What is this Audit Debacle all about?
Firstly, before going into the actual topic for this blog, it is quintessential for the readers of this blog to have at least an idea of what audit stands for. In laymen’s term, “audit in an examination of the books of accounts of a company”.
But is that so? Does that suffice the term “Audit”?
Well, to begin with “Auditing is a systematic and independent examination into the books of accounts of entity whether profit oriented or not to provide a true and fair opinion over the affairs of the entity concerned”.
The major takeaways from the definition are:
- Systematic and independent:
- Systematic Audit activities indicated audit being conducted in a planned manner with adequate level of controls to maintain the quality of work.
Whereas, Independence is judgmental. There prevails no hard bound definition inscribed on a stone tablet defining Independence of an auditor. However, it is widely accepted that Independence is that level of freedom enjoyed by an auditor in his/her work as seen from an outsider/ third party perspective.
- Examination into books of accounts:
Examination is thorough and in-depth analysis of the books of accounts maintained by the auditee. Books of accounts here means all accounting and financial records, information maintained by the auditee whether in physical or in digital format.
- Provide a true and fair opinion
True and fair opinion is the most crucial element in the definition of Audit. Auditor conducts audit with an aim to provide his opinion on whether the books of accounts and other financial information based on which Financial Statements are prepared, are maintained by the entity (or management of the entity) in a truthful and fair manner. For this it is essential that the auditor is able to get a reasonable level of assurance over the financial information presented to him/her.
Currently, in the last couple of months India, not much afar from the global scenario, is facing a turbulent times in the Auditing Sector. The IL&FS crisis, may not necessarily be a precursor to this but surely it impacted this unsettling moments this industry has ever faced in its history.
So, where did it all begin?
In July 2018, Hindu Businessline reported that the road arm of IL & FS was having difficulty making payments due on its bonds[i].
Bloomberg Quint, Business standard and Economic times reported that one of the IL & FS group of companies called IL & FS Financial services limited had defaulted on its commercial paper payments.[ii] This led to news of a possible audit by the Reserve bank of India. IL&FS Financial Services Ltd., one of the group's many financial subsidiaries had defaulted on repaying about Rs. 450 crore worth of inter-corporate deposits to Small Industries Development Bank of India (SIDBI)[iii].
It was the beginning of bursting of the bubble of overdue regulation over the quality of the auditing sector in general. So what actually lead to this crisis?
Was it on account of lack in Standards on auditing framed and controlled by the Institute of Chartered of Accountants of India?
Was it due to lack in due diligence endorsed in quality of work by the auditors?
- Examination into books of accounts:
Examination is thorough and in-depth analysis of the books of accounts maintained by the auditee. Books of accounts here means all accounting and financial records, information maintained by the auditee whether in physical or in digital format.
- Provide a true and fair opinion
True and fair opinion is the most crucial element in the definition of Audit. Auditor conducts audit with an aim to provide his opinion on whether the books of accounts and other financial information based on which Financial Statements are prepared, are maintained by the entity (or management of the entity) in a truthful and fair manner. For this it is essential that the auditor is able to get a reasonable level of assurance over the financial information presented to him/her.
Currently, in the last couple of months India, not much afar from the global scenario, is facing a turbulent times in the Auditing Sector. The IL&FS crisis, may not necessarily be a precursor to this but surely it impacted this unsettling moments this industry has ever faced in its history.
So, where did it all begin?
In July 2018, Hindu Businessline reported that the road arm of IL & FS was having difficulty making payments due on its bonds[i].
Bloomberg Quint, Business standard and Economic times reported that one of the IL & FS group of companies called IL & FS Financial services limited had defaulted on its commercial paper payments.[ii] This led to news of a possible audit by the Reserve bank of India. IL&FS Financial Services Ltd., one of the group's many financial subsidiaries had defaulted on repaying about Rs. 450 crore worth of inter-corporate deposits to Small Industries Development Bank of India (SIDBI)[iii].
It was the beginning of bursting of the bubble of overdue regulation over the quality of the auditing sector in general. So what actually lead to this crisis?
Was it on account of lack in Standards on auditing framed and controlled by the Institute of Chartered of Accountants of India?
