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Accounting firm’s failed responsibility

“Accountants’ responsibility is to investors, not their clients’ management.” This was what world’s leading charted accountant Arthur Anderson used to say often. Anderson founded and headed — until his death in 1947 — one of the five biggest global accounting firms, Arthur Andersen LLP, which was — ironically enough — convicted for ‘Obstruction of Justice’ through shredding documents relating to its audit on Enron, resulting in the Enron scandal in 2002.

Back home, at long last, accounting firm Price Waterhouse, Banglore, has accepted the truth on Satyam that the accounts were fudged and audit report and opinions in relation to the company’s financial statements for the audit period — from the quarter ended June 2000 until the quarter ended September 30, 2008 — should no longer be relied upon.

Similar to Enron

The tragic story of Satyam is similar to the ones of the erstwhile U.S.-based utility company Enron and the auditing firm (now defunct) Arthur Andersen. As it has now happened in the case of Satyam, the two global giants took advantage of not only investors but also the public as a whole to illegally increase the personal wealth of the individuals who were involved — a greed that led to the corporate debacle of December 2001, when Enron filed for bankruptcy.

Dwelling on the sordid saga of Satyam, Ved Jain, President, Institute of Chartered Accountants of India (ICAI), the regulatory body of chartered accountants in India, hits the nail on the head, when he says that auditing firms can not shy away from accepting their responsibility when the companies they have audited are found to have doctoring their accounting books.

He says: “The audit firm’s statement does not absolve it of the default committed by signing those financial statements. Our penalty is quasi criminal as action can be against natural person not artificial person. But to ensure standard and discipline we do maintain register of firms whereby we do indicate here is a firm, where partners have found guilty.”

ICAI’s view

Once the ICAI indicates the names of tainted chartered accountants or firms, their names are not considered for allotment of audit by the Reserve Bank of India. “Now we have decided to write to the Securities and Exchange Board of India (SEBI) that they should include a clause in their listing agreement that such accounting firms will not be appointed by the listed companies. Further we will put such names of the firms on the website/public domain so that any company or person appointing them knows about them,” Mr. Jain discloses.

However, the accounting firm, Price Waterhouse, Bangalore, still would like to put the blame on Satyam’s former Chairman B. Ramalinga Raju. In its letter to the newly constituted Satyam board, the firm has suggested that its audit report on the company should no longer be relied upon “in view of the contents of the resignation letter of B. Ramalinga Raju.”

Mr. Raju’s letter stated: “The gap in the balance sheet has arisen purely on account of inflated profits over a period of last several years. What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly (annualised revenue run rate of Rs. 11,276 crore in September quarter, 2008, and official reserves of Rs. 8,392 crore). The differential in the real profits and the one reflected in the books was further accentuated by the fact that the company had to carry additional resources and assets to justify higher level of operations — thereby significantly increasing the costs… Every attempt made to eliminate the gap failed… The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with the real ones.” Price Waterhouse has said the financial statements for the period were prepared by the management. On its part, it planned and performed the required audit procedures on the statements and examined the books and records produced before them by the management. “We placed reliance on management controls over financial reporting and the information and explanations provided by the management, as also the verbal and written representations made to us during the course of our audits,” Price Waterhouse has said.

Regulators’ role

Clearly, the accounting firm failed in its responsibility to the investors of the company and the public at large. “The massive fraud that was quietly being hatched away from the public eye for a few years should not have escaped the eagle-eyed scrutiny of auditors — internal and external. The regulators must quickly find out whether it was also a case of unholy complicity and abetment,” says M. N. Chaini, President, Indian Merchants’ Chamber.

It is often argued that accounting and disclosure rules are good in India and the problem lies mainly in the enforcement. This is true to a degree but when widespread malpractices prevail, rules too must be tightened materially. “Many abuses remain hidden due to lack of quarterly consolidated numbers,” points out Nilesh Jasani, Head of Research, Credit Suisse, an international financial services company, "Subsidiary balance sheets are not always available. Lack of equity method of accounting – a global practice – for the standalone results permits mis-representation".

Mr. Jasani comes up with a suggestion to circumvent the situation that the one witnessed in Satyam’s case, when he says: “ICAI should immediately work against the increasing use of direct balance sheet entries or even worse, just mention in the notes for any mark-to-market losses or impairment incurred on any assets. Insiders’ pledging or loaning of shares should attract same disclosure as their buying and selling. We urge regulators not to tweak rules for temporary protection of corporate profitability, as they normally worsen disclosure quality and harm investors.”

Market understanding

The market is sophisticated enough to understand non-recurring losses. Regulation changes to suppress them — like Reserve Bank of India’s recent measures related to restructured loans not being non-performing — reduce disclosure quality for investors.

There is also a view that the ICAI should severely reduce the permitted items that companies can book direct in balance sheets. Most mark-to-market losses and impairment charges should flow through profit and loss statements. Investors are sophisticated enough to distinguish the non-recurring losses. In the near term, companies would be made to declare all un-booked mark-to-market losses every quarter.

Satyam’s is not just a failure of an inflated company, but a failure of an inflated economy. Bubbles are a phenomenon in inflated economies. Here there are two bubbles: equity and real estate. Former RBI Governor Y. V. Reddy had repeatedly warned that these bubbles might burst any time.

The Satyam group paid heavily for having invested huge funds in the real estate business which has suffered badly in the last two years. What expedited Satyam’s fall was its appallingly bad (say fraudulent) financial management, coupled with an unprecedented fall in stock market prices world over.

Thus goes a Sanskrit Subhashita: “Satyam bruiyat, Priyam bruiyat, na bruiyat Satyam apriyam (Speak truth, speak only that is palatable, do not speak truth that is unpalatable). Suffice to say, in Satyam’s case, the company lied through the teeth, it delivered something that is palatable to its investors in the initial stages by dressing up its accounts and in the end, Ramalinga Raju came up with purported “truth” about his company which turned out to be rather unpalatable for investors in his company, its over 50,000 employees, various financial institutions and the Government.

Source:The Hindu


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