Spotlight on accounting standards after report
The Sri Lanka Accounting and Auditing Standards Monitoring Board has come in for high praise from various financial quarters following their tough stance taken against top companies, which failed to maintain proper accounting procedures for the year 2000 and 2001.

However, investors have been cautioned not to be hasty in choosing investment opportunities on the basis of company profits that are disclosed in annual reports. Dr. Dayanath Jayasuriya, Director General of the Securities and Exchange Commission (SEC) said that investors must make informed investments and not base their decision solely on figures that are stated in annual reports.

"A shareholder must also consider corporate governance, business strategies and the companies' past performance." He says that companies do sometimes make unusually large profits within a short period of time, and it's important for investors to find out the reason. "It could be a generator company that earns profits during a power crisis." Dr. Jayasuriya said that shareholders should attend the company annual general meeting in order to assess for themselves the true situation of the company.

Statements reliable
Head of Research for Asia Capital, Dushyanth Wijayasingha said that in comparison to foreign firms, financial statements presented by Sri Lankan companies are much more reliable. He said that the introduction of the SLAASMB has strengthened equity markets and their recent findings have brought about a positive effect. "It will certainly prove to be a strong deterrent to other companies."

The share market has always attached a discount on companies that did not maintain proper accounts. In such conditions, Wijayasingha points out the value of stockbrokers, who provide investors with timely warning and information on the actual position of a company. Since the stockbrokers have a strong interaction with the companies, they are in a better position to enlighten investors about a company's financial position.

Naren Godamune, Vice President of DFCC Stock Brokers said that these companies could begin to lose market confidence. "It's a bit too early to predict, but people will be a bit reluctant to invest in these companies." Even banks might begin to have reservations about granting loans to such companies.

Investment advisors should be adequately qualified and informed in order to educate shareholders on investment decisions, he said. The Institute of Chartered Accountants of Sri Lanka (ICASL) and the Sri Lanka Accounting and Auditing Standards Monitoring Board should exert more pressure on companies to disclose the true position of the companies. The legal process has a role to play in safeguarding the interests of investors, Godamune said.

Public concern has also mounted as to why the auditors had not qualified certain irregularities in their reports. An official from a leading audit firm said that the role of the audit firm was to examine the financial records of a company and express an opinion on its true and fair view. "Fair, does not mean one hundred percent accurate. It means that the economic value of such shortcomings, would not hugely affect the financial position of the company."

Before the accounting standards were gazetted in the year 2000, most Sri Lankan companies adopted the practice of presenting financial reports based on the Sri Lanka Accounting Standards (SLAS) and the industry practice. "Since we are in a transition period, where strict adherence to the SLAS is mandatory, I think it's a bit harsh on both the companies and the auditors who may have adopted the industry practice, in reporting their financial statements."

In connection with a common problem cited in the SLAASMB report, of not providing for depreciation of furniture and fittings, he said that hoteliers argue that no depreciation takes place since they incur large maintenance costs in preserving such assets. Thus deducting an additional amount in terms of depreciation would be understating the hotels profits, which could detract investors. "It's been the industry practice of some hotels, not to do so."

He added: "We function in a competitive market, where companies may try to overstate profits. But it's unfair to blame the auditor for it." Different persons can interpret the SLAS differently, which could also result in such errors. "It is also important for the public to remember that we are not detectives and we may not be in a position to detect conspiracies which are carefully planned," he said.

Riyaz Mihular, a partner at KPMG Ford Rhodes Thornton and Co., welcomed the SLAASMB's moves to encourage companies to use the SLAS to enhance its financial statements. Before the board was set up, audit firms could only make recommendations to companies to prepare their accounts in line with the SLAS.

With regards to the auditors' credibility being questioned, Mihular said that it is important to find out whether the impact of such non compliance with SLAS had a material impact on the truth and fairness of the company's financial statements, as materiality governs the application of SLAS.

If the auditor had deliberately overlooked the application of SLAS and this has a material impact on the financial statements, then obviously he has to explain this to the Board.

Auditors have to exercise professional judgement when expressing a company's true and fair view opinion, Mihular said. "In Sri Lanka we don't just blindly follow the rules. In the extremely rare circumstance, if an auditor feels that by following an accounting standard, the financial statements will not give a true and fair view, he has the option of using the true and fair view over-ride to accept a different method, with full disclosure of the use of the over-ride."

Mihular said that in the USA, accounting standards are rule based, which has made it possible for individuals to "groom transactions" to fall within the rules and thus deceive the investing public. To interpret a standard, the ICASL has set up an "Urgent Issues Task Force" which consists of a panel of leading accounting professionals, who would give an interpretation to a standard that is ambiguous.

In response to another common problem that was highlighted by the SLAASMB, with respect to the diminution in value of shares, Mihular said that Sri Lanka's Accounting Standard on Investments is weak and will be replaced when IAS 39 is adopted shortly. Mihular said that the basic idea of SLAS is to improve financial reporting. "There must, however, be a balance between enhancing high quality financial reporting and regulation thereof, which will make the stock market more attractive for companies to list in."

The SEC has appointed a committee to examine the role of the auditor. It remains to be seen as to what additional safeguards can be provided to safeguard the interest of the individual investor.

More power for audit committees - ACCA
The responsibilities of audit committees in companies should be greatly enhanced, the Sri Lanka branch of the Association of Chartered Certified Accountants (ACCA), the global professional accountancy body, said.

