Auditing the auditors

Leena Mangat of Secunderabad filed a case against Satyam for wiping out all her hard-earned savings, which resulted in the conviction last week. You can’t fault Mangat for trusting Satyam to her last rupee — the company was in the software sector which sounded risk-free, the management seemed to be doing the right things and, importantly, the audit report was spotless.

Reading an audit report is akin to reading the small print in an insurance policy due to the numerous disclaimers made in them.

After many disclaimers, the auditor finally concludes whether the financial statements present a true and fair view, or otherwise, of the financial position and profits of the auditee.

The ICAI has brought out a statement of reporting under Section 227 (1A) of the Companies Act which details how an auditor is to qualify his report.

The MCA specifies numerous items that an auditor has to report on in the Companies (Auditors’) Report, popularly known in the trade as CARO. Recently, the MCA issued a new CARO that seeks to simplify the requirements and keep them in tune with the new Companies Act, 2013.

Effectively, CARO is a laundry list of things an auditor should report on. It covers an eclectic variety of items such as inventory and fixed assets, loans and advances, and suchlike. The Companies Act, 2013 reads more like the Companies Penal Code due to its liberal use of the words fraud and imprisonment — provisions that apply to auditors also.

An audit report that is full of disclaimers may not be adequate protection for the auditor any longer. In these circumstances, it is time the ICAI and the MCA did a rethink on the effectiveness of a pre-packaged laundry list of audit check-offs.

Audit reports in other geographies offer a solution. Called an Independent Auditors’ Report, it states categorically what has been audited, what an audit of financial statements involves, and an gives an overview of the audit approach. Interestingly, the audit of financial statements involves a review of information disclosed in other pages of the Annual Report.

The auditors also state what they have considered to be materiality limits and give an overview of the scope of their audit. They go on to detail areas of particular audit focus and how the scope of their audit addressed them.

It is interesting that the auditors of Tesco had mentioned in their areas of audit focus that they were not very sure of revenue recognition in cases of dealer incentives. This could be one of the reasons why all the blame was not thrown on them instantly. The restatement of financial disclosures happened soon after this disclosure.

In certain geographies, the document reports on certain other areas of activity that are required by exception or by rule.

The Companies Act, 2013 mandates rotation of auditors to ensure their independence. The MCA can supplement this by freeing up the audit report and permitting the auditor to express what he feels instead of bogging him down with checklists.

The Companies Act has a proviso that permits auditors to report any suspected frauds (which is what most interested parties would be keen to know) concerning their auditees to the Union government directly. CARO can be used as a guidance for the auditor, but he should not consider CARO the only things he has to report on.

In an era when transactions are becoming complicated, the auditor needs to go beyond the conventionally defined CARO checklist. Hopefully, freeing up the clutter in an audit report will make the auditor truly independent and the report more meaningful.

The writer is a chartered accountant

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