The Hindu Business Line : Careful auditors

Ubiquitous as they are, auditors have been witness to winds of change since the beginning of this century, thanks to some unimaginable scams and the tendency of some entities to overdo things leading them towards bankruptcy.

Similar to wishing that a doctor identifies and cures an ailment without your going to visit him, auditors are expected to foresee and report corporate disasters.

This year has been particularly harsh on auditors since corporate bankruptcies overtook them before the ink on their report had dried. While auditors have been careful ever since Enron, they have become even more careful now.

Going Concern

Businesses exist on a very simplistic concept called ‘going concern’. This concept assumes that the business entity will continue in business in the foreseeable future. As the intention is not to close its business, the company should not value its assets at amount realisable on a forced sale/liquidation.

There have been reports that some audit firms are beginning to question the concept of going concern in the wake of the recent events. It probably was sparked off when Britain’s third-largest tour operator issued a white-as-marble set of accounts a few months before it filed for bankruptcy.

As in any concept, going concern comes with a set of assumptions, one of the main being funding. It is assumed that in case an entity borrows funds in the normal course of business, the funding pipeline would continue. Auditors would normally document a letter from the banker confirming funding for the year at least.

But in times such as these when bankers look upon every borrower as a potential defaulter, these confirmation letters are hard to come by making auditors question the going concern concept. Options before the auditor are to prepare the accounts on a going-concern basis, break-up basis if they believe the going concern concept is vitiated or express doubts about the company’s future and give some sort of a warning in their report. Britain’s Financial Reporting Council is suggesting another word, namely, “serious doubt”, in the report. This will only would add to the confusion.

The future

It is not unjust to expect auditors to foresee impending failures. After all, they are in the best position to know about a company’s business and the effect business decisions could have on the financial statements. In the same breadth, it should be said that business has become extremely complex and some of the derivative and other transactions entered into by entities could be rocket science for auditors.

Before they grapple with understanding this, time has come to sign off on the financial statements. It would be an ideal company which informs the auditors about impending risks to their business over the coming years and discuss the impact with them since there is no denying the fact that the financial statements are the responsibility of the company.

Based on this, the auditors can voice their opinion on the issue. In case the company does not disclose this to the audit team, fearing a qualification which could impact the standing of the company, it would be the duty of the auditors to qualify their report and avoid the temptation to give verbose explanations in their notes to accounts.

The concept of liability on auditors is slowly gaining footage in India making their task even more difficult. The recent move towards fair value involves a lot of valuation models all of which the auditor would have to comprehend. They have no choice now but to swim with the tide but draw attention if the tide gets worse.

(The author is a Hyderabad-based chartered accountant. blfeedback@thehindu.co.in)

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