Month: July

Expectations from Forensic
Auditors have sky rocketed after the revelation of many large value scandals,
which have rocked corporate India in the last decade. The latest one relating
to the LOU scam has crossed over Rs 11,000 crores! Not only the affected banks,
enforcement agencies, and the regulatory bodies, but even the hitherto
unaffected banks and even blue chip companies have started doing a lot of deep
diving exercises to ascertain whether they have been abused in any way. Thus,
experts in forensic accounting services are being sought out to perform this
massive task which is unprecedented in terms of size and scale.

In this backdrop, the
challenges to forensic auditors are huge. Perpetrators of financial crimes and
fraud have evolved with stronger capabilities and are armed with technology to
launch lethal attacks. This is further compounded by the growing complexities
in business operations. The nature of the business transactionssometimes are so
technical that they are not easy to comprehend for even technically qualified
experts, and to do a thorough forensic audit in such circumstances needs a huge
amount of patience and perseverance apart from the expertise. Therefore, to do
a good forensic audit in the days to come, forensic auditors will need to
adapt. In the theory of evolution, it is believed that the species which
survives the longest is not the one which is the strongest, nor that which is
the most intelligent, but that which is able to
adapt to the changing environment. Forensic auditors need to do exactly
that. They will have to adapt to the environment which poses such new
challenges.

The process of adapting
will be greatly facilitated if forensic auditors bring in creativity and
imaginative thinking. The following suggestions may facilitate a forensic auditor
to adapt better and perhaps bring in more penetrative results:

– Firstly, remove complete
reliance on standard checklists by customising them to the objectives of the
given situation. This can be better understood with a case study. In an
investigation assignment in a life insurance company, the forensic auditor had
to investigate and report on suspicious death claims based on data and
documents given to him for the last one year. He compiled a checklist, which
included selection of a test sample of transactions and applying routine
processes of vouching and verification of supporting claim documents like the
death certificates, crematorium receipts, doctors cause of death reports,
application form details, etc. The sample selection was done by using one of
the standard sampling methods like statistical sampling. The auditor’s entire
focus was on completing the work as per his checklist on a statistical sample,
and submitting his report. This procedure of applying a statistical sample and
then vouching and verifications of documents is certainly important, possibly
to gain confidence on the controls and procedures, but maynot be sufficient to
detect the possibility of fraud. One suggestion is to then reduce complete
reliance on standard sampling techniques and apply other kinds of focussed and
adapted sampling techniques additionally. The forensic auditor in this case
tried this approach. Since he had the full data dump of all the death claims on
an electronic spreadsheet, he started thinking about different ways of
extracting data samples which could possibly throw up any clues of fraud. That
was the key to his success. When one starts looking beyond the routine and
tries to visualise various possible ways of exposing a crook, amazing solutions
can come from such a thought process. In fact, it is said that a good
investigator is one who can think like a fraudster. The forensic auditor, in
this case, saw that in the data of death claims, there were many data fields
that were not addressed or checked by his audit check list. He realised that
fraudsters also realise what auditors check and what they generally don’t look
at. The forensic auditor spotted two data fields which caught his eye. Date of
birth of the deceased and date of birth of the beneficiary or the claimant.
These were not within the focus of the forensic audit at all. The forensic
auditor then decided to extract a new sample of data by filtering out those
claims paid where the date of birth of the
deceased and the date of birth of the claimant were the same. The
forensic auditor expected such instances to be nil or very miniscule. Except in
the rare situations where the claimantor beneficiary was a twin sibling of the
deceased, the date of birth of the beneficiary would be unlikely to be exactly
the same as that of the deceased. So out of 13,000 line items, he expected to
find no more than 4-5 such transactions where the date of birth of the deceased
and the beneficiary would be exactly the same. The data was filtered to those transactions
where the dates of birth were matching and to his surprise he found 82
transactions where the date of birth matched exactly for the deceased and the
beneficiary. Now the forensic auditor had a new direction of investigation and
he started examining them in greater detail. He made inquiries as regards which
branch offices had originated and paid these claims, who were the claims’
approving officers, which period during the year were these claims paid and
even how fast they were paid. He then grouped the sample data appropriately
branch wise, officer wise. The results were spectacular. 77 of the 82 claims
with the common dates of birth came from only one specific branch in North
Mumbai. A claims officer Mr. M. Thanvir was the common authorising claims
officer for all these claims. These claims were paid off 50 % faster (in number
of days after lodgement). Now the original checklist for document examination
was again used to vouch and verify in detail the claims of these 77 deaths. As
expected, solid evidence of falsified death certificates and other documents
was found and a major insurance fraud in the North Mumbai branch was exposed!
Thus customising the sampling technique, and applying appropriate additional
checks based on the revelations, did the trick. In other words adapting and
innovating was the key to the forensic auditor’s success.

– Secondly, the forensic
auditor must constantly do research and look for newer solutions and techniques
to address fraud in different situations. If the perpetrators of fraud can take
advantage of technology, so can the forensic auditors. A regular visit to
websites relating to latest fraud tools, techniques and approaches in fraud
investigations can enable a forensic auditor to meet the challenges of business
complexities and possibly gain from experiences of others. In one such
investigation assignment when a forensic auditor was stuck with limited
findings, he had come to a stage where he had to submit a report and close the
matter inconclusively stating there was lack of evidence. He had really worked
hard and found that all the documentary checks that he had applied were not
yielding any significant results, but there were plenty of warning bells and
other indicators which seemed to suggest that fraud existed. But he had no hard
core evidence. Of the many matters which were not resolved, he had one major
doubt in his mind that the credit card number that had been furnished as
evidence for payment was false, but he had no way to verify its correctness. He
did not give up hope and his patience and perseverance paid off. He surfed
through the internet looking for solutions for credit card frauds and with a
little effort he came across an algorithm called the Luhn’s algorithm. This
algorithm was able to ascertain whether a credit card number was a valid credit
card number. However, the algorithm in the form available on the internet was
difficult to use, so painstakingly the auditor prepared an electronic
spreadsheet incorporating the functions of algorithm and he was able to use it
to prove that the credit card number given as evidence of payment for an
expense was an invalid number. This forensic auditor was thus able to achieve
the objective only by doing research and adapting the forensic audit to the
needs of the situation.

While these two suggestions
stated above are possible approaches for solutions, there are other measures
too which not only forensic auditors, but all professionals should take. One,
do not allow ‘a stale procedures syndrome’ to set in. This stale procedures
syndrome is nothing but a term for ‘getting used to’, or ‘taking for granted’.
In our every day work we often get complacent when we do the same or similar
tasks again and again. There was a very interesting fraud investigation case
where an auditor was auditing the financial statements of a college for 2
decades. He was doing a reasonably good audit and generally the audit reports
issued were clean and unqualified. Unfortunately, he died and a new auditor was
appointed. The new auditor brought a fresh new wave of thought processes and he
started examining data with a completely new checklist, which was compiled
after a thorough understanding and evaluation of the activities and operations
of the college. One of the items in the financial statements which caught his
eye was the huge balance ofstudents deposits lying with the college. These were
amounts deposited by the students at the time of admission such as library
deposit, caution money deposit, etc. These deposits could be collected
by the students only when they left the college, which was usually about 4
years after their date of admission. Most students would forget to collect
these deposits for various reasons and consequently over a period of time the
college balance sheet disclosed a huge amount of unpaid students deposits.  The earlier auditor never gave much attention
to this deposit amount since this was not a part of the college’s revenue and
it was merely an unclaimed liability payable only when requested for by the
students. Nevertheless, the new auditor painstakingly studied the deposit
collection and refund procedure and performed some checks on them as a part of
his new audit checklist. While he was examining the refund procedure, something
unusual caught his eye. The ledger account of deposit repayments showed
repayments for each date person wise, amount wise strangely in an
alphabetical order. To his surprise, he found that almost throughout the
entire year (barring some random exceptions) deposits were repaid to students
in an alphabetical order of their names.

This was not only queer but
also absurd. It was unthinkable that students would come to claim their deposit
refund in an alphabetical order. The new auditor called a few of the students
who had claimed their refund. All of them confirmed his suspicions that they
had not made any request for, nor had they got any refund. It was thus revealed
that the repayments were actually effected on forged refund applications
prepared and collected by the cashier himself. The cashier had adroitly taken
great care to ensure the forged application forms were prepared with all the
necessary supporting details and were attached to the cash payment vouchers,
but he made one fatal mistake. He got the names of students from the attendance
registers of the college, which were always in an alphabetical order.The
previous auditor also would have seen this ledger, but he had been auditing for
over two decades and his mind became ‘used to’ or `stale’ and he did not spot
this absurdity. The central lesson in this for all professionals is to combat
setting in of such a stale procedures syndrome by having more than a different
person to review the work, so as to bring in freshness and a greater alertness
to spot any warning bells of fraud.

Thus, in the foreseeable
future, forensic audits can increase their chances of success if they try to
innovate and adapt. The future holds opportunities for even the middle level
and smaller sized professional firms who want to do this kind of forensic
auditing work. Presently, that may appear to be difficult, but even smaller
firms can and will get a share of the pie. For this purpose, they will have to
adapt too by undergoing training and doing intense research. This will be the
fundamental need. Once the capability has been achieved, these firms can also
get empanelled with Police, Banks, Income Tax, PSUs etc. Very soon the
need will be so intense that all companies and potential clients may not wish
to go only to giant firms but also to small specialist firms where they would
have the benefits of both economical budgets and matching quality.  

shailesh.kwebmaker

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.  

shailesh.kwebmaker

Fair Value
accounting is now strongly entrenched in the accounting cannons after centuries
of following historical cost convention. It is a shift from ENTRY perspective
to EXIT perspective. Historical cost convention was perhaps the premium for
stability and long-term prudence, to cover the business from volatility of
business and market forces. That idea of measure of value – based on original
cost – was replaced by a measure defined as exchange value (of an asset)
between knowledgeable and willing parties in an arm’s length transaction.

Does fair
value (FV) inform the user of financials better? Does it improve upon true and
fair consideration? Are users happy to pay the price of volatility to get the ‘real’
picture? REALITY, what actually happened, has been the central pillar
accounting for centuries. FV, in a lighter vein could be augmented or virtual
reality which only time will test.

This
fourth VIEW and COUNTERVIEW aims to tells the story of how fair the fair value
is and although it has had a bumpy ride in times of turbulence, it is now an
accepted norm of accounting.

VIEW: WHY FAIR
VALUE SHOULD NOT HAVE FEAR VALUE?

Dolphy D’souza  

Chartered
Accountant

Fair value
accounting is an integral aspect of Ind AS and all other global standards, such
as IFRS or US GAAP.  Since Ind AS has
been in use for more than two years now, a discussion on this topic is probably
only academic. Most entities reluctantly or otherwise have accepted this
concept, though the debate when it was first introduced was highly exacerbated.
Of course, in good times, everyone likes fair value accounting, however, in bad
times they will be complaining. 

Some argue
that fair value accounting is procyclical and caused the credit crisis a few
years ago. However, subsequent research done by SEC indicates that financial
institutions collapsed because of credit losses on doubtful mortgages, caused
by sub-prime lending, and not fair value accounting. Fair value accounting was
rather useful in highlighting the inherent problem and weaknesses of entities.

Those
criticising fair value accounting do not seem to provide any credible
alternatives. Do we take a step back to historical cost accounting, wherein,
financial assets are stated at outdated values and hence not relevant or
reliable? Is there any better way of accounting for derivatives, other than
using fair value accounting? For example, in the case of
long-term foreign exchange forward contracts there may not be an active market.
For such contracts, entities obtain MTM quotes from banks. In practice,
significant differences have been observed between quotes from various banks.
Though fair value in this case is judgemental, is it still not a much better
alternative than not accounting or accounting at historical price?

Some years
ago, an exercise was conducted by a global accounting firm to determine
employee stock option charge. By making changes to the input variables, all
within the allowable parameters of IFRS, option expense as a percentage of
reported income was found to vary as much as 40% to 155%. However, since then
valuation guidance on fair value measurement has been issued by IASB and
International Valuation Standards Council (IVSC), and overtime subjectivity and
valuation spread reduced substantially.

The next
question is what kind of assets and liabilities lend themselves better to fair
value accounting. Whilst many non-financial assets under Ind AS are accounted
at historical cost, biological assets are accounted at fair value. Unfortunately,
many biological assets are simply not subject to reliable estimates of fair
value. Take for instance, a colt, which is kept as a potential breeding stock,
grows into a fine stallion. The stallion starts winning race events and is also
used in Bollywood films. The stallion earns substantial amount for its owner
from breeding and other services. The stallion gets older, his utility
decreases. Eventually, the stallion dies of old age and the carcass used as pet
food. At each stage in the life of the horse, the fair values would change
significantly, but estimating the fair values could be extremely subjective,
difficult and make earnings highly volatile. In many ways, the stallion reminds
one of fixed assets. Changes in fair value of fixed assets are not recognised
in the income statement, then why should the treatment be different in the case
of atleast some biological non-financial assets? Certainly, an invariable
application of fair valuation is not what the author recommends.

In India,
the debate on fair value has got confused because of lack of understanding of
Ind AS. For example, a common misunderstanding is that all assets and
liabilities are stated at fair value. However,
the truth is that under Ind AS many non-financial assets such as fixed assets
or intangible assets are stated at cost less depreciation (unless an entity
chooses to apply the revaluation model, subject to conditions being fulfilled).
The apprehension of using fair value accounting is driven by tax considerations
or legal legacy. However, one may note that Ind AS financial statements are
driven towards the needs of the investor and not of any regulator. Therefore,
the income-tax and other regulatory authorities should ensure that Ind AS is
tax or statute neutral.

