Policemen stand guard at the Satyam headquarters in Hyderabad. (Reuters)

Mumbai, Jan. 14: Whether it was the dissolution of Arthur Andersen after the Enron accounting scandal or, closer home, questions about Price Waterhouse’s conduct in India’s largest corporate fraud, the role of the auditor is increasingly coming under the scanner.

Prima facie, it is rather surprising that Price Waterhouse, a firm of international repute, failed to detect that books were being cooked at Hyderabad-based Satyam Computer Services for possibly 34 quarters in a row.

It is even more mind-boggling considering the nature of the fraud. Cash balances are easy numbers to audit and it’s difficult to believe that an auditor certified some thousands of crores of cash lying in bank accounts that apparently did not exist at all.

However, the role of an auditor is separate from that of an investigator.

“The whole world is under an illusion that auditors will offer full verification and integrity of company; 99 times out of 100, auditors will not be able to detect a fraud,” said a partner of one of the Big 4 accountancy firms operating in India on condition of anonymity.

The reason is that typically, auditors rely on data and financial statements prepared by the company, conduct sample checks and look for compliance of accounting standards and procedures. The entire exercise is completed in a period of roughly three months.

“Auditors do not prepare financial statements. The extent of their statistical study is slightly more than an investment banker,” said Ernst & Young director Jayesh Desai.

Auditors put out these disclaimers as they verify the books of accounts of their clients. So how are audits done?

Typically, the partner sends out his audit team to the company where an audit programme is prepared outlining how the checks will be conducted. The team then verifies the documents presented by the company.

It makes some checks on different items like sales, cash, inventories, assets and liabilities among others. For instance, an audit may pick up the top five customers of a client and check sales invoices or, in a service industry, compare how many hours an employee has worked compared with the industry average.

If the auditor is not satisfied, he will generate queries, hold discussions with the senior managers of the company and incorporate corrections. If the company does not comply with the changes suggested, the auditor qualifies the report generated by him. These processes are verified by the partner at various stages and thereafter reviewed at the audit partner’s office.

Are the auditors’ actions audited? The Institute of Chartered Accountancy of India (ICAI), the regulatory body that governs chartered accountants in India, does that through peer reviews where the quality of the audit is examined.

“However, the peer review is not a re-audit. Therefore, it is not an investigation at all,” clarified Kamlesh Vikamsey, partner of chartered accountancy firm Khimji Kunverji & Co. and former president of the ICAI.

Auditors may not be investigators and the institute does not conduct re-audits, but the recent Satyam fraud will force the chartered accountancy community to tighten its checks and balances. “It’s clear that firms will become vigilant and thorough with their verification processes after this event,” said Vikamsey.

The ICAI has set up a committee that is examining this fraud and may come up with a fresh set of rules to tighten the present systems of audit. For instance, the period that a partner is responsible for an account — seven years at present — may be brought down.

Market regulator Sebi has already decided to institute a peer review of listed companies. A concerted effort by auditors and regulators may not ensure that frauds are erased in India Inc. but they are likely to prove to be an effective deterrent.