A Book Review: Bullshit Quotient

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Ranjeev Dubey’s recently published book “Bullshit Quotient” (I am literary correct, and haven’t resorted to swearing on my blog) pulls the wool from the eyes. The lines in the introduction pages are – “Absurdly, in our cultural fabric, spotting the little lie is a skill called wisdom; spotting the big one is a sin called cynicism”. Hopeful idealists, who believe the world will become a better place to live, will be disillusioned and disheartened reading this book. The jaded cynics will find it provocative, amusing and ruthless. If you are willing to get your rose-tinted glasses peeled off, then read this book.

Ranjeev, an attorney by profession, wrote this diatribe on Indian corporate, legal and social world to call a spade a spade. It is rare in India, that an author chooses brutal honesty over the delicate footwork of political correctness and diplomacy. Below are my three main takeaways from the book.

1.      The Cost of Economic Growth

Fittingly, Ranjeev has narrated the excessive cost of industrialization paid by economically backward and tribal communities (Adivasis) of India. Government on the pretext of acquiring land for development, irrigation etc. has made millions homeless. Without farming land and an education, these poor people have become slum dwellers in cities, and do menial tasks to make a meagre living. Those outraged by the injustice meted out to them, have joined Naxalite groups and terrorist organizations. Their anger has led them to a path of self-destruction, as after a couple of years they are either shot down in a police encounter or spend their life in prison. The urban class is completely apathetic to their plight,  as they are focused on catering to their latest self-indulgence.

Nearly one-third of Indians live below poverty line, and India cannot become a powerful nation unless these poor people start earning  a reasonable standard of living. Two big ones are required to change the situation. The anarchic land acquisition act needs to modified to give a fair price to land owners. Political will has to be strong to re-locate the displaced people.

2.      Dependence of Independent Directors

Ranjeev has raised the same question as I did before – Are the independent directors really independent. Ranjeev’s strong opinion  is – “In truth, independent directors are wall flowers, perching uneasily on the tenuous board seat, good to topple any time the promoter choses. They can’t protect themselves, leave alone the small shareholder”.

Aptly described; the independent directors appointment and continuance is dependent on the good will of the promoters.  They are not in a position to take a strong stance, as they will be labelled troublesome and jeopardize other appointments. Even well-reputed industrialists sitting on other company boards restrain from rocking the boat. In the elite club, no one wishes to spoil the business equations. Hence, it is just a mirage that independent directors are the bastions of corporate governance and will defend small investor interests.

3.      Auditor Role in Fraud

Objection, my lord; here, I beg to differ. Ranjeev has rightly pointed out auditors primarily responsibility is not to detect frauds. Auditors cannot be held responsible if a fraud remains undetected. But there are two statements, where my readers will have to defend the auditor’s reputation. Below are the extracts:

“It is not the auditor’s job to get into the details of books, records and documents. It follows that the auditor’s only job is to take a leisurely glance at the papers of the company puts before the auditor while daintily picking the sumptuous kebabs over the working lunch at the company’s office.” The lunch dig is true, it happens in India but auditors have to bury their noses in the books of accounts of the company.

The second one is more disparaging –

“He does not understand the company or its business, does not understand the environment in which the company operates and does not understand what is going on in it. His job is to look at the books and create more papers. Auditing is about reconciling paper trails, not truths.” Whoa, if an auditor hasn’t got his fundamentals right, then most probably he is delivering this poor quality work. Auditors need to figure out how to break these negative stereotype images and get appreciated for the value they offer.

Closing Thoughts

As we are given a choice between being an optimistic idealist and pessimistic cynic, I choose the former. Idealists are happy, cynics’ worldview is miserable. Nonetheless, we can’t ignore the atrocities, injustices and differences in our world. An idealist is better equipped to bring about a change, when the plans are grounded in reality. If reality stinks, we have to acknowledge and accept it before we devise a strategy for change.

This book describes the smelly portions of our society, which we want to close our eyes, ears and nose to. Besides it, the book has amusing wordplay. Here is line I liked – “Of all the bibulous ballyhoo that emerges from the loquacious lips of corporate kookaburras, the weirdest is the idea that the business of a company is delivery of value to its customers.”

Win the Book – Enter the Competition

Share your opinion here. If you agree or disagree with Ranjeev, come forward. You can win. Ranjeev will select the best comment and the book will be yours. Ranjeev has also offered to give a response to your comments. His response and the best comment will be posted on 17 October. Mind you, you will get a good defense; he is an attorney by profession.

