Auditor is a watchdog and not a bloodhound - whether relevant today?

The terminology ‘Watchdog’ is being used for auditor in normal course of audit, where the terminology ‘Bloodhound’ is being used for investigator in course of investigation.

   

Ø   What is Audit and who is Auditor?

    A person who is doing work of audit known as Auditor. As per Companies act, 2013 section 141 states that “A practising chartered accountant of India can act as an auditor”

An Audit is a process of identifying whether the results of accounting information are accurate and according to the specified norms or not. Auditing is an impartial and methodical examination of the financial statement of an entity to give an opinion on true and fair view. The word financial statement may include Balance Sheet with Notes to Accounts, Income Statement and Cash Flow Statement. The term entity refers to any organisation whether it is profit making or a charitable institution. Size and structure of the entity are also irrelevant.

Ø  What is Investigation and who is Investigator?

A person who is doing work of investigation known as investigator. It can be done by any person having expertise of doing such work or in such area.

An investigation is a severe examination of specific records so as to highlight a fact. It always start with preconceive notion. Investigation implies that an organised, detailed and critical examination of the books of accounts and transaction records (both past and present) of an entity, conducted for a specific purpose or to reveal a truth or to establish a fact with the help of evidence. The most common methods employed in the process of investigation are searching, observation, interrogation, inquiry, inspection, etc.

Ø  Auditor is Watchdog, not a Blood Hound

The word Audit is derived from the Latin word ‘Audire’ which means to hear. Justice Lopes in case of Kingston Cotton Mill (1986, UK) quoted “Auditor is a watchdog, not a bloodhound.” A watchdog is defined by the American Heritage dictionary as “One who serves as a guardian or protector against waste, loss, or illegal practices.” A bloodhound is defined informally by the same dictionary as “A relentless pursuer.”

In most audits, fraud risk will be one of several risks that are evaluated as part of the business processes under audit. If fraud is suspected, the internal auditor may be asked to perform a forensic audit specifically to detect fraud management must have a robust anti-fraud program to safeguard assets and minimize the risk of fraudulent financial reporting and misappropriation of assets.                                                                                                                                                                                   

 It is the responsibility to find true and fair value of the business and gives all the details (errors and frauds) of all the business. But this task is so difficult because people tried who arise fraud in the company gives wrong information to the company.  Auditor is always sincere, systematic, honest, truthful, and tactful. An auditor has a professional knowledge and expert in own field. In case of any unwanted situation. The remedial action has to come from the owner of the entity. He has to discharge his responsibility by informing about the irregularity found in the audit. Auditor needs to discharge his responsibility of forming an opinion and reporting responsibility as per SA 700-720 as well as given in the companies act,2013 under section 143(12) in prescribed form no ADT-4.

Auditor is responsible for protecting the interest of those who appointed him but the auditor will presume that servants of the company are honest and will rely on their statements. The auditor should investigate thoroughly but he is also not expected to be of suspicious mind.

Watchdogs keep watch and protect against waste and abuse. They remain aware of their surroundings, act upon suspicious behaviour or activity and may defer to the bloodhound when a relentless pursuit is necessary. Bloodhounds fixate on the scent of the animal and follow the trail through water, rain, sleet and snow until they detect the animal or collapse of fatigue. Obviously, this approach will result in additional fees, added time and client relationship management issues as they may often perceive our efforts as unnecessary, intrusive, and expensive. Judging by our definitions above, it would appear that auditors fall more into the role of a watchdog who possesses the ability to determine when a bloodhound is needed.

                      
The auditors’ job is merely to provide a check on management by expressing an opinion as to whether the financial statements present a ‘true and fair’ view of a company’s affairs (SA 700). However, in arriving at their opinions, As per SA 240 “The Auditors responsibilities relating to fraud in an audit of Financial Statements”, auditors are required to perform their work in such a way that they will have a reasonable care, not absolute, chance of detecting fraud, Assessment of Detection risk and Management Fraud with attitude of professional scepticism. So, an auditor will not be legally liable for failing to spot material misstatements resulting from fraud, as long as he can prove that he has undertaken reasonable procedures in trying to detect it.