Determining
fair value can be extremely excruciating in certain cases, such as biological
assets, contingent liabilities, unquoted equity shares, etc.
Notwithstanding the difficulty, determining fair value should not be an excuse
for abandoning the idea of fair valuation. Doing so would be throwing the baby
with the bath water. Fair valuation cannot be expected to provide, the same
result if different valuers were valuing it. This is because fair valuation is
not a science but an art and no guidance or methodology can ever make it a
science. IFRS 13 (Ind AS 113) and the IVSC valuation standards were certainly
helpful in bringing about clarity, consistency and in collapsing the valuation
spread between valuers.

In the
examples below, it is hard to imagine, a measurement basis other than fair
value.

In many
areas, fair valuation is simply inevitable. Fair value accounting does not
create good or bad news; rather it is an impartial messenger of the news.

counterview:
WHEREFORE FAIR VALUE?

Ashutosh Pednekar

Chartered
Accountant

A common misconception is
that wherefore means where; it is occasionally so used in
retellings of Romeo and Juliet — often for comedic effect. The meaning of “Wherefore
art thou Romeo?” is not “Where are you, Romeo?” but “Why are
you Romeo?” i.e. “Why did you have to be a Montague” ⁱ (the
family name of Romeo).

One may wonder, why in an
article that is meant to be defiant to current trends of accounting I am
quoting Shakespeare. Well, the fact remains that English as she is spoken is
not necessarily understood in the same manner by everyone. That is the bane with
Fair Value (FV) accounting too. My concept of FV could be different from your
concept. Hence, the users of financial statements could possibly, get different
perspective of financial statements. Accounting permits or requires (based on
specific conditions) different bases of measurement. The two main bases are
historical cost and current value, with current value having bases such as FV,
value in use for assets or fulfilment value for liabilities and current cost.
The IASB in March 2018 has issued the revised Conceptual Framework of
Financial Reporting. Chapter 6 describes various measurement bases and
discusses factors to be considered when selecting those. Our Indian Accounting
Standards (Ind AS) will need to follow this framework.

It is said that double
entry book keeping was first codified in a treatise 1494 in by Luca Pacioli.
Prior to that, there are records of double entry book keeping by Jews and
Koreans. The Bahi-Khata system of accounting in India was prevalent too. These
would have been times when traders of different regions and languages did
business with each other and to settle the trades needed a uniform language of
accounting acceptable to all. Double entry system of book keeping served the
purpose. Trade practices, technology and methods of transacting evolved but the
cardinal rules of accounting remained the same. Ever since Pacioli’s treatise
those rules (debit what comes in, credit what goes out, et al) have remained
consistent for more than 600 years!

_________________________________________________

i     
https://en.wiktionary.org/wiki/wherefore#English

Twentieth century saw
multiplication of world trade; money becoming more fungible, businesses
regulated, stakes increasing, higher gains, deeper losses. This led the users
of financial statements question accounting and financial statements. The
persons who were making decisions of providing resources to an entity relied on
the financial information that was available and they realised that the
financial information was inadequate – if an entity had acquired an asset fifty
years ago and it was carried at historical cost less depreciation, then that
information was not relevant to the user who wanted to take a decision of
providing resources. These decisions were made on an elaborate combination of
what price a similar asset / business fetches in an open market and / or a
calculation of future cash flows, discounted at an appropriate rate reflecting
the risk of the entity i.e. at FV. However, accounting continued on historical
cost measurement basis.

Since 1980s there was a
demand to have the needs of resource providers addressed in the financial
statements. Consequently, the concept of FV gained prominence and eventually
accounting standards included it and the concept of exit price emerged.
Along with that came in the complex arithmetical computations, statistical
assumptions & probabilities requiring use of significant estimations.

India is in the process of
converging to IFRS since April 2016 in a phased manner. The entities that are
applying Ind AS are of different sizes and structures even amongst listed
entities The experience of two years of Ind AS of preparers and auditors has
been educating as well as exasperating. The questions that promoters and many
preparers ask of accountants and auditors are:-

–   Why
my entity needs to be evaluated on an “exit price”.

–    Am
I selling my entity as on the balance sheet date?

–    What
has happened to the concept of going concern?

–   My
balance sheet used to be prepared for me and my shareholders and my bankers and
my business partners and they know how healthy or otherwise I am.

–   By
having my financial statements at an exit price am I telling the world that my
business is up for grabs at the values presented in the financial statements?

–   I
do not want to and I have no intentions of selling my business, either in parts
or as a whole, then why should I increase my costs of compliance by undertaking
valuation exercises based on various inputs that standards themselves say can
be “unobservable” So, be definition they are abstract and unreal.

–    So
am I placing a picture of my state of affairs based on presumptions, statistics
and estimations rather than at the values at which the transactions have taken
place?

Answers anyone?

The standard gives a three
level hierarchy for specific facts and circumstances. The hierarchy ranges from
simple to complex calculations. An entity is required to replicate the above at
each measurement date. If it is presenting financial results on quarterly
basis, then all these steps have to be done each quarter. The cost of
compliance with FV computations, recognition and measurement is indeed
significant. Not to mention the volatility that can enter the financial
statements. If the markets are erratic then it would get reflected in the
financial statements.  Compare this with
the stability provided by historical cost measurement, where one is certain
that the amounts at which assets and liabilities are presented are the values
that are a result of transactions that have already occurred.

One typical example of the
complexity of FV accounting is the interest free or concessional interest loans
given to employees. An entity is required to determine the FV of such loans, by
discounting the cash flows at an appropriate rate of interest and documenting
the rationale of appropriateness and then presenting the difference between the
FV of the loan and the amount of loan as employee benefits and which would be
recycled over the tenor of the loan, making it PL neutral over multiple years.
When one explains this to business owner the reaction is flabbergasting. When
one explains the rationale of this charge, then there is a reluctant nodding of
head followed by, “but when I gave the loan, this was not my intention.
Sometimes the intent was to keep my employees satisfied and that cannot be an
accounting rule / requirement”.  He
reacts by saying, “for me it is the amount of loan to employee that is
critical – on employee leaving the organization I will recover the absolute
amount and not its fair value.”

If a simple business transaction
of loan to employee causes such difficulties in FV accounting, one can only
imagine what could be the case in complex business transactions.

Some standards require
disclosure of FV of items that are carried at amortised cost! This defies logic
to some preparers as the business model permits those items to be carried at
amortised cost but disclosure requirements requires determining FV, implying
going through the grind of estimations & computations and justifying it to
all users of financial statements.

The user now has to read
the voluminous disclosures to understand the impact of the numbers in the
financial statements. Will they have the expertise of understanding the devil
in such detailed? Isn’t it fine that an entity provides such detailed information
on a need to know basis, sat, to a potential investor to whom “FV at exit
price” is more relevant rather than “historical cost”

The reaction of other
stakeholders & users of financial statements viz. bankers, lenders,
vendors, current & potential investors, tax authorities is awaited to be
seen in public domain. Reactions and responses of users of financial statements
and their impact on businesses will tell us whether FV accounting has achieved
what it had set out to; whether the benefits indeed exceeded the costs. Only
then, perhaps, we will know the answer to wherefore art thou fair value
accounting?

India is part of a global
business community and standards of performance have to be comparable. Hence,
India decided to converge with IFRS. But, is it fair that every Indian entity
that is not comparable with an international entity in terms of size and
structure is required to go through this grind of fair value and its
disclosures? Can one not look at a model of the IFRS for SMEs? For less complex
entities IFRS for SMEs give limited options w.r.t recognition & measurement
principles and disclosures are significantly less too. It would make the
financial statements more relevant and reliable.

It has taken the world six centuries to move
from historical cost measurement bases to FV measurement bases. We all
experience that lifecycle of new technologies is much short lived. Likewise,
can we equate FV as new technology prone for obsolescence a decade or five from now? And thereafter do we move to
a new technology or do we revert to historical cost.

An alternate proposition
would be that only those entities that frequently raise resources from local
and international markets, who have international investors, who have a mass
that matters or are comparable with the Fortune Global 500ⁱⁱ can be
required to have FV accounting. To understand where India stands, we have only
7 companies in this global list with the highest at 168th position. The 500^th
company on the global list has revenues of US$ 21,609 Mnⁱⁱⁱ
(INR 1,44,780 Crore). It would be worthwhile to do an analysis around this
figure and determine what would be the right size for an entity to get involved
in determination of FV and recognizing it in its financial statements. For
others (excluding sectors such as banking, insurance & lending),
historical cost could continue. FV will be need-based information, not
necessarily part of financial statements.

One size fits all is a good
dictum. However, if the size of an average Indian business entity that applies
FV accounting is much smaller than the average size of a global entity that
applies FV accounting, aren’t we justified in having something simpler commensurate
with our size and nature of business?

This debate shall certainly
not end with this article but may at the least trigger a thought process, and
for that I would like to end with apologies to William Shakespeare by a bit
rephrasing of Marallus speaking to two rejoicing commoners in Julius Ceaser,
Act 1, Scene 1^iv :-

Wherefore
rejoice

What
conquest brings fair value home?

What
levels of hierarchy follows him to the statement of financial position to grace
in probability weighted estimates

You measurement
blocks, you recognition principles, you worse than senseless disclosure
requirements

Oh you
hard hearts, you cruel men of accounting

Knew you
not historical accounting.  

________________________________________________

ii   https://timesofindia.indiatimes.com/business/india-business/40-of-fortune-500-companies-asian-india-has-7-in-list/articleshow/59707630.cms

iii  http://fortune.com/global500/list/

iv             http://www.shakespeare-monologues.org/monologues/612

shailesh.kwebmaker

Evolution Of Accounting

1     Introduction

1.1    Financial
accounting and reporting remains the core tool of entities for communication
with its stakeholders. It is the semantics for such communication. Accounting
standards are the grammar of such language used by entities in such
communication. The separation of ownership and management in the growing
businesses and modern day complexities added the importance of timely and
accurate communications. The grammar (i.e. Accounting Standards) blends
uniformity in reporting and facilitation of unambiguous communication with the
variety of stakeholders including but not limited to owners/shareholders,
employees, regulators, trade/business relations, revenue authorities etc.

1.2     The subject of accountancy and its
importance has a long history in India e.g. a treatise on economics and
political science titled ‘Kautilya’s (also known as Chanakya) Arthshasthra’,
has elaborate prescriptions on accounting (and accountability) aspects for a
treasury and government which have features of universal utility. In line with
the evolution and changes in the scale and texture of economies and society,
financial reporting and accounting standards have also evolved and witnessed
path-breaking changes.

1.3     The earliest treatise on accounting is
generally thought to be Pacioli’s Summar of 1494. However, Bahi-khata (a
double-entry system of bookkeeping) predates the ‘Italian’ method by many
centuries. Its existence in India prior to the Greek and Roman empires suggests
that Indian traders took it with them to Italy, and from there the double-entry
system spread through Europe, which then evolved itself to accrual from cash
and gradually to present day modern reporting.

2     Evolution of accountancy in major jurisdictions

2.1     America:

After
the U.S. stock market crash in 1929, many investors and market participants
felt that insufficient and misleading accounting and reporting had inflated
stock prices that eventually crashed the stock market followed by the Great
Depression. Whether that perception was true or not is a separate debate, but
those feelings made accounting world more alert and agile about its role and
the continuing pressures on the accounting profession to establish accounting
standards prompted the American Institute of Accountants (now known as the
AICPA) and the New York Stock Exchange to review financial reporting
requirements.

2.2     A few years later, the Securities Act of
1933 and the Securities Exchange Act of 1934 were passed into law to restore
investor confidence, which set forth the accounting and disclosure requirements
for the initial offering of stocks and bonds and for secondary market offerings
respectively.

2.3     The 1934 Act also created the U.S.
Securities and Exchange Commission (SEC), which was mandated with standard
setting of financial accounting and reporting for publicly-traded companies.
However, the SEC while keeping the power to set standards chose to delegate its
rule-making responsibilities to the private sector. This means that if the SEC
did not conform to a specific standard issued by the private sector, it had the
authority to change that standard. Despite delegating its
rule-making responsibility, the SEC issued its own accounting pronouncements
called Financial Reporting Releases (FRRs).

2.4     The Committee on Accounting Procedure (CAP)
and American Institute of Accountants (now AICPA) were the very first
private-sector standard setting bodies. During 1938 to 1959, the CAP issued 51
Accounting Research Bulletins (ARBs). Since, it had not established a financial
accounting conceptual framework, its rule-making approach of dealing with
accounting and reporting problems and issues was subjected to severe criticism.

2.5     The CAP was then replaced by the Accounting
Principles Board (APB) set up under the recommendation of a special committee
appointed by AICPA which issued 31 Accounting Principles Board Opinions
(APBOs), 4 Statements and several interpretations during its tenure from 1959
to 1973. In contrast to its predecessor, it attempted to establish a conceptual
framework with its APB Statement No. 4 but failed. In addition to its
unsuccessful efforts to create a framework, it was also under fire for its
apparent lack of independence because its board members were supported by the
AICPA and other interest groups or stakeholders were not represented in its
rule-making process.