Was it due to lack in due diligence endorsed in quality of work by the auditors?
Well, to be able to judge as to who is at fault, the readers need to have necessary information about the subject matter concerned regarding the allegations raised against the auditors.
The main allegations raised was that the auditors didn’t gather enough amount of audit evidence to base their opinion regarding the company’s ability to pay its massive debt and that they didn’t gather enough audit evidence to confer the valuation of assets of the company and many such similar allegations[iv].
Now having a quick glance at the allegations it seems that the auditors didn’t perform their duties satisfactorily. But is that the case? Two of the Big Fours involved in the case not performing their duties in a satisfactory manner. Are these allegations so easily gullible?
If we are to actually go deeper into the roots of the issue and the basic grounds on which the allegations are raised. We need to know that:
Firstly, the Standards on Auditing based on which auditing services are provided in India which are issued by ICAI are to be considered as the focal point of reference. As per S.A. 500, on Audit Evidence which says “SA 330 on The Auditor’s Responses to Assessed Risks requires the auditor to conclude whether sufficient appropriate audit evidence has been obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level, and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion, is a matter of professional judgment.”
The point to be focused here is that the auditor is required to get just a reasonable level of assurance to base his/her opinion and not an absolute level of assurance. For the sake of brevity reasonable level of assurance means assurance garnered by the auditor based on his/her professional judgement along with taking into account the requirements of laid under S.A.’s, Companies Act, 2013, any other act(s) as and when applicable on the referred entity.
Secondly, as per the case of Kingston Cotton Mill the Hon’ble Lord Justice Lopes in this judgement said that “the case’s judicial description of external auditors as "watchdogs" rather than "bloodhounds" established the principle that auditors’ duties involve the exercising of reasonable professional care: "What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective." The case determined that it was reasonable for the external auditor of the Kingston Cotton Mill to rely on a *management representation of inventory balances, and the auditor was not held to be liable for failing to detect a *fraud.” this conveys that the role of auditor is limited and he/she is not supposed to step into the shoes of an Investigator.
Thirdly, let’s also have a look in the minimum rates prescribed by ICAI for providing auditing services[v]
Now, let’s move on to the actual scenario in the market:
The main allegations raised was that the auditors didn’t gather enough amount of audit evidence to base their opinion regarding the company’s ability to pay its massive debt and that they didn’t gather enough audit evidence to confer the valuation of assets of the company and many such similar allegations[iv].
Now having a quick glance at the allegations it seems that the auditors didn’t perform their duties satisfactorily. But is that the case? Two of the Big Fours involved in the case not performing their duties in a satisfactory manner. Are these allegations so easily gullible?
If we are to actually go deeper into the roots of the issue and the basic grounds on which the allegations are raised. We need to know that:
Firstly, the Standards on Auditing based on which auditing services are provided in India which are issued by ICAI are to be considered as the focal point of reference. As per S.A. 500, on Audit Evidence which says “SA 330 on The Auditor’s Responses to Assessed Risks requires the auditor to conclude whether sufficient appropriate audit evidence has been obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level, and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion, is a matter of professional judgment.”
The point to be focused here is that the auditor is required to get just a reasonable level of assurance to base his/her opinion and not an absolute level of assurance. For the sake of brevity reasonable level of assurance means assurance garnered by the auditor based on his/her professional judgement along with taking into account the requirements of laid under S.A.’s, Companies Act, 2013, any other act(s) as and when applicable on the referred entity.
Secondly, as per the case of Kingston Cotton Mill the Hon’ble Lord Justice Lopes in this judgement said that “the case’s judicial description of external auditors as "watchdogs" rather than "bloodhounds" established the principle that auditors’ duties involve the exercising of reasonable professional care: "What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective." The case determined that it was reasonable for the external auditor of the Kingston Cotton Mill to rely on a *management representation of inventory balances, and the auditor was not held to be liable for failing to detect a *fraud.” this conveys that the role of auditor is limited and he/she is not supposed to step into the shoes of an Investigator.
