Should you believe in auditor reports?

add_main_imageEquity investors were rudely shocked on Tuesday to hear that audit firm Deloitte Haskins and Sells had said Financial Technologies (India) Ltd’s (FTIL) financial results for fiscal year 2012-13 should no longer be relied upon. The firm’s audited results had been released to stock exchanges on 30 May, and its annual report had already been dispatched to shareholders.

Investment blog alphaideas.in said, “The message to investors in Indian equities is clear: Believe audited accounts at your own peril.” But accounting professionals say the situation is somewhat more nuanced.NextMAds

David Jones, assurance practice leader, Grant Thornton Advisory Pvt. Ltd, says: “This is perhaps the first case that’s got so much public attention, post Satyam. But nearly all accounting firms have had to deal with similar situations, where subsequent events lead to a change in the initial opinion of the auditor and/or the financial statements. In most such cases, a superseding report is issued and the original one is withdrawn.”

Since 2009, Standard on Auditing (SA) 560 allows auditors to respond to new facts that emerge after the date of the auditor’s report.

Deloitte signed its report on FTIL on 30 May, while the crisis at FTIL’s unit National Spot Exchange Ltd (NSEL) became public end-July. The subsidiary company’s auditor reportedly withdrew its report only last week, following which Deloitte withdrew its report on the holding company as well. FTIL has related-party transactions with NSEL, which means not only its consolidated results, but even its stand-alone results are under question.

Earlier this month, Anjani Sinha, former managing director of NSEL, said in an affidavit that there were certain adjustments made in the books of NSEL and its step-down subsidiary Indian Bullion Market Association (IBMA). He added that NSEL and IBMA accounts included accounting entries that showed a profit from purchase and sale of commodities with two of its trading members as counterparties. This is unusual, to say the least, because an exchange operates merely as a go-between and isn’t supposed to trade against anyone. On one occasion, Sinha said “auditors had refused to accept any transfer from NSEL to IBMA”.

It has emerged that NSEL’s auditor is related to Jignesh Shah, the chairman of FTIL, although the company has said that the said relationship doesn’t fall under the purview of the Companies Act.

A pertinent question here is if Deloitte should have been more careful in its scrutiny. After all, NSEL and IBMA contributed to a significant chunk of consolidated profit and also had related-party transactions with the parent company and other group companies. Jones says, “While the norms in India don’t require this, international best practice demands a close involvement with the auditors of subsidiary firms. Even in India, large firms have some level of oversight over the processes followed by auditors of subsidiary firms.”sixthMAds

Deloitte didn’t respond to an email, citing client confidentiality. Shailesh V. Haribhakti, chairman, DH Consultants, says an auditor can’t turn a blind eye to subsidiary accounts, adding that it would be best for the same firm to audit subsidiary firms as well. However, India has restrictions on how many firms an audit partner can be involved with, which acts as a hindrance, Haribhakti says.

SA 560, which Deloitte has resorted to, says, “If (the) management does not take necessary steps to ensure that anyone in receipt of the previously issued financial statements is informed of the situation and does not amend the financial statements in circumstances where the auditor believes they need to be amended, the auditor shall notify (the) management and, unless all of those charged with governance are involved in managing the entity, those charged with governance, that the auditor will seek to prevent future reliance on the auditor’s report.” Haribhakti says Deloitte has done the appropriate thing under the circumstances.

Interestingly, the portion of the recently passed Companies Bill that deals with auditors’ responsibilities has still not been notified, so it’s likely that the auditors involved may get off with light punishment, even if any wrongdoing is proved. However, section 447, which deals with punishment for fraud, has been notified and can be applied for misrepresentation of financial statements—of course, if this is proved.

Already, the Securities and Exchange Board of India has said it will act against the promoters of FTIL if any wrongdoing is proved with respect to its financial statements. Until then, investors can’t really be blamed for entertaining notions that they should believe auditor reports at their own peril.