This book focuses on a ‘detailed-commentary’ and ‘step-by-step approach’ for the Forensic Audit of Financial Transactions. It also deals with each and every aspect of Forensic Audit of various items of statement of Profit & Loss and Balance Sheet. The Present Publication is the Latest Edition & is updated with all amendments and legal position up to July 2020, authored by G.C. Pipara. Understanding the Forensic Audit is not complete, without actual Case Analysis and this book includes analysis of actual company cases relating to Forensic Audit, where either fraud or misrepresentation of information is found. With the help of Case Analysis, how to achieve the maximum objective of Forensic Audit, has been explained in a lucid language with step by step approach. Each part of this book deals with the different segments of the forensic audit and each part has been devised carefully, keeping in mind – ‘Maximum Result’ and with an objective that the real purpose of Forensic Audit is served. This book deals with – · Misstatement of information in the financial statement, · Incorrect details in the financial statement, · Diversion of funds by an entity, · Siphoning of Funds by an entity, · Fraud in some of the transactions undertaken by the entity, · Fraud in books of accounts and other records, · Fraud in the balance sheet – one which is even audited, · Fraud by the auditor in helping the organization to accomplish its intention etc. The structure of the Book is as follows: · Part One Deals with the introduction of the forensic audit and look into the past, present and future of forensic audit. This part is presented to establish the foundation of the book. · Part Two Deals with important transactions pertaining to purchases of goods, sales and other major expenditures - which forms part of the statement of profit & loss account. Provisions and contingent liabilities are often used by an entity to cook the books of account and therefore, a separate chapter is presented on this issue. · Part Three The various items contained in the balance sheet, are a major part of the activities of any entity and therefore, is a major part of any forensic audit also. Therefore, in this part of the book, the following important activities of an entity’s are covered: o Fixed (Hard) Assets – hard to spot o Intangible Assets and Goodwill – neither visible nor real o Capital Work In Progress (CWIP), Stock In Progress (SIP), and Stock – not seeing the light of day o Piling Stock and Mounting Debtors – an evergreen technique for every-greening o Investments – without objectives like a traveler without a destination o Loans and Advances given – gone with the wind o Equity and Shareholders – invisible ownership Learn More

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3. Preface
“My Soul characterized by
knowledge and faith is alone eternal.
All other phases of existence to which
I am attached are external
occurrences that are transitory”.
- Lord Mahavira
Turn on the news or leaf through newspaper and chances are you’ll find
an information about economic crime or fraud. Fraudulent accounting
practices, siphoning of huge amount, fudging of records, bogus transac-
tions, share price plummets and rising NPAs have become a never ending
battle.
Fraud and economic crime rates remain at records high, impacting more
and more companies in various diverse ways than ever before.
The value of the bank fraud reported in the first half ended September,
2019 rose to a record 4,412 cases of frauds worth ` 1.13 lakh crore,
according to the Reserve Bank of India’s Financial Stability Report,
published on December 27, 2019. That compared with 6,801 cases of
frauds worth ` 71,543 crore reported in the entire financial year 2018-19.
The RBI’s Financial Stability Report, further states that the number of
large - value frauds of ` 50 crore or more each spiked. In the first half of
FY 2020, there were 398 such cases worth ` 1.05 lakh crore compared to
322 cases involving ` 61,579 crore in the previous fiscal.
I-7

4. PwC’s Global Economic Crime and Fraud Survey 2020-(https://www.pwc.
com/gx/en/forensic/gecs-2020), has found that in the past 20 years, the
level of frauds experienced in past 24 months were higher by 47% - the
second highest reported level of incidents. The survey further found
that though customer fraud was found to be the top most, accounting/
financial statement fraud was found to be 2nd top most fraud, and
assets misappropriation was found to be 3rd top most fraud.
The survey also found that accounting/financial statement fraud was
there in all types of industry - Energy, Utilities & Resources, Financial
Services, Government and Public Sector, Health Industries, Industrial
Products & Manufacturing, Technology, Media & Telecommunications etc.
Accounting Manipulation
Accounting manipulation in corporate financial reports are perennial, they
had occurred in all eras, in almost all countries. There are some “loop-
holes” in accounting and auditing standards, which provide ample leeway
to corporate accountants and thus, motivate accounting professionals to
make frequent manipulations in corporate financial reports. Accounting
manipulations involves the intentional “cooking-up” of financial records
and reports.
Forensic Accounting vs. Forensic Audit
Number of time forensic accounting is used as synonym of forensic audit.
Both the professions deals with financial statement but differ in methods,
techniques, tools used in the process and reports. The primary difference
between forensic accounting and forensic audit lies in the purpose of the
audit. A forensic accounting assignment relates to frauds against the
business - such as fraud by an employee or dispute with the vendor or
customers, as against forensic audit relates to frauds by business. Thus,
forensic audit covers forensic accounting and wide in scope as compared
to forensic accounting.
Evaluation of Forensic Audit in India
The Indian history of investigating accounting goes back to the ancient
Mauryan Times. The importance of forensic audit has been visualized
- since Kautilya’s time. The Kautilya’s Arthashastra was written about
2,400 year ago. The Arthashastra is not only of historical interest but is
one of the world’s oldest manuals on the economic administration of a
state. Kautilya was the first economist who recognized the need of the
I-8 Preface

