Recommending the joint establishment of a Financial Reporting Council as a priority

• An open letter to the President and council members, Institute of Chartered Accountants of Sri Lanka, the Chairman and Board members, Sri Lanka Accounting and Auditing Standards Monitoring Board

I trust that your attention has been drawn to the Reuters report titled ‘UK accounting watchdog says KPMG audits show “unacceptable deterioration”’. 

A copy is appended. I further trust that the President and Council Members, Institute of Chartered Accountants of Sri Lanka and the Chairman and Board Members, Sri Lanka Accounting and Auditing Standards Monitoring Board have taken due note of the several submissions made by the undersigned over the past several months, pointing out, based on current financial investigations in progress, of the serious and professionally unacceptable deterioration in the:

Integrity, transparency, quality and accuracy of  financial statements and information disclosures of financial statements and accompanying notes, reports and other disclosures

Level of due compliance with accounting and auditing standards, including avoiding the misuse of the accounting standard for small and medium-sized entities

Acceptable standards of estimation, fundamental assumptions and testing for transfer pricing and effective application of Fair Value Measurements and Impairment

Quality, professionalism, adequacy of statutory audits and effectively reporting on the “true and fair” state of financial affairs of the entities subject to audit

Compliance and expected response framework, where  there exists blatant non-compliance with laws and regulations, including requirements for:

Effective disclosure of directors’ interests in contacts, related party transactions, transactions with conflicts of interests and transactions with beneficial interests

Where money laundering, fraud, corruption, bribery and criminal breach of trust have impacted the entity and its financial state of affairs and its directors and officers

Regulations promulgated by the Financial Intelligence Unit and the Sri Lanka Accounting and Auditing Standards Monitoring Board

Requirements of Company Law, Tax Laws, Securities Laws, Banking Laws, etc.

Applicable Codes of Conduct and Ethics

You will no doubt agree that with such high impacting deteriorations in expected standards and norms, that priority collective action needs to be taken by you as lead, to develop and regulate accounting and auditing professionals in Sri Lanka.

In light of the above referred to submission, it is essential that the Institute of Chartered Accountants of Sri Lanka and the Sri Lanka Accounting and Auditing Standards Monitoring Board takes early strategic steps, with the guidance of the Central Bank, Financial Intelligence Unit, Actuarial Association of Sri Lanka and the Securities and Exchange Commission, to set up an independent and representative Financial Reporting Council, to be an independent oversight and reporting body over the professional outputs and outcomes of accounting and auditing professionals in Sri Lanka.

The Sri Lanka Financial Reporting Council to be established as suggested above can benchmark the Structure and Operational Framework of the UK Financial Reporting Council - refer https://www.frc.org.uk/about-the-frc/structure-of-the-frc. I appeal to you to take priority collective steps to evaluate and implement the above suggestion.

Chandra Jayaratne

cc. Prime Minister & Minister of Economic Affairs

      Minister of Finance

      Secretary to the President 

      Secretary, Ministry of Finance

      Governor, Central Bank of Sri Lanka,

      Chairman, Securities Exchange Commission,

      Director FIU

      Chairman, Actuarial Association of Sri Lanka

      Chairman & Secretary, START

      Commissioner General of Inland Revenue,

      Director, Financial Crimes Investigation Division

      Media for Publication

UK accounting watchdog says KPMG audits show ‘unacceptable deterioration’

London (Reuters): KPMG, one of the world’s “Big Four” accounting firms, has shown an “unacceptable deterioration” in how it audits top British firms and will be first to undergo special supervision, Britain’s accounting watchdog said on Monday.

The Financial Reporting Council (FRC) said the Big Four auditors - which also include PwC, EY and Deloitte - must act swiftly to reverse the decline in this year’s audit inspection results if they are to hit targets set by the watchdog.

It singled out KPMG, however.

“There has been an unacceptable deterioration in quality at one firm, KPMG,” the FRC said in a statement. “Fifty percent of KPMG’s FTSE 350 audits required more than just limited improvements, compared to 35 percent in the previous year.”

The decline reflects badly on action taken by the previous leadership, which was replaced during 2017, and not just on the performance of front line teams, the FRC said.

“Our key concern is the extent of challenge of management and exercise of professional scepticism by audit teams ... and more generally the inconsistent execution of audits within the firm.”

Increased scrutiny of KPMG will involve the FRC inspecting 25% more audits done by the firm in the 2018/19 financial year, the first time the FRC has taken such action. Michelle Hinchliffe, head of audit at KPMG, since October 2017, said she was disappointed with the FRC findings and that steps taken in previous years have not resulted in improvements to audit quality.

She said the findings mainly cover the time before KPMG’s new audit quality transformation program began last October.

“We cannot and will not be satisfied with these results and, as a firm, we are already working to put this right,” Hinchliffe said.

KPMG was already being investigated by the FRC over its audit of Carillion, the outsourcing company whose collapse has triggered a call from lawmakers to break up the Big Four accounting firms. They said the FRC was “timid”, piling pressure on the watchdog to crack the whip.

Banking audits

The FRC inspected a sample of audits from the eight leading accounting firms for the 2017/18 financial year.

They showed that 72% required no more than limited improvements, down from 78% in the previous period. Among the FTSE 350 leading listed companies, 73% required only limited improvements, down from 81% in the previous year.

“Across the Big Four, the fall in quality is due to a number of factors, including a failure to challenge management and show appropriate scepticism across their audits, poorer results for audits of banks,” the FRC said.

The FRC said the audits of the other four accounting firms examined, BDO, Grant Thornton, Mazars and Moore Stephens, showed general improvements in quality, the FRC said.

The green light given by auditors to accounts of banks just months before taxpayers had to rescue them in the financial crisis triggered a reform of the sector.

Two of the four key findings on EY related to bank audits. EY said it would focus on how banks account for souring loans and conduct provisions.

The FRC said Mazars should also continue to improve the audit of banks’ loan loss provisions. Mazars said it would focus on improving the quality of bank audits.

“At a time when public trust in business and in audit is in the spotlight, the Big Four must improve the quality of their audits and do so quickly,” FRC Chief Executive Stephen Haddrill said. “They must address urgently several factors that are vital to audit, including the level of challenge and scepticism by auditors, in particular in their bank audits.” A government-ordered review of the FRC is underway to see if it needs more powers to bring bad auditors to book.