Detecting and Avoiding Fraud in India

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The following is an excerpt from the April 2014  edition of India Briefing Magazine, titled “An Introduction to India’s Audit Process.”

As an incidental objective associated with annual audit, detecting fraud and error can be as important as assessing whether a company’s balance sheet accurately represents its current state of affairs. For companies with operations in India, it is important to maintain an awareness of what constitutes fraud, and the fine line between fraud and error in the eyes of an auditor.

According to KPMG’s 2012 India Fraud Survey Report, 55 percent of organizations surveyed had experienced fraud in the past two years despite efforts by management to establish a robust control environment. While management is inherently the first line of defense against fraud and error, internal and external auditors are often considered the second line of defense.

Fraud refers to the willful and deliberate misrepresentation of financial information with the intention of deceiving others (i.e. shareholders, the government, etc.). This can entail both defalcation involving the misappropriation of cash or goods, and the fraudulent manipulation of accounts by management or employees.

Defalcation involving the misappropriation of cash or goods can encompass a number of specific activities including, but not limited to:

  • Recording fictitious or bogus payments
  • Undercasting the receipt side total of a cashbook
  • Showing the same payment twice
  • Recording more payments than actual amounts paid by altering the figures on vouchers
  • Misappropriating undisbursed wages
  • Recording personal expenses as business expenses

Fraud through the manipulation of accounts typically implies presenting accounts more favorably than they are in reality, and distorting the profit or loss of a business and its financial state of affairs (also known as “window dressing”). This type of fraud is committed at the management level, and auditors will oftentimes suspect fraud if they encounter:

  • Missing vouchers, invoices, checks, or contracts
  • Balances that do not add up
  • Significant fluctuations in the gross profit and net profit margin ratio
  • A difference between the stock as per records and physically counted stock
  • When the control account does not agree with subsidiary books
  • When parties provide contradictory explanations for inconsistencies

The key difference between “fraud” and “error” often relates back to the intent to deceive, and distinguishing between the two can be challenging. Auditors are charged with exercising judgment when preparing their opinion for the final audit report, but do not make legal determinations of whether fraud has actually occurred. Rather, the auditor’s opinion is persuasive rather than conclusive in nature and based solely upon the information they reviewed and analyzed during the verification of financial statements.

If fraud is suspected by an auditor, this suspicion will be reflected in their opinion and an interested party may subsequently decide to carry out an investigation into the matter in question.

Fraud Risk Management

According to the Association of Certified Fraud Examiners 2012, the median loss caused by perpetrators of fraud in the first year of employment amounts to US$25,000 while those with more than ten years at an organization can cause a median loss of nearly US$230,000.

Mitigating the risk of fraud begins with a robust governance structure that includes the audit of budgeting processes, ethics policies, quality control, monitoring procedures by senior management, and rotation procedures. Any weakness in an organization’s governance structure creates vulnerability for fraud.

Aside from ensuring an organization possesses a robust governance structure, providing an anonymous hotline or other channel for whistleblowers to alert management of fraudulent behavior can be an effective mode of fraud detection. The Companies Act 2013 additionally mandates listed companies to establish a mechanism for whistleblowers to alert management of fraud at the director or employee level.

This article is an excerpt from the April 2014  edition of India Briefing Magazine, titled “An Introduction to India’s Audit Process.” In this edition of India Briefing Magazine, we provide readers with an overview of India’s annual audit process and offer important tips for the smooth navigation of the country’s audit regulations and accounting standards. We additionally outline key differences between the widely accepted IFRS and IAS protocols, and a number of key considerations FIEs should keep in mind to mitigate the risk of fraud of error in an organization.

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email india@dezshira.com or visit www.dezshira.com.

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