5. forensic accountants. He mentioned 38 ways of embezzlement centuries
ago, which are even relevant in present time of forensic audit:
“In all these cases, the subordinate officers, the storekeeper, the
ledger-keeper, the receiver, the payer, the official who authorized the
payment, the adviser, and the assistant shall be interrogated individually.
If any one of these tells a lie, he shall receive the same punishment as the
officer concerned.”
(Verse - 2.8.22, 23)
Not only interrogation (i.e. forensic audit), the Arthashastra also visual-
ized 2,400 years ago compensation for loss due to dishonesty:
“A proclamation shall then be issued calling on all those who had suffered
at the hands of the [dishonest] official to inform [the investigating officer].
All those who respond to the proclamation shall be compensated accord-
ing to their loss.”
(Verse - 2.8.24, 25)
What has been stated in The Arthashastra, 2,400 years ago, holds good
even today. The misrepresentation of information in the books of accounts
as well as in financial statement, diversion of funds, siphoning of funds
and fraud etc. - seems to be a new area of competition by the corporate
world. And if we do not have a proper audit - it is adding fuel to fire!
Imagine - what will happen, if even the forensic audit also does not come
to its expectation!
Discretion and subjectivity in accounting rule - cause for misstatement
and thus forensic audit
Globally regulators, accounting standards monitoring agencies, and
professional bodies of accounting and auditing have principle based
accounting standards. Accounting Standards provide some flexibility to
apply the accounting principles and methods appropriately in various
industries and business models. Consequently, they allow discretion to
preparers to apply the accounting principles stipulated in AS.
In order to apply Accounting Standards to all segment of companies, the
discretion is essential but might be misused by managers. Sometimes it
is found that the discretion is used for private benefits and accounting
policies are formulated in such way that at the cost of their benefit - the
larger interest of shareholders, creditors is ignored. Some entities adopts
I-9Preface

6. conservative approach to suit the requirement and then adopts aggres-
sive approach as that suit their reporting strategy. From shareholders,
lenders and creditors perspective any type of “management” in account-
ing is bad and not a good corporate governance - as it hides economic
reality from users of the financial statements.
Such habits of managers - some time take a large space in the financial
statement, resulting into fraud. When focus is shifted from transparent
and consistency to “need based accounting” and frequent and significant
changes in accounting rules to confuse investors, shareholders, creditors
etc., is one of the reason for forensic audit.
Discretion in accounting rules to need based accounting to corrupt
practice
The global accountancy firm EY carried out a survey “Europe, Middle East,
India and Africa Fraud Survey 2017” and found that - on an issue - are
executives setting the right example? Survey finds that “77% of board
directors and senior managers could justify unethical behaviour to help
business survive, while 1 in 5 would deliberately misstate a company’s
financial performance. These respondents are also more prepared to act
unethically to improve their remuneration than their colleagues, with 2
in 5 willing to do so”.
[Source: www.ey.com/fraud surveys]
Financial Statements fraud by external parties
Financial statement fraud is often thought of as an “inside job”. Occasion-
ally, however, fraud is perpetrated by an external - third party, sometimes
without an organization’s knowledge. These frauds are sometime no less
serious.
Fraud perpetrated by external parties - outside of management and em-
ployees - remains neglected and unmitigated risk for many organizations.
One of the five most scandalous fraud case of 2018, as referred in the
Association of Certified Fraud Examiners (ACEF) report was a USD 2 billion
fraud at PNB by external party, Nirav Modi. [http://bit.ly/2tMj1z1].
Where were the auditors’?
The entire community - may be inside or outside the organization, relies
heavily on financial statement - that are audited, with the long history of
auditing profession, entire community of users are expecting to solve the
“expectation gap” by now.
I-10 Preface

