Financial statement audit: Loopholes in the law

Different forums and seminars are these days discussing audit of financial statements of private and public bodies. Undoubtedly, this is a very good sign. For preventing corruption and fraudulent practices, transparency and accountability are very important. Again fair presentation of financial statements of business houses and public bodies is one of the preconditions for improving transparency and accountability in the society.
It is needless to mention that discussions by experts on issues like auditing financial statements contribute to improving accountability and transparency. But all discussions and views expressed will be a futile exercise if we fail to identify the root causes of distorted financial statements. Following are some issues which may be the causes of presenting distorted financial statements and possible remedial steps may also be found in the course of discussion.
CONTRADICTORY DECISIONS: The Finance Act 2014, as approved by parliament on June 29, contains some issues which need to be analysed for future economic and accounting betterment of the country. The issues are reduction of the rate of tax deducted at source from the export bill. More specifically, tax deduction at source from the export bill has been brought down to 0.30 per cent from 0.80 per cent. Secondly, special tax rate for the 100 per cent export-oriented readymade garment industry, knitting industry etc has been discontinued. If we consider the impact of the two issues, it may be clear that completely contradictory decisions have been taken by the authorities concerned.
According to the budget speech by the Finance Minister, to make the readymade garment sector more capable of facing international competition the rate of tax deducted at source from an export bill has been reduced to 0.30 per cent from 0.80 per cent. According to the tax law, the tax deduction at source is the way of payment of tax. Ultimate tax liability is determined on the basis of year-end net profit of a company.
According to the details of the Finance Act (Paripatra), the special tax rate of 10 per cent on net profit has been withdrawn with effect from July 01, 2014. The special tax rate has been withdrawn for stopping tax evasion by businesses other than the 100 per cent export-oriented readymade garment industry. So, the amount of tax deduction at source has been reduced and on the other hand, the final tax liability has been increased, which is contradictory. It will be clear if an example is given. Suppose the company X in a year exports readymade garments worth Tk 10 million and at the end of the year as per the profit and loss account the net profit is Tk 700,000. As per last year's tax policy, the total tax deduction at source was Tk 80,000 which was considered the final tax. At the end of the year, the tax liability was 10 per cent of the net profit of Tk 700,000 or Tk 70,000. But since the tax was deducted at source, the Tk 80,000 was final.
According to another provision of the tax law, i.e. under section 82(c), the tax authority will determine the net profit of the company X to cover the tax deducted at source as the final tax liability. As per the amended Finance Act 2014, tax will be deducted at source from the export bill of Tk 30,000 (0.30 per cent on Tk 10 million which will be treated as final tax. But if the company earns the net profit of Tk 700,000 as in the previous year, the final tax liability will be Tk 245,000. So, either the company will have to deposit an additional tax of Tk 210,000 or the company will have to prepare the financial statements showing the net profit at Tk 87,500 instead of Tk 700,000.
Normally, it is human nature that if money can be saved applying any alternative means, one will follow that way. It is not only the nature of humans but also the perception of the businessmen that the tax which has been deducted at source from exports will be the final tax. Accounts personnel of the company may be instructed to prepare the financial statements showing the amount as the net profit to cover the tax deducted at source in accordance with the earlier assessment order issued by the tax department. It is worthwhile to mention that the range of contradiction of issues as mentioned earlier is very wide. The rate of tax deduction has been reduced 2.67 times (rate reduced to 0.30 per cent as against 0.80 per cent) and final tax liability has been increased 3.50 times (final tax rate increased to 35 per cent as against special tax rate of 10 per cent). So, as a whole, tax liability has been increased 9.3 times compared with previous correlation between the amount of tax deduction at source and the final tax liability. The issues may be now clear from the above example. From this, it is observed that tax deducted at source from the export bill was Tk 80,000 and the final tax liability was Tk 70,000 i.e. tax deducted at source was 114 per cent of the final tax liability. On the basis of the change in the Finance Act 2014 the amount of tax deduction at source will be Tk 30,000 and the final tax liability will be Tk 245,000 i.e. tax deducted at source will be only 12.24 per cent.
RESPONSIBILITIES OF AUDITORS: From the above calculation, it appears that through the Finance Act 2014 correlation between the final tax liability and the tax deduction at source from the export bill has been increased 9.3 times (114 per cent divided by12.24 per cent) compared with that of the previous year. With the circumstances as mentioned above, another newly-inserted provision in the Finance Act-2014 is relevant to be mentioned here. An auditor will be penalised if it is found that the financial statements as audited by the chartered accountants is not prepared following the Bangladesh accounting standards and the Bangladesh financial reporting standards.
Finally, if we analyse holistically the impact of the provision as mentioned above it will be clear that the amount of tax deduction at source will be reduced. The tax which has been deducted at source will be considered as final tax, but the final tax liability has been increased. The two contradictory provisions will lead to an incorrect financial statement showing a less net profit compared with the previous year which will be complicated for the auditor to detect because of planned and intentional misstatement.
As earlier mentioned, according to another provision of the Finance Act 2014, chartered accountants will be penalised if they fail to detect and report such difficult and planned misstatement. Another important issue as regards a listed company is that if any listed company declares dividend less than 10 per cent as per tax law it will have to pay tax at the rate of 35 per cent instead of 27.50 per cent i.e. excess tax will have to be paid at the rate of 7.50 per cent. As per the content of the company law, shareholders are the authority to approve an amount of dividend in their annual general meeting. Shareholders are the owners of the company and only they are the authority to understand the betterment of the company. If shareholders of any company approve a dividend less than 10 per cent considering the requirements of the future expansion, the company will have to pay more tax, which is completely contradictory to the company law.
In addition to this, it is also pertinent to mention that as per practice of the Bangladesh Securities and Exchange Commission, if any listed company pays dividend less than 10 per cent, the company is grouped in the 'B' category and consequences of such categorisation may decrease the market price of its shares. We know the objective of investment in shares is to earn income through dividend as well as increasing the value of share price i.e. capital gain. Normally shareholders and board of directors do not want to take such a decision which will reduce the market price of their shares. So, despite having no good operational results i.e. not being capable of paying dividend, the board of directors and shareholders of the company may decide to pay dividend at 10 per cent by manipulating the financial statement to avert the fall in the market price of their shares.
Likewise, there are many other differences between the standard of accounting, taxation, VAT Act, etc, which may compel the company management which prepares financial statements to present them violating the accounting standards for getting relieved of the additional direct and indirect tax burden.  As regards presenting correct financial statements to the users, the role of the company management which prepares the statement as well as the auditor of the company is very vital. The responsibility of the auditor is to detect error and manipulation which have been hidden by the management and responsibility of the company management is to prepare the financial statements properly and correctly. We will have to keep in mind that prevention of any error is much better, easier and more important than detection. Laws, rules and regulations should be in line with preventing the intentional, unintentional errors and manipulation which take place during preparation of financial statements.
But from the above, it may be clear that our laws, rules and regulations are not in line with prevention of errors and manipulation. Rather many contents of various laws, rules and regulations are encouraging manipulating of the financial statements. As earlier mentioned, discussions are being held about quality of audit and there is no scope to deny the fact that some of the auditors are not discharging their duties properly. But we will have to agree that if there are loopholes in the law, it is difficult to detect anybody's guilt due to not following the law. So, without identifying the root cause of the failure to reflect the proper financial positions in the financial statements, ex parte allegations against chartered accountants will not bring any solution.

The writer is a chartered accountant and council member and ex-vice president of the Institute of Chartered Accountants of Bangladesh.
 abutaher011@gmail.com