If auditors disagree with the results, the financial impact of their observations will have to be plainly spelt out
As
a regulator of listed companies, the Securities and Exchange Board of India
recently issued a plethora of amendments to different regulations. One of the
significant amendments relates to filing of a statement on impact of audit
qualifications in a tabular format with stock exchanges.
Unlike
certain developed jurisdictions such as the the US, where companies are not
allowed to file financial statements with audit qualifications, Indian stock
exchanges (or SEBI or other regulators) continue to accept financial statements
with a qualified auditors’ report.
In
the US, if financial statements do not conform to the generally accepted
accounting principles or GAAP, they are presumed to be inaccurate or
misleading, irrespective of any explanatory disclosures.
Matter of difference
Audit
qualification is generally a matter of disagreement between the auditor and the
management. A modified/qualified audit report indicates that the financial
statements/results are materially misstated. The impact of qualification/s may
be quantifiable or may not be determinable.
Still,
the qualifications may indicate that financial results presented by the
management do not reflect the true and fair affairs of the financial
transactions of the company and may accordingly have a significant impact on
stakeholders’/investors’ decision making.
An
audit provides users of financial statements reasonable assurance that the
statements are in conformity with GAAP and relevant regulations. The
contribution of the independent auditor is to give credibility to financial
statements, which are relied upon by creditors, bankers, stakeholders, the
government and other interested third parties.
Ideally,
qualifications should be avoided as they bring a negative perception for
companies. This can be possible only if the issues are resolved between the
management and the auditor. Further, for qualifications that are not
quantifiable (e.g. lack of sufficient appropriate audit evidence/scope
limitation), the auditor is permitted to state the fact through a limitation of
scope or disclaimer of opinion.
While
qualification is a common practice in case of a disagreement, SEBI provided for
a mechanism to address qualified audit reports. Till November 2015, listed
entities were required to submit a form (Form B) for a qualified audit report
together with annual report.
The
qualified opinion was reviewed by a SEBI committee and the Institute of
Chartered Accountants of India (ICAI), and based on their recommendations, SEBI
could ask the companies to either get the opinion rectified or revise the
financial information to address the qualifications.
The
revised financial information was submitted as pro-forma results (revision to
the results already filed/ submitted) and companies would further adjust their
next year financial statements for a prior period error.
Further,
it should be noted that Form B was required to be submitted along with the
annual report which are filed must later than the financial results (filed
within 60 days of the year-end). Also, no information about the qualifications
was required to be filed for the quarterly results.
There’s more
While
this process provided a meaningful mechanism to address the disagreement
between the auditors and management, it failed to provide timely information to
stakeholders.
Essentially,
a financial result published by a company could be misstated by a significant
amount and not known to the investors at the time investment decisions are
being taken. Also, Form B provided for limited information — i.e.
qualifications with management explanations and not matters such as
quantification and the impact on the financial results.
In
September 2015 and May 2016, SEBI amended listing regulations which now require
a ‘statement of cumulative impact of audit qualifications’ to be filed instead
of Form B. Further, the statement needs to be submitted along with the annual
financial results.
It
seems that statement may be required for quarterly results as well. The
statement contains detailed information such as net worth, net profit,
turnover, total expenditure, earnings per share, total assets and total
liabilities in a tabular form.
The
numbers need to be disclosed on the basis of audited financial
results/statements and also after adjusting the related qualifications. Thus,
instead of simple qualification information, SEBI requires filing of adjusted
numbers.
Further,
auditor needs to continue to report for each audit qualification separately, as
far as the details, type and frequency of qualification is concerned.
The
revision by SEBI is a welcome change and addresses most of the deficiencies
noted in previous requirements. The new requirements could be challenging but
nevertheless provide the much needed information at the right time.
Also,
it seems the SEBI review mechanism of the qualified reports has been done away
with. The review needs to be undertaken by stock exchanges now.
It
is currently not clear on how the review will be performed but it is
interesting to note that in June 2016, sections related to re-opening of
accounts and revision to financial statements under the Companies Act 2013,
have been made effective. These sections became effective along with the
constitution of National Company Law Tribunal (NCLT) and National Company Law
Appellate Tribunal (NCLAT).
These
sections provide for the revision/ restatement for financial statements after
approval from NCLT/ NCLAT. Additionally, unlike the existing Indian GAAP, the
newly adopted IFRS converged standards (Ind AS) require restatement of
previously issued financial statements, in case an error is noted for past
periods. Reading all the requirements together, it seems India Inc. is entering
the world of restatement (a common phenomenon in the western countries).
Necessary changes
Accordingly
now, SEBI/ stock exchanges can apply to the Tribunal for restatement of
financial statements of a company, if they believe that the accounts were
prepared in a fraudulent manner, on the basis of qualifications filed along
with financial results. This could be a significant change from the current
practice of recording past period errors in the current year financial
statements as a prior period item.
It
should be noted that restatements have generally been viewed negatively as they
reflect inaccurate financial reporting in the past. Most of the restatements
have accompanied consequential adverse impact on the stock prices.
Overall,
the amendments bring in some very necessary changes to improve financial
reporting by corporate India and providing the relevant information on a timely
basis.
As
the changes have been introduced within a short-span of time, implementation of
the same continues to be a challenge. It is imperative that corporates’
internal processes and systems are robust enough to address the changing
requirements.
