In search of a greater assurance

ACCOUNTANCY

As the global economy gets more complex, groups and entities across political geographies require optimising their structural efficiency owing to numerous different regulatory and tax jurisdictions.

Financial instruments are becoming more complex, intangibles and derivatives are assuming central roles in the resultant tangle and even finance professionals are often at a loss to read and correctly interpret entity financials or forward-looking statements. The lay investor is obviously at sea.

In this maze there is an increasing demand by stakeholders for a greater transparency and assurance around financial statements. There is a growing realisation that such assurance can only be obtained by rigorous examination and certification of these accounts by a service provider whom investors can rely upon.

In this quest for greater assurance, it is inevitable that there would be concerns about the competence and integrity of the assurance provider. Both these attributes require equal emphasis.

However, in some jurisdictions like India, there is an obsession with visible and presumed indicators of 'integrity', very often, to the total neglect of 'competence'. This attitude is counter productive and possibly stems from a deep-seated paranoia about collusion between management and auditors. It reflects a sub-conscious distrust of the ability of regulators to detect such collusion.

Some proponents of audit quality argue that rotation of auditors, joint audits and centralised agency-driven audit appointments are a panacea. However, most of the major instances of alleged audit inadequacies in India have traditionally happened in sectors like the banking sector, where rotation, joint audits and centralised appointments, are simultaneously practiced!

Competency-based profiling of audit firms are discouraged and archaic advertisement rules prohibit firms from showcasing their competencies. Prospective users of an audit firm's services are thus denied full knowledge of comparative strengths, weaknesses and delivery capabilities of different firms.

Thus, the process of choosing a service provider either becomes very tedious or fall backs to a default mechanism of personal knowledge and proximity to a particular audit firm.

Effective auditing depends on an auditor's ability to develop a detailed understanding of the auditee's complex structures and operation. Research conducted by the American Institute of Certified Public Accountants (AICPA) in the USA, of over 400 cases of alleged audit failure, indicated that in 75 per cent cases, the auditor was performing his first or second audit of the company.

This correlates with the Bocconi Report findings that in the first year of an audit, 40 per cent more audit hours are required; audit costs are greater by 15 to 25 per cent and training period for new auditors of complex groups appear to be 2 to 3 years. Very often, in industries such as banking, insurance, telecom, sector specific knowledge is a must.

Rotation destroys the knowledge an auditor develops on specific matters related to an entity. This ultimately leads to audit firms not investing adequately in industry specialism because dis-economies of rotation or cap on number of audits do not make it feasible to do so.

In fact, any un-ethical promoter group would always encourage rotation of auditors since that would ensure that the auditors are on the learning curve continuously.

Further, these companies would even prefer a practice of joint and multiple auditors and carve out different domains of complex transactions between different auditors so that no one gets the full picture.

In addition, there is also the option to levy a cap on all other types of non-audit activities so that the auditor knows less about the detailed workings of an entity. In India, they could easily do all these with the misplaced blessings of the regulators!

For greater assurance we require a paradigm shift. Auditors' integrity should be taken for granted, but needs to be reinforced by a strong and effective system of peer review; stringent and expeditious follow up of disciplinary cases; streamlining the disciplinary provisions by eliminating outdated requirements relating to deemed advertisements and eliminating permissions required by a chartered accountant for various activities such as teaching; writing articles; participating in professional sports or growing agricultural products! We need to concentrate on fast-track decisions; wide publicity to exemplary sanctions and professional misconduct and gross negligence cases.

The author is director, Ernst & Young India Pvt Ltd. Views expressed here are his own.