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By Patricia Adversario, Senior Reporter
Recent moves by market regulators to increase
their reliance on the opinion of external auditors are causing some
“discomfort” among auditing firms.
New rules on what external auditors now have to
disclose on the financial state of the public companies, require the
external auditor, not just to render an opinion, but to report his
findings directly to the Securities and Exchange Commission (SEC).
The latest SEC circular requires the external
auditor to report his findings to the commission if his client fails
to disclose any material finding involving fraud or error; losses or
potential losses amounting to at least 10 percent of the total
assets of the company. The auditor should also disclose if the
assets of the company are no longer adequate to cover creditors’
claims.
To protect the auditor, the contract between the
company and the external auditor should state that the disclosure of
information by the latter to the SEC shall not be a ground for
civil, criminal or disciplinary proceedings against him.
Even without the new rules, external auditors
interviewed by The Manila Times pointed out that auditing standards
already oblige them to report to management, any factual finding
involving suspicion of fraud, actual fraud, or significant errors.
If these are not reflected in the financial
statement, the auditor should give his qualified opinion in the
statement that the company submits to the SEC.
This time, there is a direct channel between the
auditor and the regulator since the auditor is obliged to report his
findings directly to the SEC if the company does not submit his
findings within a specified period.
SEC Circular No. 5 takes effect January next
year and will cover audited financial statements for the fiscal year
ended June 30, 2003 and thereafter.
Sources of discomfort
Under existing auditing standards, external
auditors cannot disclose information without the consent of their
client. “The new SEC rules now oblige us to disclose
information on fraud, error, or losses if management fails to do
so,” said Editha O. Tuason, a partner at Joaquin Cunanan
& Co., a member firm of PricewaterhouseCoopers.
The new circular defines fraud as an intentional
act by one or more individuals among management, employees, or third
parties that results in a misrepresentation of financial statements
that will reduce the consolidated assets of the company by five
percent.
It may involve manipulation, falsification or
alteration of records or documents, or misappropriation of assets.
Error means an unintentional mistake in
financial statements that will reduce the consolidated total assets
of the company by five percent. It may involve mathematical or
clerical mistakes in the records and accounting data; oversight; or
misinterpretation of facts or misapplication of accounting policies.
“We’re also supposed to disclose now any
adjustments made in the financial statement. Financial reports are
already adjusted, and previously, we didn’t have to tell the SEC
what were the adjustments,” said Manuel O. Faustino, a partner at
C L Manabat & Co., a member firm of Deloitte Touche Tohmatsu.
The new rules, in effect, give external auditors
additional responsibilities because they now go beyond merely
certifying to the fairness of a financial statement. And with
more responsibilities, auditors would definitely charge higher fees,
said Vivian Liban, budget and accounting manager of listed Metro
Pacific Corp.
Even as auditors are now obliged to be a back-up
reportorial unit for the SEC, they insist that it’s still the
prime responsibility of management to report cases of fraud.
“If management and the external auditor fail
to report certain information required by the new SEC rules, the SEC
will impose the corresponding sanctions. So, it looks like it’s
now both management’s and the auditor’s responsibility to
report. I’d still like to believe it’s management’s
responsibility, ” said Tuason.
Angel Ong, chief finance officer of Benpres
Holdings Corp. agreed: “Judging from the scope of work done
by the external auditors, it’s difficult for them to decipher if
there is fraud in the financial reporting.
If you look at their engagement, they put
in a lot of disclaimers. It’s really the responsibility of the
company to submit accurate financial reports to the regulatory
bodies.”
He added that even if external auditors agree to
report fraud, “I don’t believe they’ll be effective unless
they handle the extensive work done by internal auditors. This means
they’ll be engaged to do audit on a full-time basis, which is
going to make it very expensive. And there is no assurance
that the desired results will be achieved if there is really an
intention to commit fraud.”
Confidentiality clause
At the heart of most auditors’ discomfort is
the possible violation of the confidentiality rules under the Code
of Ethics for Certified Public Accountants.
This could engender distrust and make some
companies more defensive than they already are, said auditors.
Take a case, said Faustino, where fraud was
committed.
The books were accordingly adjusted to reflect
the loss. The client agreed to the adjustments made to reflect the
loss.
“Previously, we didn’t have to announce that
fraud was committed. But now, we’re required to report the
adjustments to the SEC whether the client agrees or not. In effect,
the SEC is requiring us to tell on the client,” said Faustino.
“Reporting fraud is the company’s
responsibility. Next in line is the auditor, who is bound by
confidentiality. The fact that the company does not want to report,
and it’s now the auditor who has to report, violates that
confidentiality. In the first place, if the company wanted to
report, they would have done so,” said Cindy F. Ortiz, technical
research manager at C L Manabat.
