Investment bankers and auditors-more simillar than different

At first blush, the two could not seem more different. How can one compare a highly paid media savvy investment banker, with a lower profile 'backroom' auditor? However, when one starts to go beyond the surface and probe, there are surprising parallels

1. Regulators/Government authorities outsource work to both:-Merchant bankers are supposed to file a due diligence certificate for a capital issue(atleast in India) while auditors certify financial statements. Both these functions would otherwise come under the regulatory domain
2. Both deal in their reputation:-A reason for the famed 'IPO day1 gains' is claimed to be that merchant bankers want their reputation preserved, so they deliberately underprice the issue! But jokes apart, reputational capital is big for both auditors and investment bankers, as investors look for big brands when they invest
3. Both are mandatory-For any capital issue in India(except rights issue under Rs 50lakh i.e presently $1MM under ICDR Guidelines 2009 as amended), one needs to engage a merchant banker, while company regulators, banks and others mandate corporates and others to get an audit done for their own satisfaction
4. Both are categorized statutorily:-Be it the capital based SEBI classification based on networth or the experience/headcount based empanalment by RBI/C&AG etc, regulators and government agencies have their own categorization of these entities
5. Code of Conduct:-Both have a code of conduct, although that for auditors is much more tightly enforced.

Of course, there are differences which are there like compensation, conflict of interest etc but still these are minor imo compared to the above points

1.  

If REC ignores audit recomendations, then why have the audit?

REC is a well known equity and debt issuer, with an IPO/FPO and many successful bond issues under its belt. It even has Navratna status, and is an important partner in the Indian Government's efforts for rural electrification. But when it comes to listening to its auditors and solving their audit queries, it has a long way to go. From the Feb12 bond prospectus(http://www.sebi.gov.in/cms/sebi_data/attachdocs/1330060059753.pdf), I noticed that many points were repeating in the audit objections in Appendix I F-1 to F-4 after Pg 302, which are tabulated below in brief.

You would notice that the major violations relate to utilization of government grants, monitoring of loans given to SEBs/discoms, and an elementary thing like obtaining search reports. And despite power projects getting 'restructured' routinely, it had not occured to the management to ensure that they ascertain the viability of the revised project before according their routine sanction to the restructured loans.

And mind you, this was not the C&AG audit which is anyway expected to be critical. It was the statutory financial audit, for which the points were raised but not acted upon(hence they repeat for each year). It is not my intent to criticize the auditors-after all change takes time in government organizations, and they did play their part by qualifying the report.  Note that the financial auditor has only the audit report to apply 'moral suasion' on the company to make the change. But for some points to be unresolved for the past 4-6yrs as seen in this table, is a bit incredible. To their credit, REC did solve a few audit objections by FY11(hence they drop off) but the pace is just too slow. It is hoped that listing and the frequent bond issues will make REC more respectful of the auditor's recommendations.

How the CA profession changed circa 2011-a lookback in 2020

We cannot (yet) travel in time, so only time can test my predictions of how the CA profession will evolve. However, so many exciting changes are happening(we live in interesting times) that I just had to pen down my thoughts to connect the dots, and do some crystal ball gazing

The global subprime crisis gave a boost to principles based accounting and auditing standards(IFRS, audit standards) which were nearly universally adopted/adapted from 2008-2013. But if investors thought it would result in lesser fraud incidence, they were sadly mistaken. The IFRS transition and IFRS induced volatility, led to a comedy of errors, misunderstandings and reratings of stocks/sectors. Management subject to tighter performance linked pay, clawback etc(copied from the Western banking sector pay clampdowns) responded by gaming the metrics. And IFRS was an unwitting accomplice. Realizing that they could use aggressive accounting without earning qualified audit reports, management went all out to polish their books. And the auditors still coming to terms with IFRS, auditing standards, new formats laws etc were always one step behind.  But investors were not dummies. The savvier ones among them(FIIs, PE funds etc) demanded forensic audit to be mandatorily performed in addition.  Companies on their part, realized that investor relations was too important to be entrusted to the CFO/CS, and instead decided to develop their in house teams with business understanding/insight AND with expertise in accounting, marketing and communications.  CAs again were picked up for this role, given their integrated understanding.

