Financial audits reasons behind failures & some suggestions

 Auditing is the independent examination of financial
information of any entity, whether profit oriented or
not, and irrespective of its size or legal form, when
such an examination is conducted with a view to
expressing an opinion thereon.
 A financial audit is conducted to provide an opinion
whether "financial statements" (the information being
verified) are stated in accordance with specified
criteria. Normally, the criteria are accounting
standards, although auditors may conduct audits of
financial statements prepared using the cash basis
or some other basis of accounting appropriate for the
organisation.

 In providing an opinion whether financial statements are
fairly stated in accordance with accounting standards, the
auditor gathers evidence to determine whether the
statements contain material errors or other
misstatements.
 The auditors are playing role as watchdogs to help the
shareholder monitor the credibility of the information
presented by the management and verification of financial
statement if showing true and fair view to the shareholder.
It enhances credibility and the perception of the external
stakeholders when the external auditors express their
opinion as impartial and without conflicts of interest.
 Due to above the function of audit is also termed as “
Financial Policing” sometimes.

1. Audit Helps to Detect and Prevent Errors and Frauds
An auditor's main duty is to detect errors and frauds, preventing
such errors and frauds and taking care to avoid such frauds.
Thus, even though all organizations do not have compulsion to
audit, they make audit of all the books of accounts.
2. Audit Helps to Assess Tax
Tax authorities assess taxes on the basis of profit calculated by
the auditor. In the same way sales tax authority calculates sales
tax on the basis of sales shown in the audited statement.
3. Audit Helps to Maintain Account Regularly
An auditor raises questions if accounts are not maintained
properly. So, audit gives moral pressure on maintaining
accounts regularly.

4. Audit Facilitates to Compare & analyse
An auditor instructs an accountant in the same way which helps to
compare books of accounts of current year with the accounting of
the previous year. So, comparing the accounts of current with
previous years helps to detect errors and frauds.
5. Audit acts as deterrence for fraud perpetrators
It acts as a moral check on the employees of the organisation. The
apprehension of getting caught during audit forces them to keep
accounts up-to-date.
6. Audit Helps to determine amount available for Dividend/Bonus.
Profit from a business during the given period is certified by the
auditor while auditing books of account. This in turn helps to find
the amount available for distribution amongst
employees/shareholders.

7. Audit Helps to Present a Proof
If any case is filed by/against the audited entity, audited accounts
are many a time presented as a proof/evidence in the court of law.
8. Audit Provides Information About Profit or Loss
A businessman wants to know profit or loss of his business after a
certain period of time. So, the owner of the business can get
information about profit or loss after auditing the books of accounts.
9. Audit Helps to Prepare Future Plan
All the audited statements remain true and correct. Such true and
correct account helps to prepare for the future plans.
10. Audit Helps to Increase Goodwill
Auditing shows the profitability and financial position of an
organization which creates faith of public over the business. Thus,
auditing helps to increase goodwill of an organization.

All the organisations (which we own or work for) can be
broadly grouped under following three categories –
 Govt/Semi-Govt Departments.
 Companies/ firms and
 Not-for profit organisations
Now if we look carefully, it may be noted that while the
first group is answerable for the general well being of the
society, as it is governments responsibility to provide
basic amenities and infrastructure for its citizens including
health, education, security and other public welfare, it
largely depends on the revenue collected in the form of
taxes for all this. Not to forget that there is a need for audit
here also to check whether all the money is being spent
properly and not being misappropriated.

While the govt’s world over functions as the
enabler and facilitates trade and commerce by
providing conducive environment/regulations,
it is the second group which drives the growth
of any economy/nation which in turn effects
the general well being of the citizens of any
nation. Thus we can understand how critical is
an orderly functioning of these entities as,
directly or indirectly, it effects all of us. A proper
system ensuring a orderly function of these
entities can never be overemphasised.

Not for profit organisations ( NGO’s) are gaining lots
of clout/attention and have proved their worthiness in
today’s world. The movement which gained attention
initially few decades back with the names like Red
Cross Society today rivals big multinationals in their
size, geographical reach and deep pockets. Owing to
their stated objectives and nature of activities, they
enjoy many incentives and relaxations. This in turn
invites the unscrupulous people to assume its garb
for profiteering or sometimes run motivated
campaigns under its shelter. Here again the role of
auditors becomes significant to ensure that the
sector is functioning within its laid down parameters
and doesn’t become a tool for achieving ulterior
objectives.

 Enron Corp.
 Toshiba Corp
 Worldcom
 Lehman Brothers
 B L madoff Invest LLC
 DSQ Software Ltd
 Satyam Ltd
 Speak Asia
 Saradha Chitfund
Do the names listed below sounds familiar ?

Corporate scandals like Enron/Toshiba and management frauds like Satyam --the
fraudulent presentation of financial statements by management--has off late
attracted the critical attention of the people/press globally. This in turn has raised
a strong concern for the state of the system of corporate accounting, financial
reporting and their effective monitoring . Also because, to a large extent, the
health of the capital markets rests on the confidence that financial statements (
presented by the management and certified by the auditors) are not fraudulent.
Thus, the detection and prevention of fraudulent financial statements becomes
essential to the functioning of any vibrant economic system, and they must be
ensured by the auditing profession and the business community.
As the globe is getting more and more integrated and organisations are
becoming bigger and ever more powerful (financially), the need for effective and
timely regulation for them should never be underestimated. The suspected BEPS
(shifting of profit from high tax region/country to lower tax region/country)
accusations against the multi-national companies further indicates the need for
an independent and transparent authentication of their books of accounts.
The above is a sample list of global and local corporate scandals reported
widely in media. In almost all of above the end result was bankruptcy and
closure of company, forcing huge loss of investors/creditors money and
thousands of jobs. At the same time they also raised serious doubts on the
effectiveness of the present audit systems .

