Auditing the auditors

The Malta Independent on Sunday

Auditing the auditors

Auditors are under fire, locally as much as internationally.

The Enron bankruptcy has shown that detailed international auditing standards are insufficient by themselves to afford adequate protection to investors from unpleasant surprises of hidden losses that can zeroise` investments overnight.

That one of the major international auditing firms is facing high level investigations in a market as developed and evolved as the United States, and that it has admitted to destruction of documents to hide its professional guilt is more than indicative that there is something structurally wrong in this whole auditing practice.

What is rather perplexing is that whilst detailed code of conducts for internal corporate governance have substantially evolved this last decade to ensure suitable checks and balances on the use and abuse of power by the executive corps of commercial organisations, auditors have been left somewhat on the lose.

Auditors who are appointed by the shareholders and are meant to operate in the public interest of the shareholders, the creditors, and the community in general,` have often found themselves being bankrolled by the management.

Serious conflict of interest positions inevitably arise when auditors take on lucrative consulting assignments from management which eclipse the commercial margins available in the plain vanilla auditing assignments. No amount of internal chinese walls can adequately safeguard the shareholders, the creditors and the community from the risks of conflict of interest taken on` by public auditors who take consulting assignment in parallel to audit mandates.`

Public external auditing is a` meant to offer reliable information to investors, suppliers and the general community, about the company`s performance and` is heavily relied upon to justify the building, maintenance or reduction of exposure on commercial organisations.

Pressure is building internationally for total and complete separation of audit mandates taken from shareholders from other consulting mandates taken from the management. A public audit firm will probably be able to do either but not both to the same organisation or group.

On the local front Auditors and Accountants were unceremoniously charged by the CEO of HSBC Malta that they are not keeping to international standards and quite often do not prevent clients from misrepresenting their financial position in a way which makes a lending bank` feel uncomfortable in relying too much on audited figures for its lending and credit decisions.

The said CEO has at times spoken irrationally and I had other opportunities to criticise him. But he has my sympathy on this one.` The situation is getting serious. Traditionally and culturally lending bankers had an inner feeling that the audited figures were much more modest than reality,` and that results were probably trimmed down for reasons related to tax management. But bankers were often convinced that `reality was much better than that shown in the audited accounts. They often simply had to rely more on the security aspect as the cash flow exposed by the audited figures would not of itself justify the exposures being sought by the client.` Lending simply on cash flow would probably have excluded most corporate borrowers.

The current situation is now much more perilous as lending banks are starting to feel that audited accounts are overstating the financial situation to cushion the real losses which businesses are incurring.` Major commercial failures like Daewoo and Price Club probably could have been avoided or diminished if auditors were a bit more forthcoming or timely in their submission or if banks took the hint of late submission a bit more seriously.

But the lowering of standards is not restricted to private companies. Even public corporations have got the bug. Take Enemalta.` The financial results for the financial year to 30th September 1999 were approved by the Board on 4th October 2000 more than a year after the financial year end. The financial results for the year ended 30th September 2000 were approved on 22nd August 2001. Somewhat better but still 11 months after the financial year end. This is just not good enough.

Why should this be so And why should the Enemalta Act continue to be broken with monotonous regularity` The Act provides that Enemalta must not incur an operating loss.` Yet in the financial year 2000 Enemalta not only did not generate enough funds to provide for capital expenditure and loan repayments as stipulated in the Act but actually returned a net loss both before and after tax.` Furthermore these Accounts together with the estimates for the current financial year were not presented to Parliament before 30th September as the Act provides but were only laid on the Table last week.

Yet no one, not even the auditors point out the non-adherance of the organisation to the regulating Act. And to come to the substance of the matter how does a profit before tax of Lm9.2 million in 1998 under the amateurs of a labour administration reduce to Lm6.8 million in 1999 when the PN professionals were still bound by Labour`s hedging agreement for the purchase of oil` And how does it turn` to a net loss of Lm1.1 when the super PN professionals lost the protection of the hedging agreement`

And even more pointedly how can Enemalta project just a breakeven position for the current year yielding` a cash flow shortfall of Lm 12 million with capital expenditure proposed to be financed by bank overdraft creating for the Corporation a net current deficit.

Mr Robson will vouch that it is not just auditors that are losing standards but also management of monopolies who manage to turn an old cash cow into a cash absorbing monster. Clearly somebody is hedging his luck that the price of oil and the $ will lose value this year.` Good luck professore!` It`s our money after all.