2.6     Emphasizing the significance of an
independent standard-setting structure, the APB was reorganized in 1973 into a
new body called the Financial Accounting Standards Board (FASB). As compared to
APB’s 18-21 part-time members who mostly represented public accounting firms,
the FASB has 7 full-time members representing the accounting profession,
industry and other various interest groups/stakeholders such as the government
and accounting educators.

2.7     In 1984, FASB formed the Emerging Issues
Task Force (EITF) with members of the FASB, auditing firms and industries with
the role of responding to emerging accounting and financial reporting issues
and publish its pronouncements in the form of EITF Issues – considered to form
part of US GAAP. The function of the EITF is important because it makes the
standard-setting process more efficient and allows the FASB to concentrate on
much broader and long-term problems.

3     UK/ Europe

3.1     Meanwhile, efforts in the UK and Europe to
create an international body to establish international accounting standards
were also gaining widespread support, which led to the creation of the
International Accounting Standards Committee (IASC) in mid-1973. Just like the
FASB’s EITF, the IASC established the Standing Interpretations Committee (SIC)
in 1997 to study accounting issues and problems that required authoritative
guidance.

3.2     In 1977, the International Federation of
Accountants (IFAC) came into existence as a result of an agreement signed by 63
accounting bodies representing 49 countries. The main objective of IFAC is ‘the
development and enhancement of a co-ordinated worldwide accountancy profession
with harmonized standards’. ICAI is a member of the IFAC since its
inception.

3.3     In 2001, the IASC reorganized itself to act
as an umbrella organisation to a new standard-setting body – the International
Accounting Standards Board (IASB). The accounting standards issued by the IASB
were designated as International Financial Reporting Standards (IFRS). The IASB
continued to adopt the 41 International Accounting Standards (IAS) issued by
the IASC between 1973 and 2002. It also adopted all SIC Interpretations which
were renamed as International Financial Reporting Interpretations Committee
(IFRIC).

3.4
    IASB has no authority to enforce
compliance with IFRS and its adoption is entirely voluntary. In 2001, the
International Organization of Securities Commission (IOSCO) approved the use of
IAS/IFRS for cross-border offerings and listings and IFRS/IAS was also adopted
in 2005 by listed companies in the European Union. This adoption of IFRS/IAS by
EU companies gave a big filip for them to become gradually being adopted and
accepted across other jurisdictions.

3.5     Since October 2002, the IASB and FASB have
been working to remove differences between IFRS/IAS and US GAAP towards a
common set of high quality global accounting standards. Their commitment to the
convergence effort was embodied in a memorandum known as the Norwalk Agreement.

3.6     After 10 years of working together, some
notable convergence projects have been successfully completed. Major joint
projects completed include converged standards on Business Combinations,
Consolidation, Fair Value Measurement, Revenue Recognition and Leases.

3.7     Other projects were discontinued because
the two boards could not agree on some issues such as standards on
de-recognition, financial statement presentation, insurance contracts,
liabilities and equity, and post-employment benefits.

3.8     The major prevalent Accounting Practices in
the world today can be bifurcated to two broad categories:

i.   International Financial Reporting Standards
(IFRS) issued by International Accounting Standards Board (IASB), which are
prevalent in more than 100 countries including European Union, Australia,
Canada etc.;

ii.   US GAAP i.e. Generally Accepted Accounting
Principle followed in United States of America.

4     History & Evolution of Accounting and
Auditing in modern India

4.1     The evolution of India’s present-day
accounting system can be traced back to as early as the sixteenth century with
India’s trade links to Europe and central Asia through the historic silk route.
Earlier Indian accounting practices reflect its diversity as India has many
official languages and scores of dialects spread over numerous states.

1857:
The first ever Companies Act in India legislated.

1866:
Law relating to maintenance of accounts and audit thereof introduced. Formal
qualification as auditor was now required.

1913:
New Companies Act enacted. Books of accounts required to be maintained
specified. Formal qualifications to act as auditor were named and a Certificate
from the local government was required to act as an auditor – An unrestricted
Certificate to act as auditor throughout British India and a restricted
Certificate to act as auditor only within the Province concerned and in the
languages specified in the certificate.

1918:
Government Diploma in Accounting (GDA) was launched in Mumbai. On
completion of articleship of 3 years under an approved accountant and passing
of the Qualifying examination, the candidate would become eligible for the
grant of an Unrestricted Certificate.

1920:
The issue of Restricted Certificates discontinued.

1930:
Register of Accountants to be maintained by the Government of India to exercise
control over the members in practice. Those whose names found entry here were
called Registered Accountants (RA).

The
Governor General in Council replaced the local government as the statutory authority
to grant certificates to persons entitling them to act as auditors. Auditors
were allowed to practice throughout India.

1932:
First Accountancy Board was formed. The Board was to advise the Governor
General in Council on matters relating to accountancy and to assist him in
maintaining standards of qualification and conduct required of auditors.

1933:
First examination held by the Indian Accountancy Board. GDAs were exempted from
taking the test.

1935:
The first Final examination was held. GDAs were exempted from taking the test.

1943:
GDA was abolished.

1948:
Expert Committee formed to examine the scheme of an autonomous
association of accountants in India.

1949:
The Chartered Accountants Act, 1949 passed on 1^st May. The term
Chartered Accountant came to be used in place of Indian Registered Accountants.
The Chartered Accountants Act was brought into effect on 1st July and The
Institute of Chartered Accountants of India (ICAI) was born on 1^st
July 1949.

4.2
    The ICAI, being the premier
standard-setting body in India, constituted Accounting Standard Board (the
‘ASB’) on April 21, 1977, with the objective to formulate Accounting Standards
to enable the Council of ICAI to establish a sound and robust financial
reporting standards framework in India.

The
ASB takes into consideration the Accounting Standards at the International
Level (IFRS/IAS) and sets National Standards based on those so that National
Standards are broadly aligned to Global Accounting Principles. ASB is
represented not merely by members of ICAI but also representatives from
Government including Revenue Departments, RBI, IRDA, MCA, Chambers of Commerce.

From
1977 to 1988, ICAI notified 11 Accounting Standards (‘AS’), made in
consultative manner by ASB, but these notified AS lacked statutory recognition.

4.3     The statutory recognition and legal force
was provided to Accounting Standards by amendment made in 1999 to the Companies
Act, 1956. New sub-sections (3A), (3B) and (3C) were inserted in section 211,
which required that every balance sheet and profit & loss account of the
Company complied with the accounting standards, prescribed by the Central Government
in consultation with the National Advisory Committee on Accounting Standards
(NACAS).

The
accrual method of accounting in India also gradually evolved with growth and
evolvement of the ‘Company’ form of business organisation and mandatory
requirement prescribed under the law [Section 209(3) of 1956 Act] for the
Companies to follow ‘accrual’ basis and according to double entry system of
accounting.

5     Accounting Standards

5.1     Accounting Standards are “written
documents, policies, procedures issued by expert accounting body or government
or other regulatory body covering the aspects of recognition, measurement,
treatment, presentation and disclosure of accounting transactions in the
financial statement”.

5.2  Objective of Accounting Standards:

–   Standardise the diverse accounting policies.

–   To eliminate non-comparability of financial
statements to the possible extent.

–    Add to the reliability to the financial
statements.

–    Help understand Accounting Treatment in
financial statements.

5.3  Advantages of Accounting Standards:

–    Reduce or eliminate confusing variations in
the accounting treatments used to prepare the financial statements.

–    Disclosures beyond that required by law.

–   Facilitating comparison of financial
statements of across different companies.

–   Uniformity of accounting treatment of
identical transactions

5.4 Procedure for issuing
Accounting Standards by ICAI:

The
following procedure is adopted for formulating the accounting standards:

–    ASB constitutes Study Group to formulate
preliminary draft.

–    ASB considers the preliminary draft and
issues Exposure draft (ED) for public comments. ED is also specifically sent
for comments to specified bodies such as industry associations, regulators,
stock exchanges and others.

–    ASB considers comments received on ED and
finalises the draft AS for consideration of Council.

–  Draft approved by council is recommended to
NACAS.

–   NACAS recommends the Standard to the
Government of India (MCA) after its review and modifications, if any, in
consultation with ICAI.

–    Government of India (MCA) notifies the AS on
acceptance of recommendations made by NACAS.

6     Important Milestones of Accounting
Standards in India

–   1979 – Preface to Statements of AS & AS
1 issued.

–   1987 – Mandatory status of AS 4 & AS 5.

–   1991 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Corporate Entities)

–    1993 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Non Corporate Entities)

–    1999  
Legal recognition to ASs issued by ICAI under Companies Act, 1956.

–   2000-2003 – 12 AS were issued based on
IASs-major step towards convergence with IASs.

–   2002 – Insurance Regulatory and Development
Authority (IRDA) required Insurance Companies to comply with the Accounting
Standards issued by the ICAI.

–    2003 – Reserve Bank of India (RBI) issued
Guidelines on compliance with Accounting Standards (ASs) advising banks to
ensure strict compliance with the Accounting Standards issued by the ICAI.

–    2006 – MCA notified separate AS under Companies
(AS) Rules, 2006 which was based on work done by ASB of ICAI and approved by
NACAS. ASB decided to constitute a task force to develop a concept paper on
convergence with IFRS.

–    2007 – ASB and Council accepted
recommendations of Task Force for convergence with IFRS.

–    2010-11 Ind AS (IFRS Converged Standards)
prepared by ICAI, approved by NACAS and notified by MCA (Date not notified)

–    2015 – MCA issued the roadmap (dates of
implementation) for converged IFRS in phased manner & notified 39 Ind AS
formulated by ICAI and approved by NACAS.

–    2016 – MCA notified revised AS 2, AS 4, AS
10, AS 13, AS 14, AS 21, and AS 29 and Ind AS 11.

–    2018 – MCA notified Ind AS 115 replacing Ind
AS 11 and Ind AS 18.

7     Applicability
of Accounting Standards to Small and Medium Sized Enterprises (SMEs) and Small
and Medium-sized Companies (SMCs)

7.1     Under the Companies Act, 1956 Small and
Medium-Sized Company as defined in Clause 2(f) of the Companies (Accounting
Standards) Rules, 2006 were exempted from compliance of the Accounting
Standards AS 3 – Cash Flow Statement and AS 17 – Segment Reporting. Also AS 21
– Consolidated Financial Statements, AS 23 – Accounting for Investments in
Associates in Consolidated Financial Statements and AS 27 – Financial Reporting
of Interests in Joint Ventures (to the extent of requirements relating to
Consolidated Financial Statements were not applicable to SMCs since the
relevant Regulations did not require compliance with them. Relaxations in
respect to disclosures under certain Accounting Standards were also granted to
SMCs.

7.2    As per
‘Applicability of Accounting Standards’, issued by the ICAI (published in ‘The
Chartered Accountant’, November 2003), there are three levels of entities.
Level II entities and Level III entities are considered to be the small and
medium enterprises (SMEs). On the other hand, as per the Accounting Standards
notified by the Government, there are two levels, namely, SMCs as defined in
the Rules and companies other than SMCs. Non-SMCs are required to comply with
all the Accounting Standards in their entirety, while certain exemptions/
relaxations have been given to SMCs. Certain differences in the criteria for
classification of the levels were also noted.

Globalisation
of Accounting Standards

8.1     Globalisation of economies and evolution of
a highly interconnected world has had far reaching changes impact on economy
and the ‘accounting’ world also cannot remain unaffected there from. Since the
beginning 21^st century, there was renewed demand for global
harmonisation of accounting standards and to converge or adopt single set of
high quality standards that require transparent and comparable information in
the financial statements. There is also a significant transformation in the
fundamental accounting principles and concepts fair value measurements,
prominence to fair and faithful presentation, new components in financial
statements and so on gained acceptance.

8.2     Further, the direction of accounting
standard setting has shifted towards ‘Principles’ based standards rather
than ‘Prescriptive Rule’ based ones. There are two other major
developments also impacting standard-setting viz., the unprecedented global
financial crisis starting in 2007-08 and birth of integrated reporting
framework in 2010 having core objective of more effective communication with
stakeholders. Policy makers and Regulators are following the developments in
standard-setting area with keen interest. Therefore, accounting
standard-setting role has assumed greater responsibility and accountability.

8.3     International Financial Reporting Standards
(IFRS) area set of high quality principle-based standards and has become the
global financial reporting language with more than hundred countries accepting
or requiring IFRS based financial reporting. The U.S. Securities and Exchange
Commission has also allowed Foreign Private Issuers to file financials
statements prepared under IFRS without reconciliation to the US GAAP.

8.4     It is the primary duty of any company
irrespective of Indian company or foreign company to prepare financial
statements at the end of accounting period. While preparing financial
statements some accounting standards needs to be followed that is laid down by
Accounting Standard Board of the respective country. Subsidiary/Joint
Venture/Associate of a company located in another country need to prepare its
financial statements according to accounting standards of the country where it
is located, which leads to variation in profits. This variation in profits is
due to difference in accounting standards, which differs from country to
country. In order to remove these variation/difference in profits,
International Accounting Standard Board introduced International Financial
Reporting Standards called as IFRS.  IFRS
are the common accounting standards followed by member countries of IASB in
preparing their financial statements. IFRS helps in arriving at similar profits
regardless of the location of an entity. Before any new IFRS are issued or
amendments are made in IFRS, IASB issues exposure drafts, discussion papers and
conducts out-reach events.