The global outcry against income disparities, basic necessity deprivation, corporate ‘huge earnings’, Govt spending , corruption and crony capitalism manifested itself in the Arab spring riots(Egypt, Libya, Tunisia..), Lokpal bill struggle in India, Dodd Frank/Obamacare in USA. The Indian Govt did not set up a Lokpal but agreed to be enhance the e-governance substantially, and introduce worldclass measures like self assessment, uniform tax rates, less complexity, tight but fair penalties, deemed resolution in favour of citizen in case of delay etc. This transparency increased the willingness to pay tax, and increased the taxpayer base to 25% of the population. Of course, this was aided by more withholding taxes(TDS/TCS), transaction taxes(STT, GST) and innovative tax base(MAT, dividend tax, reverse charge etc). After plenty of struggles, GST was introduced in 2015, with dual rates

CAs saw the need to collaborate within the profession(alliances, CPE circles, benevolent fund, networking) and with other professions(LLPs).  The MCA introduction of LLP was leveraged by ICAI to permit these partnerships. And how they prospered! Engineers, architects and lawyers helped immensely in valuation, due diligence and expert opinions in audits; while company secretaries and management accountants lent their name to compliance services, cost audits and transactional services performed by LLPs. Of course, the jack of all trades(CA) remained the managing partner. Stung by the fact that LLPs of mostly other professionals were grabbing the premier cost audits, ICWAI tried to amend its bill to prevent that, but failed due to opposition from other professionals.  Networks of LLPs rose(many of them borne from ICAI networking efforts) and challenged the Big4 in specialist areas like forensic accounting, valuation, merchant banking etc.

The ICAI efforts to increase the quality of entrants in the CA profession worked well. Despite a midway oversupply(May-11 CA Final placements!), the overall consensus in 2020 was that academic toppers entering the field, had done excellently and could challenge their science peers. This reflected in the MBA entrance results where more CAs got into the premier IIMs(instead of having to wait and go abroad/to ISB), as their analytical caliber helped them to crack CAT. Of course, the CA Final exam pattern was made more practical/applied to ensure that bookworms/crammers would not get rewarded for just knowing the contents of a Rs 500 CD ROM! Recognizing that the quality and quantity of CAs was going up, industry recognized this by shifting a good chunk of Tier I and Tier II MBA college placements to the ICAI campus placements.

This would not have been possible without an improved training. Discarding the old system of relying wholly on the employer for training inputs during the 3yr period, ICAI adapted the ICAEW system of learning diaries, to be maintained and uploaded online. Like how peer review/FRRB brought out the best/worst practices for assurance practices, the review of these diaries was a valuable source of course correction for ICAI, to help those students where learning seemed too skewed. And by setting up its own coaching infrastructure(attending those to be counted as articleship!) and centres of excellence, ICAI was able to conduct many more student seminars/conferences/training programs. The communication skills training program was made on par with top MBA programs, and the Information systems course also was so interesting that CAs decided to compete with BTech system auditors!

CAs finally entered the digital age with XBRL, which made data crunching less labour intensive. While some KPOs were not happy(!), software companies embraced the movement to offer 100% automated XBRL solutions, which could then be verified by the CA.  Even the source data(ERP system) become standardized with cloudcomputing based ERP solutions, that allowed even SMEs to enjoy the benefits of ERP without the capex costs and learning costs(project failure etc). These twin developments made it more imperative for CAs to be tech savvy, capable of writing that XBRL coder on the fly if necessary, or to liason between operational staff and software persons.

