Audit firms need to be on their toes

Audit firms will now have to be more accurate and work efficiently, as they would be charged as guilty in case of any fraud or manipulation in the financial statements of companies they audit. As per media reports, audit firms and Chartered Accountants found guilty of malpractices will be liable to jail terms of up to 10 years and fines up to 3 times of the scam amount. The step is a stringent one for auditors, while in case of companies, there could be more transparency seen ahead.

The Companies Bill 2011, which was discussed in the Lok Sabha earlier, had proposed to give authority to the National Company Law Tribunal (NCLT) for taking action against errant audit firms. In response to this, the President of ICAI, G. Ramaswamy, said that the move is welcome, but action against auditors should be taken by the ICAI and not by the NCLT.

The move came after various scams that occurred recently, for which the auditors were not able to press the red button in a timely manner to alert shareholders and investors. According to media reports, Ernst and Young (E&Y) had undertaken several malpractices for Lehman. Christopher O’Mera, the Chief Financial Officer of Lehman, was formerly associated with E&Y.  Lehman used to move its assets off the balance sheet creating a false impression that it is reducing its creditors. However, that was not really happening. E&Y did not disclose the matter for more than 7 years, which resulted in a huge trap. In the case of Satyam, it seemed that the auditors failed to make adequate verifications, which lead to the scam. According to the CBI, the auditors relied on the forged bank confirmation letters given by the third party while conducting the statutory audit, and did not verify the firm's balance. 

The recent scams has put everyone into a sense of uncertainty with regard to the health of companies. Auditors are the only 3rd-party entities who provide a review of the companies according to their assessment. Retail shareholders rely on auditors and company-specific reports for their decisions about investing in companies.

This step will enforce greater transparency on the disclosures side, which will help investors with their decisions.  On the other hand, there would be more pressure on the auditors, who would feel culpable for any malpractices happening in the company.

Recently, at the 26th Western Regional Council meet of ICAI, the RBI Governor D Subbarao said that auditors are eyes and ears of the RBI, as it relies on them and expect them to give early warning signals if required. This move would definitely have a favourable impact over a longer time period. Corporate governance is an issue where India still lags way behind, and steps like proper disclosure and transparency in companies' financials and other matters will surely bring great improvement going ahead.