7. Dramatic incidents were continuous to occur. The financial crisis of 2007-
2008, with the failure and bailout of whole list of iconic companies - all
having a clean audit opinion. Still fresh occurrence have continued to
erupt, not only in India but around the globe.
The familiar cry, “where were the auditors’?” has rung often in recent
years: ` 11,300 crore Punjab National Bank fraud, an accounting fraud in
the IL & FS Group, Satyam Computers’ September 2008 balance sheet of
inflated cash and bank balance of ` 5,040 crore, and similar fraud from
Ricoh India - an Indian arm of the Japanese multinational, Ricoh Global -
of escalated revenue, CG Power of advance to related parties and unrelat-
ed parties of ` 4,800 crore understated, Diamond Power Infra of defraud-
ing banks of over ` 2,600 crore, Deloitte’s audit of National Spot Exchange
Limited (NSEL). In all these cases auditors’ has issued a clean report.
The familiar cry, “where were the auditors’?” even continues outside
India also. In the USD 625 Million judgment in the FDIC’s case against
Price Waterhouse Coopers over the failed Colonial Bank, collapse of public
contractor Carillion in the UK, the Gupta family and the USD 12 billion
write: downs taken by Steinhoff in South Africa, accounting fraud in Enron
of USA. Examples of fraud and failure in the United States include Bernard
Madoff, MF Global, Hertz, Wells Fargo and even the Academy Awards.
Equally impactful example elsewhere include Tesco in United Kingdom,
Toshiba in Japan, Petrobras in Brazil, FIFA in Switzerland, Volkswagen in
Germany, and Noble group in Hong Kong and certain others to come.
The Public expectations are that auditors perform with “zero defects”
but the shortcomings in the audit execution, absence of principles of
accounting and reporting including the auditors traditional defensive
assertions - “not in our scope” or “isolated exception” - are neither
responsive nor publicly satisfactory.
The forensic audit cannot be replaced with the routine audit i.e.
statutory audit but failure of audit is the reason for rise of forensic
audit.
Amended Companies Act - A blessing for forensic auditors
The Companies Act, 2013 has opened the doors of opportunity for the
forensic auditors.
The introduction of the Companies Act, 2013 has a significant impact on
fighting and preventing frauds. Under Section 245(1g) of the new Compa-
I-11Preface

8. nies Act, depositors and members of a company can claim damages from
auditors, management and other consultants for the wrongdoings by the
company and its management. Many consultants and senior executives
are expected to become part of the certified community.
Further, under section 140 of the Companies Act, 2013 the auditors and
their firm would be jointly liable for any frauds in the books of accounts
and many auditors are likely to become forensic auditors in the days to
come to avoid being caught on the wrong foot.
Under section 149(12) of the Companies Act, 2013, independent directors
would be held liable for the frauds in their knowledge and it is expected
that there would be a number of independent directors who could be
looking to understand the techniques of fraud investigations by way of
training and certifications.
Under section 177 of the Companies Act, 2013, the audit committee will
have the authority to investigate and the power to obtain professional
advice from external sources and have full access to information in the
records of companies. This section is going to see more references to the
certified forensic accounting professionals.
Establishment of SFIO
The Companies Act, 2013 has also paved the way to the Central Govern-
ment for establishment of an office to be called the Serious Fraud Inves-
tigation Office (SFIO) to investigate frauds relating to company. The SFIO
is headed by a director and consist of experts from the fields of banking,
taxation and forensic audit among others, and working under MCA.
India Inc’s Credit quality due to Covid-19
The credit quality of India’s corporates has deteriorated sharply since
March 2020, as cash flows were impacted due to the nationwide lock
down, said ICRA in a report.
The ratings firm said it undertook 315 negative rating actions between
March 1 and May 15, out of which 150 were downgrades. The outlook in
122 cases were changed to negative, a majority of them linked to pan-
demic. There were only 24 upgrades in that period.
The firm has a negative outlook on aviation, retail, hotels and restaurants,
textiles, automotive, metals, oil and gas and real estate sectors. It has a
stable outlook for cement, construction and downstream oil companies.
I-12 Preface

9. “Out of the top ten sectors which witnessed a negative rating action since
March 2020, a large proportion were those that were categorized as ‘High
Risk’, said ICRA.
The negative outlook on various sectors is going to open a new area of fo-
rensic audit in such cases to find out what is the true impact of pandemic
and what benefits has been taken by some companies, under the shadow
of pandemic.
Who will Benefit from Reading This Book?
Forensic auditors’ investigate fraudulent activities, uncover money laun-
dering and find missing assets through a combination of investigative
techniques and accountancy skills. The Institute of Chartered Accountants
of India, recognizing the need for forensic accounting and fraud detection
in the emerging economic scenario has decided to launch a certificate
course on the subject.
Demand for forensic auditing and fraud detection specialization is increas-
ing day by day, considering the rising incidents of NPAs in banking sector,
fraud in security market and commodity exchange, misrepresentation
in the financial statement and therefore, I believe that many parties will
benefit from lesson in how to unlock the secrets hidden in forensic audit:
- Forensic auditor being Chartered Accountant and Experts
- Financial Institutions - such as Banks and lenders etc.
- Regulators - such as RBI, SEBI, ROC etc.
- Investigating agencies - such a SFIO, EOW, CBI, Police
- Insurance Companies
- Law enforcing agencies - such as courts, lawyers etc.
- Investors - such as PE, Bond holders, debenture holders etc.
- Promoters of the company
- Management of the company
- Revenue collecting authorities - such as GST, Income-Tax etc.
- Under Insolvency and Bankruptcy Code (IBC) for identifying preferential
and undervalued transactions etc.
- InvestigationundertheCompanies(Inspection,InvestigationandEnquiry)
Rules, 2014
- Investigation of Foreign Company
I-13Preface