The general improvement in personnel, systems, tax compliance mood etc made the Govt/Regulators even more trusting, and sparked off a virtuous cycle. Human interface kept reducing(or replaced by helpdesks instead of that pesky inspector!), with the limited manpower focused on major cases/test cases only instead of picking on the small fry. Of course, the severe penalties for fraud/major mistake ensured that the tax payers/regulated parties themselves preferred the least human errors, for which systems were designed to auto generate the returns from the ERP/other MIS. This led to reduction in Finance Dept size(now one did not need so many people to manually prepare the basic stuff!).  Compliance hassles became fewer(thanks to model laws like LLP/new companies Act) as Govt focused on ensuring companies had processes in place, instead of just an accurate output. The CARO question on internal audit sufficiency and appropriateness, expanded to cover a chunk of other key processes like tax.

With all that technology push, finance departments decided to proactively respond to the double dip recession/cost push inflation/high interest rates etc. Management accounting became in vogue again, and companies began to actually read and apply their cost audit reports.  ICWAs finally got their due respect and status on par with CMAs abroad, as companies realized that they had ignored their low hanging fruits for decades. The worst hit sectors(banking, insurance, infrastructure) learnt to apply those lessons, and were now on the rescue path. 

So finally, the profession(service and practice) saw substantial changes. Those who went with the wind prospered, others were left wondering what happened.  

Why 100% audit testing is again in vogue

In the old days of hand made goods, the brand was enough to show that the craftsman had tested the good and certified its quality. As the scale of operations grew, the producers decided to retain the quality marks, but resorted to sampling(around which a whole cottage industry grew of sampling statistics, testings, Six Sigma etc). When the scope of financial audit enlarged from balance sheet audit to include transactional testing, test of controls etc; auditors just lifted the ready made library of tools/techniques from the sampling industry, under the mapping that transactions/records were like goods-for which 100% testing was not economically feasible. While that hypothesis is shrinking in physical goods with the advent of non destructive testing(like acoustic testing, use of optics etc), digitization has made it possible to apply CAATs and digital auditing to do 100% testing of information.

Technological feasibility is one reason, but the real reason is the increasing competition+globalization, which has really reduced profit margins. Companies must now innovate(to maintain the high margins/market share), or else die. The lower profit margins lead to lower audit materiality levels, and therefore need for more audit testing. After all, commodity players operating at 1% margins, would have low audit materiality levels. But even high margin financial sector players have other issues like lax controls, fraud risk, compliance testing etc. Money laundering legislations demand data mining to detect connected transactions. The stray transaction which slipped through, may result in headlines about XYZ bank being a terrorist conduit. To protect their reputational capital, those subject to money laundering legislation must have digital records. And when the underlying digital records are in place, it is a natural leap to use them for statutory financial audit purpose.

Another reason is the increasing frauds/collapse of listed companies, where the public/regulators blame the auditors for being asleep at the wheel. While this perception is due to expectation gap, the audit firms would naturally like to improve the audit quality to avoid such issues. And one of the cheapest(given their economies of scale across clients) ways to do so is to use computers effectively for 100% audit testing.

As I blogged earlier, the data analysis trend today is to use the automated bulldozer instead of the manual shovel. Hence, the need for smart work

Why auditing is increasingly resembling TQM

During my B.Com days,  I had multiple chapters on TQM, and then felt it to be totally irrelevant to what a chartered accountant would do in practice. But after studying for CA Final, some insights which I've got are shared below, which would bring out the essential similarity between the two

• Tone from the top:-This is the basic premise of TQM and is increasingly being adopted for audits. Read any audit report and they state that keeping effective internal controls is the job of management. So management turns around and informs the employees that risk is everyone's job
• Build in quality rather than inspect:-TQM prefers to build quality rather than reject defective products. Similarly, due to the quantum and volume of work, auditors now rely extensively on process integrity. Even Computer Assisted Audit Techniques(CAAT) can only do so much, and are quite difficult and expensive to apply.
• Controls are everyone's concern:-This is applied in most organizations nowadays, with all employees being told to handle risk
• Process over product:-Rather than a tick box mentality, the focus in auditing(TQM, financial, internal) is to fix the process rather than routinely complain about the defects.