Metro Pacific’s Liban, however, pointed out
that it should be part of the external auditor’s job to report any
material finding to the regulators. She said confidentiality issues
are unlikely to affect companies that already observe good corporate
governance practices and maintain transparent relations with their
auditors.
She said external auditors are duty bound not to
disclose any information on their client only on two grounds:
information that could affect the client’s competitive standing
such as details on the client’s customers and suppliers; and
information on transactions which still have to be finalized.
Material element
With the increased responsibility, auditors
would have to be more careful in the conduct of their audit, said
Art Cayanan, a director at the University of the Philippines’
Development Center for Finance.
“Before, they could claim that there was no
material element at the time they conducted the audit or they could
say their engagement is just to render an opinion, and not to
uncover fraud. But if the same company is in trouble because of
unreported fraud, they could be liable because a provision now
states that their engagement is not limited to rendering an
opinion,” said Cayanan.
Tuason, however, points out that external
auditors can only report fraud that come to their attention.
Auditors don’t audit 100 percent of the
transactions, but on test basis. If the fraud happened in a
transaction that was not part of the test, auditors are not obliged
to disclose or shouldn’t be held liable, she said.
In spite of their misgivings, auditors do
realize the need of the SEC to increase its reliance on their
opinion in financial reports.
By its own admission, the SEC does not have the
manpower to monitor all the corporations and check all the reports
submitted to them. “Through this new reportorial requirement, the
SEC wants to be informed immediately of any serious problems that
could happen,” said Tuason.
The commission also wants to make sure it can
rely on the opinion it seeks. For the first time, external auditors
for public companies now have to seek accreditation with the
commission. The high qualification standards are meant to encourage
quality control and create a disciplined financial environment, said
the SEC.
Jaime C. Laya, chairman of KPMG/Laya Mananghaya
& Co, said the accreditation requirement is a “major
change,” because previously, any licensed certified public accountant
(CPA) could audit and attest to the financial statements of any
company, large or small.
“The previously open-ended license for CPAs to
practice their profession is, in effect, restricted with
accreditation,” he said.
He added that the SEC still needs to clarify how
small auditing firms can ultimately qualify for accreditation, and
how the technical capability and ethical behavior of an accounting
firm or an individual can be tested by the accrediting agency.
Laya suggested a ranking method that would
employ several levels of accreditation, similar to the private
school system.
There could be three or four levels of
accreditation, he said. The highest rank with the highest level of
organizational, technical, and ethical standards will have maximum
privileges, in terms of the type and number of firms that it can
audit.
No assurance
Still, there is no assurance that the new
requirements would achieve the desired results.
A key issue is whether the level of compliance
of auditors is of the same professional standard.
“Some companies might prefer an auditing
firm that is perceived to be more lenient or who will gloss over the
report. If you’ve got something to hide, you might not want to be
audited by certain auditing firms,” said Cayanan.
Second, would auditors really want to avail of
that direct channel between the auditor and the regulator?
“It’s a delicate issue. We’ve not yet even
talked about the potential loss of business to auditors who would be
brave enough to avail of that channel,” said Cayanan.
While accreditation helps ensure that the work
of external auditors is consistent with Generally Accepted
Accounting Principles (GAAP) and Generally Accepted Auditing
Standards (GAAS), there are other issues that need to be addressed
in other ways, said Laya.
One, is the adequacy of GAAP and GAAS in
ensuring that properly audited financial statements present a true
picture of a company’s financial position.
“GAAP and GAAS cannot anticipate all
eventualities.
New and more complex forms of financial
derivatives, for example, are constantly being devised and it is
simply not possible for the accounting profession to keep up with
new developments and immediately come up with standard methods of
reporting for each one,” he said.
Second, not all users of financial statements
fully appreciate their meaning even if there was full disclosure and
full compliance with GAAP and GAAS.
“Users also have a responsibility to
understand the meaning and limitations of audited financial
statements, as they may otherwise still not fully appreciate the
meaning of audited financial statements even if the external audit
and company accounting were properly done,” said Laya.
Another key factor is the completeness of the
information supplied by the company to the auditor, as management
could sometimes withhold information or deliberately mislead its own
external auditor.
Obliging auditors to submit information directly
to the regulator will either make companies more cooperative — or
defensive and less transparent — with their auditors.
“If they don’t disclose all the information
needed by their auditor, it defeats the objective of this circular.
But if companies have nothing to hide, it shouldn’t be a matter of
concern,” said Faustino.
On the whole, “something good should come out
of this, even if it will cause inconvenience and discomfort to
some,” he added.
Perhaps the fact that the rules are causing some
discomfort, is, in itself, a good sign. At some point, auditors need
to be reminded that their responsibility lies in the investing
public — and not just to the client whose numbers they verify.
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