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Auditors ask firms to change software to rule out fraud

Auditors have asked companies using bespoke and standalone accounting software to shift to applications that wouldn’t allow them to change or delete any accounting entries, because auditors are now responsible for any such anomalies.

Auditors are required to flag any transaction that is changed, tweaked or deleted by companies they audit as per new regulations applicable from April 1. Auditors will also be responsible for investigating and flagging certain accounting entries where companies may be dealing with related entities or inpiduals, according to the regulations notified by the Ministry of Corporate Affairs (MCA).

Many companies in India tend to delete old accounting entries and insert new ones as they come close to the end of a quarter. While often this is done for technical reasons, many suspect that some companies may be indulging in manipulating financial statements.

A-CLOSER-LOOK

The government has said that from April, companies can only use an accounting system which has the feature of an audit trail that records all the changes done. This would mean that no accounting entry should be deleted and only a rectification entry can be passed with an explanation.

“Most large companies that work on

ERP systems

do have controls whereby they can make sure that an audit trail of accounting entries and a log is available (to check if they made any correction),” said Sudhir Soni, partner at SR Batliboi, an audit firm. “The challenges may be on standalone or bespoke applications and for medium and small companies that may be using software without such features enabled or available. Auditors will need to use technology skills to make sure that companies follow these guidelines,” he said.

This change will help investigators if there is a fraud in the company at a later stage, industry trackers said.

“This new provision will go a long way in raising the standards of financial bookkeeping and will be helpful for auditors and forensics auditors for tracing the original entries and all the audit trails,” said Kartik Radia, managing partner at Mazars India, a professional services firm.

After several corporate governance issues erupted at companies and financial institutions such as ILFS, DHFL, Reliance Capital, Kingfisher and Nirav Modi’s Firestar, the government has tried to tighten regulations for statutory auditors.

Several industry experts have been complaining that auditors are merely watchdogs and not bloodhounds—a euphemism used to stress that audit firms can only monitor up to certain extent—and yet government agencies have been going after the firms.

The government has also asked auditors to make sure that no company is dealing with related parties or inpiduals.

This is important as investigators have found that in several bankruptcy cases companies were dealing with entities related to promoter or promoter group companies to siphon off or pert money.

While this is not allowed in the law—companies would create shell companies and then deal with them to get around the regulation.

In most bankruptcy and fraud cases this was never pointed out by auditors as this was as per the regulations.

Not anymore. Now auditors will have to flag up such transactions.

“The changes will require auditors to obtain representations from management and perform procedures to ascertain that funds are not lent to intermediaries for the benefit of other parties,” said Soni of SR Batliboi. “Such transactions may sometimes be done to circumvent regulations on related party transactions, facilitate evergreening of loans or pert funds. A similar requirement is also imposed for funds received by the company. At times, the auditor may be put into the role of an investigator to discharge these requirements.”

RBI guv advises auditors to be more vigilant and tech savvy

Reserve Bank of India governor Shaktikanta Das advised the auditors to be more vigilant , tech savvy and adopt a holistic approach while auditing entities and checking on their smart accounting practices. Of late the regulator has found many instances of malpractices where the auditor could step in and help in strengthening financial stability.

The governor highlighted the of audit in checking the so called smart accounting practices followed by management to overstate profits or understate expenses and liabilities. ” Of late, several instances of related party transactions without following ‘arms-length’ principle and established transfer pricing mechanism have been observed”.

There have been instances of persion of funds and / or transfer of profits to connected parties through various means – intra-group loans on favourable terms, over or under invoicing of transactions, asset transfers without fair valuation, etc. “Auditors need to identify and thoroughly scrutinise related or connected party transactions to ensure that there is no undue transfer of income or assets” Das said.

The banking regulator has also seen cases of manipulation and misstatement of true nature of financial statements by employing opaque technological means (IT black boxes). Real transactions are camouflaged beneath various layers of IT solutions by a few entities.