You can visit Ranjeev’s website at www.ranjeevdubey.com

Building Trust Between Auditors And Business Teams

As we know, management is about formal authority, whereas leadership comes from moral authority. Leaders derive moral authority when followers trust them. Hence, the crux of people management is building a relationship of trust.

Auditors and risk managers face some serious challenges in building trusting relationships with business teams. Frequently, when the business teams hear an internal auditor is coming to meet them, the reaction is – “Why is he coming? When will he go?” Auditors are unwelcome, as business teams view them suspiciously. The relationship is as healthy as that of a divorced couple sharing parenting responsibilities. Aha, we base marriages on trust and it reminds me of this one.

A man took this beautiful finance to his attorney to sign the pre-nuptial agreement. The attorney looked her over, smiled and asked the man – “Do you trust her?” The man replied – “With my life, but why bet my money on it”.

As is obvious, the trust levels are deteriorating in most relationships. However, auditors and risk managers cannot use that as an excuse.  Internal auditors enjoy very low confidence level with business teams. A recent PWC State of Internal Audit survey stated that just 45% of the respondents were comfortable with internal audit’s management of critical risks, though 74% had enterprise risk management in place. Another point to note was less than 50% believed that their internal audit function was well coordinated with risk management functions. The scenario is dismal; there are communication gaps with business teams and risk managers. The focus has to be on building better relationships.

Auditors must look at David Maister’s trust equation. According to him:

Trust = Credibility + Reliability+ Intimacy

                                 Self-Orientation

Let us see how the four elements affect auditors’ relationships with business teams. More important is to determine a way to build trust-based relationships instead of transactional relationships.

1.  Credibility

 Establishing credibility is about meeting technical and emotional aspects. The technical knowledge of auditors and risk managers qualify them guide the business teams. If they lack relevant qualifications, experience and knowledge, the relationship of partner, mentor and advisor is doomed. However, all the knowledge and experience will fail if the business teams believe that auditors and risk managers do not walk the talk.  An auditor cannot pile on the free launches offered by business teams, and in the same breath talk about ethics. Here, to build trusting relationships, each auditor and risk manager in the team has to establish personal and professional credibility.

 2.   Reliability

People need to know where a person stands on various issues to develop a comfort level. They need to perceive the person as predictable, just, fair and ethical in his/her dealings. The business teams fear auditors and risk managers; a politically motivated report can build up a storm. The principle of issuing accurate, apolitical and balanced reports goes a long way in building a reliable reputation.  Without it, there is going to be a fight, us against them mentality with prevail between business teams and auditors. The win-lose situation created will result in  business teams viewing auditors and risk managers as the bad boss archetype.

3.   Intimacy

 This is about sharing confidences and deepest darkest secrets about the professional life.  This is not about personal life. An auditor and risk manager delve into the negative side of business – identify shortcomings and high-risk scenarios. Depending on the organization culture, these findings have an indirect impact on career development, promotions, compensation and hiring and firing of business teams.

Hence, business teams will stay silent and it is not enough for auditors to say – “I have an open door policy”. Ethan Burris in his research found that – “employees who speak up and challenge the status quo are viewed as less competent, less dedicated to the organization and more threatening compared to those who support the way things are. They are also rated as worse performers, and their ideas get less support.” No one is going to open up and identify the real risks and concerns, unless some level of intimacy is established. Hence, auditors and risk managers need to show emotional honesty to break down the barriers of communication.

 4.  Self-Orientation

 When people view a leader entering into relationships primarily to serve his/her own self-interest, then this denominator will wipe out the positives of the three elements in the numerator. The use and discard policy of transactional relationships causes engagement and commitment to plummet. In this case, as Burris says – “It can be scary to open up the lines of communication, because you don’t know what’s going to come out of it.” Thrusting relationships will not form when business teams perceive risk managers as serving their own agendas at their cost to win brownie points and laurels. They need to be transparent, altruistic and balanced in their approach.

 Closing Thoughts

 An auditor went to do a stock take of a weapons factory. The inventory manager hated the auditor. In the previous report, auditor had made many disparaging comments about the manager’s work. This time, the inventory manager in a pleasant voice said to the auditor –“Please don’t touch this, it is dynamite. The manager held the next bin and the manager said – “Oh that is just anthrax”.