10. The Bottom Line
Forensic accountants tract problem to their source and provide companies
with critical information as to what happed, why and how to fix it. It does
not matter if the problem involves a potential fraud or trying to find out
where the money has gone or how the funds has been used. All these con-
cepts has been explained in details in each of the chapter of this book. The
next time you hit a wall and need help with a problems, consider reading
this book and therefore, for the first time in the history of forensic audit, a
structure of forensic audit has been devised - termed as “T-3 Structure” of
forensic audit, for the successful and result oriented forensic audit.
Ahmedabad - India
August, 2020
Ashada Shukla Dvitia,
(Ashadi Bij),
Vikram Samvat 2077
G. C. PIPARA
CA | Trainer |Research Analyst
Centre for Correct and Accurate
Balance Sheet Analysis (CABSA)
Phone: +079-40370370
Mobile: +91 98250 38930
Email: pipara@pipara.com
@GYANPIPARA
gyan_pipara
I-14 Preface

11. Contents
PAGE
About the Author I-5
Preface I-7
Acknowledgements I-15
Structure of the Book I-17
Structure of Each Chapter I-21
List of Abbreviations I-25
Part To
unlock
Chapter Topic Page
No.
Chart
No.
Table
No.
Case
Analysis
No.
Box No.
I SETTING UP THE FOUNDATION 1
1 Introduction 3 1 1 - -
2 The Past, Present and Future
of Forensic Auditing
9 2-3 - - -
II UNLOCKINGTHESECRETSHIDDENINFORENSIC
AUDIT OF INCOME AND EXPENDITURE
21
3 Purchases of Goods and Sales
- tales of hope and despair
23 - 2-3 1-4 1-13
4 Depreciation and Amortiza-
tion-financialnumbersgame
51 4-6 - 5 14-15
5 ProvisionsandContingentLia-
bilities-jugglingasconvenient
59 7-8 - 6-7 16-25
I-23

12. Part To
unlock
Chapter Topic Page
No.
Chart
No.
Table
No.
Case
Analysis
No.
Box No.
III UNLOCKINGTHESECRETSHIDDENINFORENSIC
AUDIT OF ASSETS AND LIABILITIES
75
6 Fixed (Hard) Assets - hard
to spot
79 9 4 8-10 26-34
7 IntangibleAssetsandGoodwill
- neither visible nor real
101 - - 11-12 35-42
8 Capital Work In Progress
(CWIP) Stock In Progress (SIP)
and Stock - not seeing the
light of day
117 - 5 13-15 43-56
9 Piling Stock and Mounting
Debtors - an evergreen tech-
nique of ever-greening
147 10 - 16-18 57-60
10 Investment - without objec-
tives - like a traveller without
destination
161 - - 19-20 61-79
11 Loans and Advances given -
gone with the wind
199 11-17 6-17 21-22 80-100
12 Equity and Shareholders -
invisible ownership
241 18-21 18 23-27 101
IV KEYMETRICS-KEYsTOUNLOCKINGSECRETSOF
FORENSIC ACCOUNTING & INVESTIGATION
257
13 Key Metrics - Key to unlocking
the Secrets of Forensic Audit
261 22-24 - 28-30 102
14 The Dog ate my Accounts -
honest
273 25 19 31-32 103-106
15 He who does venture has luck
- to divert the funds
281 - - 33 107-109
V PUTTING IT ALL TOGETHER TO DECODE 287
16 The T-3 Structure - Test, Trace
and Track of Forensic Audit
289 - - - -
17 LookForward-LookBackward 295 26 - 34 110-111
VI AUDIT AND AUDITORS - AND THE FORENSIC
AUDIT
305
18 Where were the Auditor’s -
conveniently overlooking
307 27-28 20-22 35-37 112-127
Subject Index 333
I-24 Contents

