with 2. Suppressing Credit Notes issued by suppliers and or due so as to confirm that allowances and
raising a debit in the account of the those shown in Cash Book. withdrawing corresponding amounts not claimed by rebates given by them have been correctly
customer. 4. All withdrawals from the bank should be checked them. adjusted and were duly authorized.
4. Writing off a good debt as bad and by reference to corresponding entries in the bank 3. Withdrawing amounts unclaimed by suppliers, for one 3. Examine system of IC in relation to
irrecoverable. pass book. reason or another by showing that the same have purchase orders issued and identify
5. Issuing a receipt to the payee for the full 5. Income received from different sources should be been paid to them. possibilities of collusion with suppliers.
amount collected and entering only a part of scrutinized, e.g., inventory, sales summaries, rental 4. Accepting purchase invoices at prices higher than
the amount on the counterfoil registers, correspondence with customers their market prices and collecting the excess
6. Amount collected has been misappropriated. amount, paid in cash, from the suppliers.
7. Under-casting the receipts side of the Cash
Book or over-casting the payment side.
Customer Ledger
1. By teeming and lading’ method, i.e., misappropriating 1. Confirm that accounts of customers have
Inflate Cash Payment
amount collected from a customer and crediting his been debited in respect of goods supplied to
1. Making double payment of an invoice or paying 1. All the evidence as regards cash payments made,
account by the amount paid by him only when an them, entries in the Order Book should be
a false invoice. including acknowledgement by parties, should be
amount is subsequently collected from another cross-checked with those in Sales Day Book.
2. Paying personal expenses out of the business carefully scrutinized.
customer; repeating this practice with several items 2. Special attention should be paid to allowances
by falsifying details. e.g., showing betting 2. All payments by bearer cheques should be
collected and depositing back the amount so adjusted - on account of goods returned or
losses as advertisement charges. examined.
misappropriated before the close of the year. difference in price or on any other account as
3. Withdrawing unclaimed credit balances of 3. The system of recording of wages should be
2. Misappropriating amount collected from a customer well as to amounts written off as bad debts.
customers or amounts falsely credited in the reviewed, specially as regards possible over-totaling
and adjusting his account by crediting the amount on 3. Obtain confirmation of customers in respect
accounts of parties. of wage sheets, and entries in them of dummy
account of allowance or a rebate. of the amounts standing in their accounts.
4. Falsely adjusting a refund in the account of a workmen.
3. Crediting amount received from a customer to the Those of them who have no balance in their
customer and withdrawing the credit balance. 4. Petty Cash Book should be vouched and totaled.
account of another customer and subsequently accounts should be requested to confirm the
5. Wrong totalling of the wage sheets and 5. All withdrawals from the bank should be checked by
withdrawing the amount wrongly credited. statement of their account.
misappropriating the excess amount withdrawn reference to entries in the bank's pass book. All
from the bank for payment of wages. BR/BP should be checked by reference to the Bills
Books.

Inventory Frauds Procedure for Verification of Defalcation of Inventory/ Investigation Procedure

1. Employees may simply remove goods from the Inventory thefts usually are possible through collusion among no. of persons. Defalcations of inventory, sometimes, also are committed by mgt, by diverting a
premises. Therefore, entire system of receipts, storage and dispatch of all goods, etc. should part of production and the consequent shortages in production being adjusted by
be reviewed. inflating the wastage in production; similar defalcations of inventories and stores
2. Theft of goods may be concealed by w/o as
are covered up by inflating quantities issued for production.
damaged goods, etc.
The determination of factors which have been responsible for theft and
3. Inventory records may be manipulated by
establishment of guilt would be difficult in the absence of: For detecting such shortages, should take assistance of an engineer.
employees who have committed theft so that
a) a system of inventory control, and existence of detailed record of the
book quantities tally with the actual quantities movement of inventory, or Guidance can also be taken from past records showing the extent of wastage in
of inventories in hand. b) availability of sufficient data from which such a record can be constructed. production in the past. Similarly, he would be able to better judge whether the
4. Inflating quantities issued for production material issued for production was excessive and, if so to what extent.
5. Stocks actually dispatched but not entered in First step in such an investigation is to establish the different items of inventory
sales/ debtor’s account. defalcated and their quantities by checking physically the quantities in inventory held
and those shown by Inventory Book.

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