Rather than face a similar situation, it is much better to follow Blaine Lee Pardoe’s advice – “When people honour each other, there is a trust established that leads to synergy, interdependence, and deep respect. Both parties make decisions and choices based on what is right, what is best, what is valued most highly.”

 References:

  1.  PWC- State of Internal Audit Survey
  2.  David Maister – Trust Equation
  3. HBR – What is really silencing the employees – Ethan Burris

Impact of Roubini’s Perfect Storm Predictions on India

Indian economy is not doing well. It grew at just 5.5 percent in the June quarter. The slow growth continues from last quarter, and the rapid economic growth of the last decade can no longer be taken for granted. The political paralysis, frequent corruption and scam charges, and inability to pursue  reforms has all led to this sorry state of affairs. This week with much fanfare reform guidelines for foreign direct investment in retail and aviation were released. Let us see whether they make a difference in the long run.

The area of concern is that economist Nouriel Roubini dubbed ‘Dr Doom” for predicting 2008 financial crises, recently predicted a global perfect storm in 2013. He highlighted five factors that will derail the global economy.

If India’s internal problems continue and Roubini’s predictions become real, the dream of India becoming a super power by 2020, may just remain wishful thinking.  As there are divergent views on India’s growth story, let us take a look on the impact of these factors on Indian economy and growth.

1) Worsening debt crises in Europe

The European crises is more than a spanner in the wheels, it has the capacity to bring the global economy to its knees. With Greece, Ireland and Spain in doldrums and economist predicting a breakdown of Eurozone in near future, things couldn’t be worse. London and other euro cities are home to the biggest financial institutions and extensively interconnected with the rest of the world. The combined economies of Eurozone is the second largest in the world, hence anything going wrong here will impact the rest of the world.

A recently released FICCI report states that – “Indian companies doing business or which have invested in Europe have been adversely impacted. About 75% respondents said they have reported decline in their business prospects and also a loss of over 20% in business generation from the European region.” If a full-blown breakdown occurs, then Indian economy will definitely suffer. Though, a lot has been said about European institutions working together to bring financial stability and governments having the political will to take corrective measures, it seems doubtful. Good economies, Germany for one, may back out as its citizens may not wish to carry the burden of other countries.  Hence, Indian companies are spreading their business in Africa and Middle-East to counter the downturn of Europe.

2) Tax increases and spending cuts in US that may push the country in recession

Barack Obama inherited an economy in crises. Though the financial crises is over, the economy will take a few years to recover. Last six months economic indicators show progress . The annualized growth rate is ranging between 1-2% in 2012, a major improvement from -7% in 2009. The unemployment rate is around 8%, and property prices have risen in the last six months after 5 years.

As neither Barack Obama nor Mitt Romney has a magic wand, the possibility of US going in recession is high, specially as it is highly linked and dependent on Europe. For India, a US recession is firstly bad news for the outsourcing industry. Obama and Romney, both in their election campaigns have targeted Indian outsourcing business as the source of all problems prevailing in US job market.

Though Indian software industry exports were US $ 101 billion in revenues in the year ended March 2012, NASSCOM has stated difficulty in predicting Indian software exports for more than two quarters in uncertain conditions. India exported  merchandise goods to US for $57.8 billion in 2011 and is growing. Since majority contributions are of textiles, stones etc., the impact of recession  isn’t significant.

In respect to FDI’s, receives investments through Mauritius, Singapore etc and “According to the latest data released by the Department of Industrial Policy and Promotion (DIPP), India received foreign direct investment (FDI) worth US$ 1.33 billion in May 2012 while cumulative inflows for April-May 2012-13 stood at US$ 3.18 billion”. Hence, the impact of US recession on Indian FDI will not be significant.

India in all likelihood can survive a US recession without much impact on a stand alone basis. With Europe also spinning out of control, the scenario changes.

3) A hard landing for China’s economy

Chinese economy over the last two decades flourished with high investment in infrastructure projects and low manufacturing costs. It imported capital goods, though not consumer goods, and domestic consumption didn’t increase much. Now growth forecasts are in single digits, and focus has to shift internally due to the Eurozone crises and US recession.

