Synopsis–Auditors are raising questions around the authenticity of sales, inventory and debtors in the financials of several companies, say insiders. Auditors have to base their opinions on the data provided by the companies, and they are relying on the management’s representation or letters that ascertain authenticity of the figures.
Unable to check authenticity of claims made by companies due to the Covid pandemic, auditors have started asking for letters from the management assuring the numbers are correct.
In the last few months, statutory auditors, who are required to approve or raise objections to the financial numbers prepared by companies, are stranded by the pandemic and lockdown in some areas.
Auditors are raising questions around the authenticity of sales, inventory and debtors in the financials of several companies, say insiders. Auditors have to base their opinions on the data provided by the companies, and they are relying on the management’s representation or letters that ascertain authenticity of the figures.
“Auditors are facing challenges in ascertaining primary/secondary sales, sales return, collections from debtors, and physical verification of inventory,” said audit expert Vinayak Padwal. “Auditors, on several occasions, have no option but to rely on management representations. This could expose them to risk of material misstatements in financial statements if professional judgement is not exercised appropriately.”
Take sales, for instance, in some of the consumer goods companies. Earlier, auditors could verify the numbers through other sources, but that has now gone. Same is the case with debtors. In most cases, the debtors and receivables have gone up for companies.
This could have a material impact on the company’s financials, as the auditor has to verify how much money may actually come and when.
A management representation seems to be an assurance that many auditors are opting for. But that may not be enough, say industry experts.
“Auditors are responsible to obtain sufficient appropriate audit evidence to form an opinion on the authenticity of the financial statements and while additional representations from the management should be taken, this does not absolve the auditor from discharging his duties appropriately,” said Nikhil Singhi, senior partner at Singhi & Co.
“There may also be practical challenges in view of physical constraints due to Covid-19 around verifying certain line items in the financial statements, for which the auditors may need to modify the audit procedures or apply alternate audit procedures to obtain the desired comfort.”
In some of the largest frauds in the last few years, it was found that management representation and similar letters were the key, say industry experts. Auditors have been booked by investigating agencies despite these representations by management.
“Letter of representation means again issues on corporate governance and larger responsibilities of independent directors. This could also put auditors in trouble when they have to justify with their regulator adequacy of audit evidence — peer review, quality review, NAFRA (National Financial Reporting Authority),” said Padwal.
In some of the cases, auditors have been roping in their own investigators or are scrutinising transactions, which is outside the scope of auditing.
Many audit firms have also opted to resign or walk out instead of signing certain balance sheets of companies they are not comfortable with. These resignations may go up in the coming weeks as auditors are still unable to hit the ground due to the pandemic.
Some of the audit firms are relying on technology — including drones — to check certain transactions or inventory. However, there are only a handful of firms that can rely on the tech. A large number of audit firms may still have to depend on what the management says in absence of such technologies.