Concerns rise as more U.S. audit work moves to India

NEW YORK/MUMBAI Sat Oct 20, 2012 8:36am IST

U.S. 100 dollar notes are seen at a bank in this picture illustration in Seoul September 20, 2011. REUTERS/Lee Jae-Won/Files

U.S. 100 dollar notes are seen at a bank in this picture illustration in Seoul September 20, 2011.

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NEW YORK/MUMBAI (Reuters) - Auditing of U.S. corporations' financial books, a vital underpinning of investor confidence, increasingly relies on work carried out in India, where there is no clear system of oversight.

U.S. audit regulators do not conduct regular physical inspections of offshore centers in India where U.S. audit work is performed, Indian accounting officials and employees of large audit firms told Reuters.

The U.S. arms of the Big Four audit firms - Deloitte Touche Tohmatsu Ltd, KPMG, PricewaterhouseCoopers and Ernst & Young Global Ltd - said that work handled by Indian employees is routine and systematically sent back for review to the United States.

But some audit firms are layering on more complex tasks in the offshore centers and Indian workers are rising to senior positions in the auditing ranks, said Big Four firm employees and others in the accounting industry in India.

Given the failures of U.S. auditors so alarmingly displayed in recent accounting problems - for instance, February's $2 million penalty against Ernst & Young over its past Medicis Pharmaceutical Corp MRX.N audits - some experts said having more Indian auditors on the job may result in better audits.

Yet concern is growing that no coherent regulatory system exists to closely police the work in India, to gauge its quality, and to take action if problems should develop.

Perhaps as much as 5 percent of U.S. audit work is presently done in India, said M.G. Fennema, an accounting professor at Florida State University who has researched offshoring.

That is up from an estimated 1 to 2 percent about five years ago when the firms launched offshoring pilot projects.

"If it's done properly, it would be OK, but the risks are that work will be offshored that is beyond the training, skills and experience of the people that it's offshored to," said Douglas Carmichael, former chief auditor of the Public Company Accounting Oversight Board, or PCAOB, a U.S. watchdog group.

Graphic-U.S. vs Indian accountants: link.reuters.

CRUNCHING THE NUMBERS

Auditing is labor-intensive. In offshore centers scattered from Mumbai to Bangalore, swarms of entry-level workers review piles of documents and cross-check numbers on balance sheets.

In India, many rookie accountants consider $10,000 a generous annual salary; their U.S. peers earn five times that.

Attracted by wage savings and Indians' command of English, the U.S. arms of the Big Four have opened offices or joint ventures in India and hired thousands of local workers to do a range of tasks, including tax, consulting and audit work.

PCAOB Chairman James Doty said offshoring helps large firms be efficient. He added: "We have to watch, to be alert for, when efficiency becomes an enemy of quality."

The firms said that their offshored audit work meets the same quality standards as work done in the United States.

A PwC executive said about 4 percent of its U.S. corporate audit work is conducted at "alternate delivery centers," located both inside and outside the United States.

"The work performed at these delivery centers is limited to specified standardized tasks, none of which involves auditor judgment, and is reviewed and supervised by U.S. firm employees," said Michael Gallagher, a PwC managing partner.

PwC's goal is to send about 20 percent of audit work to the delivery centers, said the firm's global chairman, Dennis Nally.

Deloitte said audit workers in India "receive training consistent with their U.S. colleagues, and their work is reviewed and supervised by professionals in the United States."

Viral Thakker is a Mumbai-based partner at KPMG. Its offshore centers in India handle audit, tax and advisory work. He said offshoring gives the firm's overseas clients low-cost "access to a ton of really smart, talented individuals."

Ernst & Young did not respond to requests for comment.

TOUGH SELL FOR SOME

The Big Four started offshoring work to India about a decade ago, at first primarily to prepare tax returns. Today, the firms together employ about 22,000 people in India for offshore operations, mostly in tax and consulting, said industry sources.

Bill Gradison, a PCAOB member until early 2011, said audit firms told him they were moving slowly into offshoring, but that some firms' partners were concerned about control.

"I had a sense that there was some pushback in the United States within firms to some of this," he said.

Communication was another concern. "It is tough to supervise on a remote basis," said Carmichael, the former PCAOB chief auditor.

"You can look at the work papers, but looking the person in the eye and having them respond to spontaneous questions is where you can really assess their capabilities," he said.

With offices around the world, there is little to stop the Big Four from moving more work to countries where they can do it cheaply, said Bruce Pounder, director of professional programs for SmartPros, a firm that provides education for accountants.

In the United States, the PCAOB oversees corporate auditing. The board was set up a decade ago after the book-cooking scandals at Enron Corp and a slew of other big U.S. businesses.

Under law, any firm that audits or plays a major role in the audit of a public U.S. company must register with the PCAOB. Hundreds of firms from more than 85 countries are registered.

NO PACT WITH INDIA

In practice, this has meant the PCAOB has had to forge working relationships with national audit regulators around the world, and it has done so with at least a dozen nations, including the United Kingdom, Germany and Japan.

The PCAOB is struggling to work out a cooperative pact with China, where dozens of accounting scandals have erupted at companies listed on U.S. exchanges. The PCAOB has been barred from inspecting audit firms in China - an issue so serious the PCAOB is considering de-registering Chinese audit firms.

No country hosts more U.S. auditing work than India. No audit failures have been traced to offshore work there, and audit work done in India is routinely sent back to the United States where the PCAOB can review it.

But there is no formal agreement on offshoring with India, which allows the PCAOB unfettered access to inspect audit firms.

The PCAOB's Indian counterpart, the Institute of Chartered Accountants of India, has no oversight of the Indian offshore centers doing audit work on U.S. companies' books.

PCAOB Deputy Chief Auditor Greg Scates told Reuters: "There are no standards that limit what you can do" in the area of Indian offshoring.

He added, "The key question here is, are the staff that's doing the work properly trained and supervised?"

The PCAOB would be concerned if firms offshored audit work involving high risk and judgment, he added.

The PCAOB is considering making auditors disclose in audit reports when major parts of an audit are performed overseas. The proposal comes after PCAOB inspectors turned up numerous problems in overseas audits.

In April 2011, the PCAOB fined an Indian affiliate of PwC $1.5 million for audits of software company Satyam Computer Services (SATY.NS).

In response to the PCAOB's disclosure proposal, some audit firms have asked to be exempted from disclosure in cases where Indian offshore workers are supporting a U.S.-based audit team, which remains in control of the audit.

Like other U.S. companies, audit firms are not required by law to publicly disclose offshore hiring. Audit firms said they disclose offshoring in engagement letters - essentially contracts with their clients - but those letters are private.

Anne Simpson, corporate governance director for the California Public Employees Retirement System, the largest U.S. public pension fund and a major institutional investor, said: "If firms are fully convinced that the decisions they're making about offshoring are sensible, then it should simply be disclosed."

(Additional reporting by Tanya Agrawal in Bangalore and Huw Jones in London; editing by Kevin Drawbaugh and Matthew Lewis)

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