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Are audited financial statements reliable

Tuesday, October 21st, 2008

I am reading the article on the BBC website “Lehman Brothers Bank Collapse” dt 16-Sep-2008.

The company is an investment bank that specialises in big and complex deals and investments.
Despite this, Lehman’s collapse and the troubles of other financial institutions will probably be felt by millions of people around the world - at least indirectly.

Most of our banks and pension funds have dealings with Lehman, or with firms like hedge funds that traded extensively with Lehman.

Unwinding Lehman’s complex deals will take months if not years. During that time the global financial system will be snarled up. Many banks won’t know for sure how much they are exposed to Lehman, and will have difficulty freeing up the money in those deals.

This in turn is likely to intensify the credit crunch, with potentially dire consequences for businesses and consumers.

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The other article “Three deadly sins of portfolio credit risk management” published in June 2002.

Three deadly sins lie in wait to wreak havoc on a portfolio: a disproportionate percentage of the portfolio in the low pass categories; emphasis on higher-risk types of lending; and concentrations that build in the portfolio with a small group of borrowers. Some banks commit multiple sins–aggressively underwriting individual loans to borrowers in higher-risk types of lending and taking large positions in those loans. How does your bank fare? Is it time to pass out the pitchforks?

Prem Sikka in his article “The Auditors have failed” in Guardian explains how the top audit firms had given a clean chit to the companies whose survival today is doubtful. Moreover the audit firms have charged an atrocious amount of fees for performing the job. The directors also had fat cheques to take home.

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The question is

whether auditors should rely on management representation while commenting on true and fair view of the Balance Sheet ? Or do they have go further to investigate in the dealing to see whether they have any material impact on the financial statements ?

The reason for the fall of Lehman Brothers only became known when the bank collapsed. Who knows how many such caskets will opened to know the magnitude of damage. Should the auditors gone into the trail of the dealings to confirm the representations made by the management is correct !!!

Or to protect themselves from neglience, should the auditor insist on the management for an expert opinion in all aspect of the Balance Sheet. E.g.

Bad Debts Provision - Assessment from the legal department of the company
Brand value and goodwill - Expert opinion from valuerers
Fixed Assets - Report of the surveryor
so on and forth.

Just like how a jury relies on the experts opinions and finding on a case, should the auditor follow a similar trace. Top firms, I am sure, they should be following the convention. I don’t understand how does collapse of such magnitude is trigged every 4 years.

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The other question that is raised frequently is the audit fees are exhorbitant. Big 4 firms audit more than 80% of the fortune 1000 companies in the world.

The question is will such auditors be impartial while auditing the companies ?

Regards,

Santosh Puthran

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Do you want to be an Internal Auditor ?

Saturday, July 19th, 2008

There has been a discussion in the cma_india yahoogroups the role of internal audit function in a company. One view was that the role of Internal Audit department has been reduced to vouching and checking the records and other view is that Internal function is Management Assurance Group.

According to Wikipedia

Internal auditing activity is primarily directed at improving internal control. Under the COSO Framework, internal control is broadly defined as a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following internal control categories:

Effectiveness and efficiency of operations.

Reliability of financial reporting.

Compliance with laws and regulations.

Management is responsible for internal control. Managers establish policies and processes to help the organization achieve specific objectives in each of these categories. Internal auditors perform audits to evaluate whether the policies and processes are designed and operating effectively and provide recommendations for improvement.

Internal auditing professional standards require the function to monitor and evaluate the effectiveness of the organization’s Risk management processes. Risk management relates to how an organization sets objectives, then identifies, analyzes, and responds to those risks that could potentially impact its ability to realize its objectives.

Source: Submit Archieve

I started my career in Internal Audit Department 15 years ago and was in the department for 5 years. We generated lot of internal audit report highlighting the areas of non-compliance or breach of internal control, revenue leakages, improvement areas and so on and so forth. The internal audit report were repetitive in the contents and management did not take the reports seriously.

The statutory auditors reported their reservations in the annual audit report that Internal Audit Department was inadequate as compared to size of the company.

