How Auditors Detect / Trap Cash Siphoning : red flagging and documenting evidence

!! Academic Purpose only

🔎 How Auditors Detect / Trap Cash Siphoning

1. Related-Party Transactions (Sec. 40A(2), AS-18 / Ind AS-24)

  • Check disclosures in notes to accounts for related-party names.

  • Verify pricing: Compare payments to related parties vs. market rates.

  • Audit Trail: Match invoices with actual delivery/benefit received.

  • Trap: If related parties are paid more than fair value (inflated expenses), auditor questions management & reports under CARO/Tax Audit (Form 3CD, Clause 23/31).

2. Inflated Expenses

  • Analytical procedures: Compare expense ratios (advertising, consultancy, repairs) vs. past years/industry average.

  • Vouching: Verify supporting bills, contracts, and third-party confirmations.

  • Cash flow check: Expense shown in P&L but no matching service/goods delivered.

  • Trap: Fake vendors or repetitive round invoices without actual service.

3. Round-Tripping of Funds

  • Bank reconciliation: Unusual high-value transactions flowing out and back within short span.

  • Ledger scrutiny: Same set of entities appearing in sales & purchases, or loans given & received.

  • Trap: Circular movement of money without substance → flagged in CARO (“funds advanced and returned”).

4. Mismatch between Profit & Cash Flow

  • High profit but negative OCF (like we discussed).

  • Auditor checks debtor ageing, inventory valuation, advances.

  • Trap: Aggressive sales booked → cash not realized → possible diversion.

5. Third-Party Confirmations

  • Direct confirmation from creditors, lenders, vendors, or related parties.

  • If management resists confirmations → auditor notes “scope limitation.”

  • Trap: If balances differ from client books → possible manipulation.

6. Forensic Techniques (if suspicion is strong)

  • Data analytics: unusual patterns (split payments < ₹20,000 to avoid Section 40A(3)).

  • Benford’s Law analysis (fraud detection in invoice values).

  • KYC of counterparties (fake shell vendors often have same address/phone).

🔹 Auditor’s Reporting Duty

  • CARO 2020 (for companies): Requires reporting on related-party transactions, loans/advances, fund diversion.

  • Form 3CD (Tax Audit): Requires disclosure of related-party payments (Clause 23), cash transactions (Clause 31).

  • If siphoning is suspected → auditor qualifies report or gives Emphasis of Matter.


✅ Summary:
An auditor “traps” cash siphoning by testing related-party payments, verifying expenses, tracking fund flow, seeking confirmations, and reconciling cash flows. Any mismatch or lack of evidence forces management to explain, else auditor qualifies report.



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