As Satyajit Das mentioned in a recent blog post, the world is divided into two groups with respect to China – Sino-philia and Sino-phobia. Some pro-China model believers think China is set to become a super power. On the other hand Sino-phobic believe China is out to control the world. Hence, the perpetual predictions of China succeeding and failing. However, Das has pointed out rightly in the following words –

Nothing illustrates this better than Chinese income levels. Despite its status as the world’s second largest economy, China ranks 98 out of 181 nations in the World Bank’s ranking of GDP per capita. Based on forecasts, wealth per capita in 2016 will be only equivalent to US$13,700 against $57,300 for the US and US$48,000 for Germany. This does not take into account the massive income inequalities in China, where a large portion of the population lives on less than US$1.25 a day.

China and India suffer from the same problems of huge income disparity, over-population and poverty. The corruption in the government further distorts the situation. If Chinese economy slows down, the disparities will continue and China will have to focus internally. It does give an opportunity for India to takeover but it depends on India straightening out its internal act.

4) Further slowing down of emerging markets

The BRICS – Brazil, Russia, India, China and lately South Africa – in the last decade showed tremendous growth. They were the torch bearers of developing world. However, now it is envisaged that BRICS will be growing in single figures. With it competition from other emerging markets is heightening – Indonesia, Philippines  Vietnam etc. . On both sides India is in trouble.

Firstly, with the slower growth in emerging countries, India will lose its advantageous position. As business heads start looking at other countries for investment, the FDI will slow down. Moroever, the emerging markets provide a good cost arbitrage. For example, Philippines have taken over the call center market specially that of US, as the cultures are similar and it is cheaper than India.

As each emerging country comes up with its own unique selling proposition, the Indian industries will be impacted unless they position themselves differently. As in the BPO business, India is now attempting to position itself as knowledge managers.

Emerging markets will increase competition for India, hence gazing at the crystal ball is not going to help. India will have to tackle its poor reputation on governance, public finances, scams and democratic setup.

 5) A military confrontation with Iran.

Political pundits predict that Israel to maintain its supremacy in Middle East will bomb Iran soon. Another view is that Iran will misuse its nuclear power to foster radical Islamic activities. Iran is rapidly building stronger ties with Russia, China and Latin America. In this situation, the target is US and Europe. The crucial question is, what does a war or attack by Iran means to India.

Besides ancient cultural ties, presently Iran is the major supplier of oil to India.  India has invested in the Oil & Gas industry in Iran to ensure its export. India imports 80% of crude oil to meet its energy needs from around 30 countries. Iran caters to 11% of the total requirement.

Hence, from cultural, political and trade perspective, India is not in Iran’s first list of country targets. However, if war does break out,  India is located between Pakistan and China. China would support Iran. On the other hand, Pakistan will face the tough choice of supporting the Islamic group or US. India is far to near the epicenter of the problem to avoid the war, as it has tense relationships with both its neighbors – Pakistan and China. On the whole, India loses out if there is a war in the Middle East. Tensions in Middle East will spell trouble for Indian companies having high energy consumption as crude oil price may increase.

Closing thoughts

Risk managers need to re-evaluate country risk of India and the rest of the countries they are doing business with. Credit rating agencies are threatening to further downgrade India’s rating. With the political risks of various countries changing, some impact on import-export, supply chain, customer relationships and investor participation can be expected. Even in the recent risk reports respondents have rated geo-political risks among the highest. This is a good time to take a close look at the risk scorecard to assess changes in strategic, financial and operational risks. Strategies should be developed for the country risks identified during the country risk assessment.

References:

  1. A Global Perfect Storm – By Nouriel Roubini 
  2. Roubini sticks to 2013 ‘perfect storm’ prediction
  3. 7 economic indicators that could decide the election By Market Watch
  4. Foreign Direct Investment
  5. Indian companies facing losses in Europe: Ficci
  6. BRIC Countries Hit A Wall – Forbes India

Reflections on Reputation Risks

Indians think more highly of themselves than they are. I am not making this up, it is a factually correct statement according to the Country report of Reputation Institute. Respondents ranked India 25th with 51.93 RepTrak score. According to its own evaluation, India deserved a score of 75.67 with 11th ranking. It is ranked 5th for having perception differences between internal and external reputation. A 25th rank among 50 countries ranked isn’t anything to talk about.

In the Companies Reputation report, there was no Indian company in the top 100. Yes, my ex-company Intel was ranked 16th, though its ranking has fallen from previous years.  BMW, Sony and Walt Disney are the top three. Though reputation has a huge impact, most companies do not focus on it. Below is a chart from the Reputation Institute report on the impact of good and negative reputation of various factors.