NO.	NAME	AMOUNT (Crore)	Year
1	Telgi Scam	20,000	2002
2	2G Spectrum	1,76,000	2008
3	Satyam	14,000	2009
4	Commonwealth Games	70,000	2010
5	Wakf board land	1,50,000	2012
6	Coal	1,86,000	2012

 
As such, in doing their job, auditors are heavily reliant on management, who could potentially mislead them. To cover themselves, auditors obtain a letter from management testifying that the financial statements are fairly stated. (SA 580 “Written representation from management or those who are charged with governance”)

However after 2000 we had seen many scams, in such a case the performance of auditor is becomes questionable. User of financial statements can’t rely on opinion given by the auditor. Auditor needs to plan his audit programme (SA 300) in such a way so he can find material misstatement from financial statements in his ordinary course of work. Still there is so many frauds are existing yet to come into news. This all scams are not done in a single year. It was in existing from long term and every year auditor of respected entity had given unqualified audit report.     

If auditor found negligent in his work then he has to face consequences like loss of professional standing ((ICAI Act-1949 – Code of Ethics) or legal actions against auditor as the case may be.  Section 147(5) of the 2013 Act states that “where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil or criminal as provided in this Act or in any other law for the time being in force, for such act shall be of the partner or partners concerned of the audit firm and of the firm jointly and severally.”

·        Many lawsuits are filed against auditing firm:

No.	Law suits filed against	BY	Particular	Year	Decision / Settlement
1.	EY	New York Regulators	its role as outside auditor to bankrupt Lehman Brothers Holdings Inc.	2010
2	KPMG	U.S. Security and Exchange	U.S. Securities and Exchange Commission charges involving its audits of copier maker Xerox Corp. The SEC said KPMG Allowed Xerox to manipulate its accounting from 1997 through 2000.	2006	$22 Million
3.	Deloitte	U.S. Security Regulators	its role as auditor of bankrupt cable company Adelphia Communications Corp.	2005	$ 50 Million

After 2010 following reported accounting scams: (Source: Accounting Scandal –Wikipedia)

Compnay	Year	Audit Firm	Country	Notes
Sino-Forest Corporation	2011	EY	Canada – China	Ponzi Scherme, Folsifying Assets
Olympus Corporation	2011	EY	Japan	Tobashi Using Acquisitions
Autonomy Corporation	2012	Deloitte	USA	Subsidary of HP
Penn west Exploration	2012-2014	KPMG	Canada	Overstated Profit
Toshiba	2015	EY	Japan	Overstated Revenue
Valent Pharmaceuticals	2015	PWC	Canada	Overstated Revenue
Alberta motor Association	2016		Canada	Fraudulent Invoices
Odebrecht	2016		Brazil	Government Bribes
Taylor, Bean & Whitaker Mortagage Corporation	2016 $5.5 Billion. Largest lawsuit ever.	PWC	USA	Fraudulent Spending

The Audit Rules clarify that in case of criminal liability, the liability will devolve only on the concerned partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud.

The Audit Rules have clarified the position only with respect to the criminal liability but not the civil liability. Hence, one may argue that for civil liability, joint and several liabilities of the partners and the firm can be enforced even if all the partners have not colluded in committing the fraud

Ø  Conclusion:

The audit profession stands at a major crossroad. It can continue with business as usual and await, with near certainty, the consequences of the next major audit disaster and yet more pull by the regulators toward a new and better audit model. Alternatively, it can embrace the need for radical reform and push itself toward a new, improved audit model that provides motivation for better quality audits; ameliorates, if not eliminates, the self-serving audit bias; and goes a long way towards addressing the public interest.  Anyhow, an auditor is a watching dog but not a sleeping  watching dog.