Statutory Audit or Forensic Audit? by Nagesh Kini

 Audit is much more than checking the numbers. It has more to do with the application of analytical skills going beyond the books of accounts involving mere cross tally of figures. The auditor collects big money for attesting them all the same and the so-called disclaimers are mere fig leaves

A well-written article, All about Frauds, Corruption and Forensic Audit, in the CA Journal of September 2011, rightly examines at length the concerns of Forensic Audit vis-a-vis the Statutory Audit for corporate India today. 

The regulators—the ICAI (Institute of Chartered Accountants of India) and SEBI (Securities and Exchange Board of India)—ought to put this article on public domain inviting wider public comments from a cross section of stakeholders ranging from members of the accounting and audit profession to CFOs to RBI to individual investors.

In an interview, India-born Neeraj Monga, the analyst and Head of Research at the Toronto-based Veritas Investment Research goes back to his argument way back in 2006 that Yellow Pages, the second largest trust in Canada with a market capitalization of over $8bn, “past performance is no indicator of future results. We believe that YPG is the poster child of this adage... We thought there was a lot of dishonest accounting going on out there.” This stock that was trading at nearly $16 barely touches double digits—in pennies on the Toronto Exchange. 

Following the report released by Veritas Investment Research the shares of realty major DLF, which  has a 12% weightage on BSE Realty index, tanked on 1 March 2012 by 6.4% on BSE and 5.17% on NSE to Rs214.65 and Rs212, respectively. The report said, “In a best case scenario, DLF is worth Rs100 per share... The aggressive accounting approved by auditors, perpetuated and aided by investment bankers and media frenzy surrounding the IPO... from FY-07 to FY-11 the company inflated sales by at least Rs11,236 crore ($2,607 million) and PBT (profit before tax) by Rs7,233 crore ($1,690 million)... DLF has undertaken questionable related party transactions... The company has no free cash flow and no credible plan to de-leverage its balance sheet.” The report rightly points out that “all contributed to the myth that DLF is a corporate pillar of India.” That it is happening in our National Capital Region of New Delhi and the accounting and market regulators, ICAI and SEBI, are just watching it, this is a sad commentary on our tooth less watchdogs. 

At least DLF is a fit case for the SEBI’s new brain-child of setting up a separate Forensic Accounting Team to detect fraudulent transactions of companies, to strengthen investigation and force companies to improve corporate governance to unravel complex accounting jugglery and deal with the flood of complaints of companies rigging their financial statements and enable the regulator to take pre-emptive action. The Satyam scam is a telling regulatory failure to detect the mammoth fraud early on.  

The public perception, post-Satyam financial/accounting frauds, is one of complete of loss faith in the auditors’ reports that the shareholders are paying a bomb for, running into crores of rupees by way of audit fees for attesting the balance sheet and profit and loss accounts and separately the corporate governance, too.

The auditors’ reports are couched with enough disclaimers that seek to absolve the auditors even when they are in the know of the exact state of affairs. This leads the public at large to question whether they are neither true and fair, nor truly fair nor fairly true nor both. There is no value for money either.

Audit, it must be pointed out, is much more than checking the numbers. It has more to do with the application of analytical skills going beyond the books of accounts involving mere cross tally of figures, amounts and physical verifications or confirming that they have simply accepted certificates from the management at their face value to blatantly state in their report that the “accounts are the responsibility of the management.” The auditor needs to be reminded that he collects big money for attesting them all the same and these so-called disclaimers are mere fig leaves that cannot protect him!  

Given the changed conditions post-Enron in the US, BCCI in the UK, Satyam in India and also the frauds in Global Trust Bank and Wipro, there is absolutely no question/scope for either/or statutory or forensic audit or even a stand-alone forensic audit, it has to be a combination of both. 

The statutory audit has necessarily to revisit the approach to the audit methodology and process to upgrade it to include forensic techniques as a part of their SOP by sharpening the audit tools using analytical reviews to flag off a more detailed audit.

