In line with the ministry of corporate affairs (MCA), which is considering changes in certain provisions of the Companies Bill?2008 after the Satyam accounting fraud, accounting body Institute of Chartered Accountants of India (ICAI) has also taken up the task of working on the auditing standard SA 315 to check similar nature of fraud.
According to ICAI, companies inflate their profits in the balance sheet by increasing the cost of items such as inventory, depreciation, allowance for doubtful account that are difficult to be estimated. SA 315?Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and Its Environment?includes checking the transactions related to these kinds of items in the financial statements that cannot be measured precisely but can only be estimated. In such cases, a biased management always tries to manipulate and project a healthy picture of their own enterprise by doing wrong valuations.
ICAI said companies tend to not disclose their special purpose vehicles (SPVs) to the investors. They transfer the assets and liabilities of the company to the SPVs and undertake various financial risks on the name of these SPVs rather than on the name of the actual company. Herein arises a need for the auditors to take care as to whether the SPVs are consolidated in the manner as it has been prescribed by the accounting standard AS 21. According to AS 21 where an entity controls another entity within the meaning of AS 21, then it has to be consolidated. SA 315 also says that the auditor should understand the environment of the entity and verify the transactions accordingly. Vijay Kapoor, secretary to auditing and assurance standard board, ICAI told FE, ?Companies what they do is that they increase the value of their inventory. Since, there is a one to one relation between the figure of the closing stocks and the figure of gross profit, the moment the inventory goes up the gross profit also scrolls up.?
Here, the role of the auditor would be to identify and assess the risk of material misstatement, their understanding the environment of the entity so that the management does not succeed in playing tricks and manipulating the balance sheet. SA 315 when first introduced in 2002 laid emphasis on the valuation of the internal control system. Now, further revision of this auditing standard would lay emphasis on the valuation of risk of the entire organization. It came into force in April 2008 and is mandatory for the companies to follow.
SA 315 deals with risk based approach whereby an auditor is required to identify and assess the risk of material misstatement and verify whether the management has not played any trick while preparing the financial statements. This is only possible through understanding the entity and its environment.
Kapoor said the auditor?s role is to understand the nature of the organisation. If that is not clear then he will not be able to perform his operation properly. SA-315 is an auditing standard where the job of the auditor would be to verify that whether the accounting estimates are disclosed properly or not and whether the disclosure made in the financial statements is adequate or not.