Thu. Oct 22nd, 2020

by Avantha Munasinghe

One of the contentious issues surrounding the 20th Amendment seems to be the issue of the removal of Auditor General’s capacity to audit companies where the Government, Public Corporation or a Local Authority has a majority shareholding. Many critics seem to have picked on this issue, and most of them are resisting the proposed change. Their fear seems to be that if the Auditor General is not permitted to audit a certain government company, it is prone to be riddled with corruption and malpractices.

The audit by definition is a systematic and an independent review and investigation on certain subject matter, which in this case is the financial statements, management accounts, management reports, accounting records etc. of a company. In the case of a company, there is a statutory requirement for such review and investigation to be reported to shareholders annually. The review, is produced as an “opinion” of the “Auditor”.

Other than the shareholders, it is also customarily used by the tax authorities, banks, creditors, analysts or public for their respective decision-making and also to form their own opinion about the status of the company and its future. In all the government companies, the law required them to be audited by independent auditors, qualified to do so as specified by the Companies Act, until 2015. The 19th Amendment changed their auditor to be the Auditor General.

Auditing, just like Accounting, depends on certain commonly adopted set of principles. The audit of financial statements is normally done in accordance with International Standards on Auditing sometimes modified by local auditing standards. In Sri Lanka’s case, the Sri Lanka Auditing Standards are based on the International Standards on Auditing (ISAs) published by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC), with slight modifications to meet local conditions and needs. Thus, to begin with, whether it is the Auditor General or a private auditor, the standards applicable to the task are the same. It is the approach that is different.

There are a large number of companies in Sri Lanka whose shareholding in some way is linked to Government or quasi government entities for whom Auditor General has now become the Statutory Auditor. Some of these companies are merely an extension of government entities serving a function of the government. For example, Rakna Arakshaka Lanka Limited is a government-owned company, providing security services to government installations. Another is Ceylon Petroleum Storage Terminal Ltd., whose only customers are its parent entities i.e. Ceylon Petroleum Corporation and Lanka IOC PLC, only to whom it provides services. Such entities do not have to face competition to secure business.

However, there are also a large number of government-owned companies which do business in the marketplace competing with other local and international companies, which are publicly and privately owned. Lanka General Trading Company Ltd., Lanka Hospitals Ltd., Sri Lanka Insurance Corporation Limited and Milco (Pvt.) Ltd., are a few examples. Each of them has to compete for business with large segment of local and foreign companies which are purely driven by profit motive and enhancement of shareholders’ value.

These companies have very flexible systems and procedures. Their boards of directors can take appropriate decisions in a timely manner to make an urgent procurement or select suppliers to be more competitive and manage all their affairs just in time. They can buy their raw materials without calling for quotations if they think it is a profitable opportunity. Even a junior level executive of such a company may be able to decide a price discount to secure a sale.

The situation of a state-owned company in the marketplace in such scenarios is quite the opposite. They cannot do procurement as the situation demands. They have to dutifully follow the procurement rules, which even the board of directors cannot overrule. The officials have very little flexibility to seize a business opportunity. It is so easy for a private company to grab business from state-owned enterprises as the latter cannot be proactive. There is little surprise most such companies are loss-making and is a burden to the government and taxpayers.

The government officials and Ministers however want these quasi state organizations to be profitable or run at least without being a burden to the Treasury. The basic business model of these organizations is at a severe disadvantage to begin with. What 19th Amendment brought to such companies by way of auditing by the Auditor General was to push them from pillar to post. This is quite evident by the powers granted to the Auditor General in the National Audit Act, which even a crime investigator would envy. Some of the powers are:

(1) The Auditor-General shall…

… access or call for any written or electronic records or other information relating to the activities of an auditee entity;

… call any person whom the Auditor-General has reasonable grounds to believe to be in possession of information and documents, as he may consider necessary to carry on the functions under this Act, to obtain written or oral statements and require the production of any document, from any person, who may be either in-service or otherwise;

… examine and make copies of or take extracts from any written or electronic records and search for information whether or not in the custody of the auditee entity;

… after obtaining permission from the relevant Magistrate’s Court, examine and audit any account, transaction or activity of a financial institution, of any person, where the Auditor-General has reason to believe that money belonging to an auditee entity has been fraudulently, irregularly or wrongfully paid into such person’s account;

…require any officer of financial institutions to produce any document or provide any information relating to an account, transaction, dealing or activity of person referred to in paragraph (d) and to take copies of any document so produced, if necessary… There is a fundamental difference in the audit approach of a professional auditor and a Supreme Audit Institution such the Auditor General. In a private sector audit, the primary objective is to ensure the report’s recipient gets a true and fair view of the financial status of the company. While the professional auditor is supposed to report on adequacy of the controls in place and report any lapses to shareholders, the focus is primarily on the status of the shareholder’s investment.

The approach of Auditor General is more on ensuring the Compliance to rules, regulations and procedures. This is natural since the Auditor General is supposed to audit the manner in which a government organization has handled its allocation from the consolidated fund to provide a service to the public. The approach is, therefore, not focused on whether the organization is making adequate return on the government’s funds.

What the 19th Amendment did was to replace the professional auditor, who focused on performance of government companies by the Auditor General who is focused on compliance. The officers running such government-owned companies got a signal quite contrary to what the government officials and ministers were pushing them before. Compliance became the key. There is no better way to achieve compliance than to do nothing. The truth is in the last few years; these organization put profit motive in the back burner and wanted to escape from various audit queries raised by the Auditor General. The best way to do that is not to go that extra mile their competitors would go to make the organization profitable. Doing nothing became the modus operandi.