13. Capital Work In
Progress (CWIP)
Stock In Process
(SIP) and Stock
- not seeing the light of day
8
Chapter
Why is it Important?
The capital work in progress (CWIP), stock in process (SIP)
and stock of raw materials, finished goods etc. - are the 3
importantitemsofbalancesheetofanyentity.Considering
the similarities in CWIP & SIP and SIP & Stock, all 3 items
arecoveredinthischapterforthepurposeofbetterunder-
standingandunlockingthesecretshiddenforforensicaudit.
Capital Work in Progress
The Capital Work in Progress, also known in short as CWIP,
is one of the important part of the non-current asset of
an entity. CWIP includes building under construction, ma-
chinery under assembly etc., at the time of preparation of
balance sheet. CWIP is the work that is not yet complete
but amount has already been paid. These payment, these
funds which is claimed to have been paid for the said con-
struction, which is not yet complete or machinery or plant
which is under installation is sometime found to have been
used as route to divert or siphon the funds - and thus, a
cause for forensic audit.
117
SAMPLE CHAPTER

14. 118 Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
Purchases of item of assets at an inflated price especially from a related party
or making payment for some assets being shown as CWIP, for which no assets
has been received of economic value or even expenditure for repairs and main-
tenance recorded as CWIP are some of the areas of forensic audit. Similarly,
recording of an assets purchased as CWIP, which in effect has not actually been
received by the entity at all, are important aspect of forensic audit of CWIP.
As the name suggest that CWIP, is the work of putting plant & machinery and
constructing building which is not yet completed, the same being continued
fromonebalancesheetdatetoanother.Therefore,usedastooltoeitherinflate
the same or to divert the funds.
It is also relevant to know that so long as an asset is CWIP, the same is not
required to be considered as fixed assets and therefore, not required to be
recorded in the fixed assets register and also not required to be depreciated.
The benefit of spillover from one balance sheet to another balance sheet
- which sometimes continues in several balance sheet, is taken by the man-
agement, as for stakeholders, it is difficult to immediately identify any early
warning sign due to such spillover.
Therefore, the forensic audit of CWIP requires looking into genuineness of the
same, is it inflated and correctly shown.
The understanding of the CWIP and how to look and analyse the same, is im-
portant in forensic audit. In this chapter how to decode the CWIP is explained,
to find out how genuine the same is or there are some issues which requires
furtherinvestigationoritisusedasameans/modetodivertorsiphonthefunds.
It is also important to understand and analyse the CWIP in forensic audit, as
CWIPformspartofthetangiblenetworth(TNW)ofanentity.Therefore,toknow
actual TNW and real position of the TNW, the CWIP requires to be looked into.
Stock in Process
Stock-in-Process known in short as SIP (also known as Work-in-Progress - WIP)
is one of the important part of the current assets of an entity. Like CWIP, WIP
includes entity’s partially finished goods waiting for completion. Since, it is one
of the items for the purpose of calculation of Current Ratio, SIP plays an im-
portant role, in any loan proposals by borrowers to the Banks and/or Financial
Institutions. Since stock in process, is considered as part of the current assets,
and overall amount of current assets is one of the shining star to any financial
statements, its importance is shining as the sun rays.
In each and every financial statements, while looking at the Balance Sheet,
lenders investors, stakeholders etc., whoever has interest in the entity,

15. 119Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
always look upon the amount of current assets and particularly the amount of
Inventories, which forms integral part of the current assets. Stock-in-Process is
one of the important item of inventories in any entity. Since Stock-in-Process
indicates that manufacturing process is undergoing and the raw materials is
being processed or being manufactured, and the process is continuing, as the
stage of finished goods or final products has not yet been reached. Therefore,
higher amount of stock in process, as compared to raw materials and finished
goods is always viewed positively.
Huge inventory level of raw materials indicate that the materials have been
procuredbutnotprocessedandsimilarlyhigherleveloffinishedgoodsindicate
that an entity has manufactured the goods but not able to sell. As against this,
higher level of SIP, provides comfort to the lenders and investors that since it
is SIP, naturally the same cannot be sold and thus, not viewed adversely or not
as negative as huge inventories of raw materials and finished goods. Therefore,
benefits of this situation (considered as mind game) is sometime taken by
entities in showing huge inventory level of SIP.
Apart from above mind game, the other most important reason, for showing
huge level of inventory of SIP is that, manufacturing process of each industry is
different, manufacturing cycle being different in each industry and sometime
even in the same industry, it may be different, because of management or for
any reasons, it is easy to provide reasons and logic for higher level of SIP. Such
reasons are difficult for a layman to understand the same, as it is a technical
subjectandthus,reasonsadvancedbythecompany’smanagementisaccepted
on the face value.
It is also found that even in physical verification1
of Inventories, it is easy to
physically verify the raw materials and finished goods as compared to SIP, as
dependinguponthetypesofproductsandindustry,theremaybeseveralstages
ofSIP,whichmakesitdifficulttophysicallyverifythequantityandvaluethereof.
It is also not possible to maintain process records of SIP, as in the case of other
inventories.Itisalsodifficulttomaintaintheitemwise,stagewise,productwise,
processwise details of quantity and amount of each and every items of SIP.
Therefore, the benefit of all such situations or some of such situations are
found to be taken by those entities, who wants to either window dress the
1. Physical Verification of the inventories (which includes all inventories of raw material, SIP, finished goods
etc.) are of the area always undertaken by the lenders in each and every cash credit facility provided by
the banks in India. Such verification is carried out by the bank staff or by outside CA or Cost Accountants
on behalf of banks/financial institutions.