9      Advantages of convergence to IFRS

–    Easy Comparison: Companies always
would like to compare their performance with other companies’ performance. IFRS
make this work easier because most companies are / will follow same accounting
standards in preparing their financial statements.

–   One Accounting language company-wide:
Company with subsidiaries in foreign countries can use IFRS as common business
language in preparing its financial statements as most of the countries are
adopting / converging with IFRS.

–    IFRS facilitates Cross border movement of
capital and cross border acquisitions, enables partnerships & alliance with
foreign entities.

–   Availability of professionals
internationally: IFRS enhances the mobility of professionals internationally.

–    IFRS provides more compatibility:
IFRS provide more compatibility among sectors, industry, & companies. This
would improve relationship with investors, suppliers, customers and other
stakeholders across the globe.

–   Increased investment opportunities:
Common accounting standards help investors to understand available investment
opportunities better as opposed to financial statements prepared under
different set of national accounting standards.

–    Lower cost of capital: Greater
willingness on the part of investors to invest across borders will enable
entities to have access to global capital markets which lowers the cost of
capital.

–    Higher economic growth: Increased
investment opportunities lead to attraction of more investments which result in
higher economic growth.

–    Better quality of financial reporting:
Convergence will place better quality of financial reporting due to consistent
application of accounting principles and reliability of financial statements.

10      Road to Indian Accounting Standards (Ind-AS  i.e. 
IFRS  Converged  Standards 
in India)

10.1   The Leaders’ Statement at G-20 Summit held in
September 2009 attended by our Prime Minister Dr. Manmohan Singh at Pittsburgh
contained a commitment by the G-20 nations for convergence of accounting
standards globally.

10.2   In 2010-11, the ASB of ICAI after a
tirelessly effort came out with 35 Ind AS which, after NACAS consultation were
notified by Ministry of Corporate Affairs (MCA) in February 2011. However the
date of implementation which was scheduled to be 1^st April, 2011 was
not notified by the Government possibly, amongst other reasons, due to
tax-related concerns by corporates.

10.3   The current
government in its very first budget in July 2014 announced its intention of
implementing Ind AS from 2015 onwards. On 2^nd January 2015, the
Ministry of Corporate Affairs (MCA) issued a press release which laid down a
roadmap for adoption of Ind AS in India. 16^th February 2015 marked
the dawn of new era in accounting standards in India when MCA notified the
final roadmap for adoption of new generation accounting standards, “Indian
Accounting Standards – Ind AS” based on the size of the companies and sectors
like Banking, NBFC & Insurance.

10.4   Between 2011, when MCA deferred the
implementation of Ind ASs and this notification, the International Financial
Reporting Standards (IFRSs) had gone through a significant rejig – the biggest
ones being the new accounting standards on Consolidation (IFRS 10, 11 and 12),
Fair Value Measurement (IFRS 13), Revenue (IFRS 15) and Financial Instruments
(IFRS 9). These developments have been incorporated in the standards notified
by the MCA based on the updation by ICAI with consultation of NACAS.

11      Indian Accounting Standards (Ind AS)

11.1   The key features of Ind-AS which are
principle-based IFRS converged standards include fair value measurement, use of
time value of money and reliance on robust disclosures. These Standards are
applicable for separate as well as consolidated financial statements.

11.2   The implementation of Ind-AS has led to
enhanced qualitative reporting due to additional information requirements and
more transparency. This will help the investors to better understand the risks
and rewards associated with the investment in an entity and, therefore, it
would make investment decisions easier.

11.3   Ind AS also require greater use of judgements
and estimates. Therefore, greater disclosure requirements are prescribed under
these Standards.

–    For estimates: focus on the most difficult,
subjective and complex estimates including details of how the estimate was
derived, key assumptions involved, the process for reviewing and a sensitivity
analysis.

–    For judgements: provide sufficient
background information on the judgement, explain how the judgement was made and
the conclusion reached.

–   There is emphasis on substance over form
under these standards as they require us to look into the economic reality of a
transaction. Therefore, the substance of a financial instrument needs to be
looked into, rather that its legal form to determine its classification in the
balance sheet. For example, a compulsorily redeemable preference share is to be
classified as a financial liability under Ind AS while under Indian GAAP it was
classified as per its form i.e., it was classified as a part of equity.

11.4   Ind-AS thus, leads to more truthful
representation of transactions, e.g.

–    Where goods are sold on extended credit
terms, i.e., extending the term beyond the normal credit period; then the
financing element built into the price is segregated and considered as
‘interest’ income. For example, goods that are normally sold at price of Rs.
100 for a credit period of 3 months. If, however, they are sold for Rs. 110 for
15 months credit then Rs. 10 will be considered as ‘interest’ (say @10%) income
under Ind AS. Similarly, fixed assets or inventories purchased on deferred
credit terms having financing element, namely ‘interest’ is also to be
segregated from the ‘purchase price’.

–    Derivatives and hedge accounting was earlier
done on settlement-based approach rather than deferral approach. Ind-AS
requires fair value approach in case of these instruments.

–    Accounting for time value of money, the true
position of financials closer to reality is depicted. There are many instances
where Ind-AS requires discounting of future amounts to arrive at the present
value. Some of these instances are discounting of long term provisions,
measurement of asset retirement obligations, measurement of liability in
defined benefit plans etc.

11.5   There are several fundamental changes that
the new standards bring in when compared to the earlier Standards. One key
fundamental change is the significant increase in focus on fair value
accounting. Ind AS requires application of fair value principles, which is
resulting in significant differences from financial information being presented
earlier. Complying with fair value principles of Ind AS will also require
assistance from professionals with valuation skills to arrive at reliable fair
value estimates.

The
following four Ind AS will have substantial impact with significant operational
and procedural changes specially for Banks, NBFCs and Insurance Companies:

–    Ind AS 109, Financial Instruments which
provides the accounting and reporting norms for Financial Instruments.

Presently,
companies follow a provisioning matrix for impairment losses of financial
assets which is based on ‘incurred loss’ model wherein impairment losses were
recognised on occurrence of a credit risk trigger or event indicating objective
evidence of impairment. This could include a past due or default, significant
financial difficulty and so on.

After
Ind AS comes into place, the ‘expected loss’ model will be followed which is
based on estimating Credit Risk since initial recognition. Ind AS 109 requires
entities to recognise and measure a credit loss allowance or provision based on
an expected credit loss model.

The
new impairment model based on the expected credit losses as compared to
current  percentage-based provisioning
requirements will have a significant impact on the entities’ estimation of the
probabilities of default.

–    Ind AS 32, Financial Instruments:
Presentation which will change the presentation by the issuer of a financial
instrument as liability or equity based on principles of classification.

–    Ind AS 113, Fair Value Measurement which
defines how fair value will be measured.

–   Ind AS 115, Revenue from Contracts with
Customers which is effective from 1^st April 2018, replacing Ind AS
11, Construction Contracts and Ind AS 18, Revenue.

11.6   Carve-Outs from IFRS: The Ind AS contain
some carve-outs as compared to IFRS as mentioned below. These carve-outs have
been made either due to conceptual issues or considering Indian economic
conditions and existing accounting practices being followed in the country.

–    Events after the Reporting Period – Ind AS
10 vis-à-vis IAS 10As per IFRS, Rectification of any breach of a loan
agreement after the end of Reporting period is a non-adjusting event. Whereas,
as per Ind AS, if the lender, before the approval of Financials Statements for
issue, agrees to waive the breach, it shall be considered as an adjusting
event.

–    Leases – Ind AS 17 vis-à-vis IAS 17:
As per IFRS, all leases rentals to be charged to statement of profit and loss
on straight-line basis. Whereas, as per Ind AS, no straight-lining for
escalation of lease rentals is to be done in line with expected general
inflation.

–    Employee Benefit – Ind AS 19 vis-à-vis
IAS 19: As per IFRS, corporate bond rates are to be used as discount rate for
determining Actuarial Liabilities. Whereas, as per Ind AS, mandatory use of
government securities yields rate is to be done.

–   The Effects of changes in Foreign Exchange
rates – Ind AS 21 vis-à-vis IAS 21: As per IFRS, recognition of exchange
rate fluctuations on long-term foreign currency monetary items is to be done in
the statement of profit and loss. Whereas, as per Ind AS, there is an Option to
defer exchange rate fluctuations on long-term foreign currency monetary items
existing as at the transition date.

–    Investment in Associates and Joint Ventures
– Ind AS 28 vis-à-vis IAS 28: As per IFRS, for the purpose of applying
equity method of accounting in the preparation of investor’s financial
statements, uniform accounting policies should be used. In other words, if the
associate’s accounting policies are different from those of the investor, the
investor should change the financial statements of the associate by using same
accounting policies. Whereas, as per Ind AS, the phrase, ‘unless impracticable
to do so’ has been added in the relevant requirements.

–    Financial Instruments: Presentation – Ind AS
32 vis-à-vis IAS 32: As per IFRS, equity conversion option in case of
foreign currency denominated convertible bonds is considered a derivative
liability, which is embedded in the bond. Gains or losses arising on account of
change in fair value of the derivative need to be recognised in the statement
of profit and loss as per IAS 32. Whereas, as per Ind AS, an exception has been
included to the definition of financial liability, whereby conversion option in
a convertible bond denominated in foreign currency to acquire a fixed number of
entity’s own equity instruments is classified as an equity instrument if the
exercise price is fixed in any currency.

–    First time
Adoption – Ind AS 101 vis-à-vis IFRS 1: As per IFRS, on the date of
transition, either the items of Property, Plant and Equipment shall be
determined by applying IAS 16 ‘Property, Plant and Equipment’ retrospectively
or the same should be recorded at fair value. Whereas, as per Ind AS, an
additional option is given to use carrying values of all items of property,
plant and equipment on the date of transition in accordance with previous GAAP
as an acceptable starting point under Ind AS.

–    Business Combinations – Ind AS 103 vis-à-vis
IFRS 3:

As
per IFRS, bargain purchase gain arising on business combination is to be
recognised in Statement of profit or loss as income, whereas, as per Ind AS, it
is to be recognised in Capital Reserve.

It
is proposed to minimise carve-outs in the future in course of time. In order to
minimise the carve-outs which are due to conceptual issues, ICAI is
continuously in dialogue with IASB and raising concerns at appropriate
international forums.

The
objective of carve-outs made due to Indian economic conditions and existing
accounting practices was to smoothen the transition to Ind AS and are proposed
to be removed over a period of time when Ind AS get stabilised in India and an
environment compatible with the requirements under IFRS is developed.

12     The way forward

12.1   Changes in Accountancy, due to change in
Technology:  Globalization of national
economies and their interdependence had been strengthened by the internet,
which brings people living across the globe together in no time. This had an
impact on the working of the different professions and the profession of
accounting has not been left unaffected by this global revolution of
networking. New technologies spawn new applications and possibilities, which in
turn inspire changes to accounting methods and methodologies. The advent of
cloud-enabled computing has brought improvements to mobility and connectivity
for accountants. As a result, one is able to work with clients across the globe
from the comfort of one’s home, remotely access one’s data from a variety of
devices regardless of one’s location or the time, perform advanced computations
on the fly and retrieve real-time analytics. Technological changes to
accounting have automated many of the inputs and calculations that accountants
once had to perform manually. This allows one to play a more analytical and
consultative role in one’s interactions with clients. Of course, these advances
also require one to remain flexible, adaptable and perpetually learning in
order to keep up with the rapid pace. The evolving Block Chain technology and Artificial
Intelligence will also impact the way accounting is done, in times to come.
These are interesting times in the Accounting arena.

12.2   India has come a long way through evolving
the accounting rules towards better governance and globalization of its rapidly
growing economy. The couple of years of experience by several hundred Indian
companies ushering in IFRS converged accounting, to the say the least, is
encouraging. The existing Standards for SME/SMCs are also being upgraded to
make them compatible with Ind AS except for the complexities of Fair Value,
time value of money, etc. and this could be next era of big changes in
Indian context.  

Origin
and Evolution of Auditing

13.    Origin of Audit

13.1
  The word audit comes from the word
“Audire” (means to hear). In general, it is a synonym to control, check,
inspect, and revise. In early days an auditor used to listen to the accounts
read over by an accountant in order to check them. Auditing is as old as
accounting. It was in use in all ancient countries such as Mesopotamia, Greece,
Egypt, Rome, U.K. and India. The Vedas contain reference to accounts and
auditing. Arthasashthra by Kautilya also detailed rules for accounting and
auditing of public finances.

13.2
  In general, it is a synonym to control,
check, inspect, and revise. Auditing existed primarily as a method to maintain
governmental accountancy, and record-keeping was its mainstay. It wasn’t until
the advent of the Industrial Revolution, from 1750 to 1850, that auditing began
its evolution into a field of financial accountability. Checking clerks were
appointed in those days to check the public accounts and to find out whether
the receipts and payments are properly recorded by the person responsible.

13.3
  As trade and commerce grew extensively
globally, the involvement of public money therein also increased manifold. This
in turn created a demand from the investors to have the accounts of the
business ventures examined by a person independent of the owners and management
of the business to ensure that they were correct and reliable. Such a demand
laid down the foundation for the profession of auditing.

13.4
  Over the years, the extent of reliance
placed by the public on the auditors has increased so much with time that it
is, unreasonably, felt by the public that nothing can go wrong with an
organisation which has been audited. Though the fact that an audit has been
carried out is not a guarantee as to the future viability of an enterprise, it
is extremely important that the auditors carry out their assignments with
utmost professional care and sincerity, to uphold the faith posed by the public
in them.

