AYN454 Fraud And Investigation : Essay Fountain

Question:

Background

On 7 January 2009, the chairman of Indian IT company, Satyam Systems resigned as well as confessing to manipulating the accounts to the extent of approximately Rs 14,162 crore or US $1.04 billion.

Your Task

It is 1 July 2008 and you have just been appointed Head of Internal Audit at Satyam in India.  You have not previously worked for Satyam and on your first day in the office, members of your new internal audit team welcome you by raising concerns about a number of red flags which they believe indicate fraud is occurring.

As the new Head of Internal Audit:

  • Set out three major fraud red flags that concern you at Satyam and explain why these red flags raise concern?
  • How would you investigate the red flags to determine if fraud was occurring?
 

Answer:

Introduction To Satyam Scam

Satyam Computer Services Ltd. is an information technology company incorporated in 1987 based in Hyderabad, India that offers services like software development and software integration. The company was listed on BSE in 1991 and on the New York Stock Exchange in 2001. It is a global company that operates in 65 countries and the first Indian company to be registered on three international stock exchanges (NYSE, DOW Jones and EURONEXT). Satyam Computer Services Ltd. has been one of the fastest growing IT companies of India in the past years (Alvarez, 2013). It has won numerous awards for its services, corporate governance and corporate accountability.

As on July 1, 2008, there are particular concerns regarding the books of accounts and the booming performance of Satyam Computer Services Ltd. These concerns may prove to be an indication of an upcoming fraud and require urgent attention. In particular, I believe that the books of accounts are being manipulated and the revenues, cash balances and the profits are being overstated. This act is falsely representing the financial strength of the company to stakeholders and the world thereby inciting huge shareholders’ equity and investments and increase in the company’s share prices. The growing unprecedented cash balances and revenues require a proper background check which may reveal intricate concepts. In 2006, the revenues crossed $1 billion and have crossed $2 billion this year and the company claims a cash balance of $1.4 billion as of today. The company is audited by Price Water House Coopers (PwC) but I believe that the auditors at PwC have been incompetent enough to overlook all the fallacies in the books of accounts (Atkinson, 2012). To avoid such an issue, I think it is important to facilitate a rotation of auditors in a certain period of time and an audit board to be appointed for the company to look after the authenticity of the audit, annual reports and thereby, operations of the company to make sure that the company carries out all its endeavors lawfully and respects the established accounting principles and standards.

The following is a table which shows the operating performance of the company for the year ended 31st March, 2008:

Particulars

Amount (Rupees in millions)

Net sales

81373

Operating Profit

20857

Net Profit

17157

Operating Cash flow

13709

ROCE (%)

29.57

ROE (%)

26.12

Major Fraud Red Flags

Fake Deposits And Cash Value

I fear that the bank balances are misrepresented in the books of accounts. These balances may have risen from the fake bank fixed deposit receipts which prove the presence of deposits with the respective banks which were supposedly never made (Girard, 2014). Fake balances to be shown in the balance sheet and the profit and loss statement of the company generate from fake fixed deposits with the banks with which no such deposits are made. This means that Satyam Computer Services Ltd. Is creating fake customers of its services and creating fake invoices to show fake income from them backed by fake deposits thereby, creating fake cash (Mattessich, 2016).

Any rational company with such a huge amount of cash at hand would have either invested it or paid the excess cash to its shareholders. Therefore, presence of the huge amount is itself a red flag implying towards an upcoming fraud.

The following is an extract of cash items from Sat yam’s income statement and balance sheet:

Items

Amount

Cash and Bank balances

5361

Accrued Interest on Bank FDs

376.5

Debtors

2651

Fixed deposits

3318

 

The fixed deposits shown here are nonexistent and so is the accrued interest on fixed deposits which can be a strategy to avoid the detection of the nonexistent fixed deposits and falsely prove its presence.

 

Investigation Of Fake Deposits And Cash Value

These are the bank statements that are being provided to the audit team to verify the balances present in the books of accounts of Satyam Computer Services Ltd. These bank statements which are being provided to them by the chairman Mr. Ramalinga Raju. A double check with the help of the banks can prove if these deposits are actually being made or not (Holtzman, 2013). Once the bank statements are provided by the bank, it can be compared with the bank balances showed in the accounts of Satyam Computer Services Ltd. to discern the similarity or the doubted differences between the amounts.

Fake Invoices And Payments

The company is indulged into creating fake invoices and therefore is manipulating the accounts receivable item in the balance sheet. The regular systematic bills of the company are created by an application called Operational Real Time Management through which all the information on associated companies is created and stored (Holtzman, 2013). The Satyam Project Repository (SRP) system generates project IDs and a Project Bill Management System (PBMS) is used to generate bills. The final invoices are generated by an Invoice Management System (IMS). I believe the IMS is being used to represent fake invoices in the system by the following process:

There is a compulsory field in the IMS – Invoice Field Status which has to be filled in order to generate the invoice (Noreen, 2015). Two alphabets are being used in this field. These are ‘H’ and ‘S’ to process the order. The invoices thus created are being hidden from the finance team and all these invoices account for fake invoices that had never actually been in action and are mistreated.

