[Flashback] When auditors keep bad company

http://www.thehindubusinessline.com/opinion/columns/s-murlidharan/when-auditors-keep-bad-company/article5190351.ece

Posted by GOH Shuqi, Year 3 undergrad at the School of Accountancy, Singapore Management University

Lessons from NSEL, Satyam — managements should not appoint their own auditors.

When scams break out in the private sector, auditors, too, end up on the firing line, and rightly so. This was evident in the Enron scam in 2001, the Satyam scam in 2009 and the NSEL episode now. The massive Enron scam in the US, where future sales were booked as current, predictably took its toll on its auditor, Arthur Andersen. In the case of Satyam, the management booked fictitious sales in order to project financial and profit muscle that it did not possess. Its auditor, Price Waterhouse Coopers, got away with a rap on its knuckles.

Now, Financial Tech, the holding company of NSEL that has defaulted on paying a whopping Rs.5,500 crore to its investors is in the news — its auditor Deloitte has withdrawn its report pending revision. Withdrawing an audit report smacks of abdication of responsibility.These are high profile cases, and have therefore come to light. There are many cases of auditors’ negligence or complicity that do not hit headlines because the companies are not listed or are low profile.

CAG, AN EXCEPTION

In this depressing scenario of gloom and doom, one set of auditors stands tall, though its detractors are shrugging away its reports as exaggerated —-the Comptroller and Auditor General of India (CAG) and its nominees. The 2G and coal scams are examples. What sets apart the CAG and its private nominees who audit the accounts of public sector companies from auditors of private sector companies is their independence.

The CAG is a constitutional office enjoying considerable freedom. He or she can be removed only through the arduous process of impeachment. And private auditors nominated by the CAG do not have to fear anybody; they are not at the tender mercies of the managements of the companies concerned. They get some audit assignment or the other on a rotational basis, that eschews development of cosy relationship with the management.

The new Companies Act, 2012, has done quite a bit to restore the credibility of auditors in the eyes of the company stakeholders. Rotation of auditors, heavy penalties for mistakes, and assignment of the whistleblower role are commendable initiatives in reviving public confidence. But they fall short of the deep surgery the doctor has ordered.

AUDITORS’ INDEPENDENCE

Nothing short of insulating the auditor from the management would bring about the desired results. Even under the proposed regime of auditor rotation, it would effectively be the management at the helm that would choose the auditor and make the appointment, as well as fix the fees.

This arrangement has lowered the dignity of the office of the auditor the world over and fostered the perception that he is the handmaiden of the management; he simply cannot be counted upon to give a fearless and frank report. The only way to end this justified cynicism is to delink his appointment from the management.

Research papers, articles or theses are blind referenced to ensure freedom from bias. But accounts cannot be blind referenced to auditors, as the identity of the client would be known in the course of auditing. Yet, a device must be found that insulates the auditor from the management of the auditee — while an accused can be seen hobnobbing with his lawyer and a patient can choose his own doctor, there is no way an auditee can be seen hobnobbing with the auditor. Auditing is the only profession that casts the professional in an adversarial role vis-à-vis his client.

LEAVE IT TO SEBI

In the event, there is no escape from the CAG-like regime in place for public sector audit. An independent body should be mandated to appoint an auditor every five years for a listed company. That body should not be the ICAI because there would be a lingering suspicion that a powerful member wangled a plum audit. It must necessarily be the market watchdog, SEBI. If SEBI were to conduct the allotment of audit as a transparent exercise once in five years, in full public view, like the allotment of flats by the Delhi Development Authority, it would restore some credibility to the auditing profession.

This could be done by a draw of lots, with the names of the companies in one container and names of auditors meeting the qualifying norms in another. The two can be dipped into at random and displayed in full public view.

Appointment by an independent agency is only the first step in restoring the credibility of the profession. Internal audit has turned out to be at best audit of the efficacy of the system, including internal controls, and at worst, spying of divisional heads and profit centre heads. It would be futile for a statutory auditor to repose faith in and take shelter behind an internal auditor’s work.

A meaningful system of peer review, even if it has the effect of pitting one professional against another, must be put in place, if the system of dual audit — simultaneous audit of the same accounts by two firms of auditors — is found to be an expensive duplication.

(The author is a Delhi-based chartered accountant.)

(This article was published on October 1, 2013)
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