13.5
  Over the years, auditing has undergone
some critical developments. A change in audit approach from “verifying
transaction in the books” to “relying on system” also evolved due to the
increase in the number of transactions which resulted from the continued growth
in size and complexity of companies where it was unlikely for auditors to play
the role of verifying transactions. As a result, auditors started placing much
higher reliance on companies’ internal controls in their audit procedures.
Furthermore, auditors were required to ascertain and document the accounting
system with particular consideration to information flows and identification of
internal controls. When internal control of the company was effective, auditors reduced the level of detailed testing.

13.6
There was also a readjustment in auditors’ approaches where the assessment of
internal control systems was found to be an expensive process and so auditors
began to cut back their systems work and make greater use of analytical
procedures. An extension of this was the development during the mid-1980s of
Risk-Based Auditing (RBA). RBA is an audit approach where an auditor will focus
on those areas which are more likely to contain errors. To adopt the use of
RBA, auditors are required to gain a thorough understanding of their audit
clients in term of the organisation, key personnel, policies, and their
industries. The use of RBA places strong emphasis on examining audit evidence
derived from a wide variety of sources that is both internal and external
information for the audit client.This period also involved Introduction of
Computer Assisted Audit Techniques (CAATs) that facilitated data extraction,
sorting, and analysis procedures.

14.     Advent of computerization and auditing

14.1
Before the advent of the computer, bookkeeping was done by actual bookkeepers.
The bookkeeper would record every financial transaction the company made in a
journal, the then book of primary entry. The transaction didn’t just need to be
entered into the journal but also copied to other ledgers, for example, the
company’s general ledger.

14.2
  Prior to the advent of computers, to
ensure accounts were in balance, a ‘Trial Balance’ was used. If this internal
document revealed that the accounts were not balanced then the bookkeeper had
to undertake the arduous task of going through each transaction, check the
castings, carry-forwards, etc. until the root cause of the disparity was
located and rectified so that the accounts again balanced.

14.3
  The advent of computerisation
dramatically changed the manner in which the business was conducted. It had
significant effect on organization control, flow of document information
processing and so on. Auditing in a Computerised environment however did not
change the fundamental nature of auditing, though it caused substantial change
in the method of evidence collection and evaluation. This also required auditors
to gain knowledge about computer environment (hardware, software, etc.)
and keep pace with rapidly changing technology, even to the extent of using
sophisticated Audit software.

14.4
  Auditors generally followed an “auditing
around the computer” approach by comparing the machine’s input with its
output (parallel processing), just as he/she had compared the voucher files
with the ledger books in the early 1900s.

14.5
  With the introduction of computers,
conventional accounting systems and methods using papers, pens, etc. underwent
drastic changes, therefore exerting a great impact on internal control and
audit trails in following audit procedures. Auditors could no longer depend on
visible records but only check the existence of adequate internal control
system to ensure accuracy of operations; the number of records which could be
read only when processed by computers increased while intermediary and legible
records which existed in conventional manual accounting processes decreased and
there were many cases in which audit trails were not available. Therefore,
audit procedures had to be revised to cope with
these problems.

14.6
With rapid changes in the business world, auditors only slowly realised they
needed to be technologically proficient and, perhaps, adopt new approaches. The
21^st Century forced auditors to rather “work through the computer”
in performing their functions as virtually all business transactions were
conducted via the information technology. Computer Assisted Audit Techniques
(CAATs) were developed for using technology to assist in the completion of an
audit. CAATs automated working papers and auditors used software to perform
audits. CAATs  were very useful when
large amounts of data were involved or complex relationships of related data
were needed to be reviewed to gather appropriate audit evidence from the
aggregated data. It also increased the efficiency of the conclusions about data
analysis. Several CAATs were developed like Generalized Audit Software, Data
analysis software; Network security evaluation software/utilities; OS and DBMS
security evaluation software/utilities; Software and code testing tools”,
Interactive Data Extraction and Analysis, and Audit Command Language.

15.    Auditing in future and use of technology
for audit

15.1
  For the past two decades, auditors have
been seeking less and less audit evidence from detailed substantive testing.
Better accounting systems and the greater use of IT by clients has meant that
very few material transaction errors are being discovered by external auditors.
Therefore, audit emphasis is increasingly shifting from the detailed
examination of the routine transactions to the internal controls and the
potential of risk. These developments have to be viewed in terms of a change
from audit efficiency to audit effectiveness. There has been resurgence in the
emphasis on judgement regarding the assessment of risks and controls, judgement
regarding the interpretation of analytical reviews, and judgement in relation
to any testing (albeit on limited basis). The focus, by some firms, on the
high-level risks and controls, together with the justification of very limited
amounts of detailed substantive testing based on their risk analyses and
analytical reviews, has completely altered previous conceptions of the external
audit.

15.2
  The functions of auditors have changed
over the years unlike its antecedent “accounting”. Much later in history, this
duty changed since auditors are not guarantors and there is no way they can
ascertain 100% that the financial statements prepared and presented are free
from fraud, therefore, the auditors were expected to give reasonable skill and
care in giving their opinion on whether the financial statements faithfully
represent the financial situation of the business. The roles of auditors were
seen to be changing due to changes in the world at large. Due to this, the
assertion in an audit report has changed from “True and correct” in the past to
the present concept of “True and Fair”.

15.3   Given the
recent advances in business technologies, the continuing emphasis on the
backward-looking or historical audit is now being seen as an outdated
philosophy. Instead, the thought is that real-time solutions are needed. As
such, it is felt that auditing firms that successfully experimented with the
CAATs should give eventual consideration to more advanced programs which
contain functionalities resembling the audit of the future and provide a higher
level of assurance. Furthermore, these programs may assist in optimizing the
audit function by analyzing all financial transactions as they occur. This has
also resulted in the evolution of different fields of audit viz., Statutory
Audit, Internal Audit, Management Audit, Systems Audit, Forensic Audit and so
on. Clearly, within the overall audit function, the scope and end result or the
reporting is different in the different types of audit.

15.4
  The extent to which data, controls, and
processes are automated must be considered and discussed with the client, for
example a company that is overburdened by manual audit processes will need to
confront this issue at some point if the objective is to yield optimal benefits
from the audit. An enterprise that moves toward greater automation relative to
data, processes, controls, and monitoring tools begins to naturally structure
itself for the coming of the future audit. There are a variety of methodologies
like Embedded Audit Modules (EAM), Monitoring and Control Layer (MCL), Audit
Data Warehouse (ADW), and Audit Applications Approach that will need to
progressively adopted and used to meet the users’ expectations.

15.5   New technological
tools have the potential to enable the auditor to mine and analyze large
volumes of structured and unstructured data related to a company’s financial
information. This capability may allow auditors to test 100% of a company’s
transactions instead of only a sample of the population. Major accounting firms
have asserted that the use of these tools will enhance the audit by automating
time-consuming tasks, which are more manual and rote in nature. For example,
through the use of artificial intelligence, robotic systems could interface
with a client’s systems to transfer and compile data automatically, something
previously done manually by a junior auditor. Other areas where such
technologies may introduce efficiencies include processing of confirmation
responses or using drones for physical inventory observations.

15.6
  As a result, the auditor should have
more time to carefully examine the more complex and higher risk areas that
require increased auditor judgement and contain high levels of estimation
uncertainty. Such tools, will also enable auditors to perform advanced
analytics which will provide them with greater awareness and deeper insights
into the company’s operations. Data analytics may also allow auditors to better
track and analyze their client’s trends and risks against industry or
geographical datasets, allowing them to make more informed decisions and
assessments throughout the audit process.

15.7
  Further, through the power of big data,
auditors will be able to correlate disparate data information to develop
predictive indicators to better identify areas of higher risk, which in turn
could lead to early identification of fraud and operational risks. For example,
firms will have the ability to develop predictive models to forecast financial
distress in order to better assess the future financial viability of a company
or improve fraud detection by helping auditors assess the risk of fraud as part
of their risk assessment.

15.8
  The use of these technological tools and
methods also raise certain challenges. For example, it is important that the
data being used is reliable, complete and accurate. That is true for general
ledger data, other financial and operating data, and data from outside the
company. Data security and quality control over these tools, whether developed
in-house or by vendors, are also factors for firms to consider. And ensuring
consistency of approaches across group audits may become difficult if such
tools are not readily available to, or used by, affiliate offices. Also,
auditors should take care that they are not over relying on data analytics. As
powerful as these tools are, or are expected to become, they nonetheless are
not substitutes for the auditor’s knowledge, judgement, and exercise of
professional scepticism.

16.     Changing role of Auditors

In
the last two decades, rapid and vast development in corporate governance has
consolidated the auditor’s position as a watchdog. The perpetual accounting and
auditing failures like Enron, WorldCom, Paramalt, and more recently Satyam has
exposed serious lacuna in the auditing. India’s largest accounting fraud
“Satyam” has dented auditing profession and surfaced the inherent conflicting
position of auditors in the Indian business scenario. The recent ‘PNB’ scam and
the more recent resignation of auditors in several listed entities just before
the financial statements were to be adopted has also put the auditors; and
their role in the limelight.

16.1
  According to IFAC, objective of an audit
is to enable the auditor to express an opinion on whether the financial
statement is prepared in all material respects, in accordance with an
identified financial reporting framework. The auditor’s opinion helps to
determine the true and fair financial position and operating results of an
enterprise. This is considered as most accepted role of the auditorsand
mandated so by the corporate laws of most countries of the world. In India
also, the auditor is cast with the responsibility of ensuring this aspect.

16.2
  With development of stricter corporate
governance codes and new reporting standards both in accounting and auditing,
the auditor’s role has implicitly enhanced to a great extent as against the
traditional role of merely assessing the true and fair value of a corporation.
With financial reporting standards now focusing on concepts of ‘fair value’,
‘impairment’ and ‘going concern’, which involve a high level of judgement, the
role of auditors is becoming much more relevant than ever.

16.3
  External auditors are the oldest
watchdogs, to protect the interest of the shareholders by verifying the
financial accounts and presenting their opinion on it. In India, in the recent
decade, capital markets have grown tremendously, open access of market has been
given to foreign nationals / investors, numerous corporate frauds (including
Satyam, Ricoh, and PNB) happened, and vast developments in the field of
corporate governance have taken place. All these increase theauditor’s
responsibilities and make them an integral part of corporate governance
framework. They are now professed to play different roles and responsibilities,
other than their statutory responsibilities in this contemporary business
environment. The corporate governancereforms by SEBI in the form of Clause 49
and the more recent LODR has improved the status of auditing and given much
needed significance to the role of auditors.

17.   Standards on Auditing in India

17.1
In simplest possible terms, auditing standards represent a codification of the
best practices of the profession, which already exists. Auditing standards help
the members in proper and optimum discharge of their profession duties.
Auditing standards also promote uniformity in practice as also comparability.
Standards on Auditing help to:

–   compensate for the lack of observability of
the audit outcome by focusing on the audit process;

–    partially mitigate the information advantage
possessed by the auditor as a professional expert that might motivate the
auditor to under-audit;

–    counter balance the diversity of demand
across multiple stakeholders that might drive the audit to the lowest common
denominator and create a market based on adverse selection; and

–    provide a benchmark that facilitates the
calibration of an auditor’s legal liability in the event of a substandard
audit.

17.2
     However, the Standards does not:

–    discourage the use of judgement by auditors;

–   limit the potential demand for alternative
levels of assurance;

–   lead to excessive procedural routine or standardisation
in the conduct of the audit; or

–   be set based on an enforcement agenda.

17.3
  Since its establishment, the ICAI has
taken numerous steps to ensure that its members discharge their duties with due
professional care, competence and sincerity. One of the steps is the
establishment of the Auditing Practices Committee (APC) in September
1982. Representatives from the Reserve Bank of India, the Securities and
Exchange Board of India (SEBI) and industry were part of APC and had their say
before the ICAI formulated its guidance and statements on `Standard Auditing
Practices’. APC issued Statements on Standard Auditing Practices (SAPs) and
guidance notes without involving the public in the entire process.

17.4   In July 2002,
the central council of ICAI renamed the existing APC as Auditing and Assurance
Standards Board (AASB) to reflect the activities being undertaken by the
committee. To bring about more transparency in the auditing standards setting
process, the council also stipulated that the AASB would have four special
invitees.. Further, all exposure drafts issued by AASB are sent to specific
bodies such as the stock exchanges, Insurance Regulatory & Development
Authority (IRDA) and the Indian Banks’ Association (IBA) for their views and
comments.

17.5   The Standards
on Auditing (SAs) issued by ICAI are based on International Standards on
Auditing (ISAs) issued by IFAC.Since, ICAIis one of the founder members of
IFAC, the Standards issued by the AASB under the authority of the council of the
ICAI are in conformity with the corresponding International Standards issued by
the International Auditing and Assurance Standards Board (IAASB) established by
the IFAC. The only exception to this is SA 600 ‘Using the work of another
auditor’ which, looking to the Indian scenario where auditors can rely on
branch auditors or subsidiary auditors, is not converged with ISA 600.

