The IL&FS effect

One of the most popular tracks of the band Scorpions is called Winds of Change . All of a sudden, the staid profession of auditing is witnessing the winds of change. The IL&FS episode has had a collateral impact on many sectors of the economy, including audit firms. The financial shenanigans at IL&FS lay concealed in a maze of subsidiary companies while the holding company put up a show of being able to manage cash flows at a consolidated level. The question that is going to be asked of the auditors is: How could you miss something so big?

Over the past fortnight, auditors of the subsidiary companies of the Reliance group have captured attention. Reliance Capital and Reliance Home Finance reported that one of their joint auditors has resigned leaving the other firm as their sole auditor. The reason given by the audit firm that resigned is that as part of the ongoing audit, it noted certain transactions which, in its assessment, if not resolved satisfactorily, might be significant or material to the financial statements, and that it did not receive satisfactory response to its queries.

When the audit firm asked for responses to its queries, what it got in return was a statement that the company may initiate appropriate legal proceedings against the firm.

The audit firm stated that these actions by the company have prevented it from performing its duties as statutory auditor exercising independent judgment in making a report to the members of the company, and hence was no longer in a position to complete the audit.

The surviving auditor of Reliance Capital is also the auditor for Reliance Infrastructure. In this entity, the auditors have stated that they were unable to obtain sufficient and appropriate audit evidence about the relationship of one party with the company, the underlying commercial rationale/purpose for huge transactions relative to the size and scale of the business activities with such party and the recoverability of these amounts. They went on to state that they were unable to determine whether any adjustments, restatement, disclosures or compliances are necessary in respect of these transactions, investments and recoverable amounts in the standalone annual financial results of the company.

Due to these, they concluded their report by stating that they were unable to comment whether the financial statements presented a true and fair view. The infrastructure sector and litigation go hand in hand and Reliance Infrastructure is no exception. When Reliance Communications was being dragged to bankruptcy by a creditor, it was saved by the brother of the boss.

Though the nature of the issues have similarities, it would be preposterous to expect a repeat of IL&FS-type events at Reliance.

They may have failed at a few businesses, not repaid loans taken and have a different interpretation of the provisions of the Income Tax Act, but they still run businesses that are generating tonnes of cash. More, importantly, they come from a different pedigree.

It is evident that the impact of IL&FS is being seen in audit reports. Auditors have become ultra-careful and would rather give up an audit than bend to the diktats of the management. This is a welcome development for the profession as audit quality is bound to improve and audit reports would tell-it-all instead being camouflaged in nice language as is the wont now. IL&FS can take the credit for having woken up a profession that was just going through the motions.

The writer is a chartered accountant

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