Expert verified The forensic audit process in India is used by banks and regulators to catch massive frauds
Explore with us the step by step process of conducting forensic audits in India.
What is a Forensic Audit?
A forensic audit is a detailed investigation into the financial records of an organisation.
However, unlike regular audits, which assess the accuracy of financial statements and compliance with accounting standards, forensic audits are legal in nature and focus on identifying intentional wrongdoing.
They are specialized audits that blend accounting, auditing, investigation, and legal expertise to trace irregular transactions, quantify losses, identify perpetrators, and collect admissible evidence.
Its primary objectives include:
- Detect Fraud and Irregularities: Identify cases of embezzlement, money laundering, bribery, financial statement fraud, and asset misappropriation.
- Quantify Financial Loss: Determine the extent of monetary loss resulting from fraudulent activities.
- Identify Involved Parties: Trace the individuals or entities responsible for the fraud.
- Support Legal Proceedings: Collect and preserve evidence that meets judicial standards for admissibility.
- Assist in Litigation: Serve as expert witnesses and support legal teams with documentation and expert analysis.
When is a Forensic Audit Conducted?
Forensic audits are frequently ordered by courts, regulators, banks, and government authorities, especially when financial misconduct is suspected.
They are usually initiated under the following circumstances:
- Suspicion of Fraud: Triggered by red flags such as unusual transactions, inflated invoices, or sudden financial discrepancies.
- Regulatory Requirement: Mandated by authorities such as SEBI, RBI, SFIO, ED, or CBI in case of suspected corporate misconduct or economic crime.
- Corporate Disputes: Ordered during shareholder conflicts, internal investigations, or M&A due diligence to detect hidden liabilities or mismanagement.
- Banking Sector: Initiated by banks when large loans default or accounts are classified as NPAs under suspicious conditions.
- Insolvency Proceedings: Under the Insolvency and Bankruptcy Code (IBC), to investigate fraudulent transactions by the defaulting company’s management.
- Insurance Fraud: To validate the authenticity of suspicious claims.
- Corruption Cases: To examine financial trails under the Prevention of Corruption Act.
Who Conducts Forensic Audits?
A forensic audit requires specialized experts who know accounting, investigation, law, and digital forensics.
These can be conducted by:
1. Chartered Accountants (CAs) with Forensic Specialization:
Trained to detect fraud, embezzlement, and financial misstatements.
Many CAs complete Certified Forensic Accounting and Fraud Detection (FAFD) courses offered by ICAI.
2. Forensic Audit Firms:
These firms have accountants, investigators, IT specialists, and legal experts, who can perform these specialised audits.
3. Regulators’ Appointed Auditors:
These auditors are usually chosen from a panel of approved forensic audit firms. Regulators include
- RBI (for bank loan defaults and stressed assets).
- SEBI (for stock market and securities fraud).
- MCA/SFIO (for corporate fraud cases).
4. Internal Corporate Forensic Teams:
Large banks and multinational companies have in-house forensic audit divisions.
These teams handle internal fraud, employee misconduct, and vendor scams.
5. Government & Law Enforcement Agencies:
In sensitive cases, law enforcement agencies like CBI, ED, and SFIO conduct forensic audits or work with experts.
They use forensic auditors as part of legal investigations and court proceedings.
Step-by-Step Forensic Audit Process in India
A forensic audit in India is conducted in a structured manner. It goes beyond traditional auditing by gathering legally admissible evidence.
Here’s a six-step forensic audit process, that covers everything from engagement to expert testimony:
Step 1:Pre-Audit Engagement Initiation & Planning
Every forensic audit begins with clearly defining the scope. This stage lays the groundwork for a focused, legally compliant investigation.
Key Activities:
- Receiving the Mandate: Initiated through a formal request from a company, bank, resolution professional, or regulator (e.g., SFIO, SEBI, NCLT).
- Understanding the Allegations: The forensic audit team meets stakeholders to understand the nature and scope of suspected fraud, bribery, fund diversion, etc.
- Defining Scope & Objectives: A documented scope (period under review, departments involved, key suspects) ensures that the audit remains sharply targeted.
- Investigation Planning: A structured plan is created outlining data requirements, target systems, timelines, and roles of each investigator.
- Team Formation: A multidisciplinary team is assembled. Usually includes forensic accountants, legal advisors, IT forensics specialists, and data analysts.
Step 2: Evidence Collection & Preservation
Evidence forms the backbone of any forensic audit. Proper documentation and chain of custody are critical to ensuring that findings are admissible in legal proceedings.
Key Evidence Types:
- Financial records: Invoices, ledger entries, payment vouchers, bank statements
- Digital evidence: Emails, access logs, deleted files, forensic images of devices
- Operational data: Minutes of meetings, employee records, contracts, vendor files
Chain of Custody Protocol
Every piece of evidence is logged meticulously. All essentials – when it was collected, by whom, and how it was handled is documented. This step is mandatory
Digital Forensics
Certified digital forensic experts extract data from computers, servers, mobile devices, and cloud platforms without altering original evidence. Advanced tools are used to retrieve deleted or hidden files and trace user activities.