Now I realize that the solution was not with internal audit department but with the management of the company who had to make investment in a good IT strategy. And a commitment to make process improvement that would help the business to be competitive with profit maximization or wealth generation for its stake holders.

The questions is

Should I make my career in Internal Audit ?

I would consider two or three years would be a good time to work in internal audit. You should always explore opportunities to audits different business units or line of business. Volunteer yourself for new work. This should help you to gain understanding of the business. I do not feel that people who have worked for 10 years in internal audit are good decision makers as far as business is concerned …. the reason is they have never involved in decision making process.

You should plan your career to work in to span in financial accounting, management accounting and other areas of business. I have seen that the companies are more interested in Management Accounting round the year than in Financial Accounting. Be genuinely interested in the business of the company, talk with people on the front-line / shop floor and at the top. This will help you sharpen you business skills and address the accounting and business issues. Who knows you will start your own business !!!

The scope of internal audit is limited to internal controls and system set by your company. If you like challenges, get out of it. You will be able to play an active role in business and improving it.

Share your thoughts by adding comments to this, I am more than happy to read and discuss.

Regards,

Santosh Puthran

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Do you want to be an Internal Auditor

Saturday, July 19th, 2008

There has been a discussion in the cma_india yahoogroups the role of internal audit function in a company. One view was that the role of Internal Audit department has been reduced to vouching and checking the records and other view is that Internal function is Management Assurance Group.

According to Wikipedia

Internal auditing activity is primarily directed at improving internal control. Under the COSO Framework, internal control is broadly defined as a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following internal control categories:

Effectiveness and efficiency of operations.

Reliability of financial reporting.

Compliance with laws and regulations.

Management is responsible for internal control. Managers establish policies and processes to help the organization achieve specific objectives in each of these categories. Internal auditors perform audits to evaluate whether the policies and processes are designed and operating effectively and provide recommendations for improvement.

Internal auditing professional standards require the function to monitor and evaluate the effectiveness of the organization’s Risk management processes. Risk management relates to how an organization sets objectives, then identifies, analyzes, and responds to those risks that could potentially impact its ability to realize its objectives.

Source: Submit Archieve

I started my career in Internal Audit Department 15 years ago and was in the department for 5 years. We generated lot of internal audit report highlighting the areas of non-compliance or breach of internal control, revenue leakages, improvement areas and so on and so forth. The internal audit report were repetitive in the contents and management did not take the reports seriously.

The statutory auditors reported their reservations in the annual audit report that Internal Audit Department was inadequate as compared to size of the company.

Now I realize that the solution was not with internal audit department but with the management of the company who had to make investment in a good IT strategy. And a commitment to make process improvement that would help the business to be competitive with profit maximization or wealth generation for its stake holders.

The questions is

Should I make my career in Internal Audit ?

I would consider two or three years would be a good time to work in internal audit. You should always explore opportunities to audits different business units or line of business. Volunteer yourself for new work. This should help you to gain understanding of the business. I do not feel that people who have worked for 10 years in internal audit are good decision makers as far as business is concerned …. the reason is they have never involved in decision making process.

You should plan your career to work in to span in financial accounting, management accounting and other areas of business. I have seen that the companies are more interested in Management Accounting round the year than in Financial Accounting. Be genuinely interested in the business of the company, talk with people on the front-line / shop floor and at the top. This will help you sharpen you business skills and address the accounting and business issues. Who knows you will start your own business !!!

The scope of internal audit is limited to internal controls and system set by your company. If you like challenges, get out of it. You will be able to play an active role in business and improving it.

Share your thoughts by adding comments to this, I am more than happy to read and discuss.

Regards,

Santosh Puthran

Post Accountancy Jobs on Management Accountant Job Board

Join Management Accountant Groups

Do you like to be updated in Accountancy ?

Subscribe to Management Accountant by Email
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The Audit Cartel - Prem Sikka in Guardian

Saturday, June 7th, 2008

Prof Prem Sikka

Never mind showbusiness, there’s no business like the accountancy business. Accountancy firms have a licence to print money because they enjoy access to a state-guaranteed market for auditing. Companies, hospitals, schools, charities, universities, trade unions and housing associations have to submit to an audit, even though the auditor might issue duff reports. Anyone refusing their services faces a prison sentence.