Currently, the Standards on Auditing issued by the ICAI
are:

18. Revised Audit Reporting (Effective
for
periods beginning on or after 1^st April 2018)

18.1
The ICAI has issued revised standards on audit reporting. The same are based on
the ISAs issued by IFAC in 2016. The reason stated by IFAC for issue of the
revised ISAs is as under:

–    Continued relevance of audit

–   Improve audit quality and
professional scepticism

–    Enhance preparer focus on key
financial statement risk areas and disclosures

–    Enhance communicative value to users

–   Stimulate more robust auditor
interactions and user engagement

–   Improve users’ understanding of what
an audit is and what the auditor does.

18.2
     Key Audit Matters (KAM):

Mentioning
KAM in an audit report is one of the major changes brought about in audit
reporting from financial year 2018-19 onwards. KAM are defined as those matters
that, in the auditor’s professional judgement, were of most significance in the
audit of the financial statements of the current period. KAM are selected from
matters communicated with TCWG. KAM are required to be communicated for audits
of financial statements of all listed entities – however an auditor may also
voluntarily, or at the request of management communicate KAM. The following
considerations are used in determining matters of most significance:

–    Importance
to intended users’ understanding of the FS

–   Nature and extent of audit effort needed to
address

–   Nature of the underlying accounting policy,
its complexity or subjectivity

–    Nature and materiality, quantitatively or
qualitatively, of corrected and accumulated uncorrected misstatements due to
fraud or error (if any)

–    Severity of any control deficiencies
identified relevant to the matter (if any)

–    Nature and severity of difficulties in
applying audit procedures, evaluating the results of those procedures, and
obtaining relevant and reliable evidence

18.3
  It is felt that the introduction of KAM
in the audit reports will usher in more transparency in disclosures and
improvement in audit quality. 

conclusion

19.
    Over the last decade, the users’
expectations from financial statements and audit report thereon have undergone
a sea-change. From a time where concise financial statements and crispaudit
reports were favoured, the trend now is clearly towards more disclosures and
transparency in financial statements and audit reports with more details. An
attempt has been in this article to discuss the evolution of accounting and
auditing to meet these ever-growing expectations.  

shailesh.kwebmaker

In celebration of its 50th Volume – the BCAJ brings
a series of interviews with people of eminence, the
distinct ones we can look up to, as professionals. Those
people who have reached to the top of their chosen
sphere, people who have established a benchmark for
others to emulate.

This second interview is with Mr. Y. H. Malegam.
Mr.Yezdi Hirji Malegam is well known in the fraternity of
professionals – on both practitioners’ as well business
side. He served as president of the ICAI (1979-80), served
on the Board of the Reserve Bank of India (17 years),
and was awarded Padma Shri (2012). Academically, he
holds a particular distinction of passing both the Indian
Chartered Accountancy examination (stood first and won
a gold medal) and Society of Incorporated Accountants
examinations (stood first and won a gold medal).
Mr. Malegam was appointed on several committees/
commissions of significance. He also led one of India’s
oldest professional services firm for decades. However,
what surpasses his achievements and accolades is the
respect people have for Mr Malegam for his integrity,
clarity and the wealth of experience which is the true
hallmark of a professional.

In this interview, Mr Malegam talks to BCAJ Editor Raman
Jokhakar and BCAJ Past Editor Gautam Nayak about his
formative years, accounting and auditing aspects of the
profession, current issues before the profession, personal
anecdotes from his sixty plus years of career….

(Raman Jokhakar) Tell us a bit about yourself as a
young professional. What was it like growing up as a
fresher then?

After graduating as a B. Com, I started articles with
S. B. Billimoria & Co on 30thJune, 1952. I was 18 years
old. I spent the whole of my first year of articles at
Jamshedpur, where we were auditing Tata Iron & Steel
Co Ltd (Tata Steel) and Tata Engineering and Locomotive
Co Ltd (TELCO). It was a great learning experience.
These two companies had perhaps the best corporate
accounting systems, and they were amongst the few who
had started using the mainframe Punch-Card Hollerith
machines. It gave me the opportunity to audit a variety of
activities, including manufacturing, sales, iron ore mines,
collieries etc. This was the period when there was large
capital expenditure in Telco, and it was an opportunity
to understand how contractors’ bids and escalation
claims should be examined. It was also an opportunity
to appreciate how the use of accounting machines could
change the traditional audit programme. S. B. Billimoria
& Co were the main auditors of the Tata Group and the
Wadia Group as also Volkart Brothers, amongst a number
of business groups, and were auditors of the Reserve
Bank of India, the State Bank of India and almost all
the large Indian banks. Even while I was doing articles
for the Indian Institute, I was simultaneously doing byelaw
service for the Society of Incorporated Accountants,
London (which subsequently merged with the Institute
of Chartered Accountants in England and Wales). After I completed my articles in June 1955, I continued with the
firm for one year, during which time, I took charge of a
number of audits of the firm. I qualified in England in July
1957 and returned to India and rejoined S. B. Billimoria &
Co and became a partner on 1stJanuary, 1958.

I was immediately given some important and interesting
assignments. LIC had been formed with the amalgamation
of over 230 individual companies, and it was a gigantic
task to amalgamate the financial statements of the
companies. LIC had 12 auditors, but S. B. Billimoria & Co
was one of the four central auditors, and this task had to
be mainly done by me.

The Durgapur Steel Works were being constructed by
11 British firms under a contract with the Government of
India, whereby the individual firms sold the equipment
but formed a company (ISCON), which did the erection
on a cost plus basis. Price Waterhouse was appointed
by ISCON and we were appointed by the Government
to jointly certify the bills for construction. I was asked to
go to Calcutta to attend a meeting with ISCON and given
two large volumes of the contract, which I studied for the
first time on the long flight to Calcutta and thereafter, I
was in charge of this work. We had appointed Mr S. V.
Ayyar, a retired Chief Cost Officer of the Government
as our consultant, and he worked with me. I learnt a
lot from him as to how to audit construction invoices,
which stood me in great stead throughout my career.
For example, steel scrap had to be segregated between
structurals which were above a specified length, which
were sold as structurals, and which fetched a much
higher price as compared to those below this length,
which were sold as scrap. Similarly, for all construction
bills, it was necessary to examine the drawings and
ensure that the quantities billed were not in excess of
the quantities as per the drawings. On one occasion,
a sub-contract had a performance incentive, whereby
savings in cost was to be shared with the sub-contractor.
The incentive for which payment was made was a large
percentage of the estimated cost. I challenged this and
argued that obviously the estimates were understated.
This was disputed by the local office of ISCON, and
it was accepted only when, on a visit to UK, I met the
Company’s senior officials in the UK and convinced
them about my stand. Later, when examining the
fabrication bills for the capital expenditure at Telco, I
noticed that the escalation claims had been made and
accepted on the basis of the standard escalation claims
of the industry. I pointed out that the standard claim was
based on a standard percentage of the rate per ton of
fabrication, and it had been overlooked that there were
two rates which were applicable, namely one where steel
was supplied by Telco and second, where the steel was
supplied by the fabricator. The application of a common
percentage on both rates resulted in gross overpayment
where steel was supplied by the fabricator. This resulted
in substantial refunds from the fabricator for work already
done, and even more savings for work still to be done.

(R) What are the important parts of your daily
routine? Has it changed over the years?

From my student days, I always liked to start early in
the day. Even today, I wake up between 6 and 6.30 am,
take a morning walk and then start work by about 7.30
am. The best work, I feel, is done in the early part of the
morning, especially the work that involves thinking.

(R) What was your idea of success when you were
in your 20s? Did it change over the decades?

I am not a very ambitious person. I did not have a
concept of wanting to achieve something. However, I can
say that some incidents played an important role in shaping
my career.

In those days, there was no idea of increasing the business
by taking the work of someone else. We were the auditors
of RBI and of all its subsidiary corporations. I remember
that when the UTI was formed, we were closely involved in
its formation. You might still find some early documentation written in hand by me in formulating the regulations and Dr Pendharkar, the first CEO of UTI has acknowledged
this in his book. Since we were involved in its formation,
we expected that we would also be appointed as its first
auditors. However, after the formation, UTI appointed A
F Fergusson & Co. as auditors. After about two years,
the Chairman of UTI called Mr. Billimoria and said he
wanted to meet him. Mr. Billimoria asked for the reason
of the meeting. The Chairman said that they wanted to
appoint us as the auditors of UTI. Mr. Billimoria enquired
more about the matter, and the Chairman explained
that there were some differences with the auditors. Mr.
Billimoria asked the Chairman to give him the name of the
concerned partner, and told him that he (Mr. Billimoria)
would bring that partner of A F Ferguson & Co with him
to the UTI Chairman so that the matter can be sorted
out. These were the value systems, which have always
guided me.

(R) Who were your role models and mentors? How
did they shape your career?

My parents were my earliest mentors. My mother was
one of the first woman graduates and was a principal of
a school. Due to this, although she wanted me to study,
she insisted that after coming back from school, I should
go out and play and do school work later in the evenings.
This inculcated my interest in sports. I played cricket a lot,
both for my club and also my college, and represented my
Gymkhana in badminton and table tennis.

My father was a self-made man. He couldn’t complete his
studies in medicine due to financial difficulties, because
he lost his father when he was eight years old. He started
and ran a surgical equipments business, which he built
up successfully. He was more like a friend, and did not
impose things on me that I had to accept because he was
the father.

I was lucky to have good professors who took interest in
me in college and then of course there was Mr. Bhikaji
Billimoria. After the loss of my father, our relationship was
like father and son. He was a complete gentleman in all
respects. By his example, I learnt many things, including
how to behave with clients and colleagues, and most
importantly, never to compromise.

(R) What are the top lessons you learnt over
the past 8 decades that you wish to share with the
present generation?

i.To learn to ask questions and not be scared to show
my ignorance of a subject.
ii. Never to be patronising and to treat all persons
equally, irrespective of their social standing.
iii. Never be unwilling to admit mistakes and take
corrective action.

(R) Looking back, is there something you feel that
you could have done differently in your career?

I feel I should have given more time to understanding
information technology, where I am particularly deficient.
Earlier, I also used to practice income-tax and enjoy it.
Unfortunately, I could not devote enough time, as I got
more and more involved in the audit practice.

(Gautam Nayak) As a leader of a firm with stature
and long standing, what were the important pillars it
was built on – that new entrants could emulate?

i. We placed great emphasis on client acceptance and
retention. I had made a policy on acceptance or retention
of a client. Every partner, before taking a new client, had to
discuss it with me to ensure that the new client met those
criteria. Similarly, if a partner was unhappy with a client,
he was encouraged to discuss with me, the question of
whether the client should be retained.

ii. We never wanted to build a firm that was the largest or
the most profitable. The goal was to build a firm that was
most respected.

iii. Competence, fairness and integrity were the most
important aspects of the firm’s practice. Client’s
confidence in us was the most important aspect. Once we
felt that client confidence was not there, we would give up
the client. On one occasion, we had a different view with a
client group that constituted nearly 10% of our revenue. I
was the chairman of the Research Committee of the ICAI,
and a paper was presented at a Seminar in Mumbai which
suggested that customs duty need not be added as an
element of cost in the valuation of inventories. This paper
was sent to the Research Committee for consideration.
We thought that this was not a sound accounting practice,
and issued a guidance on that basis. One of the firm’s
clients, handled by another partner, had followed this
practice, as did many other companies after the Seminar.

Mr. Kuruvilla, CBDT Chairman, asked the CIT, Mumbai
to call me and discuss the whole issue of the accounting
practice. Since I was aware of the practice followed by
our client, I checked with the client if they would mind
me attending that meeting with the CIT to discuss the
matter. The client did agree. When I saw what the tax
department was intending to levy as additional tax on the
client, I told the department that the additional tax was
payable, but that the computation was excessive, which
the tax department accepted. However, the clients felt
that I should have defended their position, as they did
not want to change their stand. I told my partners that we
should not compromise, and that we should give up the
client. The client persuaded us not to do so, but within
a year, other issues arose, as the confidence had been
destroyed, and we gave up the group.

At the same time, it was necessary to demonstrate to the
client that we were willing to assist the client to act in any
way which was legal and permissible.

On one occasion, one of the Tata group entities suggested
an accounting adjustment, with which I did not agree.
However, on enquiry, I ascertained that they wanted to
give a dividend, but did not have enough profits to do so.
They had consistently given dividend, and wished to carry
on that practice. In those times, investment allowance
reserve was created in the accounts, which was meant
to be retained for seven years. Now that the seven years
had already passed, I suggested that this amount could
be brought back to the profit and loss account since it was
taken out from profit and loss account at the inception of the
reserve. The client took some time, and took an external
opinion, and came back saying that this was not possible.
They had taken an opinion of Fali Nariman. I asked the
client that I would like to meet Fali and discuss the matter.
After the meeting at the Oberoi, Fali Nariman agreed with
my view and even asked me to draft an opinion that he
could sign and give the client. This demonstrated to the
group that our approach to the audit was not negative and
encouraged the client to freely discuss with us all issues
with the confidence that we would permit everything which
was legal and acceptable, and at the same time not allow
anything which was not legal.

iv. When invited to speak on or contribute an article,
select a subject you do not know, rather than a subject
you are familiar with. This is the best form of learning, as
you prepare for the talk or article.

v. In building a professional practice, it is important to
attract talented individuals. In our firm, we did this by
identifying exceptional individuals at an early stage in
their career, giving them positions of responsibility and
empowering them and by having a policy of promoting
persons to partnership purely on merit, irrespective of
religion or caste or other considerations. In our firm, we
had partners of all communities, and no partner was
related to any other partner.

