Federal-Mogul Motorparts India Limited

Fraud risk discussion

Memorandum
Audit team:
Anamitra Das (Engagement Partner)
Ankit Mehra (Director)
Shankar Goel (manager)
Akshay Nogriya(Assisstant Manager)
Rahul Khaware (In-charge Accountant)
Raghav Bhatnagar (Assistant Accountant)

Purpose
The purpose of this memo is to document the discussions and actions taken
to address the requirements of Standard on Auditing 240 – The Auditors
Responsibility to Consider Fraud and Error in an Audit of Financial
Statement. Key aspects being addressed and documented per the
requirements of SA 240 include:

 A discussion among the engagement team regarding the risks of fraud

 Obtaining necessary information to identify risks of fraud
 Using information to identify risks of fraud
 Assessing identified risks of fraud after considering the entity’s
programs and controls that address the risks
 Responding to the results of the assessments

SA 240 includes two types of misstatements as a result of fraud,

misstatements arising from fraudulent financial reporting and misstatements
arising from misappropriation of assets. The discussions and actions taken
by the engagement team will address both types of fraud.

The audit team understands the importance of fraud risk assessment and the
impact it can have on the financial statements. The audit team plans to
perform procedures to obtain reasonable assurance about whether the
financial statements are free of material misstatement, whether caused by
error or fraud.

Through the discussion points here below the audit team aims to identify
risk factors and establish responses to mitigate the risk by altering audit
procedures to address the responses.

Incentive/Pressure to commit fraud

1. High vulnerability to rapid changes, such as changes in technology,

product obsolescence.

1. The Company pays MBO (Management by objective) to level above

Deputy General Manager and above and MIP (Management Incentive
Plan) to Directors based on the eligibility criteria (individual
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Fraud risk discussion

performance and company performance). These criteria are not
specific to achieving targets relating to specific activities of the entity.

Opportunities to commit fraud

1. The Company has significant related party transaction with its holding
company, where there is an opportunity to control the prices to inflate
results.

2. Following are the areas where estimates are used by management to

record provisions:
a) Provision for liability on account of e-coupons, Trade discounts
b) Provision for regulatory matters (comprising of provision for Tax
and Indirect tax litigations, assessments and other misc. labor related
matters)

Attitudes/ ability to rationalize the fraudulent

1. Disregard for the need for monitoring or reducing risks related to

misappropriations of assets

Justification for committing the fraud

We have marked ‘entity has operations in higher-risk

geographies’ as a risk indicator in the section “Risk Indicators”
since the company has its operations in India which is ranked the 87 th
country with a score of 3.3 by the Corruption Perceptions Index. A
country/territory's score indicates the perceived level of public sector
corruption on a scale of 0 - 10, where 0 means that a country is
perceived as highly corrupt and 10 means that a country is perceived
as very clean. A country's rank indicates its position relative to the
other countries/territories included in the index.

Following are the areas associated with this selection of risk

indicator:

1. Unauthorised transactions
2. Dubious payments to vendors
3. Risks in relation to litigations and cases related to regulatory matters.

Company has established following controls for prevention of risk

Per discussion with the client and understanding of the business and
financials, following observations were noted:
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Fraud risk discussion

1. The Company is a profit making entity with profits consistent year on
year.
2. Company has a process of preparing monthly MIS which is reviewed
by top management
3. The transactions are regulated by Parent Company and ultimate
holding Company in US through monitoring of budgets and MIS.
4. Company has a group policy for vendor selection process wherein
payments are made to only approved vendors
5. Company has a detailed approved Delegation of Authority (DOA)
matrix where in authority for each individual is defined and
transactions are passed as per DOA.
6. Company has internal audit function and has engaged independent
consultants for the same
7. The Company has engaged reputed lawyers and legal consultants to
resolve it’s ligitations and gets assessments done on a regular basis.

Procedures performed by Engagement Team

1. Engagement team will perform Journal Entry testing inorder to

identify any frauds if present.
2. As a part of substantive procedures we will be performing procedures
around asset authorization and procurement to address risk.
3. We will obtain independent confirmations from lawyers/attorneys.