“As such, auditors need to be technologically savvy and be able to ‘see-through’ the layers of information technology to detect the real nature of hidden transactions” he added.” It has to be kept in mind that adoption of such technology tools for auditing cannot replace professional judgment. A holistic approach would, therefore, be always required while integrating technology tools in audit”

” Stability and growth of an economy and financial markets are dependent upon trust among stakeholders. One cannot take trust for granted. With greater openness of the economy and faster transmission of information flows, thanks to the advent of technology, it has become paramount to ensure credibility and confidence in the system” Das said at the National Academy of Audit and Accounts on Monday. ” Statutory auditors play a vital role in maintaining market confidence on audited financial statements”.

“Inaccurate information may lead to sub-optimal decisions or excess resource allocation, which would be neither in public interest where a public authority is involved, nor in the interest of inpidual” Das said underscoring that financial sector entities, the audit community and the financial sector regulators and supervisors have to work together and take proactive steps to ensure good governance and ethical practices to build a strong and resilient financial sector.

New Companies Act: 137 top companies need to change auditors by 2017-18

(This story originally appeared in on Apr 17, 2014)

MUMBAI: With the implementation of new Companies Act from April 1, a majority of the top 200 listed companies will need to change their auditors over the next three years in a bid to ensure objectivity and prevent the “cozy management-auditor nexus”.

The recently notified section 139 of the Companies Act 2013 makes it mandatory for audit firms to be changed after every 10 years. The rule is applicable from April 1, 2014, on a retrospective basis (the existing term of the current auditors will be taken into account for computing the overall tenure) but provides a three-year window to comply with the provisions. Interestingly, large business groups like Reliance, the Tatas, Mahindra,

Infosys

, L&T and a few MNCs like

Maruti

,

Colgate

and P&G have vintage auditors and will soon need to initiate the transition.

An analysis done by shareholder proxy firm IiAS, shared exclusively with TOI, shows that over half of the 221 companies have auditors whose tenure has exceeded 10 years. Another 24 companies have auditors who have been auditing the accounts for at least seven years. Given that the Act provides a three-year window to comply with the provisions, these 137 companies will need to replace their existing auditors by 2017-18.

Globally, auditor rotation continues to be a subject of much debate, as regulators and policy makers around the world examine lessons from the financial crisis in order to improve and strengthen the quality of financial reporting and prevent frauds. But while critics continue to oppose the move, a broader consensus seems to be emerging on the importance of auditor rotation in ensuring audit independence and objectivity. Capping the overall tenure forces auditors to pay closer attention to details and be more sceptical in their audit approach.

India is now one of the few markets where even unlisted and private companies (above a certain threshold) need to rotate their auditors. This is welcome as it strengthens the entire financial reporting framework, an analyst from the shareholder proxy firm said.

However, Russell Parera, partner, Price Waterhouse, feels, “International studies have shown that rotation increases audit risks in the early years of change. In India, rotation of auditors in unlisted companies is beyond what is contemplated in most other jurisdictions, and will present significant challenges for companies and auditors with the timeframe.”

In India, the auditing industry is fragmented and comprises a large number of small- to medium-sized audit firms, while at the top end the industry is still characterized as an oligopoly, primarily due to the dominance of the Big 4 – Deloitte, PwC, Ernst & Young and KPMG. In India, these firms operate through their respective audit networks which comprise local partner firms.

In 2012-13, 57% of the S&P BSE 200 and CNX 200 companies were audited by the Big 4. Deloitte has the largest presence, followed by E&Y.

IiAS expects listed companies, especially those in the S&P BSE 200 and CNX 200, to take the lead and start complying with the spirit of the regulations. This will enhance the integrity of the audit process and go a long way in improving investor perception about the accuracy and quality of financial reporting, it says.

