Due Diligence, Investigation & Forensic Accounting: formula sheet

Key formulas

Meaning

Due diligence = independent verification of facts and risks of a target before a transaction decision

Use this as the opening line of any definition question.

Financial due diligence

Quality of earnings + assets and liabilities (including contingent and off-balance-sheet) + working capital + cash flows

Checks that reported profits are sustainable and that debt-like items are identified.

Legal due diligence

Title + contracts + litigation + statutory and regulatory compliance + corporate records

Looks at legal ownership, obligations and pending claims.

Tax due diligence

Tax compliance + open assessments and disputes + tax positions + exposure to future demands

Covers direct and indirect taxes.

Operational due diligence

Processes + capacity + supply chain + systems + management and people

Tests whether the business can deliver the projected performance.

Commercial due diligence

Market + customers + competition + growth assumptions

Tests whether the business plan and forecasts are realistic.

Audit versus due diligence

Audit: past financial statements, statutory, opinion on true and fair view. Due diligence: purpose-specific, client-defined scope, forward-looking, report of findings

A favourite comparison question.

Core flow of due diligence

Scope → Planning → Information gathering → Analysis → Red flags → Quantification → Report

Use this sequence as the skeleton of any descriptive answer.

Common types by area

Financial, Tax, Legal, Commercial, Operational, HR, IT, Environmental

Name the type that suits the case; many deals need several.

Typical report content

Purpose and scope + Basis and sources + Limitations + Findings + Impact + Recommendations

There is no fixed statutory format, so show these elements.

Treatment of a red flag

Identify → Probe → Quantify → Report → Recommend protection

Protection can be price cut, indemnity, escrow or a closing condition.

Core logic of an investigation

Purpose → Scope → Plan → Evidence → Findings → Report

Use this as the skeleton for any procedure question.

Audit vs investigation: objective

Audit: opinion on true and fair view | Investigation: establish facts on a specific matter

The most common comparison point in exams.

Audit vs investigation: scope and period

Audit: general, usually one financial year | Investigation: specific, any period needed

Scope of investigation is set by the engagement terms.

Audit vs investigation: who appoints and reports

Audit: statutory or by members | Investigation: by the party needing the facts (management, bank, buyer, court, regulator)

Report goes to the appointing party in the agreed form.

Audit vs investigation: approach

Audit: sampling, risk-based | Investigation: detailed, often 100% checking of the relevant items

Depth is high because the question is narrow.

Net worth method (unexplained income)

Unexplained income = (Closing net worth − Opening net worth) + Living expenses − Known legitimate income

Net worth = total assets − total liabilities, taken at cost. A positive result suggests income from an undisclosed source.

Expenditure method (source and application)

Unexplained income = Total expenditure and asset acquisitions − Known legitimate sources of funds

Useful when assets are spent or consumed rather than held, so net worth barely changes.

Fund tracing logic

Source of funds = Application of funds (every rupee in must be traced to a use)

Used to follow diverted money. Two common approaches are tracing forward from the source and backward from the asset.

Forensic vs statutory audit: core contrast

Statutory audit: true and fair view, sampling, materiality. Forensic: proof of fraud, focused, often full-population testing, no materiality limit

Learn this as a one-line comparison and expand it into a table in your answer.

Fraud triangle

Fraud = Incentive/Pressure + Opportunity + Rationalisation

All three conditions are present together. Removing one reduces the risk.

Fraud diamond

Fraud triangle + Capability

Capability covers position, skill and confidence to commit and conceal the fraud.

Fraud vs error

Fraud = intentional; Error = unintentional

Both cause misstatement. Intent separates them.

Two fraud types relevant to the auditor (SA 240)

Fraudulent financial reporting; Misappropriation of assets

Management fraud is usually the former; employee fraud is usually the latter.

Auditor's stance

Reasonable assurance + professional scepticism

Not absolute assurance. Unavoidable risk of undetected fraud remains, higher for fraud than error because of concealment.

Forensic audit sequence

Acceptance → Planning → Evidence collection → Analysis → Reporting → Testimony

Use this as the skeleton for any process question.

Evidence integrity rule

Identify → Preserve → Image/copy → Analyse the copy → Document chain of custody

Apply to digital evidence. Never analyse the original device or file.

Report content checklist

Engagement and scope + Background + Procedures + Findings with evidence + Conclusion + Limitations

Keep facts separate from opinion. State limitations and any reliance on experts or management information.

Quick revision

• Due diligence is a review of a target or transaction before a decision; it is not a statutory audit opinion.
• Common due diligence areas are financial, tax, legal, commercial and operational.
• Scope and limits of a due diligence or investigation come from the engagement terms, so agree them in writing.
• The due diligence report is addressed to the party who engaged you and states findings, risks and limitations.
• Investigation seeks to establish facts about a specific matter; its scope is narrower and driven by the purpose.
• Forensic accounting combines accounting, auditing and investigative skills to produce evidence usable in legal proceedings.
• The fraud triangle has three elements: pressure (incentive), opportunity and rationalisation.
• Fraud is intentional deception; error is unintentional. Intent is the difference.
• Red flags are warning signs, not proof of fraud; they call for further inquiry.
• Preserve evidence carefully and keep a clear record of how it was obtained and handled.
• Forensic audit reports state facts found, method used, evidence and conclusions without going beyond what the evidence supports.
• Keep confidentiality and professional ethics in mind in every special-purpose engagement.

Common mistakes

• Treating due diligence as the same as a statutory audit. Fix: Remember the differences: purpose, who engages, scope set by the client, focus on risk and future, and no true and fair opinion.
• Naming only financial due diligence as the type. Fix: Always list financial, legal, tax, operational and commercial, and choose the one that fits the case facts.
• Treating due diligence as a statutory audit with a true and fair opinion Fix: State that it is a purpose-specific engagement with agreed scope and findings-based reporting, not a statutory opinion.
• Listing generic steps without linking to the case Fix: Pick the steps that matter for the case facts and refer to the target, the deal and the red flags given.
• Treating an investigation as just a bigger audit. Fix: Always contrast purpose, scope, period, appointment and depth. State that an investigation answers a specific question.
• Giving a generic audit procedure list for a case question. Fix: Tie each step to the case: fund tracing for fraud, repayment capacity for loans, quality of earnings for acquisitions.
• Saying forensic audit gives a true and fair opinion like a statutory audit. Fix: State that forensic work gives findings and evidence on specific matters, not an opinion on true and fair view.
• Applying materiality limits to a forensic examination. Fix: Say that small amounts can matter in forensic work because the aim is to establish fraud, not to judge overall misstatement.
• Treating red flags as proof of fraud. Fix: Say red flags are indicators that raise risk and call for further procedures. The auditor does not make legal determinations.
• Saying the auditor is responsible for preventing fraud. Fix: Prevention and detection rest primarily with management and those charged with governance. The auditor gets reasonable assurance on the financial statements.

Exam tips

• For a 'discuss the types' question, name each type with its focus area and attach one case-based check. Do not stop at a list.
• In case scenarios, underline the risk words (dispute, notice, capacity, market) and map them to a type.
• For audit versus due diligence, write in a two-column style using points on purpose, scope, basis, time focus and output.
• Always mention that scope is set by the engagement letter and that the report goes to the client who engaged you.
• In MCQs, watch for options that say the practitioner gives an audit opinion or guarantees the deal. These are wrong.
• Always name the client and the purpose first. The scope and emphasis depend on them.
• Show stages in order and link each to case facts. Marks go for application.
• For case MCQs, remember that due diligence is not a statutory audit and its scope comes from the engagement terms.