Regaining audit’s credibility

Jan 21,2014

The Delhi High Court verdict empowering the government to conduct a CAG audit of telecom companies has raised a lot of eyebrows -- especially the court’s remark that the CAG remit is extended to every rupee accrued to the Consolidated Fund of India (all revenues received by the government via taxes and other receipts).

This could mean the CAG should audit the entire nation — which is well nigh impossible, nor was it contemplated by the Constitution makers.

On that logic all auditors in private practice must join its ranks. The institution of audit would have been nationalised in that case.

Even non-profits and trusts enjoying income tax exemption could be examined with a fine toothcomb to ascertain if the tax exemption given was justified and legally tenable.

At the same time, there is a compelling case for embracing the CAG brand of auditing given the widespread cynicism about auditing.

Credibility crisis

The world over,auditors suffer from a credibility crisis. Audit of private sector companies is by and large a farce because their auditors are practically appointed by the managements.

The public perception is that auditors, appointed as they are by managements, remain beholden to them and do their job desultorily. In the process, skeletons — even if they surface — are kept firmly inside the cupboard.

This perception is not a product of paranoia.

The nation was aghast not long ago when Satyam happened. Its promoter Ramalinga Raju made a public confession that he cooked the books just to remain in the good books of foreign investors. While his confession cut ice, the public did not buy the argument of its auditors that the monumental fraud went unreported because they thought nothing was remiss in the accounts.

The fundamental lesson given to wannabe auditors is to look for evidence. Satyam auditors didn’t ask for confirmation from banks for Satyam’s deposits supposedly held with them.

People talk wink-wink, nudge-nudge that the hefty fee of R 4 crore lulled the auditors into complacency.

Act impartial

Auditors will regain their credibility only when their appointment is delinked from managements.

To ask a company to find its own auditor is akin to asking a culprit to find his own judge. The only difference is while a court proceeding mostly takes place in full public view, auditing occurs away from public gaze; there are no witnesses with documents telling their own story buttressed by an explanation or two from time to time.

If a judge should be independent so should be the auditor. The way forward to restore credibility of auditors and the institution of auditing is to follow the CAG brand of auditing.

Public sector companies are audited by private practitioners, but the appointment is done by CAG randomly from a panel of chartered accountants. This is akin to blind-referencing in academia.

In fact, the CAG also tells the world that the accounts of public sector companies have been blind-referenced, as it were.

The Companies Act, 2013, has done its bit for restoring credibility in auditing, but it hasn’t gone the full hog.

More than auditing

To make the auditor the ultimate whistleblower may seem appealing, just as he should suffer a hefty penalty for a shoddy job., But the key is comprehensive reform in the manner of his appointment and remuneration.

There is no reason why a beginning cannot be made with listed companies that come under the SEBI. The SEBI should appoint auditors of private, listed companies just as the CAG does for public sector companies.

It is not enough if auditors focus on accounting standards alone. They have been for too long allowed to get away with the self-serving argument that they are watchdogs and not bloodhounds.

The Companies Act, 2013, must be complimented for disabusing this notion by vesting in them the onerous role of a whistleblower, which obviously wrenches away from them the watchdog-not-bloodhound argument.

Auditing would never be independent if auditors are appointed by managements. Rotation is not enough unless the rotation is done by an independent agency like the SEBI with no axe to grind.

Even in the new regime brought about by the Companies Act, a company would find its own auditor.

This should go.