A discussion among the engagement team regarding the risks of

fraud

Based on previous years’ experience and other developments audit team

had a brain storming session and identified the below areas which are
susceptible to fraud and may lead to material misstatement to financial
information and misappropriation of assets:-

1) Inventory
2) Fixed assets
3) Employee expenses
4) Operating expenses
5) Revenue cut off
6) Journal entry authorization
7) Accounting Estimates
8) Taxes

Further in respect of IT processing controls, management uses SAP for their

accounting purposes. Company gets it IT control testing done on annual
basis.
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Fraud risk discussion

Obtaining necessary information to identify risks of fraud and using
information to identify risks of fraud

Based on above areas being identified, inquiries were being made with the
management in respect of surrounding controls in these areas and audit
procedures to be performed were being identified:-

Management controls

1) There are no cash collection being made at any of the locations

2) All the collection are being centralized at Corporate and in case of
some cheques received at units, same are being sent to Corporate for
further action.
3) All the vendor payments are being centralized except for some local
vendor payments being made from respective plants.
4) All employee re-imbursements are being made through petty cash
5) Frequent reconciliation of bank accounts
6) No cash incentives are being made.
7) No history of any misstatement or fraud in this area.
8) Payments are being authorized as per the designed authorization
matrix.

Audit procedures

Risk Assessmen
t
Misappropriation of asset Low
Misstatement in financial Low
statement

Based on discussion with the management and existing controls risk we will
perform below procedures:-

1) Bank reconciliation will be verified with supporting documents

Inventory – (valuation and existence)

Person with whom discussion held : Ms. Saranya Devi Finance Controller

Management controls
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Fraud risk discussion

Existence controls
1) Movement of inventory is being traced through SAP
2) Adequate safeguard is in place towards thefts from employees
towards physical checks during movement from the premises
3) Wall to wall annual verification is being conducted at all the locations
at or near to period end.
4) No major adjustments have been observed as per physical and as per
books of accounts in the past.
5) No history of any misstatement or fraud in this area.
6) Finished goods inventory are being duly tagged in term of nature,
timing of production and quantity of product.

Valuation controls
1) Provision towards slow and non-moving inventory is being done on the
basis of global policy (which factors estimated sales and actual sales)
2) Inventory in WIP is being assessed based on the physical verification
at various stages These stages are clearly identified and locations
defined in SAP as well.

Audit procedures

Risk Assessment
Misappropriation of asset Medium
Misstatement in financial High
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

Existence controls
1) Wall to wall physical verification will be done at or near end along
with the Company personnel at the location being selected on
sampling basis.
2) Purchase cut off procedures will be done to ensure that the goods
being received or where the risk has been transferred as per terms
are duly accounted for in the inventory.
3) Additionally analytical procedures (turnover ratios etc) will also be
performed.

Valuation controls
1) Valuation will be checked at the year-end in thorough details.
2) All the estimates will be re-assessed as per the group policy
3) Analytical procedures will be made with comparative periods.
4) Completeness test of the overhead allocation will be performed.
5) Provision towards net valuation will be assessed on qualitative basis.
6) Any change in estimate as compared to last year will be inquired in
details.
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Fraud risk discussion

7) Physical quantity verified by us will be reconciled with the inventory
being valued at the year end.

Fixed assets

Person with whom discussion held : Ms. Saranya Dev Finance controller

Management controls

Existence controls
1) Movement of fixed assets is taced through SAP
2) Fixed assets are being serially numbered.
3) Fixed assets primarily comprises of heavy non moveable machinery
and do not carry risk of being stolen. Only laptops, desktop and office
equipment are prone of being stolen for which adequate safeguard is
in place.
4) Adequate safeguard is in place towards thefts from employees by way
of physical checks during movement from the premises.
5) Physical verification of assets is being conducted in a phased manner
over period of three years.
6) Physical verification is also being conducted by the internal auditors
on periodic basis.
7) No major adjustments have been observed as per physical and as per
books of accounts in the past.
8) No history of any misstatement or fraud in this area.

Other controls over valuation

1) All the acquisition are being per-approved as per authorization matrix
2) Depreciation is being charged as per FM Group policy and is being
done through automated system run.
3) Adequate controls are in place towards accounting for acquisition
cost.
4) No major audit observation has been observed in this area
5) Assessment of impairment is being done over assets on each reporting
period.