Reputation Institute Company Report 2012

Customers, society, employees and investors – all are influenced by the reputation of the company. While companies may enjoy a good local reputation, as is the case for many Indian companies, maintaining a global reputation is a different ball game altogether. From the above chart it is clear, investing in a good reputation pays off and adds to the profit margin. Question is what all is required to build a good reputation. Another chart from the report highlights the main aspects:

Seven factors – leadership, performance, products/services, innovation, workplace, governance and citizenship are required to build a global reputation. For instance, Intel was among the top ten for – governance, workplace, performance, and products and services.

On the other hand, in respect of reputation damage, risk managers mostly focus on reputation damage due to misstatement of financial statements and governance. That accounts to just 28% of reputation.  The impact on reputation of other aspects are generally ignored. The question is how can these be built into a risk assessment framework? Besides reducing downside risks, this gives a good option to leverage upside risks. Here are a few things that risk managers can look into:

1. Reputation map – Does the company have a reputation map covering these parameters and defining its progress through the years?

2. Integration level – Is reputation aspects integrated into all the functions of the organization, or is it left to the advertising and communications department?

3. External perceptions – Is the organization depending on advertisements to build its reputation or is it undertaking CSR and other activities also?

4. Participation in industry competitions – Does the organization participate and win industry competitions, for instance “great place to work”, “most innovative company” etc. ?

5. Social Media – How is the company using social media to build its reputation and manage the negative feedback?

6. Risk assessment – Is a risk assessment for reputation conducted to highlight the risks in all the seven areas and mitigation plans prepared?

Closing thoughts

Reputation damage is difficult to quantify and often the risks are not categorically listed. In social media environment, it is far easier to lose the reputation and more difficult to build a good one. In the present environment, they old age thinking  – no news is good news – has become redundant. Just because the organization name hasn’t made headlines for the wrong reasons, it doesn’t mean all is well. The negative under currents slowly erode the good name of the organization. Hence, risk managers need to actively address reputation risks on all seven parameters.

References:

Reputation Institute reports

PS: I changed the background and added a little color to the blog. How is it looking? Please give feedback.

Auditor’s Communication With Audit Committee

Finally, the US audit committees will be getting the full picture of the financial statements from the auditors. The Public Company Accounting Oversight Board (“PCAOB” or the “Board”) of US  is adopting Auditing Standard No. 16 – Communications with Audit Committees. It is aimed at improving dialogue between auditors and audit committees to enable better oversight and financial reporting.

The scope of communications has increased from the previous practice of discussing – accounting policies, procedures and estimates, quality of financial reporting, unusual transactions and significant auditing and accounting matters. It covers a  more matters that will increase clarity.

Previously the status of communication was aptly described by George Bernard Shaw’s quote – “The single biggest problem in communication is the illusion that it has taken place.” Audit committees in my view lacked critical information . Secondly, as there is a shortage of financial experts (just one is mandatory) they were in no position to analyse the details of the financial statements. It was easy to hide artistic accounting from them. This standard will reduce communication gap between the auditors and audit committee.

In India, though the roles and responsibilities of the auditor and audit committee are defined in the Listing Agreement of SEBI and New Companies Bill, the nature, content and quality of communication is not specified. It mandates audit committee should meet at least four times a year, however doesn’t shed light on the quality of discussion to take place. The audit committees in India, are required to look into loan transactions, related party transactions and a couple of other things. These requirements are not mentioned in the list below.

In brief, as per Auditing Standard No. 16 the auditor would be required to communicate the following to the audit committee:

a.  The terms of appointment and engagement, objective of the audit, and responsibilities of management and auditor.

b. An overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified including risk assessment procedures, and significant changes to the planned audit strategy or identified risks;

c. Information about the nature and extent of specialized skill or knowledge needed in the audit, the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;

d. The basis for the auditor’s determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors;

e. Significant accounting policies and practices including changes. Reasons certain policies and procedures were considered critical and the effect on them in respect to current and future events. Effect of policies and disclosures in controversial area and where there is lack of authoritative guidance.

f. Situations in which the auditor identified a concern regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting;

g. Description of process for developing critical accounting estimates including the significant assumptions. If any significant changes are made in the process or estimates.

