New Year Resolution For Auditors: Bring Back Trust In The Numbers

2019 was the accounting community’s annus horribilis..Consider the happenings in this year:.· The Serious Fraud Investigation Office filed a charge sheet against IL&FS Financial Services also accusing the auditors, BSR & Co LLP and Deloitte Haskins & Sells LLP of helping to conceal information and falsify accounts. Related to this, the Ministry of Corporate Affairs sought a five-year ban on the two audit firms.· The National Financial Reporting Authority published its first-ever audit quality review pointing out serious shortcomings in Deloitte’s audit of IFIN in financial year 2017-18. The report gave us the complicated backstory of an audit.· The Securities Appellate Tribunal (SAT) overturned SEBI’s order on Price Waterhouse banning it from auditing listed companies for two years because of the poor quality of the Satyam Computer audit. The audit firm’s joy was short-lived, because in less than two months the Supreme Court stayed SAT’s acquittal of PW.· The Mumbai Police arrested two partners of S V Ghatalia & Co, the statutory auditors of National Spot Exchange Limited, for allegedly failing to flag lack of internal control mechanism in the exchange and “conspiring” with NSEL to project a “healthy picture”.· The Mumbai Police arrested two statutory auditors and a concurrent auditor of Punjab & Maharashtra Cooperative Bank who allegedly had not raised red-flags over suspicious entries in its books.· The Reserve Bank of India banned S R Batliboi & Co from auditing banks for two years “due to lapses in a statutory audit carried out by the firm”, reportedly over the divergence in non-performing assets reported by Yes Bank Ltd.· A record number of auditors resigned from NSE-listed companies in April- September 2019. The companies (auditors) included Reliance Capital Ltd. and Reliance Home Finance Ltd. (both Price Waterhouse), Dewan Housing Finance Corporation Ltd. (Deloitte), IL&FS Engineering & Construction Co. Ltd. (BSR and Associates LLP) and Infibeam Avenues Ltd. (SRBC & Co LLP, this was a termination).· The Securities and Exchange Board of India issued guidelines requiring auditors of listed companies to complete the quarterly limited review and inform the chairman of the audit committee of their concerns before resignation. .I have not seen actions of this nature, scale and speed from the government and the regulators for as long as I can remember. The clichéd epithet “unprecedented” suits each of them. Many of the changes in the legal and regulatory environment are irreversible. What explains the drastic response of the state and how can the accounting community protect itself?.Business failure is a train wreck in slow motion, but auditors should know earlier than investors..Often, a company’s auditors have an intuition of an impending business collapse. Their unique understanding of accounting, finance, business and law gives them insights that are unavailable to others. Slowing economy, rising interest rates, falling customer orders, mounting inventories, increasing unpaid supplier invoices, excessive borrowing, default on principal and interest payments, and lower capacity utilisation are leading indicators of trouble..A watchful auditor would look for management’s attempts to overstate the financial results in order to deflect attention from business problems. There are tell-tale signs of manipulation such as aggressive revenue recognition, lower depreciation expense, inflation of inventory value, inexplicable changes in accounting methods and estimates, and huge off-balance sheet liabilities, contingent liabilities and commitments..If only the auditor cares to look around..A corporate collapse resulting from business failure is not the auditor’s fault. However, the auditor should share the blame for failure to report violations of accounting principles and standards designed to hide a business failure..Questioning whether a troubled business is a going concern is a powerful weapon available to the auditor. Unfortunately, that weapon is rarely deployed with the result that investors, lenders and others are not forewarned about the impending train wreck. Rightly, auditors have to take the flak after a collapse..Is NFRA Being Undermined?.Independence, Audit Quality And Responsibility.Independence is the cornerstone of auditing..There is no question that competence is important. Competence is a skill, so it can be acquired but independence is a personal and professional value. Unfortunately, since companies see auditing as nothing more than a burden, they feel it should be got rid of by paying a pittance. Therefore, auditing is destined to be a low-price activity. Auditors who are keenly aware of this situation strive to make themselves more relevant, and thereby earn more from the companies they audit, by providing non-audit services to them. The lucre that non-audit services offer is simply too tempting. As a result, unprofitable, underappreciated, and boring audit is nothing more than a gateway to the promise of riches from unrelated work. End of auditor independence..Lack of independence leads to lower audit quality..The argument goes as follows: since I (the auditor) am not going to do and say what I should, I may as well do the bare minimum while taking care to create the appearance of having done a good audit in order to avoid punishment for low quality, if detected. So the auditor sets up a system of box-ticking that has the form of auditing but with little substance. Management, boards, and often external advisers such as lawyers, valuers, rating agencies and investment bankers are willing parties in this charade and farce called auditing. Of course, everyone gets their share of the bounty. In these circumstances, decision-makers may be no worse off if they use unaudited financial statements..Clearly, auditors lack a sense of responsibility to those who use the financial statements examined by them. This is because they think of corporate management as their “client”. The truth is investors, lenders and other users of the financial statements are their real clients. .In fact, the purpose of an audit is to protect them (investors) from management’s misdeeds. In a perverse twist of this position, auditors have come to view management as their client and investors as a nobody..The New Year’s Resolution.The sobering list at the beginning of this article indicates that the tide has turned at last and for all time to come. The systematic suppression of non-performing assets by banks over many years and the recent unravelling of the IL&FS group and DHFL has led to an extraordinary contraction in credit. This is seen by many observers as a major cause of the ongoing economic slowdown. Therefore, it cannot be business as usual..I would commend the following new year’s resolution to auditors: I shall bring back trust in the financial statements. To get there, I shall.maintain my independence at all costs;overcome my addiction to providing non-audit services to companies whose financial statements I audit;think of the mostly invisible users of the financial statements I audit as my real clients,give early warnings of impending problems by questioning the going-concern assumption, andraise my audit fee to an economical level consistent with the risk of fraud and other misstatement in the financial statements..R Narayanaswamy is Professor of Finance and Accounting at Indian Institute of Management, Bangalore..The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team..Form But No Substance In Deloitte’s IFIN Audit, Says R Narayanaswamy

New Year Resolution For Auditors: Bring Back Trust In The Numbers

Clearly, auditors lack a sense of responsibility to those who use the financial statements examined by them.

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