"They should be mandatory for all listed companies and should be required to report publicly on auditor independence," the ACCA said in a statement.
The audit committees should publish annual reviews on the independence of the external auditors' review and justify publicly the provision by auditors of any permitted non-audit services, it said.

Auditors should also provide more detailed information about the fees earned by auditors for non-audit services and publish annual reports of the audit committee's work including risk management and internal control reviews, it said.
The statement was in response to the findings of the Sri Lanka Accounting Standards Monitoring Board in the years 2000 and 2001 that certain firms had not complied with the standards.

"It appears that there is no hint of fraud or even an attempt to mislead in any of the nine "significant" cases found by the SLAASMB," it said. "Audit committee members should be paid adequately but their pay should not be dependent on the company's share price or short term performance," the statement said.

"With regard to corporate governance in Sri Lanka, ACCA believes that the compensation packages of senior management need to be aligned, not to short-term profits, but to the creation of long-term shareholder value."

The ACCA also said that non-executive director's need to be able to demonstrate that they are independent of the companies on whose boards they serve and under no circumstances should be paid in stock options, since this would link their remuneration to the company's market performance in the short term.

"Attention has tended to focus on the tension inherent in the relationship between the Chief Financial Officer [CFO], and the Chief Executive Officer (CEO) on the one hand and between the CFO and the Audit Committee on the other.

"It has been suggested that by improving the financial expertise of the audit committee and by enhancing or upgrading its responsibility for issues such as management of the audit relationship, one can somehow defuse or neutralise the possibility of an errant CFO embarking on aggressive earnings management schemes in order to satisfy the demands of his/her CEO."

The companies and the board
The companies that were detected by the SLAASMB to be non-compliant with the SLAS were Seylan Merchant Bank, Seylan Bank Ltd and Merchant Bank of Sri Lanka Ltd for the year 2000. In the year 2001, the board found Asian Hotels Corporation Ltd, Trans Asia Hotels Ltd, Alliance Finance Co. Ltd, Central Finance Co. Ltd, Blue Diamond Jewellery Worldwide Ltd and Kandy Hotels Co. Ltd as those that did not adhere to the SLAS.

The Sri Lanka Accounting and Auditing Standards Monitoring Board has been established by the Act No.15 of 1995. All members of the Board are either ex-officio members by virtue of holding a specified public office, or, are members appointed out of persons nominated by specified institutions such as the ICASL, CIMA and the Bar Association of Sri Lanka.

ICASL says …
President of the Institute of Chartered Accountants of Sri Lanka, Asite Talwatte said the financial services sector has a higher risk involved in terms of the inherent nature of their business, and called for closer regulation by the Central Bank.

Though commercial banks are strictly monitored, non-commercial banks such as merchant banks need to be watched a bit more closely. "Considering the amount of business failures across the world, such financial services must be regulated, because of possible implications on the economy stake."

In the wake of the Sri Lanka Accounting and Auditing Standards Monitoring Board (SLAASMB) highlighting that in some cases the auditors had not qualified certain incidents in their reports, Talwatte said, "The role of auditors is often misunderstood." Auditors only give an opinion of the true and fair view of the financial statements taken as a whole, in terms of materiality, which is termed as a reasonable assurance and not an absolute assurance, in accordance with the international accounting standards, he said.

Auditors only conduct forensic auditing or investigative auditing, only when a company suspects that there is a fraud in its accounts. An audit is not a 100 percent stamp check of accuracy. It could be likened to a routine medical check up rather than a full-scale medical investigation.

Talwatte also said that an auditor's report on a company's financial statement is aimed at providing investors and financial analysts with a reliable picture of the company's true position. "The question you have to ask yourself is, whether the auditor's decision not to qualify certain aspects in his report, would have really affected an investor's decision."

Commenting on the professional judgement taken by auditors in selecting an alternate treatment in respect of financial reporting, Talwatte said that out of the 37 standards that have been gazetted, only five or six standards have been allowed such options. "The fact that anyone can interpret the SLAS differently is unacceptable." He says that the 'Urgent Issues Task Force' coming under the ICASL, has, since its inception in 1999, made itself available to professionals, who require interpretation of the SLAS.

Companies that used industry practice in their financial reporting must be given at least two years in reverting to the SLAS, Talwatte said. Such companies must however inform shareholders and investors before making such a change.

As an institute that plays an active role in developing and setting accounting standards, industries such as hotels, if they deem necessary, can make a special appeal to the SLAASMB and the ICASL, to set up a special set of accounting standards for their industry. So far only the plantations, banks and finance companies have such special accounting standards. Talwatte said that permitting such requests would be on their justification, and in line with the framework of accounting standards.

Talwatte, though still not informed by the SLAASMB on the true facts of each case, said he is doubtful as to whether there was negligence on the part of the auditors, due to the training and skills that auditors possess.

"The role of the ICASL is to induce professionalism in auditors and accountants." The ICASL has been instrumental in updating its members on the current developments in financial reporting, by issuing standards and procedural manuals to its members. The institute also conducts regular seminars and workshops for its members.

When asked as to what type of action the institute plans to take in connection with the SLAASMB's report, Talwatte said that the ICASL has the power only to regulate its members. If a complaint is made against a member, and he is found to be guilty following an inquiry, he can be reprimanded, fined or suspended from the Institute, under the Chartered Accountants Act.

Talwatte however believes that it would be unwise for the ICASL to overreact under the present circumstances. He said: "Our role is to improve the standard and the objectives of the accounting profession as a whole."

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