16. 120 Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
financial or mis-represent the facts about good financial positions of the
entity, by showing higher level of SIP than the actual.
And that is why wherever the amount and quantity or overall value of SIP is
found higher, as compared to overall inventory level, overall business volume
and/or overall sales, the detailed analysis of SIP is very important and desirable
too, in forensic audit, to find out is there anything serious or wrong in the level
ofSIP,asSIPnormally formspartoftheprimarysecurityfortheWorkingCapital
Loan or a Cash Credit Facility provided by the banks or financial institutions to
the entity.
Similarities in CWIP and SIP
Asexplainedindetailshereinabove,bothCWIPandSIPareundergoingitemsof
balance sheet date. Though, CWIP is part of non-current assets but SIP is part
of current assets. Due to the fact that both have not attained the final shape
and therefore, difficult to verify as compared to finished assets.
This peculiar stage - stage of under progress/process, which sometime un-
necessarily extended and after long progress and process, which keeps on
progressing and progressing but never end and as a result these CWIP and
SIP are unable to see the lights of the day!
Stock of raw material and finished goods
Apart from stock in process (SIP), the other inventories - such as raw materials,
finished goods, stores and spares, packing materials etc., which are intended
for consumption or sale in the normal course of operating cycle, also forms
part of the inventory.
For the purpose of forensic audit of an entity for genuineness of inventories,
these items of inventories are also requires to be examined.
Nodoubt,themajorconcernofforensicauditorisforSIP(asexplainedindetails
above) but the other inventories cannot be ignored and in some cases, it may
be the other inventories - which pose more seriousness, as compared to SIP.
In the case of a trading entity, the stock-in-trade i.e. the goods acquired for the
purpose of trading, which remained as stock at the balance sheet date, is also
relevant in forensic audit of such trading.
Similarities in SIP and Stock
Both forms part of inventories and both are current assets. Stock in process
and stock of other inventories - requires to be examined by a forensic auditor,
on same parameters, except some additional verification with respect to SIP.

17. 121Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
Inventory Fraud
Inventory is one of the biggest assets on a manufacturing entity. It’s also one
of the hardest assets to measure and track.
Thousandsoftransactionsflowthroughtheinventoryaccounteachyear—and
many of these journal entries require subjective estimates, such as overhead
allocations,write-offs,andvaluationadjustments.Inaddition,manyemployees
have direct daily access to inventory or inventory accounting records, providing
an ongoing temptation to steal or cook the books.
Inventory Fraud Example
ConsiderABCManufacturing,afictitiouscompanythatfellvictimtoa$300,000
inventory fraud scheme involving three trusted employees. Their scam was
simple: The shipping clerk sent most finished goods to legitimate customers
or company-owned retail outlets. But a few shipments to retail outlets were
redirected to the home of the payables clerk. Later, the controller picked up
the stolen goods to resell them on the Internet.
ABC’s retail outlets weren’t invoiced for shipments at the time of delivery. So
there was no paper trail identifying what had happened to the redirected ship-
ments. Without physical inventory counts, the perps were able to pull the wool
over the owner’s eyes for more than 18 months. Eventually, the shipping clerk
became overwhelmed with guilt and confessed the scheme to the owner. With
stronger internal controls, the scheme might have been detected sooner — or
prevented from ever occurring.
(Source - www.lbmc.com)
What Makes Inventory Vulnerable to Fraud?
Inventory is vulnerable to fraud because it’s eventually closed out to cost of
goods sold (COGS). This is an expense account that winds up as part of retained
earnings at the end of the accounting period.
The formulas for computing COGS are:
Beginning inventory + purchases during the year = goods available for sale
Goods available for sale - ending inventory = COGS
These formulas make sense for retailers or distributors that don’t add value
to the goods they sold and, therefore, handle only finished goods. But they’re
oversimplifiedformanufacturersthatprocessrawmaterialsintofinishedgoods.
Manufacturers typically possess three types of inventories:
u finished goods