Major company audits are the most lucrative and that market is dominated by just four global auditing firms. PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young have global revenues of over $80 billion (£41bn) a year, which is exceeded by the gross domestic product of only 54 nation states. These firms dominate the structures that make accounting and auditing rules.

Following the Enron and WorldCom debacles and the demise of Arthur Andersen, the auditing market has become further concentrated in those four firms. Many major companies looking for global coverage find that the auditor choice is very restricted.

Click here to read Prem Sikka’s column in Guardian

Cheers,

Santosh Puthran

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The Audit Cartel Prem Sikka in Guardian

Saturday, June 7th, 2008

Prof Prem Sikka

Never mind showbusiness, there’s no business like the accountancy business. Accountancy firms have a licence to print money because they enjoy access to a state-guaranteed market for auditing. Companies, hospitals, schools, charities, universities, trade unions and housing associations have to submit to an audit, even though the auditor might issue duff reports. Anyone refusing their services faces a prison sentence.

Major company audits are the most lucrative and that market is dominated by just four global auditing firms. PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young have global revenues of over $80 billion (£41bn) a year, which is exceeded by the gross domestic product of only 54 nation states. These firms dominate the structures that make accounting and auditing rules.

Following the Enron and WorldCom debacles and the demise of Arthur Andersen, the auditing market has become further concentrated in those four firms. Many major companies looking for global coverage find that the auditor choice is very restricted.

Click here to read Prem Sikka’s column in Guardian

Cheers,

Santosh Puthran

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Corporate Goverance - UK

Saturday, May 17th, 2008

Corporate governance is the process by which companies are controlled and directed - a company’s board is ultimately responsible for this. The key to good corporate governance is having the right strategy, leadership and control structures in place to produce and sustain the delivery of value to shareholders.

Good corporate governance, and its visibility, gives confidence to all associated with a company that it is being managed well and that value is being created. Our objective in this report is to summarise the key elements of the Company’s governance structure and relate this to the principles in the UK ’s Combined Code on Corporate Governance – a code of good practice for listed companies.

THE BOARD

“Every company should be headed by an effective board, which is collectively responsible for the success of the company.” Combined Code – Main Principle A.1

CHAIRMAN AND CHIEF EXECUTIVE

“There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.” Combined Code – Main Principle A.2

BOARD BALANCE AND INDEPENDENCE

“The Board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such not no individual or small group of individuals can dominate the board’s decision making.” Combined Code – Main Principle A.3

APPOINTMENTS TO THE BOARD

“There should be a formal rigorous and transparent procedure for the appointment of new directors to the board.” Combined Code - Main Principle A.4

INFORMATION AND PROFESSIONAL DEVELOPMENT

“The Board should be supplied in a timely manner with information in a form and of a quality to enable it to discharge its duties. All Directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.” Combined Code - Main Principle A.5

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PERFORMANCE EVALUATION

“The Board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.” Combined Code - Main Principle A.6

RE-ELECTION

“All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of the board.” Combined Code - Main Principle A.7

FINANCIAL REPORTING

“The board should present a balanced and understandable assessment of the company’s position and prospects.” Combined Code - Main Principle C.1

INTERNAL CONTROL

” The board should maintain a sound system of internal controls to safeguard shareholders’ investments and the company’s assets.” Combined Code - Main Principle C.2

RELATIONS WITH SHAREHOLDERS

“There should be a dialogue with shareholders based on the mutual understanding of objectives. The Board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. Combined Code” – Main Principle D.1

AUDIT COMMITTEE AND AUDITORS

The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company’s auditors. Combined Code Main principle C.3

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Sources:

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Corporate Goverance in the UK

Saturday, May 17th, 2008

Corporate governance is the process by which companies are controlled and directed - a company’s board is ultimately responsible for this. The key to good corporate governance is having the right strategy, leadership and control structures in place to produce and sustain the delivery of value to shareholders.