There are other points as well, but these salient points caught my attention

• 
  

Safety first-IRDA investment management regulation.

      I compiled the below analysis from the various IRDA regulations in force. Those interested are welcome to    browse the IRDA website to locate these and more. The LIC 'deficit' allegation did tarnish IRDAs image a bit but then LIC is the 800pound gorilla of Indian insurance/investing, which can get away with murder! Below are some examples of how investment managers of insurance assets are put on a tight leash.

1. Except the role of independent investment advisor, insurance companies cannot outsource any of the investment management function. And the limited outsourcing allowed(asset class specialist/NAV calculation agent) cannot be charged to policyholders account , but must be borne by insurance company itself.
2. While the Front office(fund manager+dealer) reports to CIO(Chief Investment Officer) who reports to CEO, the Middle office/Back office report to CFO. As both CIO/CFO report to CEO, there is some balance of control between front office and its control functions(middle/back office)
3. Also, transfer of data   from Front Office to Back Office is 100% electronic(no manual intervention, even faulty data can only be rejected NOT edited), to avoid chance of cooking the books post transaction.
4. For valuing quoted securities, market value is accepted only for quote not older than 30days. Otherwise, book value(net of provisions) is used. This heavy penalty would incentivize investment in liquid stocks, OR having a 'friendly broker' to trade in those shares prior to accounts closure. In contrast, SEBI permits using good faith valuation methodologies based on DCF, which incorporate the liquidity discount.
5. To avoid the excuse of 'ratings dependence', IRDA clearly specifies(wef Aug'08) that rating is not a substitute for risk analysis(quite obvious but then the most simple things are often overlooked).

Oil & Gas Industry-some interesting finance points

For a business plan competition recently, I chose to read the internal audit guides for both upstream(http://220.227.161.86/21005upstreamoilgas.pdf)  and downstream(http://220.227.161.86/20999tg_oilgas_downstreamIA.pdf). They are worth reading in their entirety for for their lucidity and glossary, so it would be time well spent. Some observations are below

• Paying for information:- The owner of a well benefits by greater information when oil reserves are proven in the adjacent field. Hence, there is practice by that owner to pay bottom hole contribution to encourage the drilling of a well to help in evaluation of his own acreage or a payment made to ensure information about the result of a well drilled by another oil company. It is paid on reaching XYZ depth. Dry hole contribution is similar, but paid only when the well is proven to be dry(useless!)
• Depletion/Depreciation/Amortization(DD&A): Probably the clearest explanation of the difference. Depletion relates to the reservoir, depreciation to the capitalised assets and amortisation to the cost of the license interest. This distinction is important during financial projections. 
• Impairment testing asset group-field:- Impairment accounting tests often face the difficult question to determine whether assets are truly independent or not. Oil fields may consist of single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. Hence, determining the group of assets of challenging in this case

Other general observations are about the importance of certain key financial management areas. For instance,

• Refinery output mixes can be infinite, hence a proper LPP design is needed to optimize product mix. Reliance apparently uses 10,000+ variables in its LPP for Jamnagar refinery. 
• The transport cost can be vital, and lead to savings at the retail level, so managing that is crucial. 
• Given the large gap between cost incurrence and flow of revenues, the risk of assets turning bad('impairment') is quite high, for both operational and economic reasons(just becoming unviable at present lower oil and gas rates). Hence, one needs an asset level MIS to run that calculation
• Capital budgeting needs to be top key, because the amount to bid for in a competitive scenario would not only depend on outside rates, but also one's confidence in forecasting abilities, which can only come from an objective record and evaluation of corporate level forecasting records

 

