Related-party deals on the rise, auditors must be alert: RBI governor Das

RBI governor's statement follows two-year ban on Haribhakti & Co from conducting audits

Reserve Bank of India (RBI) Governor Shaktikanta Das on Monday said auditors must be careful about the rise in innovative accounting and related-party transactions and must flag them to the regulator promptly.  

His remarks came days after the RBI banned auditing firm Haribhakti & Co for two years from conducting audits on its regulated entities from the next financial year.

Without naming any firm, Das said the auditors, in some cases, failed to catch manipulation and misstatements in accounts, and clever accounting should be dealt with more strictly. It is also the job of the auditor to report immediately to the regulator about accounting manipulation, but in some cases those have not been done.

The RBI banned Haribhakti & Co, auditor of SREI Infrastructure Finance, under section 45MA of the RBI Act. The section says an auditor would be penalised and would be duty-bound to inquire whether the firm being audited has furnished all the details on its deposits, assets, and liabilities, profit-and-loss account, etc. to the RBI that would form the basis of disclosure related instructions, or even special audit on the firm.

The RBI governor, in his speech at the National Academy of Audit and Accounts, said auditors were the first line of defence against economic fraud, and there was a need for a robust audit for the economy.

“Economic decisions are increasingly made based on the available evidence and information. Inaccurate information may lead to suboptimal decisions or excess resource allocation, which would be neither in public interest where a public authority is involved, nor in the interest of individual stakeholders,” the RBI governor said.

When a bank sanctions a loan to a company based on wrong information, and the company doesn’t repay the money, it will ultimately hit the safety of depositors. Banks will turn risk averse because of bad loans, and to recover their losses will increase their interest rates. This will also crimp economic recovery and compromise the safety of depositors.

“Statutory auditors play a vital role in maintaining market confidence on audited financial statements. In the banking industry, this public role is particularly relevant for financial stability, given that banks hold public deposits. Audit quality is key to the effectiveness of such a public role,” the RBI governor said.

“A statutory auditor has a duty to report directly to the supervisor (RBI) on matters of material significance arising from the audit of banks and other regulated entities. For these reasons, the RBI as the supervisor of banks and NBFCs has a keen interest in the manner with which statutory auditors perform audits in the regulated entities,” Das said.

“Audit failures usually arise when the independence of the auditor is compromised, or the auditor lacks competence,” he said, justifying greater scrutiny on auditors.

The RBI governor said auditors should also be careful about subjectivity in IND-AS accounting. The standard is applicable for all regulated entities, except banks for now. The IND-AS 109 has an expected credit loss approach, which allows the management to take the route of innovative accounting, and this has been observed in several cases.

According to the RBI governor, 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 diversion 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.,” he said, adding the auditors have a responsibility to ensure that there is no such undue transfer.

According to the RBI governor, increasingly opaque technological means, such as IT black boxes, where real transactions are camouflaged beneath various layers of IT solutions. Auditors must be tech-savvy to detect these. “Lot of work has been done, but a lot needs to be done,” the RBI governor said.