The
fraud committed by Ramalinga Raju, the CMD of Satyam Computers Ltd, the fourth
biggest software exporter in India ,
has attracted the attention of the investors world-wide. What has surprised the
investors in general is the fact that the fraud was committed over a period of
seven years without absolutely attracting any attention of a highly reputed
international audit firm like PWC. Added to this was the fact that the internal
audit department of the company was given an international award for
maintaining excellent standards in its audit functions!
While
the normal external audit of a company involves following certain procedures,
well-documented, as per the requirements of the Indian companies act and
followed rigidly by the chartered Accountant firms in general, the guidelines
for the internal audit vary in different companies depending on the risk
factors assessed over a period of time. While it is difficult to make out as to
where exactly the internal audit failed in playing its intended role in Satyam,
one conclusion could be easily arrived at. That is - it failed to cover three
most important basic assets of the company - the cash/ bank balance, deposits/other
investments and the debtors! If only the internal auditors and the external
auditors had just covered these three major current assets of the company just
as a matter of routine, the story could have been totally different today.
Before
we go into the methodology to be followed while looking at these items during
external/internal audit, let us first analyse how the audit of a software
company is different from that of a manufacturing or a trading company. It may
be noted here that the major portion of revenues of software companies are
derived out of exports. But here again, the aspects to be audited are much
simpler unlike in case of a merchandise exporter. The exports are invisible and
are devoid of shipping documents, duties, customs clearance, insurance
coverage, licensing requirements etc. In general an auditor of a software
company enjoys the luxury of having no responsibility to audit the following:
1. There is no burden of physical
verification and valuation of inventory, which is a major head ache to the
auditors, particularly the work-in-progress.
2. There is no need to verify insurance
coverage, identifying the non-moving stock and verification of under/over
invoicing of finished stock etc.
3. As no bank finance is involved,
it saves the burden of verification of interest charged by the bankers, etc.
Let us now come to those aspects
which the external auditors should have covered in the normal course for a
software company like Satyam.
The
Receivables
The first and the foremost is the
portfolio of receivables or book debts. The performance of a Software company
depends mainly on the velocity of liquidation of receivables it raises in its
books against its clients. The company will have several clients who have
entered into long term contracts with it. The terms of payment are specifically
mentioned in the relevant agreements. The billing (raising of book debts) is
also done in the books of the company in accordance with the specified payment
terms. Once a bill is raised and sent to the clients, the company should follow
up for payment as agreed by the client. There may be several clients for whom
the company may be executing individual projects. Here again, the billing may have to be done
progressively or only on completion depending on the terms agreed for the
individual projects. There may also be many clients for whom the company may be
lending services of its employees (body shopping). In such cases the billing is
done on the basis of number of employees and number of hours worked. The
billing in such cases is generally done on a monthly basis.
The auditors’ role here is cut out
as follows:
Ø
Verify
whether bills are raised promptly and correctly as per terms of contract.
Ø
Verify
whether payments for the bills are received in full as agreed and in time.
Ø
Whether
there is a proper monitoring of overdue bills, if any?
Ø
Whether
the overdue position is escalated to the appropriate authorities?
Ø
In
case of delayed payments whether there is any system of collecting penalties or
overdue interest? Whether such matters are escalated so that the decision is taken
at the right level?
Ø
Whether
the total outstanding book debts are in tune with the industry standards?
Ø
Whether
any bills have been raised without the backing of relevant agreements or
contracts?
Ø
Whether
the bills have been raised for higher amounts to show higher revenues in the
books? This aspect is to be focused more for the last quarter of the financial
year.
Ø
Are
there any instances where the payments have been received, but the bills are
allowed to outstand intentionally?
Ø
In
case advance payments are made as per contract terms whether the same are
adjusted as agreed while raising the bills?
The
bank deposits/other investments
Most of the top Software companies
generally have huge cash reserves in their books. The companies may use the
cash for expansion of business and/or acquiring other companies or liquidate
the same by paying huge dividends. Till such time the money has to be parked in
liquid securities like bank deposits/mutual funds/short-term bonds. A small
percentage of cash may be held in bank current accounts also to meet the
exigencies. The auditors’ role boils down to:
Ø
Verification
of whether the investments made are in line with the company’s investment
policy.
Ø
Verification
of the physical securities in full covering bank deposit receipts, mutual fund
certificates/demat accounts and bond certificates.
Ø
Verification
of receipt of periodical interest on the deposits and bonds and dividend in
case of mutual funds.
Ø
Verification
of certificates of tax deducted at source by the banks on the deposits held
with them.
Ø
Verification
of whether the company has taken into account such tax deducted at source while
arriving and remitting advance tax for the year.
Ø
In
case if the total tax deducted is exceeding the total tax payable by the
company, whether refund of such excess tax deducted at source is sought from
the tax authority?
Cash
and bank balances
The auditor’s will have the
following aspects to be covered:
Ø
Whether
the petty cash held by the company offices are reasonable with the business
needs?
Ø
Whether
the balances held in current accounts are reasonable? In cases of huge balances
the reasons are to be ascertained as such balances do not earn any interest to
the company.
Ø
Whether
the bank statements are received periodically and reconciled with the company’s
books?
Ø
Whether
the unreconciled items if any are followed up with the bank and reconciled at
the earliest?
Ø
Whether
there are any huge withdrawals from the accounts not connected to the normal
business of the company? If so the beneficiaries are to be ascertained to see
whether there is any diversion of funds.
The auditors have to
ensure that they cover all the bank accounts. They are also expected to
directly call for balance confirmations (certificate of balances) from the
concerned banks to ensure that the company has not manipulated the bank
balances and deposits in its books.
Conclusion
The
letter of Ramalinga Raju, CMD, mentions three major areas of manipulation in
the company’s books. They are cash and bank balances, debtors and non-existing
accrued interest. It is also being reported in the media that fake bank deposit
receipts and certificates of tax deducted at source were produced to the
auditors for verification by the company.
It
is apparent from the above mentioned check points that the fraud in all the
above areas including non-existent accrued interest could have been easily
detected by the auditors if only they had followed the check list thoroughly.
However, it may be interesting to find out as to how Raju could raise Rs1,230 crore
without accounting the same in the books of the company. The margin of only 3
percent mentioned by Raju also raises major questions. We have to wait for the
completion of the enquiries to know the ‘modus operandi’ followed in one of the
greatest corporate frauds ever committed in India .