Thirdly, let’s also have a look in the minimum rates prescribed by ICAI for providing auditing services[v]
Now, let’s move on to the actual scenario in the market:
Firstly, there is no possibility of raising a questioning someone’s professional judgement as this differs on case to case basis. Accordingly, an X series of document may be enough audit evidence for creating an opinion by Auditor A, whereas for Auditor B, Y series of document may commensurate as enough audit evidence to frame an opinion, whereas for Auditor C, maybe X and Y both series of documents are required which shall constitute as sufficient and appropriate audit evidence. So, the question of evaluation of professional judgement being exercised by auditor to frame an audit opinion differs in case to case basis.
Secondly, as rightly mentioned in the case Kingston Cotton Mills Case, it is clearly evident that an Investigation into the books of accounts of the company/ entity is not the objective for an audit.
Lastly, merely looking at the rates prescribed by the ICAI; it is nothing but superficial to think that in case of small entities, the management will be willing to pay such high costs and then there comes the other side of the spectrum; the large companies having thousands of crores of turnover and naturally billions of transactions for the period under audit, in this scenario, the auditor cannot work for such low costs merely by looking at the quantum of operations involved.
Conclusion: As the Presumption of Innocence says that an accused is not considered a criminal unless proved one, so we should not be hastily coming on the conclusion as to who is the main party who lead to this debacle. Both the Big Fours have kept their stand constant that it has been thorough and diligent in the performance of its duties as an auditor. The firms stood fully for its audit work which has been conducted in full compliance with the professional standards in India, as well as all applicable laws and regulations; and they are ready to prove the same as and when asked to do so. I personally believe that it is just too soon for us as readers to form our opinion on this topic.
[i] "Debt downgraded, ILFS road arm says facing defaults". Hindu businessline. 22 July 2018. Retrieved 26 September 2018.
[ii] Mukherjee, Andy (17 September 2018). "The IL&FS fiasco represents India's domestic belt and road quicksand". Business Standard (originally reported by Bloomberg). Retrieved 26 September 2018.
[iii] Saxena, Ridhima (28 September 2018). "RBI Asks Shareholders To Rescue IL&FS". Bloomberg Quint. Retrieved 29 September 2018.
[iv] “Inside the audit lapses that led to IL&FS crisis” posted by livemint.
[v] Rates as prescribed by Committee for Capacity Building Members in Practice (CCBMP), ICAI initiative for prescribing the Revised Minimum Recommended Scale of Fees for the Professional Assignments done by the Chartered Accountants - (13-12-2017).
Secondly, as rightly mentioned in the case Kingston Cotton Mills Case, it is clearly evident that an Investigation into the books of accounts of the company/ entity is not the objective for an audit.
Lastly, merely looking at the rates prescribed by the ICAI; it is nothing but superficial to think that in case of small entities, the management will be willing to pay such high costs and then there comes the other side of the spectrum; the large companies having thousands of crores of turnover and naturally billions of transactions for the period under audit, in this scenario, the auditor cannot work for such low costs merely by looking at the quantum of operations involved.
Conclusion: As the Presumption of Innocence says that an accused is not considered a criminal unless proved one, so we should not be hastily coming on the conclusion as to who is the main party who lead to this debacle. Both the Big Fours have kept their stand constant that it has been thorough and diligent in the performance of its duties as an auditor. The firms stood fully for its audit work which has been conducted in full compliance with the professional standards in India, as well as all applicable laws and regulations; and they are ready to prove the same as and when asked to do so. I personally believe that it is just too soon for us as readers to form our opinion on this topic.
[i] "Debt downgraded, ILFS road arm says facing defaults". Hindu businessline. 22 July 2018. Retrieved 26 September 2018.
[ii] Mukherjee, Andy (17 September 2018). "The IL&FS fiasco represents India's domestic belt and road quicksand". Business Standard (originally reported by Bloomberg). Retrieved 26 September 2018.
[iii] Saxena, Ridhima (28 September 2018). "RBI Asks Shareholders To Rescue IL&FS". Bloomberg Quint. Retrieved 29 September 2018.
[iv] “Inside the audit lapses that led to IL&FS crisis” posted by livemint.
[v] Rates as prescribed by Committee for Capacity Building Members in Practice (CCBMP), ICAI initiative for prescribing the Revised Minimum Recommended Scale of Fees for the Professional Assignments done by the Chartered Accountants - (13-12-2017).
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