The Growing Despair of Accounting Frauds and Audit Failures!
Accounting firms coming under the hammer of the regulators and being fined bigger and bigger sums for failing to do their principal duty of reporting to the shareholders the frauds and fissures in the financial statements is ceasing to cause any greater alarm than the routine reporting of road accidents in the media in different cities!
 
Almost every other week, if not more often, is news flashed from across the globe about the fines levied on audit firms for issuing defective and false audit reports.
 
The only differentiation is whether the fine is accompanied by a ban of the entire firm for a period of time, or just a ban of a few audit partners and staff who worked on the tainted assignment.
 
 
Evergrande’s collapse more than in a small measure, contributed to the bust in the property boom in China, impacting its economy, and resulting in significant loan losses to the lenders. 
 
Evergrande in 2019 and 2020 had inflated its revenue by just US$78bn (billion)! 
 
China Securities Regulatory Commission’ investigation centred on PwC’s audit of the property developer’s annual results in 2019 and 2020. 
 
 
At its earnest best, the words of the global chair of PwC sound like a regret that his favourite baseball team of the Chicago White Sox failed to make the semifinal in the National League Championship.
 
And less like the global head of an organisation taking due responsibility for a monumental failure of one of its arms! 
 
All member firms of global audit firms like the PwC contribute financially to the main global firm for technical and quality-related support.
 
Auditing Evergrande, with US$300bn debt on its book (Enron’s US$13.5bn debt looks a pigmy) a figure greater than the GDP of Finland or New Zealand, must have deserved the most critical attention of the global leadership and constant oversight!
 
The inescapable question is: How much attention the global quality team gave to the affiliate in China that audited Evergrande.
 
The recent fining of PwC outstrips the fine levied on Deloitte in 2023 for its failure to audit an asset management company. 
 
 
Deloitte’s failure in this case was eerily similar to its failure in the IL&FS case in India which resulted in huge holes in the balance sheet not getting picked up!
 
In the UK, the financial reporting council (FRC) has been having a bumper harvest in 2023-24 with a record £48.2mn levied in fines, greatly assisted by KPMG in Carillion plc, surpassing the previous two years’ £40.5mn and £46.5mn!
 
Recently, the SEC in the US has, despite the strong opposition of the big-4 firms, approved a new regulation of the PCAOB that requires firms that audit a significant number of public issuers to have an oversight board with independent outsiders.
 
 
The consequences of shoddy audits leading to loss for the investors, and shaking their confidence in the capital market, are way more worrying in an ecosystem that depends on market mechanics to raise capital and seeks sufficient inbuilt checks & balances to boost the investors’ confidence. 
 
A recent research report of a think tank attached to one of the universities in the UK has brought out many aspects of the imperfections and oddities in the audit market and a few of the highlights of the same are given below.
 
 
A few months back, the Financial Times, UK had carried a detailed article stressing the significant increase in audit fees in recent years and the lack of a commensurate quality improvement. Some excerpts -
 
 
The system in India to investigate and punish the erring audit firms is tardy and often gets stuck in the courts, which have little understanding of such technical matters.
 
The Institute of Chartered Accountants of India (ICAI), which historically wielded the powers to try cases of audit lapses under the professional misconduct rules, was rarely earnest in the task given that it is a mutual association of the professionals it is expected to check!
 
The advent of the National Financial Reporting Authority (NFRA), much resisted by the ICAI, may have slightly altered the pitch in pulling up the errant firms but it is still significantly lagging its international peers in the speed and substance of its actions.
 
Cases like the levy of a Rs10 crore fine on an Indian affiliate of KPMG in the audit failure at Café Coffee Day are noteworthy exceptions.
 
The ministry of corporate affairs (MCA), anxious to demonstrate action, may be barking up the wrong tree in believing that by banning audit firms from doing non-audit services, the ills plaguing the audit profession in India would be redressed.
 
A proposal as reported in the Mint, is another attempt to amend the company law in this regard. 
 
The key issue is the expanse of this ban. As the provisions of the law presently stand, the rendering of non audit services are impacted only if rendered by the audit firm itself or by another firm controlled by the audit firm’s partners or by a firm that uses the trademark or the brand used by the audit firm.
 
If the company that renders the non-audit services has a name or a brand that is outwardly different, and the partners of the audit firm do not directly exercise any control, yet both operate under some common international network, affiliation or alliance and work in tandem, then the ban proposed may not make a big dent.
 
It is neither rash nor unreasonable to feel that audit in the traditional form is in its hour of deep crisis. It is difficult to visualise possible reformatory actions to change course as most such initiatives seem exhausted.
 
This article will continue to argue why the situation looks bleaker than before in the Indian context! 
 
This is part of a multi-part series.
 
 
(Ranganathan V  is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
Comments
parimalshah1
3 months ago
This is how the issue can be addressed.
The tax authority should empanel all CAs.
The tax authority should decide which CA to be deputed for audit of which business house.
The tax authority should decide quantum of payment based on the size of the business to be audited.
CA is to be paid by the tax authorities.
The business houses need to pay audit fees directly to the tax authorities.
Since the tax authorities have to communicate digitally with DIN, the system can be very transparent.
This removes the conflict of interest.
The auditor does NOT depend on his fees on the business house.
angelo.extross
3 months ago
As some reports suggest, it is very common practice to take "consultancy" services from auditing firms. Invariably they are paid separately for auditing (where fees may be capped) and separately for their "consultancy", which is almost always writing the books of accounts. The conflict of interest is totally overlooked. On the contrary it is seen as a "WIN-WIN" situation, which will last while the going is good. This practice is rampant with Co-op Housing Societies.
The ICAI looks the other way and eventually makes the complainant repent for raising the complaint in the first place. The desired publicity has not been accorded to NFRA. Please educate us on NFRA.
saran2sai
3 months ago
PWC has been hitting the headlines for almost a decade for wrong reasons, starting from (or even before) the Sathyam Software in 2010.
spa
3 months ago
Why would a Corporate retain an auditor who report against it, when it is hiring and paying .
khonestreview
3 months ago
The junks of the audit in India lacks independence. If you qulaify or report next year auditor will be changed or they dont get any work. Majority of the firms forced to continue with the clean report by not covering statutory reporting requirements. Also accepting others support services which are not warranted or affect the independence. Serious action is required in this regards, otherwise it will be a sin in audit world.
Kamal Garg
3 months ago
I think one of the reasons for such audit failure is that often the same audit firm does not audit all the subsidiaries/branches/associates and they state in their certificate that such audit has not been done by them and has been done by some other audit firm and that they have relied upon either some other audit firm's statement or management's discussion and statement; and both these leave ample room for irregularity, oversight mistakes and dubious practices; which must be stopped henceforth.
One audit firm should be accountable for the audit of entire/all the operations of any business enterprises including all subsidiaries and associates companies.
parimalshah1
3 months ago
Why would an auditor want to be against the corporate that pays his/her fees?
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