(G) Can you share your experience of the move from
heading a leading CA firm to being part of a Big N firm?

We had international affiliations for many years even
before I became a partner. However, this was mainly an
arrangement for mutual assistance. The international firms
referred clients to us and we allowed them to examine
our working papers to give them confidence about the
quality of our work. We also attended their international
conferences and built up personal relationships.

When we joined Deloitte Touche Tohmatsu in 2004, the
Indian firm consisted of S. B. Billimoria Co, C. C. Chokshi
Co and Fraser and Ross. N. V. Iyer and I became Co-
Chairmen of the firm. We shared a wonderful relationship,
as we were, and still remain, good friends. We both retired
in 2004, and A. F. Ferguson & Co. joined thereafter. The
Indian firm is, therefore, a combination of 4 large national firms. It is not controlled by an overseas entity. Only for
the purpose of technology or certain technical matters,
we had people from overseas. The benefits also flowed
the other way – when our Indian clients invested and
expanded overseas, Deloitte was appointed to do their
work in those countries.

One change that did happen. As the number of partners
increased, it became necessary to share profits on a
more results-based system and performance gradation
criteria became important for both partners and staff.
The international affiliation has greatly increased the
competence of the firm, as it had greater access to
technical inputs from overseas, as also the ability to refer
to international offices for guidance on specific issues.

(G) Worldwide, more and more reliance is being
placed on valuations and estimates, which are often
highly subjective, for the purpose of accounting.
Valuers are not as regulated as public accountants are.
Is the increasing role of valuation in accounting, more
specifically in relation to fair value measurements,
making the accounts more subjective and perhaps,
less reliable too?

The one area, other than audit, where I have done much
work, and to which I can claim expertise, is valuations.
When you do valuations, you have to have access to
information, which is otherwise not available in the public
domain. My view has always been that valuation based
approach should be applied to instruments listed in the
markets because the information is available. Valuation
based approach is also justified for associates and
subsidiaries, because the information is also available.
But applying fair value to unlisted entities does not seem
reasonable and practical since the information in the
public domain is often inadequate.

Fair value is largely applied to financial instruments, where
estimates are involved. Therefore, most other entities are
not significantly affected by fair value measurements.

(R) Is auditing becoming more a task of form over
substance? There is documentation and paperwork,
but auditor’s judgement could be missing. These
days, 60% or more time goes into documentation as
compared to actual testing and asking questions.
Is proving that procedures have been followed
becoming more important than the actual application
of mind? Is this desirable? Have the fundamentals of
audit changed?

One thing is that the auditor needs to be more
sceptical. In the olden days, you assumed that everyone
was a gentleman, and you accepted what they said. Now
you have to be sceptical of the people at the highest
level because all of these frauds take place. Not fraud in
terms of taking money out from the company, but fraud
in falsification of accounts for a number of purposes.
This is a grey line, at which things can be done without
your knowledge, so you have to be much more sceptical
during the audit.

I think you also need to realise that documentation is there
for your protection, but documentation alone does not add
to the value of audit. Except, of course, the very process
of creating documentation means that you do not leave
out some essential parts of the audit. To that extent, it is
useful, but it is not an excuse for not doing a good audit.

The other feeling is that when you had a lot of manual
work, which was being done earlier, accuracy of
accounting was one of the objectives. You had to balance
the trial balance, you had to take totals, you had to do
postings; now all that is gone – machines are doing all
that. Therefore, in the olden days, you needed a lot of
junior staff to do this work. Now that need does not arise.
Therefore, an audit cannot be done by junior staff. You
now need to do audits only with higher level of staff. And
therefore, the professional now has to think about this –
that can you afford to do auditing, when you rely upon
the work of juniors, when in effect the skills needed are of
a much higher level? That, I think, is affecting firms from
properly addressing the problem.

If I may take an example, if you are talking of concurrent
audit in banks – the whole purpose of the concurrent
audit was to prevent a malpractice before damage takes
place. And therefore it was nothing else, but equivalent
to internal audit, but internal audit done concurrently.
Therefore, you need much higher skills. And if you do not
do that, if you entrust that work to the articled clerks or the
people who have no maturity or the understanding of this,
you are not serving any purpose. In fact, you are creating
a worse situation, because you rely upon something, you
assume that is done, but there is no such control. That I
think is the big area, which you have to address.

And the other thing is, I think, increasingly now the
purpose of audit is changing. In the past, the purpose of
audit was to give some degree of reliability to the financial
information. Now, reliability by itself is not enough, with
increased computerisation, it is assumed that it will be
reliable. What is now needed is some assurance that
there is no mismanagement, that there is no fraud; some
assurance that you are able to provide to the reader. See
and answer the questions like – What is the future of this
company? Is this run as efficiently as it should be run?
This is where the changes are taking place.

(R) How do you see the audit profession developing
in the future? Would use of technology, such as
artificial intelligence, replace a significant part of the
audit process and audit judgement in the future? Or
would it only help in reducing test checks?

One of the things perhaps I was thinking about, is the
perception that the big firms are doing better audit. I think
one of the reasons perhaps is, that in the big firms there is
now specialisation. The Audit partner does only audit, the
tax partner does only tax. Now, in the smaller firms, the
same person is doing both audit and tax. I feel somehow,
that maybe you are not developing sufficient skills in either
area, in trying to do both. You may be an average auditor
and an average taxman, whereas if you specialise, you
would probably be a very good auditor and a very good tax
practitioner. Now this is the problem which is faced, and
therefore, what can the profession do? We are producing
a large number of members, and there is just not enough
work in the audit profession for them. Therefore, for those
areas which are more individual oriented, where you need
individual skills, there is no harm in having small firms, just
as you can have a lawyer who is appearing in the court as
an individual. He can have few support staff, and he can
have a huge practice. But you can’t have a solicitor’s firm
without having a large number of people specialising in
different areas. Now that is one of the basic issues in the
profession. If you want to go into the audit area, people
must get together and create larger entities; without that,
you cannot function, because you need larger staff, you
need more finances for systems, for machines and for
various other purposes.

The second is – that the skills have to be upgraded and I
don’t know whether we are doing that adequately. If you,
for example, find that people want more assurance than
there is available today, then obviously you will need to
have the skill to do that. What is needed is to understand
what is a good system of internal control, to know how
you detect fraud and what are the forensics skills that you
need. I think we are not doing enough of it in the training.
We keep on doing the same training over and over again.
I used to tell that even in the olden days to my staff – I
said “You are only looking at the paper. If someone gives
you a bill that he travelled by taxi, you will accept that bill.
You don’t know who has signed that receipt or if such a
person exists, but if a man tells you that he travelled by
taxi, you will not believe him. Now, perhaps you can be a
better judge to see whether that is a person, whose word
you can rely on, rather than a piece of paper”. Now that is
the skill which you have to develop, what is the relevant
evidence for checking the transaction, not just a piece of
paper. That is the whole point.

(R) Meaning, the amount of questioning or the type
of questioning and judgement?

Not just questioning. First is, that you are dealing with
people you must have the ability to assess, on whom you
can rely, and on whom you cannot rely. You have to be a
good judge of people, and you can find that out straight
away. There are some people whose honesty you do not
doubt. I am talking about intellectual honesty. Then there
are other people – you feel that maybe he is just trying to
tell you what you want to hear. So you have to understand
that you have to be polite, good but, at the same time,
sceptical. You have to put yourself in the shoes of that
person. If there is a company which is making losses, the
normal practice will be to try and reduce the loss, if it is
making profits, the practice will be to put some cushion
there, that sort of a thing.

(R) Few questions on the professional scene in
India: The Chartered Accountancy profession was
built on certain values and principles. People who
know you, hold you in the highest regard in terms of
abiding in and living those values. As you interact with
professionals – be it Directors, Auditors, Regulators
– do you feel that some of those fundamentals have
undergone a change?

I have personally not come across people for
whom I would say that I have some reservations about
them, but I have at the same time found the general
impression of others to be that standards have declined.
That is unfortunate.

I will give you a specific example. I was talking to some
bank people, the Managing Director of a bank, and I was
trying to work out how we can make better systems,
so I was making some suggestions, and I said, “If you
can get the borrower to submit audited certificates on
these aspects, then it will give you a better control.” And
I was shocked to find the response from that person,
when he said, “No, no, no, after all, all these auditors
certificates are fake certificates. We cannot rely upon any
of these auditors certificates”. And this, unfortunately, is
happening, because either the auditor or the person who
gives the certificate doesn’t understand the importance
of that certificate or he is too much indebted to that client
that he cannot afford not to do this.

Therefore, as far as the profession is concerned; we
have to have a zero tolerance practice. Again, I will
give you an illustration. When I was the president, there
was Mr. D’Souza who was the Commissioner of Income
tax. In the morning one day, I read in the newspaper a
report about some raid, and one Chartered Accountant
who was involved. So I went that morning to Mr. D’Souza
and I said, “Can you make a complaint against this
chartered accountant?” He was shocked, and he said,
as a President, he had expected me to protect the
member, and here I was asking him to make a complaint
against a member. I told him that “Sir, I am protecting
my members. By making a complaint and by punishing
this person, I will give the right message to the rest of
my profession. Whereas without that, it will be assumed
that the whole profession is of that type”. So that’s why I
am saying that we have to have zero tolerance. Anytime
something happens, you have to punish people who are
guilty because ultimately they are the custodians of a
brand. Chartered Accountancy is something which should
carry a lot of respect. The fact that you are a chartered
accountant must be synonymous with the fact that
you are a person of integrity. Now if that brand is
damaged, the whole profession gets damaged.

Unfortunately, our value systems have changed. You
admire a person who is very successful and how do you
measure success? You measure success by the fact that
he has got a large practice, or that is he making a lot of
money or that is he able to buy a large office. In our days,
we never looked at it in that fashion. We looked only at the
respect a person commanded, and the fact whether he
had a large practice or small practice didn’t matter.

(G) Related to this fact – Some people believe that
the distinction between business and professions,
such as the CA profession, has now blurred, and that
every profession has to function like a business to
grow and survive. What is your view?

See, I think there is some force in that. What has
happened is, that you have composite firms. You
have firms that do auditing, they do taxation, they do
management consultancy, they do advisory services etc.
So when that happens, naturally the people you take on
in the firm include non Chartered Accountants. In the old
days, you had one or two or a few of these people, now
a majority of the people are non Chartered Accountants.
They don’t have the same background, discipline etc.,-
they are result oriented. And when they are result
oriented, their whole value systems are different. Not that
they are dishonest, but for them getting work, making
larger profits, these all are more important. What is
happening, therefore, is that in these firms, the Chartered
Accountants are feeling the heat. Their performance
evaluation etc. is now being judged on the same lines
as the others. And therefore, there is a strong temptation
sometimes to cut corners. Even in the olden days, when you had people, in say a commercial organisation, you
had a chartered accountant and you had an MBA, and
the MBA seemed to be more progressive, more dynamic
and then the chartered accountant in order to survive, had
to become more dynamic – that sort of a thing. So there
is that risk, but ultimately this is what I feel – no individual
can use this as an excuse for rationalisation. The final test
for an individual is to be his own judge. If he believes that
what he is doing is ethical, his conduct is correct etc., then
it doesn’t matter whether the whole thing is becoming a
profession or not, or whether it is becoming a business.
Even within a business, you can act like a profession.

(R) About Work and Lifestyle that is changing these
days – Today in spite of technology, most people
around us are more stressed. There is more stress
and burnout amongst CAs. You worked during times
when there were no calculators, and everything had
to be done manually. What has changed?

The burnout is not because of technology, in fact,
technology helps you. This burnout is again because of
how you measure success. What do you want to achieve?
Contentment is a very difficult quality. Peer pressure is
there, and all of these situations lead to it.

[R] Having been a director of many companies,
what are your views on the overall quality of audit in
India and the independence of auditors?

Well, I have not had any occasion whereby I can say
that I have had any reservation about the quality of audit
or about the independence of the auditors. In fact, I would
say that the audit quality over the years is quite good and
it has improved. But I have been connected for auditing
with some big audits and big firms; I can’t really judge this
for smaller companies. But as I said, it’s only in some of
the financial institutions, where this feeling is there that
the reliance on the information which is provided, duly
audited, is not of the quality that one would have expected.

(G) With so many high-profile frauds becoming
public, auditors are being blamed. Is the criticism
justified? What are the real causes for this? You
mentioned about bank directors feeling a certain way.
Do you feel that the role of auditors needs to undergo
a change to match changing public expectations? Or
is a publicity initiative required to educate the public
(besides the Government) as to limitations of an
audit? What, in your opinion, is the long-term remedy
to meet this mismatch?

You see, it is very difficult at this stage to say, but
basically, you can have frauds which are facilitated by
a number of things. You can have a situation of a fraud
where there is collusion between the borrower and
the staff, or there is failure of the staff to perform their
functions. I don’t think external auditors can have a role
in this. You can have a problem, where the borrower and
the staff exploit the gap in the internal control system, and
that perhaps is an area where to some extent the external
auditor may have a responsibility.

And just to illustrate, this question of where you have
a letter of undertaking, which is not recorded in the
accounting system itself. Then, whether the system is
such that it should have been recorded – that system failure
is perhaps where the auditor has some responsibility.
You cannot expect an auditor to look at the failure of the
internal control regulation, or internal control procedures.
That the internal auditor has to do so. I would say thisto
the extent to which there is a fraud in the nature of
the falsification of financial information, I think the auditor
needs to be held responsible.