Audit procedures

Risk Assessment
Misappropriation of asset Low
Misstatement of financial Medium
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

Existence controls
1) Fixed assets verification report will be taken from the management
and any major observation and adjustment will be inquired into.
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Fraud risk discussion

Valuation controls
1) Additions will be vouched on sample basis along with supporting
2) Authorisation for acquisition and related approval will be checked.
3) Deprecation will be rationalized as per accounting policies.
4) Inquiries will be made towards impairment indicators based on
operational efficiency, management future plans and actual utilization
as compared to actual capacity.

Employee compensation

Person with whom discussion held : HR Head and HR team at Chennai

Management controls

1) Head count details are being maintained

2) Access cards are being maintained and attendance is being marked on
basis of biometric devices.
3) Employee master files are being maintained with the outsource
consultant Hewitt.
4) Processing of salary is done by Hewitt.
5) Provision towards post-retirement benefits and leave encashment is
being done on the basis of valuation done by Actuary and no manual
intervention is being done by the management.
6) Hewitt is a well-known consultant, they have adequate controls over
confidential employee related information.
7) Employees are being made aware of the Company ethical policy and
are being encouraged to raise the relevant issues well within time.
8) Never had any audit observation towards fictitious payments being
made to employees.

Audit procedures

Risk Assessment
Misappropriation of asset NA
Misstatement of financial Low
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

1) Walk through of employee will be done at each location

2) Actuarial assumptions will be tested and will be checked for
consistency.
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Operating expenses

Person with whom discussion held : Ms. Saranya Dev Finance controller

Management controls

1) Expenses are being authorized as per the approved authorization

matrix (Refer hard for the same)
2) The access to system is granted as per the security access controls.
3) All the vendors master creation is being centralized and identification
details are being taken by each vendor to check the authenticity of the
vendor.
4) Vendor centralization ensure the payment is being to authorized
personnel only
5) All vendor payments are being made through cheques and in
centralized at Corporate to have better controls except for small
vendor being made at respective plants.
6) Provision for respective expenses is being made on monthly basis,
closely in line with the actual expenses.

Audit procedures

Risk Assessment
Misappropriation of asset Low
Misstatement of financial Medium
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

1) Search for unrecorded liability will be done for payment in

subsequent period.
2) Provision made towards expenses will be compared with the last year
provision and actual payment expense in the subsequent period
3) Vendor testing will be done through walkthrough over new vendors,
vendors discontinued and continuing vendors.
4) Expenses like. Legal and professional and rates and taxes will be
checked in details to assess the nature of payments being made and to
see if payment are being made towards litigation being disclosed.
5) Authenticity, authorisation and accuracy will be checked for regular
and unusual expenses on sample basis to ensure the existing controls
and if any fictitious payments being made.
6) Cheque cut off procedures will be done to ensure the completeness of
the payments are duly accounted for.

Indirect taxes
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Fraud risk discussion

Person with whom discussion held : Ms. Saranya Devi Finance controller

Management controls

1) Reconciliation is being done on periodic basis with the amount due

and returns being filed
2) Tax provision is being handled by respective tax manager at each
location and tax head at Head office.
3) Consultants are being hired in case of any litigations are to be filed

Audit procedures

Risk Assessment
Misappropriation of asset NA
Misstatement of financial High
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

1) Monthly reconciliation will be reviewed with the regulatory filings

2) Deposit of amount due will be checked with challan
3) Expenses like. Legal and professional and rates and taxes will be
checked in details to assess the nature of payments being made
and to see if payment are being made towards litigation being
disclosed.
4) Notices received during the period will be reviewed and consulted
with indirect tax team internally to assess the expected outcomes
and related effects

Revenue Cut off

Person with whom discussion held : Ms. Saranya Devi Finance controller

Management controls

1) Documented policy is in place towards recognition criteria on delivery

based .
2) Revenue is being recognized on actual delivery of goods.
3) Delivery of goods is being cross checked with the delivery
acknowledgement.
4) Reversal is being made for goods not delivered at the reporting
period.
5) No adjustment entry has been observed in terms of in-correct revenue
recognition.

Audit procedures
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Fraud risk discussion

Risk Assessment
Misappropriation of asset NA
Misstatement of financial High
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

1) Revenue cut off procedure will be performed in details at the

December end and also cut off will be ensured during the stock count
at the respective location.
2) Delivery acknowledgment will be checked with the period dispatches
to ensure correctness
3) Period end sales will be specifically scrutinized to ensure that no
fictitious sales are being recorded.
4) Reversal made on non-delivery at period end will be checked to
ensure completeness.