There is a user ID by the name of ‘Super User’ uploaded into the source code of the IMS which has the power of hiding or showing invoices within the system. The invoices that are being hidden by the user ID ‘Super User’ are all anticipated to be fake and their values are being shown in the books of accounts as receivable accounts.

Several fake payments are being made in the name of salaries to fictitious employees. These employees are non existent (Paul, 2014). According the books of accounts, 53000 employees of Satyam Computers are on payroll but I believe that the actual number of employees of Satyam Computers on payroll is 43000 and the rest of them are bogus employees created to show the dispatch of payments in the form of salaries. Therefore, I believe the employee codes being used in the system are bogus to direct fake payments.

Investigation Of Fake Invoices And Payments

These issues need to be addressed with the help of cyber forensics to find out the different ways how the computer systems of the company are being exploited to show fake amounts in the books (Parrino, 2013). An investigation of the entire accounting software system of Satyam Computer Services Ltd. is required in order to find all the loopholes associated with the system and fraudulent practices embedded through the system. It is important that cyber security is made compulsory to prevent any cyber crime or financial crime through cyber security breach.

Fake Sale By Promoters And Fake Intercorporate Payments

A cluster of investment companies has been created to divert payments from Satyam Computer Services Ltd. The estimated number of these companies is 356. The interoperate payments, investments, advances and loans with these companies are being used to reroute payments from Satyam Computer Services Ltd. Satyam Computers is allegedly pulling off projects in the name of fictitious nonexistent companies like Mobitel, Hargreaves, Cellnet (White, 2013). There are several cash flows in the name of interoperate payments with these companies. One such company which has a paid up capital of Rs. 5 lakhs has made an investment of Rs. 90.25 crore and Satyam Computer Services Ltd. has advanced to this company a sloppy loan of Rs. 600 crore.

Another alerting red flag is the fact that the promoters of Satyam Computer Services Ltd. have been substantially reducing their stake holdings every year (Seal, 2012).

The drastic fall in promoters’ stake holdings every year is itself a red flag and raises a question as to why the promoters of the company themselves are selling their stakes gradually. The percentage of promoters’ stake holding in the company which was 25.6 % has gradually been decreasing and is 2.18 % as of today.

The following is a table that shows the sale of stakes by some of the main promoters:

Name of promoters

No. of shares sold

B. Ramalinga Raju

9825000

B. Rama Raju

11318500

B. Suryanarayana Raju

111000

B. Nandini Raju

4047000

B. Radha

3873500

B. Jhasi Rani

100000

B. Pritam Teja

942250

B. Rama Raju (Jr.)

934250

Inspection Of Fake Sale By Promoters And Fake Intercorporate Payments

A proper research about these companies, their existence, activities and transactions with Satyam Computer Services Ltd. is necessary to determine the authenticity of these financial transactions. A background check of these companies, their owners, their financial strength, their shareholders, the services provided by the company, debts and annual profits of these companies, etc. can, if any, reveal any fraudulent activity associated with the companies (Siciliano, 2015).

The monitoring of the huge amounts of money that the promoters are earning from the sale of these stakes can bring out the reasons why they are selling their stakes continuously amidst the growing prosperity of the company (Warren, 2017). The monitoring of these cash balances can lead to the entire plot behind a fraud, if any. The reports obtained from the monitoring process will be testimony to the fact that a fraud is occurring. 

 

References:

Alvarez, F. (2013). Financial statement analysis. Hoboken, N.J.: Wiley.

Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.

Girard, S. L. (2014). Business finance basics. Pompton Plains, NJ: Career Press.

Holtzman, M. (2013). Managerial Accounting For Dummies. Hoboken, NJ: Wiley.

Mattessich, R. (2016). Reality and accounting. [S.I.]: Routledge.

Noreen, E. (2015). The theory of constraints and its implications for management accounting. Great Barrington, MA: North River Press.

Parrino, R. (2013). Fundamentals of Corporate Finance, 2nd Edition. Milton: John Wiley & Sons.

Paul, K. (2014). Managing extreme financial risk. Oxford: Academic Press, Elsevier.

Seal, W. (2012). Management accounting. Maidenhead: McGraw-Hill Higher Education.

Siciliano, G. (2015). Finance for Nonfinancial Managers. New York: McGraw-Hill.

Warren, C. S. (2017). Accounting . [S.I.]: South-Western College Pub

White, T. S. (2013). The 60 minute ABC book. Bedford: Consortium for Advanced Manufacturing International. 

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