Chapter 17: Due Diligence, Investigation & Forensic Audit
1. Audit vs Investigation vs Due Diligence Comparison
| Parameter | Statutory Audit | Investigation | Due Diligence |
|---|---|---|---|
| Scope & Objective | Express opinion on true & fair view of FS; general purpose. | Establish facts regarding specific allegation / suspicion / fraud. | Evaluate investment/acquisition risks and commercial viability. |
| Attitude / Approach | Professional Skepticism (neither suspicious nor gullible). | Inquisitorial / Suspicious (predicated on assumption of wrongdoing). | Prudent Investor's Lens (commercial & valuation focus). |
| Time Period | Generally 1 Financial Year. | Whatever period is relevant to the issue (can span multiple years). | Historical (3–5 years) + future projections review. |
| Sampling vs 100% | Test-checking / audit sampling permitted. | Detailed, exhaustive examination of relevant records; sampling not appropriate. | Targeted risk-based analysis of key value drivers and liabilities. |
2. Financial Due Diligence (FDD) Focus Areas
Core Objective of Due Diligence
Due diligence enables a prospective buyer or investor to verify assumptions, uncover hidden liabilities, determine normalized earnings, and negotiate price or indemnities before closing a transaction.
| FDD Focus Area | Critical Items Examined by Practitioner |
|---|---|
| Quality of Earnings (QoE) | Adjust EBITDA for non-recurring income/expenses, related party transactions at non-arm's length, owner perks, and aggressive revenue recognition. |
| Hidden / Off-Balance Sheet Liabilities | Tax litigations (GST/Income Tax disputes), unrecorded gratuity/leave encashment liabilities, pending environmental claims, corporate guarantees given for third parties. |
| Working Capital Peg & Cash Debt | Define Target / Normalized Working Capital; identify debt-like items (overdue vendor dues, customer advances, deferred capex payables). |
| Asset Recoverability | Realizability of aged debtors, obsolete inventory valuation, title deeds of properties, intellectual property ownership. |
3. Investigation under Companies Act 2013
| Section | Nature of Investigation | Trigger / Initiating Authority |
|---|---|---|
| Section 210 | Investigation into affairs of company | Central Govt order: (a) on receipt of report of RoC/inspector; (b) on special resolution passed by company; or (c) in public interest. |
| Section 212 | Investigation by Serious Fraud Investigation Office (SFIO) | Central Govt assigns investigation to SFIO if opinion formed that it is necessary in public interest, on request of govt dept, or RoC report. No other agency can proceed with parallel investigation once assigned to SFIO! |
| Section 213 | Investigation on application of members or other persons | NCLT order on application of: ≥100 members or ≥1/10th voting power (having share capital) OR ≥1/5th members (no share capital); showing fraud, misfeasance, or oppression. |
| Section 216 | Investigation into ownership of company | Central Govt appoints inspectors to determine true persons who are financially interested in company or control its policy. |
4. Forensic Accounting & FAIS Standards
The Fraud Triangle (Cressey's Model)
1. Pressure / Incentive: Financial distress, greed, impossible performance targets.
2. Opportunity: Weak internal controls, lack of supervision, override by management.
3. Rationalisation: Justifying fraud ("They underpay me", "I'll return it after next month").
| Forensic Practice Area | Statutory / Technical Guideline |
|---|---|
| Digital Forensics & Chain of Custody | Preserve digital evidence without alteration; bit-stream image created; cryptographic hash value (MD5 / SHA-256) computed before and after imaging to verify integrity in court. |
| ICAI FAIS Standards | Forensic Accounting and Investigation Standards (FAIS 100 to 500 series) provide mandatory framework for planning, evidence collection, interviewing, and reporting in forensic assignments. |
| Forensic Interviewing Techniques | Progressive questioning: Introductory → Informational → Assessment → Closing → Admission-Seeking questions. |