(R) Self-regulation is seen as a conflict of interest.
Why so? There are so many places where there is
similar apparent conflict of interest – legislators
passing laws to approve their own emoluments, a
tax officer becoming an appellate officer, or a lawyerfriendly
with fellow lawyers becoming a judge before
whom these fellow lawyers now appear. Do you
agree that self-regulation is a conflict of interest, or
that it has failed? Recently we have seen quite a bit
happening – how accountants can self-regulate is
being questioned.

I believe that all professions should have selfregulation,
but I also believe that there is no harm
in having an oversight. But it’s a question of what is
oversight. Oversight is not regulation – that is the big
difference which you have to make. The oversight is to
ensure that the system of self-regulation is functioning,
but the oversight does not take over the functions of the
self-regulator.

Having said that, it is also the responsibility of the selfregulator
to be able to demonstrate that the self-regulation
is effective, that you have sufficient independence, that
there are penalties for failures, and so on. If again, I may
give an example.You look at the Microfinance industry.
The Microfinance industry was in a shambles. Then,
when we made that report, we had made a number of
regulations about what a Microfinance company could
do, could not do, etc. And, at the Reserve Bank, I was
asked, who is going to monitor all this, and I said: “Our
recommendation is that you have a self-regulatory body.
Because the whole idea is that a regulator does not have
the resources to enforce regulation”.

Years ago, when I was asked to chair the committee on
the offer documents by SEBI or it’s predecessor. Before
every prospectus was to be cleared, it was examined by
the department. And it took 2 months to clear that. Then
I said that it was ridiculous, why should you do that? You
appoint an intermediary. The merchant banker is your
intermediary. He has to ensure that all the regulations
are complied with. And then you enforce discipline on
the Merchant Banker. If the Merchant Banker does
not function, you deregister him. Now, the threat of
deregistration is sufficient to ensure that he does his job.
Similarly, SEBI doesn’t regulate, the stock exchange is
the regulator. So, there also, you may have an oversight
body, but there must be a self-regulatory body, like the
Institute, which must ensure that the regulations are
followed.

(R) In this context, do you feel that NFRA, the way
it is constituted now, in its present form justified?
Given the qualifications required of NFRA members,
do you feel that they would be able to understand the
audit process, constraints and judgement calls taken
by an auditor?

I have not studied it in detail, but my general feeling is
that the oversight body has to see the functioning of the
self-regulator, but not take over its work.

(R): Right now they have powers to investigate,
they can enforce AS and SA and they can directly
reach auditors.

I feel, that perhaps is too much. That is not the correct
approach. But then you have to demonstrate that you
are doing your job adequately. Otherwise, the rationale
of doing this is because they feel it’s not being done
adequately.

[R] What is your view on rotation for public
interest entities, particularly given the international
experience showing that rotation leads to audit
concentration?

I have always been against rotation of audits, to be
quite honest. And I think the rationale for rotation, that
I pointed out repeatedly is, that if you imposed rotation,
you will be in fact destroying the second level firms. What
has happened is that a number of the companies grow,
and as they grow, they still want to retain the auditors with
whom they have grown. But when you impose rotation,
you give them an opportunity to change their auditor,
and when they have to change, they will go to a big 4
firm. So, in a sense, a lot of the work which is there with
the second level firms will flow into the big 4 firms. And I
don’t think, quite honestly, that rotation is the answer to
lack of independence. Whereas, the answer to that is the
restriction on exposure.

I mean, if you said, for example, that you cannot have
more than X percent of your work from a single group.
Because they say, at that level what will happen is, as
I said, that if I gave up 10% of my work I could afford to
give it up, but if it was 30% of my work, I would have had
second thoughts of giving up that work. So you must not
allow firms to get into the situation where they are overall
dependent on a particular client or a particular group.

(G) For that do you feel that the concept of joint
audit should be introduced in India, to encourage
the growth of medium-sized firms, and reduce audit
concentration?

I think quite honestly the whole motivation for joint audit
is wrong. You cannot impose regulation on audit to help
yourself. This is what has created a strong dislike of the
profession, especially in the case of banks. Every time,
our Institute has gone to the Reserve Bank of India to
say, give us branch audits, because if we don’t do branch
audits, then what will our members do, it has destroyed
it’s credibility.

Is it the responsibility of the client to provide work or
is it the responsibility of the profession to offer to the
client the service which the client needs? If you tell me that the joint audit is there and it helps because the
client is not dependent on a single auditor, and it helps
independence, I would agree with that view. But then, the
client must be free to appoint anyone as a joint auditor.
But, as soon as you go and tell the client that the law says
that you must appoint a joint auditor because it will help the
smaller auditor to get work, then that’s completely wrong.
And when the profession adopts or the Institute adopts
such an attitude, then you are creating a big damage to
your image.

(R) Sir, how do you view SEBI’s recent order against
Price Waterhouse? SEBI has sought to debar not just
a partner or two or not even just the firm involved, but
it has debarred the whole group. What is your view
on this? Secondly, SEBI also brought out a lower test
of ‘preponderance of probability’ as a sufficient test
in this specific matter instead of applying the test of
‘beyond reasonable doubt’.

I don’t know the details of this ‘preponderance of
probability’ which you are talking about, but I do feel that,
when you take action against a firm, and you take action
against an individual, the action against the individual
should be on the ground that the punishment for an
individual should be to debar him from doing the work
for a period of time or for all time, depending upon the
severity of his offence. The action against the firm should
only be a financial penalty, unless you can show that the
firm itself directed the individual, and the individual was
acting as an agent of the firm for the purpose of doing this.
That is the whole approach.

(R) Recently the ICAI made certain changes,
bringing the firm in, or the amendments in the
Companies Act, 2013 relating to the liability of the firm
– all of this is becoming more serious for auditors.

I feel it is virtually impossible, I mean it’s like saying
that every time the officer of the company commits an
offence, you can stop the company from doing business,
you can’t do this.

[R] Also Sir, what is your view on the Supreme
Court observations and directions on the operation of
Multinational Accounting Firms (MAF) in India? SC has
directed the Institute to take action against MAF who
are acting as surrogates of foreign accounting firms.

What is meant by surrogates?

[R] ICAI in their reports stated that some of firms
operating in India are in violation of foreign investment
norms. Accounting and auditing service is blocked
under GATS.

[G] Some firms have received subsidy from foreign
entities to acquire Indian firms – example was Price
Waterhouse – other example – there is a private
limited company where there is foreign investment,
you have Indian firm – Indian firm is regulated – but
office and staff are same – same visiting card, sharing
the same office, – on paper they are separate, but in
reality, acting as one entity.

No, I personally believe that if you have an Indian firm
and it is a part of the international membership, there is
no harm in a network arrangement, because it is like all
enterprises you work everywhere – work in cooperation,
collaboration, you get synergy out of this. If you do work
here for a foreign company, then you should do it on arm’s
length basis, then you should charge for it. But if a foreign
company or firm does something here indirectly, what it
cannot do directly, then obviously there is an offence.

(G) The Institute has issued letters to all firms who
are members of associations, not even networks.
Firms other than Big 4 – Indian firms who are members
of an association, have also been issued a letter.

I don’t see any difference in them. Having an
arrangement with an international firm, which gives
you access to technology, is no different from having a
company having a technical collaboration agreement with
someone. I do not see any particular reason if you are
paying a royalty to an international firm for using their
name. Then again, you have to see that there is a royalty
agreement which is in place. But if that International firm
has a network here, and you are doing that work on their
behalf, then it is a different situation. So you have to go
on the facts of each case – you cannot generalise the
situation.

(G) Indian Firms expanding overseas: Why has
the Indian accountancy profession not been able to
go global? What do you see as the biggest stumbling
blocks to Indian firms going global?

The question is like this – an Indian firm expanding
overseas would start off with the proposition that you are
an Indian group which is operating outside.
If you have, let’s say, a large number of Indian client
companies / groups having foreign subsidiaries, then
clearly you may need local firms to handle that work.
Suppose, for argument’s sake, you have a company, which
has a subsidiary in Spain. Now, you can either have a local
accountant there in Spain, or if you have a large number of
clients in Spain, you can have a firm there, which has an
affiliation with you, and that firm can do that work for you.

(G) The problem when you talk about collaboration
here is, the Institute does not allow sharing of fees
with non chartered accountants – typically, the ICAI
looks at it this way – a payment of fees to the foreign
firms is regarded as a violation of code of conduct.

I think, there is nothing which prevents you from
subcontracting work to a foreign firm. Sharing of fees
and paying for services are two entirely different things.
Sharing of fees means, the top line you are sharing.
Example, if you get work done from a solicitors firm, if
you get work done from a lawyer – why should you not get
work done from a chartered accountant or an accountant
there. If you are making payment for services rendered,
that is not sharing of fees.

[R] Constraints on Advertisement – Do you feel
that the constraints on advertisement and publicity
on Indian CA firms need to undergo a change, and
to what extent, especially when increasing number
of services can also be rendered by non-CA firms
– like GST or tax work or internal audit – who have
no restriction on advertisement? Do you feel that
such regulations in a competitive environment are
detrimental to the growth of the profession?

I think, perhaps the answer to that is, that you should
have a separate firm doing non-audit services. If you
have a separate firm which is doing non audit services,
then that firm because it is competing with non chartered
accountants should be allowed to advertise, but if you
have the same firm, then the question is that preferably
the names should be different – you cannot have indirectly,
a brand extension.

[R]: But then the ownership…

The ownership can remain the same. Same people
can be partners in both the firms.

[R] The role of ICAI has already been curtailed
significantly – disciplinary action and standard
setting going out. It is today left with education and
registration of members. What is happening and how
do you see its role going forward – will it remain with
these two functions?

See, in fact you have to go back, I don’t know enough
about the present situation. The Institute started as a
regulatory body and an examination body, that is how it
started. Then it developed, it setup a Coaching Board. So,
the core function of the Institute is still there.

Now, the question which arises is the standard setting.
Everywhere in the world, the standard setter is a separate
body. Now, there is no harm in the Institute being an
Accounting Standards Board, but the difficulty, which I
had always pointed out, was we set up an Accounting
Standards Board, and its composition was of the Council
Members plus a few outsiders. The authority of the
Accounting Standards Board was subservient to the
authority of the Council; the standards were issued not
by the Accounting Standards Board, but by the Council.
Now the question is, does the membership of the Council
have the competence to do this? The difficulty is that we
were not willing to shed power and responsibility. If you
had created an Accounting Standards Board, where you
have the right to appoint members for the Accounting
Standards Board, but with a composition which said that
majority of the members would be from outside, that the
chairman of Accounting Standards Board would be an
outside person, that the Board had the authority to issue
standards, and the Council was only concerned with the
procedural part and not the technical part, then you can
have it within; otherwise you can have it outside.That’s
your standard setting function. What happened with the
disciplinary action? The disciplinary action was, and
this again I had been pointing out for a long time; you
had to make a distinction between normal complaints
which were received and information received from the
regulatory bodies.

I will tell you in practice, the stand that we were taking,
in the Reserve Bank. We had a Board of Financial
Supervision, then there was a sub-committee of the
Board, which was called the Audit Committee. Now it’s no longer there. In my time, it was there. The function
of that Audit Committee really was to examine, whether
there was any lapse on the part of the auditor. When an
inspection report brought out that there was something
wrong, and that the NPAs were not properly disclosed,
we would insist on first sending a notice to the auditor, to
see what his explanation was. Then, as an independent
body, we would consider this. And if we were convinced
that there had been a failure, then we would go ahead
and make a complaint to the Institute or inform the
Institute. What does the Institute say- it said No! You
have to make a formal complaint, and if you are to make
a formal complaint, then your people must come and
give evidence, and you must do all that is required of a
complainant. Now, no regulator is willing to do that. After
we made a reference, no action was taken for years. So
what did we do finally? We decided that if we were prima
facie satisfied, we would take action on our own. We
don’t have to wait for the Institute. Now, this was when
the Institute didn’t make a distinction initially between the
matters of public interest, matters of internal obligation,
the independence of the disciplinary committee and its
functioning. These are not some things which happened
today or tomorrow. They happened over a period, and a
bad image was created. As a result of that, you gave an
excuse to the government to take away those functions.
Now you can’t blame the government for doing this.

(R) It is a result of things that have happened over
the years.

Yes.

(R) Do you feel at some point, we should have,
like in some countries, they have multiple Institutes,
meaning there is no one body that will give the
license.

There is only licensing, like that of the Board of Trade
in England, because there are separate Institutes which
exist. I don’t think that would probably come here.

(G): One aspect about image of Chartered
Accountants, which you mentioned. Amongst banks,
the image is quite negative. What do you think needs
to be done now? How does one arrest this problem
going forward? One is, of course zero tolerance
policy you mentioned. What needs to be done now
going forward?

I think it is a long drawn out process, but you have
to build up confidence. The important thing is that
for a profession, what you need, is not the brilliance
of the few, but the competence of the many. You are
holding out that as a member of the profession, your
members have a certain minimum level of competence.
You have to ensure that the competence is there; you
have to ensure that the work is taken by people who have
the ability to discharge that work. But if you are acting
like a politician, where you are trying to please your
voters and get more work for people without ensuring it’s
need or the competence, you are damaging the image of
the profession.

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