Audited financial statements are at the core of every lender’s credit assessment process and the backbone of lending proposals at banks. Suffice to say, lenders heavily rely on the veracity of financial statements.
One would assume that being this critical, the firms that produce them would be comprehensively regulated, like in other parts of the world. Many countries have powerful regulators and stringent requirements governing the audit industry. Their oversight focuses on the following.
First, they prescribe exacting criteria for firms to register as statutory auditors, with varying levels of stringency, depending on the types of companies audit firms cater to. Second, they have rigorous systems of monitoring the performance and work-quality of audit firms. Third, they have in place robust methods of investigation to ensure discipline, in case of reported malpractices etc..
And lastly, they also assume responsibility to establish auditing and professional standards across the industry.
Despite this, frauds, collusion by audit firms - even by reputed ones - and misrepresentation occur with monotonous regularity. However, it is extremely disquieting to note no such regulatory authority exists in the UAE.
This basically means that the audit industry is unregulated (but licensed), leaving auditors to do as they please, reliant purely on self-regulation. Self-regulation is obviously apposite only to those who have a reputation to protect and whose business is particularly susceptible to reputation risk.
The others, perhaps making up 90 per cent of the trade, are not bound by any scruples. The result – nobody (other than hapless lenders) questions the quality of audited financial statements, no discipline is enforced, no punitive action taken, no common standards set and nobody collectively blacklists errant auditors. Simply put, auditors have run completely amok, unfettered and non-superintended.
Naturally, this state of affairs affects lenders the most. A not insignificant portion of the blame for the lending crisis that occurred in the UAE between 2015-17 must be borne by sub-standard and low- grade auditors, who constitute the majority. While business owners and CFOs of companies who fabricate accounts are the root cause of the problem, it is difficult and perhaps pointless to differentiate between inept or incompetent auditors and plain dodgy ones who, knowingly or otherwise, fabricate accounts of clients.
It doesn’t matter if an audit firm is unqualified or incapable, or whether it is mixed up in the fraud of business owners. The end result is the same and lenders are utterly misled.
The number of audit firms in the UAE has burgeoned as a result of undemanding criteria for a licence. The majority are bucket shops, conducting audits for as low as Dh1,000 and churning out audited financial statements in a day. An auditor is supposed not only to verify the accounts they certify, they are also expected to test the underlying processes that determine the production of accounts by their clients, apart from other checks.
It does not take much to surmise that at such low fees, audit firms cannot afford an adequate number of staff, or the quality required to do justice to the audit process.
The industry is rife with malpractices. Here are only some instances. We hear of unqualified people conducting “audits”, producing audited financial statements that are then taken to dodgy licenced firms that issue the same accounts as audited statements. There are other audit firms who act as book-keepers and finance managers, and issue audited statements for the same client, resulting in a heady conflict of interest.
A third example is of audit firms being involved in arranging bank finance for their clients, in addition to auditing the latter’s accounts. Obviously, the motivation to produce inflated and duplicitous accounts will be singularly high. Audit firms operating at the bottom of the food chain also simply cannot afford to train their staff in the latest developments in accounting standards – the implementation of the latest IFRS directives, for a start.
Another aspect of this sordid situation is the fight for survival - competition has become so acute in this trade that not only are corners vigorously cut, auditors vie with each other to concoct increasingly creative solutions to facilitate the manipulation of accounts.
I think the picture is starkly clear. However, what is surprising is the lack of oversight this industry suffers from could have been compensated for by the banking industry taking an unified approach to the problem. Or the UAE Banking Federation taking a leading role. Sadly, this has not happened.
Banks do not appear to have processes to rate auditors and most have “approved lists of auditors”, which are not discerning in any manner. Neither has any effort been made to develop a common ratings methodology that could be applied to banks. Nor has a common blacklist of auditors shared between banks.
This is a breach the UAE Banking Federation ought to have stepped into.
Regulation of this industry is a necessity and will only serve to instil more confidence in lenders, which will play a catalytic role in stimulating growth. The government has taken excellent steps in creating growth-oriented initiatives over recent weeks. Addressing the issue of auditing could be yet another such initiative.
Vikram Venkataraman is Managing Director of Vianta Advisors.