In this article, Brinda Dubey pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the review mechanism prescribed by SEBI for the audit qualifications contained in the audit reports of the listed entities.
What is an audit qualification?
Audit Report is the communication to the shareholders/investors and other bodies by which an auditor expresses his opinion about the financial statement of the company audited by him. Audit report is an important aspect in the audit process. An audit qualification is typically a statement of the auditor’s opinion written on any check done by a professional auditor. It indicates that financial results presented by the management do not reflect the true and fair affairs of the financial transactions of the company and can hence have a considerable impact stakeholders’/investors’ decision making.
An audit provides those who have to rely on/look to financial statements, adequate assurance that the statements are in conformity with Generally accepted accounting principles 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.
In case auditor has any reservation in respect of certain methods mentioned in the financial statements he may qualify his report. If the accounting standards issued by Institute of Chartered Accounts of India is not followed by the company the auditor may qualify his report.
Additionally as per Companies Auditors Report Order rules the auditor may qualify in his report in respect of inventories, Fixed Assets, loan given or taken by the company, internal control procedures, internal audit system, acceptance of public deposits, maintenance of cost records, payment of statutory dues, transaction prejudicial to the interests of the company, etc.
Audit qualification generally a suggests a lack of consensus 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.
Generally, qualifications are harbingers of negative perception for companies and should be avoided. This can be possible only if the issues are resolved between the management and the auditor.The management had to compulsorily include all adversities and qualifications in the board report from time to time as well and hence be answerable. 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.
A clear description of all the substantive reasons of the qualifications should be included in the report and, unless impracticable, a quantification of the possible effect(s), individually and in aggregate, on the financial statements should be mentioned.When not practically feasible to quantify the effect of modifications made in the audit report accurately, the auditor may carry out plausible audit tests and base the estimates made by the management while clearly indicating the same thereto.
Previous review mechanism
As a regulator of companies which are listed, the Securities and Exchange Board of India recently, after taking into consideration best international practices based upon detailed analysis of the inspection systems of the audit regulators around the world, introduced some consequential amendments relating to a new mechanism to review audit qualifications contained in the audit reports of listed entities ,these amendments will come into for all the annual audited standalone/consolidated financial results, submitted by the listed entities for the period ended on March 31, 2016.
Till November 2015, listed entities were required to submit a form (Form B) for a qualified audit report together with annual report and a Form A if submitting an audit report with unmodified opinion. These forms are to be signed by the Chief Executive Officer/Managing Director, Chief Financial Officer, Auditor and Chairman of the Audit Committee.
The qualified opinion was reviewed by Qualified Audit Report Review Committee (QARC) comprising of stock exchanges, representatives from the Institute of Chartered Accountants of India (ICAI), other stakeholders, and contingent on their recommendations, SEBI asked the companies to either get the opinion rectified or revise the financial information to address the qualifications. In cases where the QARC determined that the qualifications were major and explanations were not to their satisfaction, the audit report would be referred to the Financial Reporting Review Board (FRRB). If the FRRB was of the opinion that the qualifications were justified, SEBI mandated a restatement of accounts of the company and require the company to inform its shareholders through intimation to the respective stock exchange. 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 to the error however relaxation in terms of the period has been given to cushion from tax impacts.
The Board has also divested powers for the well being of the investors to take any action, regarding the above, as they saw fit. Further, annual report was filed at a later time than financial results which are to be filed within 60 days of the end of the year and Form B was required to be filed along with the annual report and no such information on qualifications was required with the filing of quarterly results.
The FRRB reviews financial statements of listed companies to determine to the possible extent their compliance with generally accepted accounting principles in the preparation and presentation of financial statements, disclosure requirements prescribed by regulatory bodies, statutes and rules and regulations relevant to the enterprise and compliance with reporting obligations of the enterprise as well as the auditor.
Changes after 2016 Amendment
Divesting of timely information to stakeholders which was one of the primary concerns was not being addressed by this mechanism, hence with the amendments certain changes were made to it along with the process getting more streamlined.
Primarily, a financial result of a company could be misstating by a significant amount and not known to the investors at the time investment decisions are being taken. Also, Form B provided limited information — i.e. qualifications with respect to management explanations and matters of quantification and the impact on the financial results were not prescribed in the form.
With the notifications of September 2016 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. Management of the company also has to provide it’s views on the qualifications. The listed entity will have to furnish a declaration in case there are no audit qualifications.
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 firms will have to make submission about details, types, frequency of audit qualification too.
Instead of simple qualification information, SEBI requires filing of numbers along with adjusted numbers. Frequency, types and details of audit qualifications done also have to be spelt out of each qualification separately.
Revisions rectify and fills lacuna of the previous requirements. The compliances might be more demanding but nevertheless, information is cumulatively disseminated at the right time. Most importantly, the most outstanding difference might be that the SEBI review mechanism of the qualified reports has discontinued. The review is undertaken by stock exchanges now.
There is not much clarity at present about the exact performance of the review but sections related to re-opening of accounts and revision to financial statements under the Companies Act 2013, have been made effective/notified in June 2016 following 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. A sound interpretation of requirements hints that India might be gravitating towards a world of restatement (a prevalent phenomenon in the west)
Similarly 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.
Restatements though have an unfavorable effect on the stock prices and is to be seen as and is viewed as walking on a bed of coals.
Even as we battle the implementation of the changes as they have been brought about in a short span of time, these recent changes should bring out more transparency and efficiency in financial reporting in the corporate sector. It is absolutely essential that corporates’ internal processes and systems are sturdy enough to withstand and deal with the changing requirements.
References
- CIR/CFD/CMD/56/2016
- CIR/CFD/CMD/15/2015
- (Listing and Other Disclosure Requirements) Regulations, 2015 (‘Listing Regulations)
- CIR/CFD/DIL/9/2013
- http://taxguru.in/chartered-accountant/qualified-opinion-auditors-report.html
- Newspaper reports
