The abysmal quality of audit and weak oversight by the financial regulator merit immediate action by the government to bring changes in the country’s existing legal, financial audit and reporting framework.

The lamentable performance by both auditors and regulator has put the interests of all stakeholders at stake.

The existing monitoring system lacks a stringent mechanism to check malpractice by audit firms that compromise on quality. The recent default by statutory auditors of brokerage houses is proof of deteriorating quality.

Many statutory auditors or auditing firms avoid comprehensive audits and adopt the option of ‘test checking’ in which a few transactions are selected at random from a large number of transactions and if the selection is found to be correct, the auditor ‘presumes’ that all other transactions would also be correct. In the auditing profession, this test checking is considered a substitute for detailed checking of company records.

This assumption is altogether contrary to the norms of justice and transparency as the choice for testing methods is fully dependent on the discretion of the auditor.

It is important that the regulator scrutinise ‘test checks’ in audit programmes to improve the quality of statutory audit.

Over the years ‘audit reports’ have lost much of their required credibility. Auditors focus mostly on compliance of international standards of accounting, reporting and audit, which have limited application in Pakistan. Required reporting by auditors on mismanagement, fraud or fund leakage is often found wanting.

The existing financial regulator must take the initiative to make reporting on fraud and mismanagement an integral part of the audit report by making the necessary amendments in the Companies’ Law.

Auditors should have an appropriate authority — with the proper mechanism put in place — to report significant matters, including fraud and mismanagement to the SECP directly. The mechanism for appointment of statutory auditors should also be made transparent and more independent of the majority shareholders.

Further, in order to safeguard the interests of all investors and stakeholders, the regulator must make it legally binding on companies to have credible cost-based and operational audits for better performance.

It must be realised that financial audit alone will not suffice as it merely reports compliance with the so-called regulatory requirements. Credible audit means that the financial audit should be reliable and credible so as to lead to good governance, better performance and improved service delivery of public and private sector entities.

While auditing has always been a self-regulated profession, corporate failures and scandals in the recent past have raised questions about the validity and suitability of self-regulation in auditing.

The self-regulation model is now being challenged as it has not resulted in any significant improvement in audit quality owing to the absence of any penal provisions against non-compliance of financial reporting lapses and submission of incorrect or false audit reports to regulators.

At the professional bodies’ level, there are inherent weaknesses as far as disciplining and enforcement is concerned.

To improve overall audit quality and restore public confidence, many countries have either established, or are intending to create ‘super regulatory or oversight bodies’ to frame accounting and auditing standards and regulate the performance of auditors.

In South Asia, Sri Lanka was a pioneer in establishing an independent financial reporting body way back in 1995.

The Monitory Board is responsible for monitoring compliance of accounting and auditing standards in relation to financial statements, as specified in the related Act, and is also empowered to impose fines.

In case of non-compliance, the courts in Sri Lanka may impose penalties extending up to five years’ imprisonment. The Chairman of the Monitoring Board is a nominee of the governor of the Central Bank of Sri Lanka.

Bangladesh is setting up a high-powered Financial Reporting Council which is currently awaiting approval by the Ministry of Law.

In India, the government is all set to establish the ‘National Financial Regulatory Authority’ which would oversee the quality of service and monitor and enforce compliance with accounting standards. The proposed NFRA would also have the same powers as vested with a civil court under the Code of Civil Procedure.

The creation of an independent financial watchdog in Pakistan would also stimulate private sector growth and foreign investments. It would allow investors to evaluate corporate prospects and make informed decisions resulting in lower cost of capital and better allocation of resources.

It would also facilitate integration into global financial and capital markets and strengthen the country’s financial architecture.

— The writer is president, ICMA Pakistan

Published in Dawn, Business & Finance weekly, April 24th, 2017