18. 122 Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
u work-in-progress (WIP)
u raw materials
WIPinventoriesincludechargesforrawmaterials,directlabour,andoverhead.
Sometimes there are additional charges when the production of components
is outsourced to a third party.
Inaddition,manufacturerscanuseavarietyoftechniquestoaccountforfinished
goodsinventoriesunderGenerallyAcceptedAccountingPrinciples.Theseinclude
the lower of cost or market; first-in, first-out (FIFO); and last-in, first-out (LIFO).
The more complicated a company’s inventory reporting process, the more
opportunities employees have to commit fraud.
Types of Inventory Fraud
Small manufacturers often operate like families. Owners can’t fathom that a
trusted“familymember”wouldeverstealinventory.Butithappensmoreoften
than thought. When faced with financial pressure and given an opportunity to
steal, an employee may rationalize the theft of inventory.
Inventory fraud may also occur within the accounting department. For exam-
ple, the controller or CFO may try to overstate inventory by artificially inflating
inventory counts or values, recording false entries into the general ledger, or
failing to write off old, obsolete or damaged items.
Moreover, the inventory account may become a “slush fund” for other internal
fraud schemes. Inventory overstatements might be used to manage earnings
or to meet financial covenants.
How to Prevent Inventory Fraud
Unearthing financial misstatements involving inventory overstatements is
less straightforward than catching people who directly steal physical assets.
A forensic auditor help by benchmarking financial statement trends, verifying
sourcedocumentsandbuildingacasethatwillhelptofindoutpersoninvolved.
Fast facts - before Decoding
Presentation of details
Capital work-in-progress
The amount of CWIP is requires to be shown separately on the face of balance
sheet, as part of fixed assets under non-current assets.
Inventories
The inventories are required to be classified as:

19. 123Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
(a) Raw materials;
(b) Work-in-progress;
(c) Finished goods;
(d) Stock-in-trade (in respect of goods acquired for trading);
(e) Stores and spares;
(f) Loose tools;
(g) Others (nature to be specified).
Further,goods-in-transitisrequiredtobedisclosedundertherelevantsub-head
ofinventoriesandmodeofvaluationofinventories,isalsorequiredtobestated.
Meaning of inventories
As per Ind AS 2, “Inventories” - the inventory has been defined as assets:
(a) Held for sale in the ordinary course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be consumed in the production
or in the rendering of services.
Inventories held for sale in the ordinary course of business
Inventories held for sale in the ordinary course of business are finished goods
of a manufacturing entity or trading goods of a trading units. Standard prod-
ucts available with software developers or data base provider or e-learning
developers for example CD of study material, anti-virus software etc. are also
treated as inventories under Ind AS 2, as these items are held for sales in the
ordinarycourseofbusiness.Similarly,whenadatabaseproviderore-education
provider gives access to subscribers, while the data base is an intangible asset,
the cost of creating access points, if material, is treated as service inventories.
Any unsold access points will be accounted for applying Ind AS 2.
Supplies, loose tools, stores and spare are example of ‘material or supplies to
consume in the production process or in the rendering of services’.
Inventories encompass goods purchased and held for resale including mer-
chandise purchased by a retailer and held for resale, or land and other property
held for resale.
Inventoriesalsoencompassfinishedgoodsproduced,orworkinprogressbeing
produced, by the entity and include materials and supplies awaiting use in the
production process.

20. 124 Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
How to Decode?
The decoding of CWIP, SIP and Stock for the purpose of forensic audit requires
examination of several critical issues. In the following table, the important
critical parameters on which CWIP, SIP and Stock, requires to be verified for
the purpose of forensic audit are given:-
Sr.
No.
Verify/ Examine CWIP SIP Stock
1 Use usable in the busi-
ness
usable as finished
goods
raw materials us-
able in manufac-
turing and finished
goods for sale
2 Period of use morethanoneyear Immediately in fin-
ished goods
during operating
cycle
3 Examine the
details
what constitute of
CWIP
what constitute of
SIP
Item-wisedetailsof
raw materials and
finished goods
4 Business of
entity
are CWIP in line
with business of
entity
are SIP in line with
manufacturing pro-
cess
are the stock of
inventories related
to business
5 Details of
acquisition
details of the par-
ties to whom paid
details of relevant
raw materials and
manufacturing cost
details of the major
suppliersofrawma-
terialsanddetailsof
manufacturingcost
6 Internal control over acquisition of
items of CWIP
over purchases of
relevant items of
raw materials
over sale of fini-
shed goods
7 Verification of
existence
of CWIP items of SIP items of stock
8 Verification of
agreement,
purchase
deeds, delivery
challans etc.
to know genuine-
ness
to know genuine-
ness
to know genuine-
ness
9 Complete
records
to establish actual
amount
to establish actual
amount
to establish actual
amount
10 Verification of
cut off
toknowpropercap-
italization
to know proper SIP to know stock
11 Rights of
ownership
to find out diver-
sion, if any
tofindoutdiversion,
if any
to find out diver-
sion, if any
Contd.