Journal entry (JE) authorization

Person with whom discussion held : Ms. Saranya Devi Finance controller

Management controls

1) Journal entries are being authorized as per the approved

authorization matrix (Refer hard file)
2) The access to system is granted as per the security access controls
3) No unusual entries are being passed without prior authority.

Audit procedures

Risk Assessment
Misappropriation of asset NA
Misstatement of financial High
statement

Based on discussion with the management and existing controls, we will

perform below procedures:-

1) Completeness check on JE dump will be ensured.

2) Period end entries will be specifically checked.
3) JE testing will be performed on selected criteria to ensure the unusual
nature of entries. Proper authentication will be checked.
- Entries with round numbers
- Entries passed on non-working days and on Sundays (Saturday
being normally a working day at plants)
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Fraud risk discussion

- Entries passed by an unathorised person or by person (who are
eligible but normally doesn’t record entries (e.g. CFO, Plant
Controller etc)
- Shift of authority in case of non-availability of authorized person.

Accounting Estimates

Financial statements include certain estimates that might be significant to

the overall results of the Company. These estimates include items like
provision for debtors, accrual for discounts (TO discounts, Fitment coupons,
Dealer Incentives etc), useful lives of debtors, litigation assessments
inventory valuation etc. involve subjective judgments or estimates. The
Company’s processes of developing such estimates are reviewed by the
senior management and will be subject to review by the auditors. The
Company’s senior management has competitive personnel to ensure such
judgments are appropriately accounted for. Audit team will do detailed
review of significant estimates and ensure the appropriateness of the same
and its comparison with the previous period estimates

Members of local management with whom the discussions were held:

Name: Responsibility: Initials:

Ms. Saranya Dev Finance controller AKP

The following enquiries were made;

1. Obtain an understanding of the accounting and internal control

systems management has put in place to address such risk.
The management’s assessment of risk material misstatement in the
financial statements as a result of fraud is low. As discussed in Risk of
management override control, the management of the company also
undertakes internal audits. Any finding that arise as a result of such review
during the year, is discussed with the management and the responsible
person in-charge and remediation steps are initiated at the earliest which
are further re-validated in next year.

2. Obtain knowledge of management's understanding regarding the

accounting and internal control systems in place to prevent and detect
error.

Management believes that the present organizational structure of the

Company is effective enough to prevent, detect and/ or deter occurrence of
any fraud in the organization. The system is characterized by the following:

1. The Company has a system of inbuilt internal checks wherein job of each
employee is checked/ reviewed by another person as a part of the job
profile.
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Fraud risk discussion

2. The Company has a well-established system of authorisation matrix

(delegation of power). All the transaction entered into by the company is
routed through the said authorisation matrix.

3. The company carries out internal audit on regular basis

Further, the Company has established the following specific procedures in
respect of the following areas:
1. Frequent physical verification of inventory at periodic intervals.
2. Expense claims to be accompanied by adequate supporting vouchers /
bills and approved as per the approval matrix of the Company.
3. Bank reconciliations at frequent intervals
4. No cash purchases

3. Determine whether management is aware of any known fraud that has

affected the entity or suspected fraud that the entity is investigating.

Per discussion with the client/enquiries made, no fraud was reported during
the current year, nor is there a suspect or investigation of the same under
process.

Enquiries were also made of the management in respect of any regulatory

investigations and non compliance with any laws or regulations or
accusations of fraud involving owners or management.

4. Enquire whether there are particular subsidiary locations, business

segments, types of transactions, account balances or financial
statement categories where the possibility of error may be high, or
where fraud risk factors may exist, and how they are being addressed
by management.

Management is of the opinion that the Company has set up an adequate

internal control system commensurate with the size and nature of
operations of the Company and no risk of unnoticed fraud is likely to exist.

5. Enquire about the entity's internal audit function and whether

internal audit has identified fraud or any serious weaknesses in the
system of internal control.

Company has sound internal control system and company has interal audit
function and engaged independent consultant for the same.