SC stays SAT’s order holding that Sebi lacks power to bar auditors

MUMBAI: The Supreme Court Monday stayed an earlier order of the Securities Appellate Tribunal (SAT), which had held that market regulator Securities and Exchange Board of India (Sebi) did not have the power to debar auditors.

A bench comprising Justices Arun Mishra and Indira Banerjee also issued notices to Price Waterhouse & Co, its associate audit firms, and two of its auditors on an appeal filed by Sebi against SAT’s September 9 order.

The apex court on Monday stayed Para 78 of the tribunal’s order, which had said Sebi shouldn’t adopt punitive measures against the auditors Sebi challenged SAT’s decision to quash its two-year ban on audit firm Price Waterhouse, a penalty imposed in the wake of the Satyam Computer accounting fraud in 2009.

“In a given case, a measure of debarring a person from entering the securities market will be justified, but in our view, banning an audit firm or an auditor from auditing the books of a listed Company or from certifying any report of a listed company cannot be justified. By no stretch of imagination, a direction debarring an auditor from auditing the books of a listed company can be said to be remedial in nature,” the relevant Para 78 of the SAT order had said.

“The direction to debar the auditor from auditing the books of a listed company is neither remedial nor preventive. In fact, the direction is clearly punitive and violative of Article 19(1) (g) of the Constitution of India, as it takes away the fundamental right to carry on its business,” SAT had said in its order.

The tribunal had also said that the role of debarment was beyond the scope and powers of the Sebi Act.

Attorney general KK Venugopal represented Sebi, while Mukul Rohatgi appeared for Price Waterhouse.

The tribunal had partially upheld the Sebi order on disgorgement of more than Rs 13 crore.

The Sebi order had earlier debarred Price Waterhouse and others from auditing listed companies and had also ordered disgorgement.

“The Supreme Court will determine whether ‘auditing a listed company’s books’ is ‘dealing in securities’ since Sebi’s regulations on Fraudulent and Unfair Trade Practices can be invoked only if there is dealing in securities – directly or indirectly,” said Sumit Agrawal, founder, Regstreet Law and a former Sebi official. “There is another question of law here. Are auditors ‘persons associated with securities market’ and hence amenable to Sebi’s jurisdiction? While Bombay HC had said so, the Supreme Court has not decided this issue so far.”

( Originally published on Nov 18, 2019 )

In Video: Satyam case: SC restores Sebi’s power to restrain erring auditing firms

Concept of joint audit has worked very well: Amarjit Chopra, ex-president, ICAI

The central bank’s recent norms governing the functioning of auditors at financial firms have drawn its share of opposition. But several other auditors have backed the new directives, arguing that the changes would simultaneously enhance oversight standards while breaking the dominance of a few.

Amarjit Chopra, past president of the Institute of Chartered Accountants of India (ICAI), tells ET CFO in an interview that the Reserve bank of India (RBI) should stick to its stand. Edited excerpts:

A few large auditors and the industry have indicated that the RBI’s new norms for auditors could negatively impact audit quality, causing unnecessary disruptions. What are your views?

As per the new norms, there shall be joint audits in certain entities beyond a threshold. Can having two auditors or more instead of one impact the quality of audit? Certainly not. Having more than one opinion is always better. The concept of joint audits has worked very well at Public Sector Banks (PSBs), Public Sector Undertakings (PSUs) and in certain corporations as well. So, I do not see challenges here.

There are allegations that the changes are being implemented in a hurry, without consultations…
Generally, it is seen that anything that gets delayed is postponed indefinitely. The RBI is simply trying to implement the remedial measures as quickly as possible. It will be wrong to say that there is strong opposition to the new norms from auditors… you may say a few auditors whose interests are affected are opposing the changes. But that is bound to happen. Have we seen industry associations commenting when there are cases of fund persions or accounting manipulations by certain business houses? Have they ever debarred such business entities and their promoters to be their members? I sincerely wish that RBI takes a stance that may accommodate a few genuine concerns without yielding ground on critical issues. It may allow some kind of level playing field to mid-sized Indian firms and provide them the impetus to grow.

