Due Diligence, Investigation & Forensic Accounting
22 theoretical questions from ICAI Study Material
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Refer Financial Due Diligence given in Para 3.
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Refer Over-Valued Assets Part given in Para 3.
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In order to ensure that the manufacturing unit of SV Ltd. will be able to meet the cash requirements internally, one is required to verify: (a) Is the company able to honor its commitments to its trade payables, to the banks, to the government and other stakeholders? (b) How well is the company able to convert its trade receivables and inventories? (c) How well the Company deploys its funds? (d) Are there any funds lying idle or is the company able to reap maximum benefits out of the available funds? (e) What is the investment pattern of the company and are they easily realizable? Refer Cash Flow in Para 3.
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(a) The activity described in the situation is Due diligence. Due diligence is a measure of prudence activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstance, not measured by any absolute standard but depending upon the relative facts of the case. It involves a careful study of financial and non-financial possibilities. It implies a general duty to take care in any transaction. Due diligence is a process of investigation, performed by investors, into the details of a potential investment such as an examination of operations and management and the verification of material facts. It entails conducting inquiries for the purpose of timely, sufficient and accurate disclosure of all material statements/information or documents, which may influence the outcome of the transaction. Due diligence involves a careful study of the financial as well as non-financial possibilities for successful implementation of restructuring plans. Due diligence involves an analysis carried out before acquiring a controlling interest in a company to determine that the conditions of the business conform with what has DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING been presented about the target business. Also, due diligence can apply to recommendation for an investment or advancing a loan/credit. (b) There would be no difference in answer if above activity was to be performed by a person who is not a Chartered Accountant. The activity would remain due diligence. Due diligence can be performed by any person. It is not necessary that due diligence can only be carried out by a Chartered Accountant. As due diligence involves exercise of prudence and general duty to take care in any transaction, it can be undertaken by any person. (c) The areas where due diligence may be undertaken are: - (i) Corporate restructuring (ii) Venture capital financing (iii) Public offerings
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Refer Cash Receipts embezzlement in Para 11.4.1.
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In assessing the turnover which the business would be able to maintain in the future, the following factors 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? 17.82
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Refer Inventory Fraud in Para 11.4.1.
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Refer Areas to be verified in case of embezzlement in supplier’s ledger in Para 11.4.1.
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In a forensic accounting engagement, professional undertakes a scrutiny and detailed examination of all transactions and balances relevant to the mandate so that evidence gathered is suitable in a Court of Law i.e. in compliance with legal requirements where it can be challenged through cross-examination by the defending party. It is important that team is skilled in collecting evidence that can be used in a court case keeping a clear chain of custody till evidence is presented in court. If there are gaps in chain of custody, then the evidence may be challenged in court or even become inadmissible. In the given case, team has failed to keep record of matters such as persons gathering relevant evidence, date and time of collection and storage of evidence. Therefore, team has failed to maintain the chain of custody. It can, therefore, defeat the objective of forensic accounting engagement as evidence may be challenged in Court of law by defending parties and may become inadmissible.
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Refer Inventory Frauds Part given in Para 11.4.3.
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Refer hidden liabilities Part given in Para 3.
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In the instant case, Quality Ltd. is engaged in the business of manufacturing and distribution of various ready-to-cook products like vegetables, noodles etc. Further, management was looking for some financial investor to fund some part of the proposed expansion. Aman is interested in funding; therefore, he initiated investigation of audited financial statements to ensure the appropriateness of the valuation of the shares. For initiating the same it may be considered that if the investigation has been launched because of some doubt in the audited statement of account, no question of reliance on the audited statement of account arises. However, if the investigator has been requested to establish value of a business or a share or the amount of goodwill payable by an incoming partner, ordinarily the investigator would be entitled to put DUE DILIGENCE, INVESTIGATION & FORENSIC ACCOUNTING reliance on audited materials made available to him unless, in the course of his test verification, he finds the audit to have been carried on very casually or unless his terms of appointment clearly require to test everything afresh. • If the statements of account produced before the investigator were not audited by a qualified accountant, then of course there arises a natural duty to get the figures in the accounts properly checked and verified. • However, when the accounts produced to the investigator have been specially prepared by a professional accountant, who knows or ought to have known that these were prepared for purposes of the investigation, he could accept them as correct relying on the principle of liability to third parties. • It would be prudent to see first that such accounts were prepared with objectivity and that no bias has crept in to give advantage to the person on whose behalf these were prepared.
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