Last week I met a few
friends from my accounting fraternity – and the discussions hovered around a
rather difficult recent phenomenon: Whether the audit-clients are becoming more
unethical nowadays? Or is it that the accounting community carrying out audits,
raising themselves from slumber and becoming stricter?
Just think of the scenario:
It is reported that during the five-month period January to May 2018, 32 firms
have resigned as auditors midterm from companies, compared to 36 auditor
resignations in the whole of 2017-18 and 18 in 2016-17. The numbers in earlier
years were all significantly lower. Fearing probable repercussions from
regulatory authorities on corporate governance standards, more auditing firms
are dropping their assignments like hot potatoes.
Deloitte resigned as
auditor of Manpasand Beverages, the producer of MangoSip – one of the largest
mango-drinks in India, after the auditee-company reportedly failed to share key
data. Price Waterhouse (PwC) quit as auditor for construction and infrastructure
company Atlanta Limited. Same happened at Vakrangee Ltd. where PwC quit, citing
concerns to the corporate affairs ministry about the books of accounts, mainly
related to its bullion and jewellery business.
Apart from the
resignations, the audit of many big names have come under stricter ‘audit
opinions’, with auditors flagging off some sticky issues. For instance, at Jet
Airways, L&T Shipbuilding and Reliance Naval and Engineering, auditors have
raised doubts whether these companies can continue as a “going
concern”.
And these are all bad news!
It may be noted that each
auditee, where auditor resignations have taken place, has since then denied any
irregularities, though their clarifications do not exactly answer the doubts
raised by the concerned audit firms.
The key
question is: have the environment changed and made auditors behave more
responsibly? Prima facie, the exodus of auditors
seem to be motivated by the fear of being pulled up by the market-regulator or
worse the company getting caught with their hands stuck in the hanky-panky
bowl.
Do
Corporates Cheat?
The vexed
question is: do businesses swindle? And if they do, then the auditors have a
lot to ponder, plan and perform.
A corporation is an
artificial legal entity – it can buy, sell, borrow, lend and produce – but can
it deceive and deceit? And if a company does cheat, then who should be held
responsible? Is it not the people within who cheat? If the employees of a
company cheat, can the responsibilities of the corporation be far behind?
Be it by choice or
compulsion, the corporate world has not been immune to cheating. Businesses are
a microcosm of our society and are made up of people like you and me. They have
the same strengths and weaknesses as
the people it consists of. Greed has been a major influencer for human
behaviour since long. No wonder, it has been said that many in the corporate
world have the feet of clay.
Auditors will therefore
have to be aware that cheating can and will take place. Some will try to cut
the corners, but many will not. It is the task of the auditors to sift through
the basket of eggs to find the ones which are either rotten or are in the
course of becoming decomposed.
Who is
responsible?
When a corporation commits
fraud, who should be held responsible – the management, the shareholders, the
finance managers or the auditors?
Time and again companies
have been penalised, taken to task and admonished for wrong doing. But the top
management, who would have masterminded the unlawful activity, generally have
got away rather lightly, if not scot-free. Take the example of Jeffrey
Skilling, the ex-CEO of Enron Corporation, who spearheaded one of the worst
accounting frauds in history and destroyed the company and trampled on the
lifelines of thousands of employees. But Skilling got away with a relatively
light punishment. Initially jailed in 2006 for 24 years, but his imprisonment
term was reduced by 10 years, only to walk away soon, a free man by 2019.
Are shareholders, the
ultimate owners of a joint-stock company, responsible for frauds if any? Let us
take a peep into a corporation, by lifting its corporate-veil. While in
theory the shareholders own a company, but in reality it is the directors and
the top management who run a corporation. They decide everything – how much
dividend to declare, how much bonus shares to issue and how much stock options
to be allotted to themselves. Shareholders in general, hardly possess the
ability or the wherewithal to influence corporate’s behavior – negatively or
otherwise, unless of course it’s the controlling shareholders.
