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Corporate accounting reporting and ethics need for CAs

Srikanthan 
on 06 July 2012

LinkedIn


Introduction

All around us there is this talk of lack of ethics, corruption, inability of a normal Citizen to get justice in time, so on and so forth. The biggest irony is that the  normal  citizen who talks about injustices in several cases become the perpetrators in a different role. The same citizen who does not get justice or of whom bribes are demanded becomes the perpetrator in a different avatar. He could be the one complained about. We play different roles and wear different suits. Ethical standards are different , one for preaching and one for personal practice. Human mind is so innovative that they find creative ways of justifying and rationalizing things. While each one of us talks of hypocrisy, if we do a honest assessment, just a miniscule percentage amongst us only would come with flying colours. While this may be true of the entire society, the aim here is to take stock of and introspect as to what needs to be done of the malaise to whatever extent is prevalent  in our own profession, the Chartered accountants.

Ethics or rather the lack of it amongst professionals

Let me start with something which had received wide publicity to set the tone for the theme. In one of the episodes of his program “Satyameve Jayate”, the Bollywood super star and celebrity, Aamir Khan   brought out the unsavory aspect of lack of ethics amongst some members of the medical profession. This caused a huge furor within the medical profession, at least with the Indian medical association which sought an apology. The unholy nexus that exists between the Hospitals, the diagnostic centers and the doctors and also various other tactics followed by some of the Hospitals geared towards revenue and profit generation is a topic discussed in our drawing rooms, offices  and a matter, some of us would have experienced in our own lives. This is not to paint the entire profession with the same brush. You have several members of the profession rendering yeomen service, but, that cannot take away the fact that there exists a fairly significant number of people, professionally qualified doctors and others associated in the medical profession indulging in practices which what one can term as completely anti- patient. One also finds it difficult to digest the fact as to why we have never heard of the same Indian medical association taking up cudgels against malpractices in the medical profession. They might have done in a few cases but would never publicize it. Good as well as bad have to be publicized. To say that there exists no wrong doing and hence no need for punishment is just living in denial.

We ,the , Chartered accountants need to take stock of ourselves on the Ethics front

It is also a fashion to talk of lack of ethics and wrong doings in all professions other than their own ones. I have heard lawyers and Chartered accountants and people from various other professions discussing freely and with a lot of passion and righteous anger of sharp and downright fraudulent practices amongst the “other professionals”. Let all of us, Chartered accountants ask ourselves an honest question. Is there not lack of ethics and indulgence in sharp practices amongst the Chartered accountants? CA s has great, some stated and some unstated, fiduciary responsibilities to the society. Don’t we have unethical practitioners amongst us? In fact, Finance professionals (not necessarily Chartered Accountants), post 2008, with all the derivative and credit blow up were and are now also one of the most reviled professionals. That of course is a story for another day. My idea is more to deal with areas in corporate accounting and reporting responsibility of Chartered accountants where there have been failures and continues to be so and issue of ethics in the profession.

 Bigger wrongs  do not make lesser wrongs  all right

While co professionals talk of lack of ethics and corrupt practices amongst “other professionals”, when a motley crowd of professionals (lawyers, CA s and doctors etc ) are together they conveniently talk animatedly about the lack of ethics and corruption levels amongst politicians and the funny aspect is when the politicians meet, they talk of the huge levels of corruption at the ministerial level. All these to justify their own misdemeanours ,which by their own perception are small and in fact  not wrong at all, typical escapism and a perverted way of rationalizing our wrongs.

"Corporate Governance issues” an euphemism for inflated financials and misreporting

One frequently comes across shares, which, in spite of apparently good financial numbers are priced low in the stock market, even factoring in all other factors like Industry, the business cycle etc. The reason, spoken in hush hush tone is “Corporate Governance issues”. What are these Corporate Governance issues? Corporate Governance by its very nature consists of the way the Company is structured and decisions are taken and transacting of business in such a way that the long term interest of the shareholders and various other stakeholders are protected and furthered. Corporate Governance includes amongst other things good business processes, good business practices, ethics, transparency and well calibrated decisions by the Trustees (the Board) with the risk and return in perspective on various decisions . Lack of these could be termed as lack of Corporate Governance. 

