There is an urgent need to converge accounting standards
March, 24th 2008
During a conversation a decade ago with a senior regulator on the prevalence and acceptance of qualified audit reports in India, the regulator remarked Why would a qualified audit report be considered undesirable? I would have thought a qualified audit report would mean that the audit report or the auditee had some additional attributes, just like we speak of a qualified person. This one incident etched in my mind all that bedevils India when it comes to stakeholders understanding of an audit report or placing confidence thereon.
Globally, audit reports are unqualified, meaning that the auditor would without any reservation express his confidence on fairness of the financial statements. Issuance of a qualified opinion, globally, is in the rarest of rare scenarios only. However, in India, convention, practice, and business usages have combined in a manner in which a qualified audit opinion is an extremely common occurrence.
A number of these qualifications arise because the auditor wants to play safe since the past history of regulatory action does not provide confidence of regulators appreciating the materiality aspects of reporting. While Audit works on a framework of designing processes and finally reporting results based on materiality thresholds which are linked to the size of the entity and its results, regulators and external reviewers in India tend to stray far from such a materiality driven approach.
When confronted with an aberration which in absolute terms may look quite big but in relative materiality quite insignificant, auditors and regulators tend to give more importance to the absolute size of the item and not its relative insignificance. This is one major reason why qualifications clutter up Indian audit reports. Another type of qualification pertains to wrong or impermissible accounting. These are commonly expressed in phrases like such and such has been accounted for in so and so manner, which is not in accordance with the Accounting Standards X issued by ICAI,subject to our observations, the accounts givetrue and fair view. This is unacceptable from a global point of view.
The SEC in the United States does not accept a qualified audit report under the Securities Act of 1933. As a result, all listed entities in the United States have to necessarily correct their accounts for any qualification. However, in India we go to the other extreme where a qualification is considered to be so routine that a few years back the Companies Act was amended to require that all qualificatory comments should be separately printed in italics so as to draw the readers attention!
Though, the Indian Auditing Standard on reporting is modelled after the relevant International Standard, its actual implementation is quite different in India. Three points of significant difference comprise a) the tendency to qualify immaterial items, b) the tendency to simply qualified items which in aggregate or individually would be material and in most other jurisdictions would end up in a not true and fair opinion, and c) increasing usage of the Matter of Emphasis option whereby an auditor merely draws the attention of the reader to some uncertainty without qualifying his opinion. There is a possibility of this being used in cases like provisioning for disputed claims and debts, where in most jurisdictions the auditors would be expected to make a judgment call and quantify under provision.
These accepted practices of audit reporting, along with Indias unique GAAS provision relating to responsibilities of Joint Auditors where though all the auditors sign the same set of financials, each is only responsible for the work done by himself and is not responsible for the work done by the other auditors which is contradictory to the joint and several responsibility concept of auditors elsewhere in the world significantly impacts the credibility of Indian audit reports.
What is the way out? A simple answer is to require that the accounts of all Public Interest Entities would have to be restated to ensure that they are free from audit qualifications/scope limitations/matters of emphasis, disclaimers and negative comments. As an intermediary step, Corporate Law may be amended to ensure that dividend distribution can only be made out of available surplus after adjusting the impact of all audit qualifications.
While we are working towards converging with International Accounting Standards, the goal of convergence and global acceptance cannot be achieved if we do not also simultaneously converge our Auditing Standards and practices.
The author is, Director, Ernst & Young India Pvt Ltd. Views expressed are that of his own.