Want to sharpen your audit awareness/knowledge? Read these free documents

It is said that the 'best things in life are free'. A counter to that is that 'easy come easy go' and that 'free things have no value'. While the truth lies somewhere in between these two extremes, one should note that RTI and public disclosure norms often ensure that Govt organizations disclose very useful information at times. This is mostly lost in the morass of trivial data, till somebody uncovers them. Below are some examples

1. CAG:- Their entire site is a gem(reports, guidelines etc) but their directions issued under Section 619(3) of the Companies Act 1956, are very informative, wherein they extend the audit scope. I've not seen some of these points even in the best checklists. Read those directions here(http://cagofindia.delhi.nic.in/caempanel/directions_2010.htm)
2. FCI:- These days, the Food Corporation of India is more in the headlines for rotting foodgrains than for anything commendable. Still, by posting the circular of its stock taking directions(http://fciweb.nic.in//upload/circulars/APV%20Instructions.pdf) along with the stock sheet proforma(http://fciweb.nic.in//upload/circulars/APV%20FORMATS.pdf), it provides a very educative source of information for students and agriculture sector accountants. 
3. CCI:- The Competition Commission of India may have goofed up in its order penalizing NSE for 'predatory pricing'(though it may have spurred NSE to start charging from the month post the order), but its sector reports are quite useful and incisive. Often, media/management sees things through rose tinted glasses and 'professional skeptism' is lost, but reading the CCI reports ensures that one is well grounded in reality. For instance, this report(http://www.cci.gov.in/images/media/completed/transport_20090723115524.pdf)  on competition in Railways/Ports was written in 2009 but is still quite valid and insightful-it speaks equally of the quality of research and lethargic pace of reforms. Read their other reports and orders too. 

How auditors try to detect financial reporting fraud-and why they often fail

Post the Satyam scam, where even cash balances were found to be non existent, investors/analysts may be forgiven for thinking that auditors are watchdogs who bark after the horse has bolten from the stable. However, this is not for want of intellect, ability, training or even professional norms. An entire professional standard SA-240 covers this topic(read this here http://220.227.161.86/15374Link9_240SA_REVISED.pdf). This standard has several interesting aspects for both students and investors/analysts.

1. Financial audit being post facto, it relies on evidence, often 'triangulating' it by seeking consistent evidence from multiple sources. However, collusion between management and third parties(bank officials, warehouse keepers etc) may cause the auditor to believe that audit evidence is persuasive when it is, in fact, false. For example, non existent customers may confirm debts! 
2. With the advent of principles based accounting rules(IFRS/Indian GAAP), it is difficult for the auditor
   to determine whether misstatements in judgment areas such as accounting estimates are caused by fraud or error. At best, the auditor can insist on the company tabulating a sensitivity analysis to show range of P&L outcomes, but this may easily be overlooked. And remember that the auditor cannot second guess management judgement, even if it is at the aggressive end of a valid/possible range. 
3. Like most other professional standards(even other professions like valuers do this), tone at the top is assumed, that management will create a culture of honesty and ethical behavior. Investors are not babes in the wood, and often know which companies(even those in Nifty/Sensex) are not having that tone at the top. When that is the case, the investors should know that they are knowingly bearing greater fraud risk, and should not protest too much on fraud being discovered. 
4. While management has discretion to select and apply accounting policies(compliant with AS), auditor shall, to check for earnings management efforts, evaluate whether that choice is indicative of fraudulent reporting. Some examples(personal, not in SA 240) are including cost of land for measuring percentage completion, overuse of 'strategic investment rationale' to defer impairment charges, using gross method over net method etc. As these examples show, that risk is more for transactions involving subjective measurements and complex transactions.
5. Good professionals will accept clients only when convinced of their integrity. This may make them unsuspecting.To prevent bias, SA 240 mandates professional skeptism,  despite the auditor's belief  that management and those charged with governance are honest and have integrity
6. Fraudsters should be fooled by randomness! So an element of unpredictability in the selection of the
   nature, timing and extent of audit procedures is desired.