International investors look for reputed brands of audit firms when investing in a company and the RBI’s rules could be seen to be discouraging the big firms…
Investors generally look at the integrity of their business partners and above all, the quality of the project. If they are convinced that the investments will give fair returns, those investments will certainly happen. To an extent, the larger firms have been able to market their services based on brand value. But have some of the investors not realised that things have gone wrong despite these firms being the auditors? And surprisingly, this has happened internationally and not only in India.

What are your views on the investments necessary in the auditing industry itself?
On the incentives to invest in audit, what applies to the Big 8 or 10 firms applies to mid-sized firms as well. Why should they invest in audit in case they feel that there is no level playing field? The Big 8 or 10 were investing in audit as they found that income from non-audit services to the audit clients or the firms under the same network was far more lucrative. Restrictions on these practices are bound to pinch them more than anything else. And unless the government and various regulators see the pride in developing Indian firms by appropriate measures, the concept of Aatmanirbhar Bharat would only be on paper.

Auditors under close watch, Big 4 tells its partners to take it easy with targets

As the role of auditors comes under increased scrutiny in India, some of the biggest firms in the business, including EY, PwC, Deloitte and KPMG, are either removing or relaxing revenue targets for their audit partners.

In the past few months, some of the audit firms have either told their partners that they would not have any revenue targets, or have delinked their pay packets from the revenue they would help generate.

According to the earlier arrangement, an audit partner — normally leading a team of about 10-12 professionals — would be given a revenue target. In return, the partner would get anywhere between 20% and 35% of the revenue as compensation.

“When audit rotation happened, partners were expected to go out and win big accounts. In some cases, the auditor’s compensation also depended on how much business he or she helped generate for other verticals,” said a senior audit partner with one of the major firms.

Industry trackers say that caution has set in after the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) came down heavily on auditors in cases of financial fraud. The auditor’s role was questioned in several cases and Sebi banned a network firm of PwC for two years from auditing listed firms.

The removal of revenue targets also comes at a time when several firms are resigning as auditors of companies. Since January, about 40 firms have resigned mid-term, compared with about 7 auditor resignations in 2017, data collated by Prime Database Group showed.

To replace work that was lost in audit rotation, many aggressive audit partners had accepted assignments of some of the companies without much due diligence. “A year since the audit rotation, the skeletons are tumbling out. The firms realise that revenue targets for audit partners could backfire as the most important thing about auditing is perception,” said a senior audit partner with one of the bigger firms.

An audit partner recently discovered, in one of the assignments, that promoters were siphoning off money. “The promoters had exaggerated the cost of some of the investments done by them in the past few years. We resigned as the auditors as Rs 2 crore (charged as audit fees) is not worth the risk,” said the partner, who resigned from a BSE-listed company recently.

Removing revenue targets for partners and their teams in auditing could mean no pressure to retain a client in case of detection of a corporate governance breach. Revenue per partner in these firms ranges from Rs 5 crore to Rs 15 crore, of which about a third goes directly to the partner.

“While we did not have direct revenue targets for audit partners, their compensation depended on how much business they generated for our advisory or tax teams,” said the India head of one of the firms.

In India, the big four operate through separately-owned subsidiaries for auditing as foreign firms cannot be the auditor. Corporate governance issues are not limited to the big four, though.

A well-known Indian firm, that was auditing a Mumbai-based real estate company, is under investigation for its role in a loan fraud. Insiders point out that the client was brought on board around the time of audit rotation when some of the bigger companies were choosing foreign firm affiliates over the Indian firm.

Some of the firms are now appraising partners merely on the quality of their audits and also for the work they bring for other service lines.Their compensation would be decided by that, too.

