Satyam, IL&FS, Enron and Wirecard frauds brought auditors’ independence and professional scepticism to the fore: NFRA Chairman – The Economic Times

Clipped from: https://economictimes.indiatimes.com/industry/services/consultancy-/-audit/satyam-ilfs-enron-and-wirecard-frauds-brought-auditors-independence-and-professional-scepticism-to-the-fore-nfra-chairman/articleshow/79957416.cmsSynopsis

Sridharan said that problems cited in the FRC’s latest report included an overreliance on letters from management without further audit checks, and a tendency to give information from a client company more weight than external data when testing assumptions.

Mumbai: Auditor independence is only one parameter for an audit quality and to move towards sufficiency, it has to be accompanied by professional scepticism and a questioning mind that is always alert to errors or fraud, and always critically evaluates evidence, R. Sridharan, Chairperson, National Financial Reporting Authority (NFRA) said in a speech.

In his speech, the chairman also touched upon the various major audit failures in the last two decades or so, including SatyamNSE 0.13 %Enron, IL&FS and Wirecard.

“2009 also saw the Satyam issue. In its essentials, the audit failure in Satyam was not caused by a “rocket science” kind of problem. At the heart of the audit failure in this case was the nonperformance of the most elementary of audit checks,” said Sridharan.

NFRA, the audit regulator, uploaded Sridharan’s speech on its website with a message that The Western India Regional Council (WIRC) of the Institute of Chartered Accountants of India had invited him to be the Chief Guest at their 35th Regional Conference on the 24th. First, it was rescheduled and later WIRC sent a message that “accommodating the Chairperson’s speech in the conference schedule would not be possible.”

NFRA, part of the Ministry of Corporate Affairs (MCA) now has the mandate to regulate the audit firms.

In his speech Sridharan argued that auditors have to be independent. “Auditor independence is only a necessary condition for audit quality. To move towards sufficiency, it has to be accompanied by professional scepticism, the attitude of a questioning mind that is always alert to conditions that may indicate possible misstatement due to error or fraud, and always critically evaluates evidence,” he said.

Sridharan said that often auditors have been relying more on the management (company) as against data available.

“..scepticism is the very foundation of all rational decision making. When we ignore this requirement, we fall into the logical trap that Daniel Kahneman, the Nobel Prize winning psychologist calls the WYSIATI fallacy; standing for What You See is All There Is. The FRC has recently stated that in more than 80% of the audits they reviewed over the past two years, and that were assessed as “improvements required” or “significant improvements required” identified ineffective challenge of management as a key driver of our overall assessment of that audit,” he said.

Sridharan said that problems cited in the FRC’s latest report included an overreliance on letters from management without further audit checks, and a tendency to give information from a client company more weight than external data when testing assumptions.

In his view, NFRA’s experience so far has not been different.

The regulator in a recent audit quality review report had also stressed on conflict of interest and which services can audit firms provide to their clients.

As per the current regulations audit firms cannot offer “management services” to their clients. The question is what constitutes management services. In its report NFRA quoted Oxford dictionary to define management. It said that it needs to be kept in mind that “management” would mean “act of running and controlling a business or similar organisation” and/or the “people who run or control a business or similar organisation.”

Experts say that it’s an issue arising out of Section 144 of the Companies Act 2013 that says that ‘management services’ are not permitted to the auditors.

But there’s confusion on the definition of management services and to which affiliates in a network firm, the rules apply.

And in India network firms — all Big Four firms — take up audits through affiliates that are separate legal entities. In absence of a clear definition the network firms use the internationally acknowledged The International Ethics Standards Board for Accountants (IESBA) definition with regards to services they can offer their audit clients.

While the NFRA report doesn’t specifically point out which services shouldn’t be offered by an audit firm to its client, it hints that any service that impairs “independence” should be avoided.

The independence argument is brought forth by NFRA while debating whether or not the audit firm was independent.

For most audit firms in India—this is a major issue. Most firms—both Indian as well as multinational—operate through a particular structure. So, while audit services are offered through one firm, other services such as taxation, consulting and digital are offered through separate firms. In most cases firms argue that these are different firms.

“Auditors always need to keep in mind that their ultimate accountability is to the shareholders of a company. It is never to the management. As a means of practically giving effect to this important distinction, the Standards on Auditing have developed the concept of Those Charged With Governance, or TCWG. An entire separate Standard deals with the Auditor’s responsibility for communicating to TCWG all important matters arising in the course of the audit,” he said.

Sridharan also stressed on how more resources have to be devoted to the auditing process as the auditors have to safeguard shareholders’ interest. “Good audit quality requires much more resources being devoted to the audit product. The resources should be used for sincere and meticulous compliance with the law, an important part of which are the accounting and auditing standards. Companies are sure to find that the expenditure would be well rewarded,” he added.

“Auditors always need to keep in mind that their ultimate accountability is to the shareholders of a company. It is never to the management,” he said.

This is perhaps for the first time that any senior official from NFRA has come on a public forum and spoke about the basic thought process and rationale the regulator follows while assessing and monitoring audit firms.

Sridharan also stressed on how more resources have to be devoted to the auditing process as the auditors have to safeguard shareholders’ interest.

“Good audit quality requires much more resources being devoted to the audit product. The resources should be used for sincere and meticulous compliance with the law, an important part of which are the accounting and auditing standards. Companies are sure to find that the expenditure would be well rewarded,” he added.

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