6. How management communicates to employees its view on responsible

business practices and ethical behavior, such as through ethics
policies or codes of conduct.
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Fraud risk discussion

The Company has an established ‘Code of conduct’ which is applicable to

all employees of the Company. The primary area covered by this code of
conduct is guidance on ethical standards relating to conflict of interest,
treatment of business opportunities etc. The primary areas covered by this
documented code of conduct are:
1. Guidance on ethical standards relating to conflict of interest, treatment
of business opportunities etc.
2. Procedure for annual affirmations to the Code of conduct by Directors
and the senior management.

7. What are the controls that the management have on recording journal
entries? How is it ensured that the journal entries are passed only by
authorised individuals and are reviewed by
a responsible authority?

There are individuals who have been assigned responsibilities to initiate

record and approve the JEs. There are user access passwords which
restricts unauthorized access.

8. Explanations for significant or unusual fluctuations or anomalies, if

any, brought out by our preliminary analytical procedures.

Preliminary analytical procedures were carried out on the basis of draft

first cut financials. Most of the variances could be explained on the basis of
the events that occurred during the year and no unusual fluctuations were
noted, considering the overall slowdown in the economy.

9. Awareness or allegations of fraud, errors, non compliance with laws

or regulations or other irregularities during the period.

Per discussion with client, no allegations of fraud or errors have been

reported during the period
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Fraud risk discussion

Overstatement of As mentioned above, there are chances The audit team shall perfo
inventories that overheads may not be allocated testing of valuation of
properly and thus leading to distorted inventories and will ensur
inventory number that overheads are allocat
appropriately.
Recorded receivables The company may not make adequate The audit team shall
not valid provision for doubtful debts and debtors scrutinize debtors ageing
does not exist. and identify potential
provisions. Also team will
circularize independent
debtors confirmations
Overstatement of Fictitious sales Team will circularize
revenue independent debtors
confirmations invoice wise
We will verify the
completeness of revenue
will perform cut off
procedures and will also
perform excise
reconciliation.

Misappropriation of Assets

Following item are most susceptible to misappropriation:

• Inventory
Misappropriation of the above assets may happen primarily through
embezzlement/theft.

However, we understand that management has implemented following

controls:

Controls implemented to safeguard Cash/Bank:

(A) Bar on issue of bearer cheques
(B) Bank reconciliation at frequent intervals
(C) Expense claims to be accompanied by adequate supporting
vouchers
(D) No cash purchases
(E) Prohibition on cash collection from customers

Controls implemented to safeguard Inventory:

•Proper authorization procedures are defined and followed for inter location
transfer of inventory
•Implementation of ERP to track movement of stock and review of plant’s
financial statements by the management on a periodic basis
•Periodic physical verification of stock and appropriate level of review;
ensuring proper adjustment in the books of accounts
•Damaged goods requires authorization before disposal
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Fraud risk discussion

Significant Fraud Risk Factors that may result in the risk of Material
Misstatement due to Fraud:
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Fraud risk discussion

Particulars Fraud risk factors Planned audit procedures
Management i. Management bias in Review the Company fraud risk
override of measuring management assessment and internal controls to
controls estimates mitigate the risks identified
(Presumed ii. Journal entries passed Consider the potential for bias in
fraud risk) close to the reporting judgments and estimates, including
period performing retrospective analysis
Perform tests of journal entries
particularly those passed at year-end
Evaluate identified audit adjustments
(recorded and passed) for potential
fraud
Consider the impact of the identified
control deficiencies for potential frau

Excessive Profitability or trend level Engage in periodic fraud discussio

pressure expectations of with certain members of sen
exists for Investment analysts, management and others, including t
management creditors and others audit committee as appropriate
to meet the Identify unusual trends in accou
requirements balances and ratios
or Perform tests of journal entr
expectations particularly those passed at year-end
of third Consider the potential for bias
parties judgments and estimates, includi
performing retrospective analysis
Evaluate identified audit adjustmen
(recorded and passed) for potent
fraud
Consider the impact of the identifi
control deficiencies for potential frau
Compare actual performance with t
anticipated performance (such
budgets, forecast, etc.)

Perform Cut offs procedures. The tea

Misstatements arising from fraudulent will obtain the first 5 and last 5 sa
Revenue financial reporting invoices and check the dispat
Recognition documents for the same.
(Presumed
Fraud Risk)