Independent Audit Crucial To Markets

Q: Concepts of corporate governance are making waves in India now. What is the state of the art in the US on the issue?

A: Obviously, the right balance of business ethics and values in governance are of paramount importance, in terms of compositions of boards, management and senior executives, the duties boards take on, relative to the duties of managements. Boards are becoming more involved in looking at strategic plans and investment decisions of companies, not taking the decisions but evaluating, being provided with information. If you look at governance in terms of the real long span, there is a move to flat organisational structures, much more empowerment of managers on the line to make decisions, commit resources and build your business. You have to see more of that here.

 

Q: How is the role of audit changing in the context of the current ideas on corporate governance? How important is the audit committee of the board becoming in the US?

A: I think its changed and is becoming more and more important in the US. The role of the audit committee and the auditor is critical to the stability of the capital markets in the US. The US is the leader among countries which have the strongest capital markets and a big piece of that is the role that the auditor is playing in that environment. There is a whole infrastructure of well managed securities markets and the like and the reliability of financial information is a key piece of that. The investing public looks to the independence of the auditing firms to provide that information and I think this is something the directors and audit committees look to in terms of the perception of independence and the position of the auditing firms in that marketplace. The chairman of the SEC has spoken out about that and is working with the auditing firms to make sure that there is not only a perception but a reality of that auditor independence in the marketplace because it is so crucial.

Q: What is the kind of liability claims that auditors have to face in the US?

A: I think we have a much more litigious environment in the US than anywhere in the world. We are going through a process with the SEC to help bring better balance, so that you dont have frivolous law suits. People make investment decisions and when they dont go right they look for someone to blame. No one wants to admit that I made an error in judgement and very often the last people standing in the line are the accountants. But there are cases when accountants make mistakes, and when we miss something we should be taken to task. It is not the responsibility of the auditor to detect fraud but to certify the fairness of a set of financial statements. And we have prescribed procedures for doing that. There are cases when sometimes those procedures are not followed and we are called to task.

Q: A fraud, once detected, can change the bottomline to something quite different from what had been certified.

A: I am not going to focus on fraud. I am going to focus on professional auditing responsibilities. If there is something that we should have done in certifying those accounts in the audit process, we should be called to task for it. That is what people pay us for. But you cant say, every time there is a fraud, that the accountants didnt do something.

Q: When issues like BCCI (Price Waterhouse was one of its UK auditors) or the Indian securities scam come up, people ask, shouldnt someone have blown the whistle earlier? What were the auditors doing? How has life changed after BCCI?

A: Life has changed after BCCI in terms of our own personal risk management. How do you select people you want to do business with and make sure you understand better and learn something from BCCI. As a global organisation, Price Waterhouse found you are only as strong as the person interfacing with that management at the end of the day and you have to make sure you know your partner. Public documents and the Bank of England will tell you that we perceive ourselves as part of the solution, not the problem.

Q: There are frequent talks that Indian accounting standards have to come up to international standards. Can you briefly describe the gap between the Indian GAAP (generally accepted accounting practice) and the US one on the one hand and the US and British one on the other?

A: In Price Waterhouse we practice a high international accounting and auditing standard and we certify to that standard. The expectation is that all of our people certify to that standard.

Q: What are the one or two little things that we do not find in Indian financial statements now but will in the course of time?

Ganguli: Broadly speaking, international accounting standards require a number of expense heads to be written off as expenses but under Indian practices they are allowed to be carried forward as assets for much longer periods. One example is R&D, another is what we in India call miscellaneous expenditure, which can be carried forward for all time to come in the life of the company. Another item is depreciation, where there are much stricter standards internationally, and I wont say the US or the UK because those are pretty close. So what Indian readers will find is that, broadly speaking, profits will drop when international standards are applied. Take Daimler Benz. When they wanted a listing on the New York Stock Exchange, it took them three years to go through that process of aligning German accounting standards and practices with the US GAAP. They had to write off DM 6 billion before they had their accounts accepted under the US GAAP! So that is what is going to happen if Indian accounts are put through a similar process. Indian accounting practices have tended to be aligned towards tax treatment and on particular decisions that people get from a court of law.

Q: What about tax claims that are not charged until the final appeal has been lost?

Ganguli: Deferred tax accounting is another practice which is not followed in India. International accounting standards mandate that there should be accounting for deferred taxation. Indian accounting practices are actually very legally oriented, because we have that bent of mind plus, frankly speaking, industry has an outlook that aligns Indian accounting practices to the legalistic approach. The Indian Institute of Chartered Accountants brought out a disclosure draft for accounting leases some years ago and the next day someone went to court and got a writ issued to stay that. What it would have meant if they had applied it is that lease income and depreciation on the leased asset would have been aligned which was not being done. Depreciation was being charged for tax purposes and income was being taken differently.

Schiro: The non-politicisation of accounting standards has been achieved in the US through a separate board that sets accounting standards. In other countries where you have legislatures setting accounting standards through government laws and regulations, you dont get in some cases the economic presentations that the Venicians originally set out to have when they set up double entry book keeping as the benchmark of accounting. Accounting should be an economic measure of reality, not a book of fiction.

Q: In India, there are two ways of computing net profit, one for tax purposes and the other for book profit. Is this a global practice?

A: It is familiar in the US but the bridge that Mr Ganguli talked about in terms of deferred tax accounting will get you an economic equalisation of the two. You may be taking tax deductions on an accelerated basis for tax purposes, but you would equalise that adjustment in a differed tax account in the financial statement in the US. Another aspect which will be critical and difficult over the long term in this country is the concept of consolidated financial statements for groups under common control. I would like to see our firm play a critical role in this. We have a lot of expertise. We were the firm that put together the first set of consolidated financial statements in the US in the form of US Steel at the turn of the century.

Q: How do we take account of the fact that a group is being controlled on the basis of minority stakes of say, 20 per cent?

A: Control is critical. In the US we have, based upon different facts and circumstances, proportional consolidation, equity accounting of the investments and a lot of that depends upon the structure and interdependence of entities and the control environment. If someone has 20 per cent ownership and there is a perceived concept that you have some form of control, the holding company will have a set of accounts. They will in fact pick up a 20 per cent ownership in this other entity and consolidate it on an equity accounting basis. Thats a technical accounting way to describe it, but you really have to look at those relationships on a transaction by transaction basis. But the more import thing is to be able to describe in the footnotes to the financial statement the related party transactions between those entities.

Ganguli: I know you are thinking of these complex chains of control in India. In the US elaborate rules have been laid out as to what constitutes control for the purpose of full consolidation, that is consolidating every item and showing the minority interest as a liability and that includes control other than 51 per cent share holding. For example, do they have the power to appoint directors and so on. In India a lot of the control is indirect, exercised through trusts and religious charities. The answer to your question really is, that in India it would be very difficult to establish what constitutes control. Therefore, it would be very difficult to say that it should be consolidated.

Consolidated financial statements for groups under common control will be critical and difficult over the long term in this country. We have a lot of expertise in this. We put together the first such statement for

US Steel at the turn of the century