While the each case listed above and are different in their modus-
operandi and occurred at different time triggering new set of
regulations, they do expose the gaps persistent in the system. While
the regulators have tried to keep pace with the changing environment,
there are some inherent limitations of the system -
1.The cost has no direct EVA:
Testing involves extra cost to the organization which is considered as a
burden. It involves operational disruptions in many cases. The auditor
has to concentrate more even though there are disruptions
notwithstanding the natural resistance. It is almost impossible to
quantify the benefits of the process.
2. Evidence is not conclusive
Audit evidence is not conclusive in nature the confirmation of debtors is
not conclusive evidence that all amount will be collected, the
conclusions are persuasive rather than conclusive.

3. Not easy to detect some frauds
It’s not easy for an auditor to detect the deeply laid frauds which involves
acts designed to conceal them such as forgery, false explanation, and not
recording transaction and so on.
4. All transactions cannot be checked
It is not possible for an auditor to check each and every transaction; he has
to check them on sample basis.
5. Rapid change in technology:
There is innovation and development of advance technology which is used
in the business organization so, there is risk that the auditor may not cope
with latest technology and audit tools.
6. Rely on experts
The auditor has to rely on experts like lawyers, engineers, valuers etc. for
estimation of contingent liability and valuation of fixed assets.

7. Audit cannot assure about profitability or efficiency of management
Even though the accounts are audited it doesn’t mean that the user can
take granted the future profitability or prospects of concern as audit don’t
comment on efficiency of the management.
8. The push for Tax / Performance optimisation
Most of the time an auditor is faced with one of the two auditee stance,
while one group is constantly pushing to minimise its tax liability , the other
one is more interested in boosting its performance report as the incentives
are linked and want to meet/better market analyst projections.
9. Auditors Independence
Though under the law shareholders appoint auditors but in fact it is the
directors (who are majority shareholders or controlled by majority
shareholders) who appoint auditors, so this raises concerns on the
independence of auditors.

Like we have read before – auditors are also known as
financial police. Now for a moment just think about the
police force in your city. You must be reading about the
crime reports in the newspapers daily. Does it mean that
the police is not doing their job and the department should
be shut down?
The answer is - No.
A normal response is - find the ways and means to make
them more effective.
Similar is the case of audit also - the need is to help the
profession by removing the constraints and strengthening
it with effective regulatory support.

Let’s look at some of the measures / suggestions which can be
taken to improve the process -
1. Audit independence –
The single most important aspect of the discussion as the
auditor is supposed to give its findings and report on a person
who appointed the firm and shall pay its fee. The underlying
concept limiting the role of an auditor as a watchdog (can bark –
not supposed to bite) is fine but then don’t let the dog get fed by
the stranger.
2. Appointment-
The very first step needed for maintaining auditors
independence is, to secure his appointment or removal, from
the auditee. In the absence of it, all other measures runs the
risk of getting compromised however good they may sound.

3. Remuneration –
Renowned investor Warren Buffet once said about the auditors
remuneration in his famous annual newsletter – “whose bread I eat, I
will sing his song”. It is imperative that the audit fee is regulated by an
independent regulator to insulate auditor from any coercive situation.
4. Rotation –
It is a normal human behaviour where – “familiarity breeds contempt”.
And contempt for the routine processes may prove fatal as far as the
routine audit works are concerned. Just because they are repetitive in
nature doesn’t make them any less effective. To avoid this situation it is
necessary that a new auditor assumes the role at regular interval.
5. Restriction on non-audit services -
The non-audit works from a auditee may influence an auditors
judgement and estimation. It is hence advisable to bar the auditors from
doing any non-audit work in order to keep him free from any undue
influence.

6. Follow-up action on reports -
It is observed that the concerned authorities fails to take notice
and required action on the basis of qualifications/observations
given by the auditor in its report. This sometimes dampens the
spirit of the professionals as his efforts seems futile.
7. Peer review-
It helps in identifying the weak areas of any audit firm and acts
as trigger for improvement thereon.
8. Knowledge updation-
In the rapidly changing world where technology is making
everyone obsolete, regulations change every day and
organisations assume the size bigger then many nations(
financially), it is a constant tread-mill running for any
professional to keep himself updated.

9. Independent regulator –
To remove any concern from the mind of every stakeholder, it is
necessary that the profession should have an independent
regulator.
The auditors are playing a very important role in modern day
society. The duty of the auditors is to “perform the audit to
obtain reasonable assurance about whether the entity
maintained effective control over the financial statement”.
Auditors assurance that the financial statement represents true
and fair picture of organisation to the user of financial statement
such as shareholder, employee, government and overall society
where organization operates, is paramount in functioning of the
overall system.

Questions Please ?
!
Thank You
hikumaronline@gmail.com
Twitter handle : @kumarspoint

Financial audits reasons behind failures & some suggestions

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