The “Corporate Governance issues” that the market players talk of is completely different. It is understood by all the players but rarely spelt out in so many words. “Corporate Governance issues” they talk of is nothing but manipulation of financial numbers. To be fair to the Professional accounting bodies and accounting fraternity and the people framing the accounting regulations, a number of changes have been brought out to ensure that Companies do not take refuge under practices which used to be inadvisable but not prohibited. Consolidation of accounts, segment reporting and few others have furthered the cause of transparency and investor information to make an informed investment decision. What one is talking about is downright manipulation of accounts and misreporting which are swept under the carpet under the garb of aggressive accounting. Just have a look at the financials of the Companies which supposedly have   “Corporate Governance issues”. You will see bloated current assets in most cases and in some cases bloated fixed assets and several other cases “Goodwill” which were possibly an Associate Company making losses bought over or merged at a premium.  A look at the cash flows of such Companies is very revealing. Year after year, you have these Companies show profits but the operational cash flow continues to be negative year after year.

Number manipulation -Innocuousness of the start and snow balling impact.

 Dressing up of numbers starts with a typical and apparently extenuating and appealing  reason like “compulsions from the Banks” (to ensure continuation of the working Capital loan) and a more typical and convincing remedy, “we will make it up next year”.   

Next year the story is repeated with a different story line. This time it could be potential foreign associations in the offing for which a good set of numbers are a must.

The very next year, there could be a potential Private equity investor intending to invest. The numbers have to appear good for a good valuation. The belief is that once the PE investor puts in money, the Company with the extra cash would be able to turnaround.

Move to the next year, the compulsion is a potential strategic investor. We need a good set of numbers to ensure a good valuation and keep the dilution levels low. In some of these cases, the strategic investor buys out the promoters partially and pumps in additional equity for expansions. You can see the reason.

The year after that could be a case of “impending listing”. Once listed the financials massaging get on to a quarterly frequency. The story continues.

These Companies or rather the promoters keep looking for one big deal to sweep all the past sins under the carpet and make money for themselves. This is nothing more than a lottery.

The justification includes the aspect of trying to protect the employees of the Company. The promoters claim that they have a duty to protect the Company in the short term to protect the interests of the employee.This is an emotionally appealing justification but the underlying reason is just selfish and protection of themselves.

In all these cases, you do have qualified Chartered accountants working as part of the Company and churning out these numbers. The combination of being a trained accountant and being focused on ensuring good numbers pushes them to find innovative ways of inflating the profits and going around the audit. Are the auditors backed by very smart set of Chartered accountants missing out the obvious? There are two reasons. You have one set of auditors whose cost structure is so high that they can spend the least amount of time to ensure maximization of revenues Vis –a Vis their cost and there is another set of auditors who have grown with the Company and who can’t afford to antagonize the client lest they lose the client.

Some known cases

You have had several live cases of some of these Companies which had “Corporate Governance issues” surviving in the short term and to the outside world, sometime, even thriving for some time and going turtle after a few years. Few of the retail companies were clear cases of accounting manipulation and many more listed Companies resort to sale of controlling interest or sale of part of the business to raise cash and  reduce debt. They apparently took debt for expansion but the truth most times is quite different. Debts have been taken to fund losses or get cash to replace cash losses.

All these Companies, I am sure have had involvement of Chartered accountants, some of them employed full time and some of them involved as auditors and several others as part of lending Banks and institutions. It is sad but true that they have been sometime active perpetrators or sometimes silent spectators and in rare cases unknowing spectator. Whichever way you look at it is a huge failure either in discharging their fiduciary responsibility to the Shareholders, the investors and potential investors and the society at large or sheer incompetence. Incompetence is a very small percentage one would think. It is mostly a case of active perpetration or turning a blind eye to the whole thing.

I see most of the professional bodies lauding the great work done by their respective members, most of it may be true but there is need to come down heavily on wrong doings. Not only is it necessary to punish, it is more important to publicize such punishments.

Even in United State of America which calls or at least called itself a very evolved financial regulatory system, you had the biggest scams. Theyare tightening  their laws and have in fact been coming down heavily on Corporate and Financial frauds including “Insider trading”.

