Undesirable practices and structures, including incorrect assumptions in determining provisioning requirement for financial assets, diversion of funds and/or transfer of profits to connected parties, and real transactions getting camouflaged beneath various layers of IT solutions, should draw the attention of the auditors, according to Reserve Bank of India Governor Shaktikanta Das.
“One of the important roles of audit is to check the so called smart accounting practices, if any, followed by management to overstate profits or understate expenses / liabilities,” Das said in his address at the National Academy of Audit and Accounts (NAAA), Shimla.
Referring to Ind-AS (Indian Accounting Standards), which has been implemented for all listed companies (other than banks) in India, including NBFCs having net worth of more than ₹250 crore, the Governor observed that within Ind-AS, Ind-AS 109 with Expected Credit Loss (ECL) approach allows the management to exercise discretion and judgment in determining the provisioning requirement for their financial assets.
Das said: “Such flexibility and forward-looking nature of assessment, however, poses the ‘model risk’,that is, the model may rely on incorrect assumptions and may be far from representing the real-life scenarios. “This has been observed in several cases. Hence, auditors are expected to test the models used by the entities, challenge the management and validate the model outputs.”
Diversion of funds
The Governor said of late, several instances of related party transactions, without following ‘arms-length’ principle and established transfer pricing mechanism, have been observed.
“There have been instances of diversion of funds and/or transfer of profits to connected parties through various means – intra-group loans on favourable terms, over or under invoicing of transactions, asset transfers without fair valuation, etc,” he said.
Das emphasised that auditors need to identify and thoroughly scrutinise related or connected party transactions to ensure that there is no undue transfer of income or assets.
‘See-through’ IT layers
The Governor also flagged cases of manipulation and misstatement of the true nature of financial statements by employing opaque technological means (IT black boxes).
“Real transactions are camouflaged beneath various layers of IT solutions by a few entities. As such, auditors need to be technologically savvy and be able to ‘see-through’ the layers of information technology to detect the real nature of hidden transactions,” he said.
Das said since RBI, as the supervisor of the financial system, relies and leverages on the work done by auditors, the audit professionals are being sensitised through various fora to improve the quality of their reporting
He highlighted that:“We are constantly engaged with individual auditors, audit firms and the Institute of Chartered Accountants of India (ICAI) to improve the quality and depth of audit. A lot of work has been done in this area, but lot more needs to be done.”
Good governance
The Governor said the management has the responsibility for demonstrating, through its actions, the importance of ethical conduct.
While this is relevant for all businesses, it is even more important for financial institutions which hold public trust and depositors’ money in fiduciary capacity.
Das felt that financial sector entities, the audit community and the financial sector regulators and supervisors have to work together and take proactive steps to ensure good governance and ethical practices to build a strong and resilient financial sector.
Tech adoption
The Governor stressed that the auditing profession cannot afford to lag in adoption of technology. “Adopting technology tools such as computer-assisted audit tools and techniques (CAATTs) through constant upgradation and integration of new technologies will bring in a lot of efficiency in audits.
“In parallel, it has to be kept in mind that adoption of such technology tools for auditing cannot replace professional judgment,” he said.
A holistic approach is required while integrating technology tools in audit. The Governor said:“The profile of tomorrow’s auditor will be that of a critical, yet constructive challenger, with a clear focus on public interest and quality audits. There is a need to be even more professional, qualified, impartial, value-driven, ethical and display awareness and foresight.”