h. Significant unusual transactions with policy and procedures used by management for accounting unusual transaction;

i. Quality of financial reporting including whether auditor identified bias in management’s judgement about the amounts and disclosures in financial statements. Assessment and conclusion of critical accounting policies. Auditor’s understanding of the business rationale for significant unusual transactions.

j. The results of auditor’s evaluation about financial statement presentation. Whether the reporting including form, content and arrangement are in conformity to standards.

k. Difficult or contentious matters for which auditors consulted external consultants

l. Auditor is aware management consulted external sources, the auditors should also give their opinion;

m. The auditor’s evaluation of going concern;

n. Uncorrected and corrected mis-statements including those discussed with management;

o. Material written communication with management

p. Disagreements with the management

q. Departure from the auditor’s standard report;

r. Difficulties encountered in performing the audit, and

s. Other matters arising from the audit that are significant to the oversight of the company¡¦s financial reporting process, including complaints or concerns regarding accounting or auditing matters.

Closing thoughts

The various auditing and accounting standards in India cover most of the points mentioned above. The auditor is required to ensure conformity to the standards and comment on the same if there are variances. However, there is no specific guideline for communication between auditor and audit committee. As the US standard just defines minimum communication requirements it would be beneficial to formulate and adopt a similar one in India and other countries. It will ensure a specific level of interaction with auditor and audit committee is maintained and the audit committee makes informed decisions.

What do you say? Should there be a global standard for communication with audit committees? What other steps can be taken to reduce barriers to communication between the auditor and audit committees?

References:

PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees, and Amendments to other PCAOB Standards

 

Why Auditors Fail To Detect Frauds?

When media reports a new fraud, the first few thoughts of public are – “What were the auditors doing? How did they miss it? Were they involved?” The auditors get labelled as morons, conspirators or criminals. Generally most people jump to the conclusion that auditors had malafide intentions and became accomplices to get more business. While this may be true in some cases, auditors need the benefit of doubt. They sometimes genuinely miss the cases despite their best effort to diligently perform their duties. This post is an attempt to explain why auditors miss the frauds.

I want to share a joke with you before I explain. Two drunkards were walking on a railway track. The first said to other – “I am really tired, I hope the steps will end soon.” The second replied – ‘Yeah. I wish they had put the handrails at a better height, my back is killing me.”

1. Auditors responsibility to detect frauds

We can laugh at this, but if I say most of us don’t see clearly, there will a lot of angry reactions. So I am not saying anything, and am requesting you to watch this video.

Now did you see the moon walking bear?

Auditors have the same problem. They have to to give a true and fair opinion on the financial statements. They are not required to focus on detecting frauds. Hence, the audit programs are not designed to conduct tests to  detect fraud symptoms and probability. Therefore, with no specific coverage auditors fail at detecting frauds. Extract from Section 143 of New Companies Bill is given below:

The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statements which are required by or under this Act to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder or under any order made under sub-section (11) and to the best of his information and knowledge, the said accounts, financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.”

2. Auditors punishment on failure

The second question frequently debated is – “Should auditors be punished if they fail to detect frauds?” Section 147, clause 4 of New Companies Bill states auditor’s liabilities in respect to fraud in the following words:

Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil or criminal as provided in this Act or in any other law for the time being in force, for such act shall be of the partner or partners of the audit firm and of the firm jointly and severally and such partner or partners of the audit firm shall also be punishable in the manner as provided in section 447.”

This clause puts auditors on shaky ground. It is difficult to prove innocence once a fraud is detected. How can an auditor state – “I did my work properly, saw these documents, looked at the same audit evidence but didn’t find anything wrong with it.” Most will jump to the conclusion that the auditor knowingly ignored all the evidence. So here is another video. Watch it, and then you will see how this situation can occur.

According to various experiments, 75% of the people failed to observe the person swap in the experiment.

Think of this from an audit evidence perspective. An auditor is checking 100 vouchers with supports. One voucher among the 100 is fraudulent. What is the probability of the auditor noticing it? One can safely assume that it will be less than 25%.

Is it surprising that auditors fail to detect frauds after seeing these experiments. Though they are trained, they are human. The same psychology works with them too.

Closing thoughts

The success rate of detecting frauds will be higher when the auditors – external and internal – have specific responsibility to detect frauds. Without the specific responsibility, regulators can continue to complain and investors will share their anguish, however all will be futile. The laws need to be devised to hold someone responsibly for detecting frauds. What is your opinion?