While an auditors have an unique(less than only promoters/management) access to the books/records/operations, fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Auditors are capable of uncovering the fraud, but like other professionals must operate within the scope of their mandate. Fraud check would need expensive forensic accounting/investigative skills, which not all companies can afford. While law mandates having an internal audit system appropriate to the size/set up of the company, this cannot avert management fraud-where management itself overrides the system.

The reason why public sector company audits take so much time.

This term, my friend and I were doing a project to rank annual reports of Nifty companies. While the private sector cos(barring R-ADAG group cos) have largely released their annual reports within 4 months from year end, public sector companies have not. Only SBI(being a bank thereby subject to 'peer pressure' of releasing accounts within 1 month) has done so, while blue chips like ONGC have not. Why is this so? One cannot even blame the respective Government department for that, because these companies have substantial functional autonomy, and have functioning Board of Directors to approve the accounts.
The reasons are

1. C&AG issues additional guidelines to the statutory auditor(http://cagofindia.delhi.nic.in/caempanel/directions_2010.htm). Most of these points are anyways checked within the scope of most well planned audits, but some of these guidelines involve substantial elements of operational audit, performance audit and 100% check-which all eats up large amount of time.
2. Also, while the auditee PSU is bound to provide all information expediently(http://cagofindia.delhi.nic.in/caempanel/annexure-terms2011.htm), the draft audit report must be approved by the C&AG Audit Boards, which may seek the audit working papers as well. This ability to requisition working papers routinely, is unique to such audits, and makes the auditor wary of even the smallest mistakes, thus reducing the materiality limits. 
3. The C&AG may take its own time to approve the draft audit report, adding its own comments later
4. Once the accounts are finalized, the concerned Ministry then kicks in with its demand of dividends(as per Finance Ministry edicts). This negotiations with PSU management eats up more time. 

Therefore, delayed circulation of annual accounts for PSUs is not a sign of poor accounting/corporate governance, but is a systemic issue. Investors should keep this in mind. 

Lending agreements-increasing trend of outsourcing monitoring to professionals

Conventional financial theory holds that financial intermediaries(like banks) add value('spread'/NIM) by aggregating deposits and lending them to qualified borrowers. For these loans to be profitable, banks should have the expertise in credit risk assessment and monitoring. But the past few years(decades?) trend seems to be negating this theory. While banks are focusing their energies on gathering deposits(more channels, multiple access mechanisms, marketing) and processing loan applications faster('retail loan factories'), their response to scams seems to outsource that monitoring function to a professional. For example

1. Some banks give 0.25%-0.5% interest rate discount to their SME borrowers with credit ratings. 
2. Stock audits/financial audits(where not otherwise done) are made mandatory for those with working capital/other operating facilities.Incidentally, this is the mainstay of many a SME practice.
3. For borrowers with multiple bank relationships('consortium lending etc), RBI has mandated a compliance certificate to be issued certifying governance issues, no fund diversion etc. Interestingly, this circular also contains a best practice of different statutory/internal auditors for group companies, where facilities cross Rs 50crores.
4. Often, the audit clause contains a 'Big 4' auditor appointment insistence-this is true of the Indian private sector banks, but this trend seems going down though. 
5. In additional to the general purpose financial statements, auditors are often asked to sign a compliance certificate(under the lending agreement) which contains proforma ratio calculations, covenant compliance affirmation etc. When the auditor is tasked to do this(albeit for extra fees), he is in reality doing the monitoring function of the bank.
6. Auditor/CAs are often asked to certify the utilization of the earlier sanctioned funds, before the next disbursal is approved. 

 Conceptually, there is little quarrel with the proposition of 'bundling of services' or delegating to experts. When the auditors/credit rating agency are expected to know the client well and perform their tasks with due diligence, then the bank is entitled to rely on them. The only possible issues with this, is that the processing fee/interest rates should reflect this reduced risk, as well as reduced costs for bank. Otherwise, the benefit from these activities directly flow to the bank's bottomline. Btw, the professional referred to in this are practising CAs/CSs/CWAs-most of whom can do the above work. Still, the statutory auditor is preferred for most of this.