Presently we have in place, in addition to the Statutory Audit, other concurrently conducted audits in the same domain like internal, tax, proprietary, revenue, and special audit, etc, etc. This makes a strong case for combining the Forensic Audit as a part and parcel of Statutory Audit by extending its scope more particularly and essentially as fraud detection measures.    

Frauds in the form of manipulation of accounts, concealments, skimming, kickbacks, payoffs, greasing palms, bribes, embezzlement of cash, fudging and inflating of expenses and purchases, padding pay rolls, multiple reimbursements, collusive bidding, abuse of insider information paying ‘professional charges’ to cover payoffs, under-invoicing are common both the private and public sector and will continue in the PPP and SPVs, too.

It is here that an auditor has an effective and proactive role to play without reservations—to necessarily assume everyone to be guilty until proven otherwise to go into frauds lying concealed behind every other transaction that challenges the auditor to uncover them. The perpetrator of the fraud can be a lowly clerk in a remote corner of the country or the chairman at the corporate headquarters, a la Ramlinga Raju of Satyam. The amounts involved may be a few rupees of conveyance pinched at one extreme to the millions defrauded at the other. The auditor is paid to be pro-active and make use of his skills and diligence and not say that the fraud has not come his way. When he smells a fraud it is his duty to go deeper to ascertain flaws in the internal control system.  If everyone was so honest there would be no need for any auditor!

Gone are the good old days of a century-old English verdict laying down that the auditors are no bloodhounds but watchdogs! Unfortunately today, this one time so-called watchdog has failed dismally even to bark, leave alone to bite the culprit who, in the present circumstances, coolly walks away with crores of the hard-earned investments of aam janata, elders, pensioners and widows. By not reporting, to put the public on guard, the auditors are failing in their solemn duty. The US SEC (Securities and Exchange Commission) has indicted the auditors of Wipro and Satyam in the US but we are seen to be dragging our feet by penalizing the small fry in the audit and letting the big guns off the hook on technical grounds.

The present day auditors are only too keen on being done with completing the audit process so as to sign off as soon as possible and to collect their fat fee cheques. More of a business deal rather than remuneration for rendering an honest honourable professional service. The auditors today hesitate to ask questions or venture to go deeper to carry out in-depth checks even selectively. This is true when the epicentre of the fraud goes high above to the board level in the client’s organization. 

The auditors avoid qualified reports as it is perceived they would possibly tarnish the lily-white image of the client-company’s top management. The auditor needs have the courage of his conviction to question the dubious transactions that can embarrassing the high paying client’s top management that can land him in legal hassles leading to his removal as auditor at the next annual general meeting. Financial mis-statements have thus become the order of the day. The audit remark “Without meaning to qualify, we report that...” to me conveys nothing. This does figure in auditors’ reports of listed companies. Does this amount to a disclaimer of sorts? 

Now with the expanding role of the government and the public sector collaborating with the private sector via the PPP (public private partnership) and SPV (special purpose vehicle) in diverse fields including civic, military, defence and aviation sectors, it is now incumbent for the audit profession to come to accept and share with the equal role of the of the commercial audit of the office of the Comptroller & Auditor General of India (CAG).With their detailed diligently prepared exhaustive reports on the spectrum valuation, hydrocarbon allocation, Commonwealth Games and many more, the CAG has come to be accepted as a force to reckon with in India the fight against corruption. One telcom company furnished separate audited statements widely differing from their annual accounts. Both of them were duly attested by auditors.

A statement of the deputy chairman of the Planning Commission opposing the CAG scrutiny of the PPP projects running into thousands of crores alleging that they take away the flexibility for the private partner, simply smacks of the arrogance of the sarkari babu who sees that the opportunity for skimming via PPP is lost for him. After all, who better than the CAG knows how the babu’s mindset functions? The CA profession, in making a foray into the newer avenues of audits of the upcoming PPP, NGO and local self governmental sectors, needs to work more closely with the CAG to get an insight into these hitherto uncharted audit areas.    

(Nagesh Kini is a Mumbai-based chartered accountant. While in active professional practice has travelled the length and breadth of India in carrying out both private and public sector audits, was on the CAG and RBI audit panels. He has now turned into a financial activist.)