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Audit of public sector enterprises
February, 08th 2010

Recently, in the context of discussion on quality of audit, serious concern has been expressed on the issue of independence of auditors in the private sector. While adjudging the quality of audit in private sector and that of public sector enterprises (PSEs), it is well acknowledged that there is a creditability crisis in auditing profession in respect of audit of private sector because of a deficient system of appointment of auditors and the audit of public sector enterprises is of far superior quality because of established system of checks and balance to ensure independence of auditors.

The poor quality of private sector audit may have various root causes inherent in the system including criteria of appointment of auditors, influence of the dominant shareholders, fixation of remuneration, non-rotation of auditors, absence of joint audit system, ad-hoc selection criteria and, most importantly, lack of oversight mechanism.

In order to regain credibility and investor confidence, the fundamental prerequisite is that the auditors should adhere to the core values of integrity, objectivity, honesty, trust and professional ethics.

In the light of accounting and governance scandals, both domestic and international and prevalent environment of creative accounting in corporate sector, the office of the Comptroller and Auditor General of India (C&AG) reviewed its audit methodology and practices, and further geared up its oversight functioning to ensure better accountability, transparency, probity, equity and fairness in the audit of PSEs.

Appointment of Auditors

In order to select the right firms for the right job, the C&AG follows a transparent, objective, well-structured, Web-based registration system, computerised empanelment process in consultation with ICAI and objective and transparent system of allocation of audit assignments based on predetermined acceptable parameters, adjudging competence, experience and suitability.

Initiatives to ensure independence: The statutory auditors have a fiduciary duty to provide independent, professional opinion on the financial statements of the company audited by them. Independence of the statutory auditors is ensured by appointing joint auditors for major PSEs and listed companies, rotating the auditors after a term of four years subject to case to case evaluation of firms, and also prohibition of certain non-audit assignments. The statutory auditors with unsatisfactory performance are either cautioned or debarred for allotment of audit.

Directions: Before commencement of audit, expectations from the auditors are spelt out explicitly by issuing general and industry specific directions.

Financial statement: Preparation of financial statement by the management and audit thereof by the statutory auditors procedurally is similar to that of the private sector.

Supplementary audit: The certified accounts along with report of the Statutory Auditors are reviewed by C&AG. On the basis of the review and parameters, a decision is taken whether to conduct supplementary audit of the financial statements of PSEs. This supplementary audit carried out independently is limited primarily to the inquiries of the statutory auditors and company personnel and a selective examination of some of the accounting records. Based on such a supplementary audit, significant audit observations are reported under section 619 (4) of the Companies Act, 1956, to be placed before the Annual General Meeting and in certain cases financial statements and auditors reports are revised.

New Initiatives

An intensified, innovative, focused and result-oriented new audit methodology to financial audit called Three Phased Audit System was introduced from the accounting year 2008-09 in 78 selected central PSEs falling under the categories of listed, navratna, miniratna Government companies, and statutory corporations where C&AG is the sole auditor. This methodology has been widely appreciated by the CEOs, CFOs and statutory auditors of these PSEs. Therefore, this has been extended to 114 CPSEs for the financial statements of 2009-10. Further, instructions were strengthened for independent third party confirmation of balances and reporting results.

Thus, there are adequate checks and balances for ensuring independence of auditors through the system of their appointment, putting restrictions on taking non-audit assignments, issuing directions to the auditors and overseeing the work performed by them.

On the contrary, in private sector, including widely-held listed companies in which large numbers of small investors are interested, auditors are appointed by the management and there is no system of rotation of auditors and overseeing their work performed by auditors. To overcome credibility crises of audit of such companies, there is need for taking adequate measure for ensuring independence of the auditors as well as an effective system of overseeing the work performed by them.

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