Standards as public goods-the case for free downloads.

In the good old days, only doctors, lawyers and accountants were considered professionals. Now, every service businessperson clamors to be recognized as a professionals. Right from actuaries, investment professionals, valuers, risk managers etc, associations of professionals establish institutes like CFA, FRM etc, and then attempt to get monopoly status for their members. Now, nothing per se is wrong with this attempt, though one can argue on how successful these 'professional associations' are in terms of value added to their members and society. After all, skilled work does benefit from licensing and discipline.

Now, professional standards not only propogate 'best practice' in the area, they also educate the users of what to expect from their licensed professional. So, charging a fee for those standards reduces the dissemination not only to members(unless purchasing them is tied in with the annual membership fee), but also to students and the laypersons(public/journalist). And this reduced circulation would impact analysis, dissemination and critiques by those not able to pay for them, especially in emerging economies.

Now, one may argue that nothing which comes free is ever valued. That is why one can follow the path of the international accounting standard setter(IASB, responsible for IFRS). It is a non profit organization dependent on its members for funding, but which aims to self sufficiency. Therefore, the standards themselves are free, but the value added guidance notes/interpretations are not free. The rationale being that only experts/professionals would require those, and can very well pay for them. There is special pricing for students and academics, while journalists have free access.

Or one can follow the path of the Indian accounting regulator(ICAI) with more than 10lakh students+members. It uploads all its publications in PDF format on its portal, thus allowing knowledge to spread freely. In a country like ours where knowledge is valued(but purchasing power is low), such a approach will work wonders in the years to come.

Cost Audit Rules 2011-finally recognizes management accountants

For ages, Board of Directors dealt with atleast 3 auditors. The statutory auditor for accounts/tax, the internal auditor for improvements and the cost auditor for cost accountancy. Internally, there was this feeling that cost auditors are just the Government's spy, who do not give any value add to the company. Though the cost audit report did contain an optional space for cost auditor's to fill, the bulk of the report entailed verifying numbers/ratios from management accounts, mainly for purposes of tariffs, taxes and subsidies. Otherwise, the report did not add value directly to the company, and expected it to analyze the numbers itself.

The Cost Audit Report Rules 2011(http://www.icwai.org/icwai/docs/Revised_Report_Rules_03jun11.pdf) framed in June-11, promise to bring a paradigm shift. The Cost auditor has to submit a performance appraisal report to the company's Board of Directors.The report format is reproduced below.

FORM-III 
FORM OF THE PERFORMANCE APPRAISAL REPORT 
 Name of Company: __________________________ Period of Report: ______________ 
(indicative list of areas to be covered in the report)y(emphasis added) 
1.  Capacity Utilization Analysis  
2.  Productivity/Efficiency Analysis  
3.  Utilities/Energy Efficiency Analysis 
4.  Key-Costs & Contribution Analysis 
5.  Product/Service Profitability Analysis 
6.  Market/Customer Profitability Analysis 
7.  Working Capital & Inventory Management Analysis 
8.  Manpower Analysis 
9.  Impact of IFRS on the Cost Structure, Cash-Flows and Profitability(emphasis added)
10. Application of Management Accounting Tools(emphasis added)  

While any well managed company would be anyway doing most of this, the report serves as a second opinion. Also, given that IFRS will impact Indian companies from this fiscal(2011-12) onwards, Boards would be interested in knowing the effect of IFRS on their reported earnings etc. And then, a cost auditor with multiple clients is well equipped to comment on the application of management accounting tools.

Anyways, if the report is done by the auditor himself(instead of cut pasting internal audit reports), then respect for the profession will increase. And it would certainly be a value add, and intellectually challenging exercise.