“The most critical goal for our audit partners is audit quality, and this will continue to be a key priority going forward. Attracting and retaining highquality talent and adoption of technology in audit are other areas of focus for our audit partners. With the audit rotation activity behind us, our audit partners are fully geared to delivering high-quality audits to our clients,” said Jamil Khatri, head of Audit, BSR & Co, an affiliate of KPMG India.

“Our top priority has always been the delivery of the highest quality audits to promote trust and confidence in financial reporting. Quality is an important aspect of how we evaluate our partners and people,” said a spokesperson for SR Batliboi & Co, an EY India affiliate firm.

NCLAT dismisses Deloitte, KPMG and auditors pleas against impleadment in IL&FS matter

The NCLAT on Wednesday dismissed the pleas of auditors of debt-ridden IL&FSDeloitte Haskins & Sells and KPMG arm BSR & Associates — along with independent directors challenging their impleadment in the case of alleged fraud at a group firm IFIN.

A two-member bench of the NCLAT upheld the directions of the Mumbai bench of the National Company Law Tribunal, saying it can not be termed as “illegal”. The NCLT had directed them to implead the auditors and independent directors as party.

The NCLT is empowered to pass order to implead them under Section 242 of the Companies Act, 2013 in a petition under Section 241(2) if “it forms opinion that the affairs of the company have been conducted in a manner prejudicial to the public interest”, the appellate tribunal further said.

“Once such opinion is formed by the Tribunal, it may pass any order as it deem fit and proper,”said the National Company Law Appellate Tribunal (NCLAT) bench headed by Chairperson Justice S J Mukhopadhaya.

The case relates to IFIN, a subsidiary of IL&FS.

Rejecting the contention of the auditors and others that they cannot be treated as part of the management, which is responsible for managing the affairs of the company and therefore should not be charged as per the said section, the NCLAT said that rules of natural justice are to be followed.

“As rules of natural justice are to be followed, if any order is passed against one or other, including investigation, it is always open to the Tribunal to ask such party to be impleaded,” the NCLAT said.

The MCA had asked the NCLT to freeze the assets of the former auditors in the case, involving alleged fraud in IFIN.

The appellate tribunal, however, granted relief to both the auditors and other independent directors by allowing the operation of its earlier interim order passed on July 29, 2019 for two weeks.

After the judgment was pronounced by the NCLAT in the open court, a request was made by counsels, representing accounting firms and other independent directors, to allow the interim order passed by it on July 29, 2019 for two weeks, which was accepted by the appellate tribunal.

“We allow the prayer and continue the interim order passed on 29th July, 2019 for another two weeks,” the bench said.

On July 29, the NCLAT stayed the order of the Mumbai bench of the National Company Law Tribunal (NCLT) to implead the auditors and independent directors of IL&FS.

Earlier on July 23, the NCLT had allowed the plea of the Ministry of Corporate Affairs (MCA) to implead the auditors and independent directors of IFIN.

Moreover, visualsing the possible impact of IL&FS crisis on the Indian economy, the NCLAT in its 72-page-long order said that various acts “prejudicial to public interest” have been highlighted, which has cascading impact on various sectors of economy and even the Department of Economic Affairs — which is responsible for the financial stability of the country — too has raised “Red Signals” of the likely collapse of ‘IL&FS’ in its confidential note dated September 30, 2018.

“In the circumstances, before passing any appropriate order in public interest and to save the economy of the Country from collapse, if the Tribunal is of the opinion that it requires to give appropriate hearing to the concerned parties, including those who audited ‘IL&FS’ and/ or those who have managed or were concerned with ‘IL&FS’ or its Group Companies, it cannot be held to be illegal.

“We find no merit in these appeals. They are accordingly, dismissed,” the NCLAT said.

The central government had submitted that the act of fraud perpetuated is on account of “mis-representation and falsehoods about the financial state of affairs” of the concerned company, which has jeopardized the financial health apart from causing serious damage and financial loss to various stakeholders.

However, the tribuanl said that as the matter is still pending before the NCLT, it is “not inclined to express any opinion whether the allegations made against one or other require further investigation and the order what is required to be passed in public interest”.