Now comes the finance team,
the accountants and most importantly the CFO. Are they responsible? The CFO and
her team, have a lot of responsibility on good governance. When it comes to
doctoring the books of accounts, they would generally have the primary
responsibility. However, there could be frauds committed ‘on’ the corporation,
of which the finance team may not be aware. But for that purpose, a robust
internal control process with concomitant internal audit system needs to be put
into place.
According to the Companies
Act 2013, the introduction of Internal Financial Control (IFC) has ordained the
finance team to ensure orderly and efficient conduct of business, including
adherence to company policies, safeguarding of its assets, prevention and
detection of frauds and errors, accuracy and completeness of accounting records
and timely preparation of reliable financial information. These are all onerous
tasks. In addition, listed companies need to submit a certification from both
the CEO and CFO under Regulation 33 of the SEBI Listing Obligations &
Disclosure Requirements (LODR), 2015 has given an onerous task to the two top
guys. They will need to not only confirm that to their best of knowledge the
financial statements do not contain any materially untrue statements, no
transactions are fraudulent and illegal and they have communicated to the
auditors and the Audit Committee of instances of any significant frauds they
have been aware of.
There is another important
aspect the accounting team needs to consider. Most of the CFO team members
would be employees of an organisation. If the employer desires to carry out
hanky-panky, it is well neigh impossible for most employee-accountants to
negate the ulterior intent of their bosses. And this is the greatest conundrum
which faces most of the accounting community. What do you do when you know
things are not above board? Should you protest? Can you walk out or should you join
the bandwagon to save your skin with the job? Most literature would suggest
that ethics is the king, and being ethical is any accountants’ dharma. But when
the employer pulls the strings of poor governance, little in my view, are the
choices which can be made by the employees.
Now let us shift our
attention to the auditors. What is the level of their responsibility? Can they
take the sanctuary of the accounting reports and statements being ‘true and
fair’, and do not guarantee its complete ‘accuracy’? The primary responsibility
for prevention and detection of fraud lies with the management team. An auditor
do not guarantee that all material misstatements shall be detected. Auditors
opinion on the financial statements is based on the concept of obtaining
reasonable assurance from the documents, records and management team. In addition, if an auditor finds during the
course of audit that fraud has been committed by the company or its employees,
it must be reported immediately.
Let us look at the role of
the Auditors in some more detail.
Auditors
and Auditees
Auditors are the eyes and
ears of the shareholders and their boards. Their financial statements are
relied on by the outside world to take a view on a company’s state of affairs.
Auditors verify whether accounting information and reports have been prepared
appropriately (in fact, it should be prepared accurately subject to accounting
judgements wherever applicable). Auditors are looked upon as protectors of the
interest of the shareholders, creditors and the governments.
However, the trust reposed
on the auditors are sometimes belied and some of them miss out in doing their
duties fairly. And this the challenge the accounting fraternity is currently
fighting against.
Many a times, the auditors
fail to acknowledge that they have the responsibility of detecting impending
financial disaster in a corporation and highlight on ongoing fraud. Time and
again auditors tend to wash their hands off on the plea that they were led up
the garden path by the management, and they believed in what they were told and
showed. This basic tenet may get challenged sooner than later, not only by
public pressure but also by the accounting oversight boards set up by the
various Governments.
It is a fact that some
auditees would try to get a ‘better than actual’ picture certified. Not all
have this tendency but many have. And this is where the ethical standards of
auditors get tested. What does an auditor do when audit fees are at stake? A very
vexed question indeed, which the auditor and accounting community have been
grappling since time immemorial.
Rap on
the knuckles
Prime Minister Narendra
Modi gave Chartered Accountancy community a big jolt through his speech on
Chartered Accountants’ Day on July 1, 2017. The speech powerfully suggested at
CAs’ involvement in money-laundering and tax evasion. He also highlighted the
ICAI’s apparent poor record of disciplining its members. Used to being lauded
for its efforts in “nation-building”, the CA community was stunned by the Prime
Minister’s candor and the threat of severe action against errant CAs. This was
a clarion call to get the CA community on board with ethical practice.