Some of the supporters of Auditor General’s auditing argue that his mere presence stops corruption. Stamping out corruption was the all-pervasive theme of the 19th Amendment. So many new entities were instituted under it to check corruption. Where are we today? Do we see any positive results? In the Corruption Perception Index published by the Transparency International in the year 2015, when the 19th Amendment was enacted, Sri Lanka’s scored 37 out of hundred. In 2019, our score was only 38. We rank 93 out of 198 countries, four places down. It is no secret that the public perceives state sector organizations as corrupt as ever and certainly more corrupt than any private sector organization in this country. The Auditor General has been auditing these state sector organizations for more than 200 years. If the cure against corruption is audit being done by the Auditor General, why are we in this situation today?

The truth is the Auditor General’s presence is a necessary evil in any government ministry or department, which does not have a commercial objective. His presence does ensure at least some level of corruption is made more difficult to accomplish. However, we must not come into the false conclusion that the presence of the Auditor General is the way to root out corruption. In a State-Owned Enterprise (SoE) with commercial objectives, his presence certainly does more harm than benefit.

There is a wrong perception that most public companies are loss making and, therefore, they should be subjected to an Audit by the Auditor General so that the “control” of public funds will put things right. As explained above, it is the business model and restrictions placed that is the very cause for loss-making SoEs to proliferate. If this argument is correct, we should see, out of more than 120 or so government companies, at last one which became profitable due to the Auditor General’s presence during last five years. There is none to show. In fact, this remedy will only make the patient even more sick.

Another untruth floated on the matter is that the financial statements of the government companies are not required to be submitted to Parliament unless they are audited by the Auditor General and that would undermine parliamentary financial oversight. The truth is that the entity, which is the shareholder in these companies, have to consolidate the company’s financial statements with that of the parent entity and the latter is certainly subjected to parliamentary oversight with financial statements of the company audited by a private auditor.

Another misconception is that supervision by COPE will put everything right in the public institutions. COPE’s examination carried out by set of parliamentarians, who on most occasions have no knowledge of the particular business, is not what is required to put these organizations right. In most cases it is the bad business model rather than lack of COPE’s oversight that fail these businesses.

SriLankan Airlines is a case of point. Many people say the bad procurement deals, continued losses and increased dependence on the Treasury by the airline would continue to happen if the Auditor General is not auditing the airline. It was making losses ever since it was set up with or without Auditor General as the auditor. The Airline business is one of the most competitive businesses globally. Even the largest airlines sometimes find it difficult to be in the black. The industry needs split second decisions to be made by professional management. As said before, this is not possible at SriLankan Airlines. We have seen Chairmen and Directors coming and going with every change of the subject minister. Nobody is having a long-term commitment to make it a success. Its competitors have boards, which are removed only if the airline makes losses, not if their political masters change. Without changing the business model, even if we have hundred auditors to audit SriLankan Airlines, nothing will change.

We all know that our country is suffering from a severe debt crisis. We invested on massive infrastructure projects, which were all debt financed. To balance that off, we desperately need to bring foreign equity into our economy. Further debt, while giving us temporary solace, will only aggravate the problem. The government is devising Public Private Partnership (PPP) programs to bring Foreign Investment from large global corporations. The government also needs to be in control of them. The 19th Amendment requires such PPP companies to have the Auditor General as its Auditor. Which global business entity would drop their global audit arrangements by the likes of KPMG, Ernst & Young or PwC and accept this arrangement? We can talk till the cows come home on how professional our Auditor General is and how independent he is, but the reality is that we live in a dream if we seriously want to promote PPP structures with this kind of legislation on.

The effective functioning of Superior Audit Institutions such as the Auditor General is definitely an essential requirement of a functioning democracy. However, let’s not fool ourselves – it is not a panacea for all ills.

Even in India where the previous Companies Act required the appointment of Auditors to Government Companies by the Controller and Auditor General of India, the arrangement has been questioned in the Report of the Expert Committee On Company Law, which said “The Committee discussed the application of the corporate law framework to Government companies on many occasions and took the view that in general, there should not be any special dispensation for such companies. …Therefore, the extension of special exemptions and protections to various commercial ventures taken up by Government companies in the course of their commercial operations along with strategic partners or general public should be done away with so that such entities can operate in the market place on the same terms and conditions as other entities. In particular, reflection of financial information of such ventures by Government companies and their audit should be subject to the common legal regime applicable. The existing delays are enabling a large number of corporate entities to evade their responsibilities and liability for correct disclosure of true and fair financial information in a timely manner. In this context, the relevance of the present section 619B of the Act was considered appropriate for a review.”

If the government needs its companies to compete with private sector, the way forward is to make their management more flexible. Throwing those decision-makers to the Auditor General is the last thing required to be done if we want them to compete effectively with the private sector. While the world is moving to embrace the scarce private capital by making things easier for such investors, some of our so-called professionals seem to be, while paying lip service for bringing more and more FDI, doing exactly the opposite by criticizing the removal of this disastrous piece of legislature brought in by the 19th Amendment.

(The writer is an Accountant based in New South Wales, Australia)

Source

By Editor

Leave a Reply

Your email address will not be published. Required fields are marked *