Difficulties in being ethical in a world where you can survive only by currying favors

Wherever one goes or whoever one approaches, say, for completion of a tax  assessment or an appellate proceedings ,the clients , even the assesses whose accounts are clean and who has been compliant with the laws of the land , there is this expectation of favors from the authorities  and the professional CA  is guided by the client or sometimes the CA  guides the client to extend the “favor “ and incur the “lesser cost” to avoid a larger future cost .The larger cost could be just the nuisance value of assessments not being completed or it could be threat of some tax claims on the client . The equation at most times is a no brainer. Also take the case of a professional who refuses to go by this. He stands a definite chance of losing the client for which there always hawks waiting in the wings to pick up. Not for a moment one can deny the difficulty of surviving in a world where the unstated and tacitly accepted norm is exchange of favours.But when we talk so proudly of a great profession, don’t we have the responsibility of being different. It is sad that there is a tacit acceptance that passing on favors is okay. Even now the aspect of “Financial frauds” and favors to ensure lower taxes and similar white collar crimes are considered okay. They are not viewed with the same degree of distaste that  a physical crime is. In the author’s view ( I am sure that would be the case with most ) the social cost of white collar crime is significantly larger than the cost of physical harm to anyone. An “Enron” caused a lot more damage to its own employees and investors than any type of physical violence. It deprived several employees and other investors their lifetime savings and the means to live a dignified retirement life.

Consequences and the fallout

First and foremost is the belief amongst the public that the accountants are there to manipulate and support the owners of business  and that they do not perceive that they have a responsibility to the society. There is a certain degree of  negative perception about the profession.

Second is the belief that Professional accountants need to be employed so that the negotiation base for “favors” is on a strong footing. Extent of favor is a function of knowledge and non-compliance. A professional with a better knowledge base of the subject as well as the likely consequences, can weigh the cost of favor Vis a Vis the likely consequential cost .This is nothing but a glorified intermediation for an anti-social activity. The profession’s standing in the eyes of the public goes down.

The good work of Chartered accountants’ professional work in general is not something which shows up as a socially benefitting area of work in terms of its proximate and direct benefit. The benefits are multifold and huge but quite a derived one. One should be able to easily gauge the impact it has on the society by looking at the damage to society in the absence of the accounting professionals or failure by the accounting professionals in discharging their duties. The case of “Enron” mentioned above stands ample testimony to that.

Widespread “financials” manipulation gives rise to lack of credibility in shares and even inclination to avoid Companies which have a good business model and with transparent financials.  

Possible remedial steps

There are several steps that can be suggested to bring down the incidence of financial manipulation but the greatest single step would be for the CA s to take a resolution of not being a party to manipulations. That may happen in an utopian world. For the record, however, one can bring down the incidence with the following broad steps.

1. High focus of automation of all Governmental processes and building a system driven work flow. I recall Mr. Narayanmurthy, Founder Infosys talking about this in an interview connected to "Lok pal movement "and one definitely agrees with the fact that this can bring down corruption and need for Professional like CA to curry favours.The CA s should spearhead these and come out with suggestions on this front, in fact the CA Institute should have a focussed committee to suggest areas where automation can be targeted to bring down malpractices.

2. Need for the CA institute and the professional accounting bodies not to be studiously avoiding embarrassing topics like lack of ethics. They need to boldly talk about it in various forums and emphasise the need for CA s to refrain from non-ethical practices. There is a need to get over the hesitation in talking about wrongs. The more we talk the better is it for the profession to correct itself.

3. Unethical and misreporting and manipulation of accounts should have a high penal cost. The cost should include a ban from practice plus punishment under the criminal provisions. One is sure that there are possibly laws to that effect in our Country. As is the normal problem, such laws are rarely enforced. Need is to make a few examples.

4. Make the CA's allegiance to the Institute larger than their allegiance to the employers. Have a cell where CA and others can report existence of non-ethical practises in the Companies. Initially have a practice of protecting the identity of the informer. Gradually we can look at greater disclosures.

5. System of compulsory rotation of Statutory auditors atleast once in 3-4 years.

Some of the above are just suggestions. I am sure several of my fellow CA professional would come out with far better ideas to remedy the situation buy we have to make a start somewhere.

S.Srikanthan

Membership No 024079

Email: Srikanthansanthanam2001@yahoo.co.in and  srikanth@onesourceindia.net




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