Then came the unfortunate
Nirav Modi scandal at PNB. The Rs. 14,000-crore bank fraud perpetrated that
surfaced in February 2018 has raised fresh questions about the effectiveness of
auditing in banks. The public outcry gained ground when it came to the fore
that Public sector banks (PSBs) have a variety of audits done by CAs including
statutory, branch, concurrent, and stock audit. This development did not augur
well for the accounting fraternity. Unfortunately, the rising non-performing
assets of banks have also raised questions about the auditors’ failure to
review asset quality carefully and insist on provisions for bad loans.
In a significant move, the
Central Government in March 2018 approved setting up of the independent
regulator National Financial Reporting Authority (NFRA) that will have sweeping
powers to act against erring auditors and auditing firms. The PNB fraud became
the trigger point for this development. The CA community could not convince the
powers that be, especially the Ministry of Corporate Affairs, that the ICAI was
doing a good job in taking to task the recalcitrant auditors. And I tend to
agree with the general belief that ICAI could have done a much better job to
detect and punish the defaulting fellow members. The NFRA now becomes an
overarching watchdog for the auditing profession, with the powers of the ICAI
to act against erring chartered accountants getting now vested with the new
regulator.
Another development which
has made life a bit more difficult for the auditors is the Insolvency and
Bankruptcy Code 2016. Many defaulting borrowers failing to repay their
committed debt amounts, could be subject to forensic audit. Fingers can then
get pointed towards the auditors, if things are not found to be in order.
The appointment of NFRA and
instituting of bankruptcy proceedings, have definitely made things tough and
harsher for the auditors. No wonder that we are seeing more resignations of
auditors in the recent times. If any nation has to develop and flourish, it is
very important that the financial reports certified by the auditors, need to be
reliable. There is nothing wrong in making movement towards attainment of this
goal to make financial reporting more credible and dependable.
It may be also noted that
the Companies Act 2013 have granted legal status to Serious Fraud Investigation
Office (SFIO). This is a significant development exposing the accounting
fraternity to the vagaries of a third-party government controlled
investigations.
Let’s be
careful and team-up
While many businesses
prepare their accounting records to present the true picture of its health,
there are several who play ducks and drakes with numbers. Accounting fraud
usually begins small – by cutting some corners here and enhancing some revenue
there. However, it is like riding a tiger. Very difficult to disembark. Once
the mischief is done – the next quarter’s profits are never sufficient to undo
mistakes or mischiefs committed in the past.
Methodologies adopted by
the tricksters and fraudsters are numerous. And the reality is accounting
manipulations have been happening since the birth of accounting. Instances
exist where auditors have been hand in glove with their clients. There are also
numerous examples where auditors have not been able to detect wrongdoing in
their client companies.
As economy progresses and
information availability enhanced, the pressure on the auditors will only go
up. The CA community who conducts most of the audits and especially the
statutory audits, have to now come up to the expectations. There will continue
to be wayward clients bent upon taking short-cuts to meet their immediate
goals.
The moot point now is: the
auditing community which is mostly consisting of CAs, now needs to hold
themselves together against the unscrupulous in the business community. The
problem will be, if one auditor resigns and stands firm on ethics, others
should not give way. This is yet not happening. The resigning auditors’
positions are being taken by someone else. But if, we the CA community stand
firm on good governance, only we can be the winners – no doubt the economy and
the country will come out with flying colours under the banner of clean and
good governance.
The last
words
At the gathering when I and
my fellow CA fraternity members were debating what is in store for all of us,
the consensus was clearly that increasing premium will be placed on good
judgement, ability to distinguish the signal from the noise when it comes to
reporting and auditing. The audit profession will evolve significantly in the
next five years or so, changing more than what it has happened in the last
several decades.
Keeping pace with advancing
technology, discouraging immoral practices, sticking to ethics and acting
‘together’ against the black-sheep in the client-community, will become the fulcrum
for the accounting and auditing community’s continued relevance.
