• Degree of security levels and policy of escalations.

• Interaction with process heads to understand and to obtain requisite reports from them.

• Reconciliations of MIS reports with financial data.

• Testing the effectiveness of controls by performing ‘walk throughs’.

• Verify the audit trail for critical transactions and test the result outside the system.

• To study IT policy, IT business reports, compliance status, report of external expert, etc.

• If needed, have a meeting with back office/accounting software vendors.

• To verify whether end-to-end integration, process of validations, maker-checkers are in place or not.

• Review physical securities, access logs, network accounts, remote access, no. of servers, connectivity, etc.

Creative accounting refers to accounting practices that may "follow the letter of the rules of standard accounting practices, but certainly deviate from the spirit of those rules." They are characterised by excessive complication and use of novel ways of determining income, assets or liabilities. Such innovative and aggressive ideas are also found in accounting of financial intermediaries. These ideas/practices are used for variety of reasons which include favourable effect on share prices, improved credit rating, incentive compensation plans, promises given to private equity investors, etc. Even smaller companies sometimes resort to such practices for tax planning.

The book on ‘The Financial Numbers Game’ by Charles W. Mulford and Eugene M. Chomiskey has described in details how to detect such practices. The duty of the auditor in such circumstances is very delicate. He should be in a position to distinguish fraud from error by identifying the presence of intention. Recurrence of non-recurring items, inappropriate accruals, exotic products and innovative valuations are some of the forms of creative accounting. It is said that the great tragedies of history have occurred when both parties were right. Therefore, if some accounting treatments are ‘not wrong’, the auditor should clearly spell out that "they are not right".

Accounting for Financial Instruments :

Accounting Standards, AS-30, 31 and 32 have been recently notified by ICAI, detailing recognition, measurement, presentation and disclosures of financial instruments, including derivatives contracts. These standards are set to form new rules of accounting for financial products. Fair value accounting and hedge accounting are two major departures from the principles of convertism and prudence. Though the recent U.S. economic crisis has given rise to some doubts on ‘fair value accounting’, as of now it remains on the books.

The auditor needs to obtain thorough understanding of these standards, especially for derivatives contracts. Off-balance sheet exposures, marked to market valuations, fair value identification, hedge relationships are a few of the tricky situations where the auditor needs to exercise judgment. At times, in volatile market, post-balance sheet events are very critical for framing an audit opinion. The more complex is a contract, the simpler and clearer should be its accounting entries, is a fundamental rule. Even in case of sub-prime crisis, nobody knew where the ultimate loss rests — in other words — who is bearing the loss. The auditor should understand and pierce the web of complex contracts created with the help of multi-layered corporations.

It is, I repeat, necessary to apply the standards of ‘fair valuation’.

Apart from emphasis on above specific approaches, the auditor has to give due importance to the following procedures :

• Review internal audit reports, their scope, coverage and observations.

• Review of critical operations outsourced to external agencies.

• Review of audit committee’s observations.

• Adherence to the requirements of clause 49 for corporate governance.

• Decision-making processes, whether system-based or person-based.

• Continuous review of latest Circulars, Notifications applicable to the auditee.

• Mapping of all the procedures in a sequential flow, so as to establish reliability on final output.

• Whether there is bifurcation of own funds and securities from client fund and securities at all levels.

• Rotation of audit staff and giving them adequate training and authority to conduct audit.

• Interaction with departmental heads and review of business reports.

• Do comparative analysis with other entities in the same industry.

• Verify the transactions with related parties/ group concerns.

The accounting system is currently under stress. On the one hand, creative solutions and interpretations on complex issues are put forward in the name of innovations to suit intentions and achieve objectives and on the other hand the value system is diluting.

Though the old principle of auditing, ‘Independence, Integrity, Objectivity’ coupled with competence still holds good, one needs to re-invent the audit approach. Auditor’s ‘Independence of fact’ blended with ‘Independence of appearance’ is of utmost importance to maintain public confidence and to enhance the value of audit function.

These are challenges of change. Though the challenges are tough, I have no doubt that the profession will change faster than the change and grow stronger than the challenges.

Source : Article by Mr.Bhavesh Vora, a renowed Chartered Accountant.