Step 3: Financial Analysis & Investigation
This is the analytical phase where the audit team uncovers fraud patterns and traces misappropriated assets.
Detailed tracing of funds and financial transactions is performed to identify anomalies, hidden beneficiaries, or misappropriations.
Common Techniques:
- Bank reconciliation and vendor verification
- Round-figure or same-day payments analysis
- Related-party transaction checks
- Benford’s Law for numeric anomalies
- Matching invoices to payments
- Lifestyle analysis vs. declared income
Example: Many loan frauds are uncovered through transaction tracing to shell companies or personal accounts.
Interviews & Interrogations
Interviews are conducted with key employees, vendors, or consultants who may have knowledge of the suspected fraud or irregularities.
Interviews are documented with timestamps, participants, and summaries. Signed statements may also be obtained.
Digital Forensics & IT Investigation
When digital systems are involved, forensic IT specialists investigate unauthorized access, file deletion, manipulation, or cyber misuse.
Corroboration & External Validations
To strengthen findings, auditors seek third-party confirmations and independent data that support or refute the internal records.
This may include Bank confirmations, Supplier/customer letters or Income tax portal traces (Form 26AS, AIS)
External validation is crucial for proving willful fraud or collusion in legal and regulatory proceedings.
Step 4: Reporting the Findings
A professional forensic audit report is the final deliverable that must be defensible in a court of law or regulatory inquiry.
Report Structure
- Executive Summary: Summarizes allegations, findings, and implicated individuals.
- Scope & Methodology: Clarifies what was reviewed and the approach taken.
- Detailed Findings: Presents key evidence, analysis, and data visualizations.
- Conclusion & Recommendations: Indicates whether fraud occurred and suggests remedial action.
- Loss Quantification: Pinpoints the financial loss with calculation support.
Regulators like SEBI and courts expect findings to be evidence-linked, legally defensible, and free from opinionated language.
Step 5: Court Proceedings & Legal Support
Forensic auditors often play a vital post-report role in legal proceedings and dispute resolution.
Auditors may be called by courts (NCLT, Civil, or Criminal) to:
- Explain complex transactions in layman’s terms.
- Defend the methodology and findings.
- Interpret accounting evidence during cross-examination.
The forensic team assists legal counsel by preparing cross-examination questions, reviewing rebuttal evidence, and offering expert opinions in settlement discussions or arbitration.
Step 6: Case Closure & Asset Recovery
While outside the formal scope of auditing, a well-documented forensic report supports actionable outcomes.
Findings can be used to:
- File FIRs with CBI or the Economic Offences Wing (EOW)
- Support civil suits for financial recovery
- Assist regulators (SEBI, MCA, RBI) in pursuing action
In insolvency situations, resolution professionals use forensic reports to:
- Reverse fraudulent transactions under Sections 43–66 of the IBC.
- Challenge preferential or undervalued transactions.
Example Scenario: Forensic Audit in Action
Case: A company defaults on a ₹500 crore loan. The promoters claim the failure was due to market conditions, but the bank suspects siphoning and diversion of funds.
Steps Taken by Forensic Auditors:
- Transaction Mapping: Auditors traced loan funds and found that instead of upgrading machinery, large sums were diverted to questionable “vendor” companies.
- Vendor Due Diligence: Investigation revealed these vendors were shell entities with fake addresses and links to relatives of the company’s promoters.
- Document & Communication Review: Invoices showed inflated project costs. E.g., ₹10 crore machinery billed at ₹25 crore. Emails indicated collusion between management and vendors.
- Lifestyle & Expense Analysis: Audit uncovered misuse of company funds for promoters’ personal luxuries including real estate, foreign travel. These were falsely booked as business expenses.
Outcome:
The forensic report conclusively quantifies that ₹350 crore was deliberately diverted. It provides a clear money trail, linking the siphoned funds directly to the promoters.
Legal Action: With this evidence, the bank files a criminal complaint with the CBI for cheating and criminal conspiracy.
Recovery Proceedings: Simultaneously, the bank initiates civil recovery suits against the company and the promoters personally.
Regulatory Action: The findings are also shared with the SFIO, triggering an investigation into the broader corporate governance fraud at the company.
Major Forensic Audit Cases in India
The Satyam and PNB are two of the most prominent scams that came to light after forensic audits.
Read all about the role of forensic audits in fraud cases here.
FAQs About Forensic Audit Process in India
A forensic audit is an investigation into a company’s financial records to detect fraud, corruption, or mismanagement. It goes beyond normal auditing and is often used as legal evidence in court.
Forensic audits are usually conducted by Chartered Accountants (CAs) with specialized training. Forensic consulting firms, and regulators’ appointed auditors also handle these cases.
A forensic audit is needed when there’s suspicion of fraud, embezzlement, money laundering, or loan diversion. Regulators like RBI and SEBI, law enforcement agencies, banks, or a company’s board can order a forensic audit.
A statutory audit checks if financial statements are accurate and comply with laws. A forensic audit investigates financial crimes and collects evidence for court or regulatory use.
The time frame depends on the case size and complexity. It can take a few weeks for small matters and several months for large corporate frauds.