While commenting on the development, Deloite India spokesperson said: “We will review the written order before determining our further course of action, which may include an appeal”.

Auditors cannot be treated as part of the management which is responsible for managing the affairs of the company and therefore should not be charged, the spokesperson said.

“We will continue to present and protect its position, supported by the facts, to the relevant authorities. The firm remains committed to high standards of audit quality and ethical conduct in its professional practice,” he added.

There was no immediate comment from KPMG.

UK’s Big Four auditors await shake-up as corruption probes add up

London: Britain’s audit sector, dominated by the so-called Big Four accountancy giants, is shortly expected to discover how it must reinvent itself amid a series of probes into alleged corruption, including one linked to the collapse of German electronic payments group Wirecard.

UK authorities want the industry to separate audit and consulting activities, while increasing oversight and competition following allegations of malpractice by Britain’s Big Four — comprising accountants Deloitte, EY, KPMG and PwC.

The Department for Business, Energy and Industrial Strategy (BEIS) is reportedly set to publish reform proposals before Christmas amid fraud probes into EY-linked activities at Denmark’s Danske Bank and Wirecard.

“Strengthening our corporate governance and audit regime will help to ensure that the UK remains a world leader in corporate transparency and advance it status as a place of the highest standards in audit,” a BEIS spokesman told AFP.

‘Repeatedly failing’

Simon Youel, head of policy at Positive Money — which campaigns against market dominance in the financial sector — said there is “a real problem with the UK market dominated by these four firms”.

“They have been repeatedly failing,” he told AFP.

EY has been accused of failing to warn about suspicious transactions at Danish bank Danske Bank worth billions of euros.

It was responsible also for validating the books of Wirecard before the company became subject to one of the most well-known modern-day corporate bankruptcies.

Wirecard, a former darling of the fintech sector, collapsed in June after it was forced to admit that 1.9 billion euros ($2.2 billion) missing from its accounts did not exist.

Pressure group Spotlight on Corruption has urged the UK government’s Crown Commercial Service — which procures goods and services — to temporarily block London-based EY from public sector contracts for three years.

Spotlight has accused the accounting giant of “grave professional misconduct that renders EY’s integrity questionable”.

EY “strongly” disputes the claims, insisting that it takes its responsibilities “seriously” in a highly-regulated industry.

The UK auditing sector as a whole faces outcry over its failure to identify or prevent major UK bankruptcies that sparked massive job losses — including at department store BHS in 2016, construction firm Carillion in 2018, and tour operator Thomas Cook in 2019.

PwC had been the auditor of BHS, while KPMG oversaw Carillion accounts and has been heavily criticised for its role.

As for Deloitte, it was fined £15 million ($19.7 million, 16.6 million euros) in September for serious misconduct after UK regulators investigated its audit of British software firm Autonomy ahead of a disastrous takeover by US tech giant Hewlett-Packard in 2011.

‘Corruption is rare’

Questioned about the Spotlight findings, Laura Empson, a business professor at City University London, told AFP that explicit corruption was “relatively rare within the audit sector”.

“The problems lie with the considerable scope that exists within the current regulations and the strong incentives that exist within the firms, to engage in practices which fail to protect the public interest.

“It is this mismatch between government regulations, firms’ incentives, and public expectations, which has given rise to the scandals and reputational damage of recent years,” she added.

Empson noted that the scandals had provoked extensive anxiety and introspection within the Big Four.

“Some partners within these firms have long been concerned about the direction of travel, but there has been a strong pressures from internal politics to disregard these concerned voices.

“The scandals have therefore given the leaders of these firms the incentive but also the authority they need to force through changes which would previously have been inconceivable,” she noted.

The government has meanwhile already announced plans to replace the Financial Reporting Council regulator with the Audit, Reporting and Governance Authority which has been handed fresh enforcement powers.