A modified version of this article was published in the Middle East Accountant Magazine.

Risk Assessment of Marketing Function

The global economy is facing turbulent times with US in recession, Europe in economic crises and emerging markets growth slowing down. Frequently organizations panic on hearing forecasts of looming recession. They cut down marketing budgets, innovation of products and capital investments. The reaction further adds to the woes, and accelerates the downward trend in sales. Risk managers normally do not focus on marketing department activities and generally are not called upon to share their views on marketing strategies. A look on these areas may prevent the company from going in red and thrive in chaotic times. Here are a few suggestions for risk managers.

1. Bench-mark Marketing Function

The complexities of business world are escalating marketing risks. For survival and growth organizations need resilient marketing and sales functions. They have to identify strategic inflection points in the market and adapt accordingly. In recession customers interest, values and budgets change. With new competition and changing regulations, organizations need to reinvent business models. Hence, as a first step risk managers  need to bench-mark the organization’s marketing function.

Philip Kotler and Johan A. Caslione in their book “Chaotics – The business of managing and marketing in the age of turbulence” have presented a table on marketing function attributes. Out of the 14 attributes, below are 5 critical ones distinguishing between poor, good  and great marketing functions.

Srl    Poor                                        Good                                              Great

1. Product driven                    Market driven                                    Market driving

2. Product offer                       Augmented product offer                 Customer solutions offer

3. Price driven                        Quality driven                                     Value driven

4. Reacting to competitors    Bench-marking competitors             Leapfrogging competitors

5. Function oriented               Process oriented                                Outcome oriented

McDonalds marketing strategies reflect these attributes. In India, McDonalds is opening a purely vegetarian restaurant near Vaishu Devi ( a renowned Hindu temple) and Golden Temple (Sikh’s foremost gurdwara). It is catering to the Indian sentiments; in most religions Indians do not eat non-vegetarian food in a place of worship. Near the temples, generally local vegetarian eating joints thrive and there are no global food chains. The huge number of devotees provide a large market.

A few years back, McDonalds customized its menu according to Indian tastes and introduced vegetarian burgers. The McAloo Tikki (a potato burger) contributes to 25% of the total sales.  It may shock the Americans, but no beef burgers are served in India.

2. Evaluate Cost-cutting Measures

The attitude frequently is to cut costs across board. For instance, if marketing budget is XXX dollars, the total budget will be reduced by 25% without assessing the details and profitable products. Here risk managers need to assess the soundness of decisions taken to reduce costs. Below are a few examples to look for:

a) Advertising : Is the total advertising budget reduced? This would be a wrong move. During recession, the core products that contribute to revenue need aggressive advertisement. The advertising budget spent non-core products and loss making products can be dropped. Moreover, explore cheaper advertising models – social media, internet etc. and reduce budgets on paper and television media.

b) Discounts : Another option adopted to increase sales is to discount all products by a certain percentage. This is a self-destructive strategy as discounts on core premium products would damage the revenue stream in the long-run. If customers require cheaper products, cut the frills in the premium products and introduce a bare minimum model. This will maintain the brand and revenue.

3. Assess Strategy and Systems

Risk managers must assess the marketing strategy and systems to ensure that the risks are systematically identified in a timely manner. Here are a few examples of the same:

a) Core products: Does the strategy focus on core products? Are there systems in place to show the winners and losers? If the systems are inadequate profitability, market spend and customer behavior cannot be captured accurately. Hence, the organization will be unable to adapt strategy to the changing marketing trends and customer behavior. Moreover, companies cannot  reduce costs without identifying inefficient spending.

b) New products : Has the organization delayed the launch of new products during recession? The customers require cheaper products during hard times. Hence, the strategy should be to delay expensive products but focus on products that cater to the new customer requirements and changes in behavior.

Closing thoughts

With economies slowing down, the marketing functions are facing many challenges. Customers are better informed through social media and internet, competitors copy products faster, and price of the product is a driving factor. Risk managers can contribute by conducting risk assessments of the marketing function and helping the teams in identifying the upside and downside risks to their strategies. This is a good place to add to  profitability.

References:

  1. Chaotics – The business of managing and marketing in the age of turbulence – Philip Kotler and Johan A. Caslione
  2. Beefy McDonald’s to Open Veg-Only Outlet in Katra – Economic Times