Good corporate governance, and its visibility, gives confidence to all associated with a company that it is being managed well and that value is being created. Our objective in this report is to summarise the key elements of the Company’s governance structure and relate this to the principles in the UK ’s Combined Code on Corporate Governance – a code of good practice for listed companies.

THE BOARD

“Every company should be headed by an effective board, which is collectively responsible for the success of the company.” Combined Code – Main Principle A.1

CHAIRMAN AND CHIEF EXECUTIVE

“There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.” Combined Code – Main Principle A.2

BOARD BALANCE AND INDEPENDENCE

“The Board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such not no individual or small group of individuals can dominate the board’s decision making.” Combined Code – Main Principle A.3

APPOINTMENTS TO THE BOARD

“There should be a formal rigorous and transparent procedure for the appointment of new directors to the board.” Combined Code - Main Principle A.4

INFORMATION AND PROFESSIONAL DEVELOPMENT

“The Board should be supplied in a timely manner with information in a form and of a quality to enable it to discharge its duties. All Directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.” Combined Code - Main Principle A.5

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Source: Chicks drinking

PERFORMANCE EVALUATION

“The Board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.” Combined Code - Main Principle A.6

RE-ELECTION

“All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of the board.” Combined Code - Main Principle A.7

FINANCIAL REPORTING

“The board should present a balanced and understandable assessment of the company’s position and prospects.” Combined Code - Main Principle C.1

INTERNAL CONTROL

” The board should maintain a sound system of internal controls to safeguard shareholders’ investments and the company’s assets.” Combined Code - Main Principle C.2

RELATIONS WITH SHAREHOLDERS

“There should be a dialogue with shareholders based on the mutual understanding of objectives. The Board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. Combined Code” – Main Principle D.1

AUDIT COMMITTEE AND AUDITORS

The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company’s auditors. Combined Code Main principle C.3

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The Rising Cost of Audit

Friday, April 25th, 2008

It goes without saying that the international regime has certainly put the cost of audit up and in most cases, the extent of these costs are sometimes irrecoverable – meaning that audit is becoming more of a hindrance to professional firms than a benefit. Invariably, clients will express their dissatisfaction at their fees going up by anymore than the annual rate of inflation and even that can sometimes ‘ruffle feathers’.

So why did the standards change so dramatically, and how can firms at the smaller end of the scale manage the increased costs inherent with the audit process?

Click here Accounting Web - Steve Collings

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Top audit firms push to use their own judgment

Thursday, January 17th, 2008

Auditors and corporate finance departments must be able to use professional judgment without being second-guessed if countries continue to adopt principle-based accounting standards, the chief executives of the top six global accounting networks argued in a white paper on Tuesday.

The paper, presented at a Global Public Policy Symposium in New York, urged regulators and other stakeholders to create a system where reasonable auditor judgments are accepted.

“Investors are best served when financial reports are clear and easy to understand and use,” the CEOs of Deloitte Touche Tohmatsu [DLTE.UL], Ernst & Young [ERNY.UL], PricewaterhouseCoopers [PWC.UL], KPMG [KPMG.UL], Grant Thornton, and BDO Seidman wrote.

click here to read more on Reuters

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Regards,

Santosh Puthran

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AS-22 introduced by ICAI - Deferred Tax Accounting

Monday, December 10th, 2007

Keeping pace with international practices, AS-22 was introduced by the Indian Institute of Chartered Accountants (ICAI) and deferred tax accounting was made mandatory for all Indian listed companies.

As per AS-22, a company is liable to provide for deferred tax liability on the first day it accounts for such income. The basic premise being that revenues and expenses of an accounting period should meet matching principle and disparity in computing income for tax and book purposes should be appropriately resolved.

Differences between the two sets of computation of income can be classified into two categories; permanent and timing differences. Permanent differences arise with respect to expenditure legitimately incurred but are wholly or partially disallowed for tax purposes.

Such expenses do not give rise to deferred tax provision. Temporary differences are those that arise due to timing reasons. A typical example is provision for depreciation with varying rates for book purposes and tax purposes. Rates prescribed for company law are minimum rates, taking into consideration useful life of the asset.

Click here to read more

Regards,

Santosh Puthran
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