21. 125Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
Sr.
No.
Verify/ Examine CWIP SIP Stock
12 Valuation to know inflated
CWIP
to know inflated SIP to know inflated
valuation
13 Verification of
existence
to find out siphon
of funds
to find out siphon
of funds
to find out siphon
of funds
14 Presentation
and disclosure
in financial
statement
to find out any
mis-statement
to find out any mis-
statement
to find out any mis-
statement
15 Purchases
from related
or connected
party
to find out genu-
ineness
to find out genu-
ineness
to find out genu-
ineness
16 Reconciliation toknowcorrectness
anddiversion,ifany
toknowcorrectness
and diversion, if any
toknowcorrectness
anddiversion,ifany
17 Auditor’s
Report
is there any qualifi-
cationordiscussion
about CWIP
is there any qualifi-
cation or discussion
about SIP
is there any qualifi-
cationordiscussion
about Stock
18 CARO Report - SIP has been physi-
cally verified by the
management
all the inventories
has been physically
verifiedbytheman-
agement
19 Any disclaimer
by auditor
any disclaimer with
respect to CWIP, in-
dicateearlywarning
signs
any disclaimer with
respect to valuation
and quantity indi-
cate early warning
sign
Any disclaimer for
inventory indicate
early warning sign
20. And the most important
After the above process is carried out, the most important part of forensic
audit of CWIP, SIP and stock is to determine, since how long the same has
been shown as CWIP or SIP or stock. The period of construction of building
or assembling plant and machinery, if found to be substantially longer (say
more than 2 years) then genuineness of the same need to be critically exam-
ined, depending upon the size of capitalization and industry. Similarly in the
case of SIP, the process of manufacturing in the terms of time to be kept in
mind while decoding about the genuineness of SIP. In case of stock also, huge
inventory level need to be critically examined by forensic auditor.

22. 126 Capital Work In Progress (CWIP) Stock In Process (SIP) and Stock
CHAPTER 8
The longer and longer the period of CWIP or SIP, is an area of doubt and the
same requires more detailed verification in forensic audit, to find out is it
inflated or there are reasonable reasons for the same.
Case analysis-13
SAL Steel Limited - How CWIP could not see the light of day.
SAL Steel Limited (SAL Steel) is a Gujarat based company incorporated for
backward integration project for Shah Alloys Limited. The finished products of
SAL Steel become the raw material for Shah Alloys Limited and SAL Steel is a
coal based sponge iron producer using coal as reductant, as disclosed by the
company in its website www.salsteel.co.in.
On the perusal of the annual report as available on the website of the SAL Steel,
it has been found that for FY 2009 to FY 2014, substantial amount has been
shown as Capital Work In Progress. In the Box 43 below, the details of CWIP for
FY 2009 to FY 2014 are given:
BOX 43
SAL STEEL LIMITED
BALANCE SHEET - FIXED ASSETS FOR FY 2009 TO FY 2014
(` in crore)
Particulars FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014
(1) Non-current assets
(a) Fixed assets
(i) Tangible assets 206.34 187.23 169.07 152.91 173.76 156.22
(ii) Intangible assets - - - 0.43 0.20 0.06
(iii) Capital work in
progress 127.08 137.68 169.31 134.04 104.00 103.89
Total 333.42 324.91 338.38 287.38 277.96 260.17
Breakup of the CWIP
Building and plant & machin-
ery Not
avail-
able
Not
avail-
able
Not
avail-
able
80.72 63.60 63.49
Pre-operative expenses 36.30 26.48 26.48
Amount of borrowing cost
capitalized 17.02 13.92 13.92
Total 127.08 137.68 169.31 134.04 104.00 103.89
(Box Contd.)

23. ThePresentPublicationistheLatestEdition&isupdatedwithallamendmentsand
legalpositionuptoJuly2020.
Thisbookfocusesonadetailed-commentaryandstep-by-stepapproachfortheFo-
rensicAuditoffinancialtransactions.ItalsodealswitheachandeveryaspectofFo-
rensicAuditofvariousitemsofstatementofProfit&LossandBalanceSheet.
UnderstandingtheForensicAuditisnotcomplete,withoutactualCaseAnalysisand
thisbookincludesanalysisofactualcompanycasesrelatingtoForensicAudit,
whereeitherfraudormisrepresentationofinformationisfound.Withthehelpof
CaseAnalysis,howtoachievethemaximum objectiveofForensicAudit,hasbeen
explainedinalucidlanguagewithstepbystepapproach.
EachpartofthisbookdealswiththediffeEachpartofthisbookdealswiththedifferentsegmentsoftheforensicauditand
eachparthasbeendevisedcarefully,keepinginmind-“Maximum Result”andwith
anobjectivethattherealpurposeofForensicAuditisserved.
Thisbookdealswith–
Misstatementofinformationinfinancialstatement
Incorrectdetailsinfinancialstatement
Diversionoffundsbyanentity