Cost Accounting Rules 2011-the fine-print & sea change

When the Central Government notified The Companies (Cost Accounting Records) Rules, 2011(http://www.icwai.org/icwai/docs/Common_Record_Rules_03jun11.pdf) in June-11, cost accountants(or management accountants as they are better known) and their institute the ICWAI must cried with joy for the extra assignments which these rules entail. After all, more certifications/audits mean more business for professions. But the fine print brings out the devil in the details.

1. Rule 2(c) includes a permanent employee of the company(who has the ICWAI qualification), in the definition of cost accountant. So he is allowed to certify the compliance report that the company maintains appropriate records. To be fair, this is pari materia with the secretarial record keeping, which a company secretary in employment can certify. But it is absurd, because the form of declaration('Form B' does not merely ask reassurance that records have been maintained. The wording is nearly a replica of what the statutory financial auditor has to give. I do not understand what they wish to achieve here. Do they expect a permanent employee to admit that 'I/We have/have not obtained all the information and explanations, which to the best of my/our knowledge and belief were necessary for the purpose of this compliance report' or even that 'In my/our opinion, the said books and records give/do not give the information required by the Companies Act, 1956 in the manner so required.'. Such matters of opinion should be left to professionals in my opinion. 
2. IT companies(!) will be covered under the definition of processing activities under Rule 2(l)(xi)-(xii). 
3. Mere value addition or services,  are brought under the ambit of 'production activity' under Rule 2(o)(iii) with this masterpiece  “Production Activity”  includes any act, process, or method employed  in relation to -(iii) creation of value or wealth by producing goods or services
4. It is common knowledge that the reconciliation statement in Cost Audit report, is often the starting point of any indirect tax inquiry. But this was not explicit from the format etc. Now, the Govt has dropped the pretense and added a footnote below the reconciliation statement format, to make the department's job even easier.  That footnote reads -----------------------------------------------------------NOTES:(i) For produced/manufactured product groups, use the nomenclature as used in the Central Excise Act/Rules, as applicable.(ii) For services groups, use the nomenclature as used in the Finance Act/Central Service Tax Rules, as applicable.

The tale of 2 campus placements-will mandatory cost audits change things?

From the website of the Western India regional council of the ICWAI, I retrieved the most recent placement statistics from page1 of the journal(http://www.icwai-wirc.org/pdf_files/June%202011.pdf).


Contrast this with the placements of the ICAI(retrieved from the campus placement report for Feb-11'Mar-11, reported on Pg 1724, of the May-2011 CA journal http://220.227.161.86/22701may2011journal.pdf). 35% of the candidates finally accepted the job offers.

The pan India ICWAI placement figures are not available, but I suspect that will portray a worse picture, considering that the best paymasters are typically in the Western Region(Maharashtra, Goa, Gujarat).

Why is this? Till recently(2007), as any informed person would attest to, getting the ICWAI certification was quite easy compared to CA, and the curriculum was dated. While one may say that given the (often) considerable work experience profile of the candidates, they would anyway be knowing the relevant costing practices etc, this did not reflect well on the course. Add to that the notoriously inefficient administration, Kolkata HQ(and concurrent attitude!) and the trend of blindly aping the exam papers of other institutes, and you see why this had happened. Employers did not much rely on the ICWAI qualification, and those who got it were typically those with considerable experience, who considered it an added feather on the cap.

Since 2008, things have changed. Administration has improved and become more student friendly/responsive, there is a world class curriculum in place, and there is the requirement to do a mandatory 3 years internship(or workexp in lieu of that). That should address the supply side-both quality and quantity wise. The Indian Government obliged the profession by making cost audit mandatory. While opening the floodgates to cost auditors, the real juice may seem in the added services like efficiency assessment etc. But there, they do face a competition from CAs and management consultants.
My conclusion: Cost Accountancy firms will mushroom, but the corporate demand for Cost Accountants is unlikely to go up. While firms will pick up candidates, they would not match the industry pay. So this state of affairs is likely to continue atleast till companies realize that they need cost accountants, in addition to their existing accounting/finance professionals.