The Satyam Fraud-Role of the Auditors

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.