Corruption hides truth in audit reports

The value of banks' assets reported by public accountants is far lower than those disclosed by international auditors assigned by the government to revalue the assets in a due diligence. Economist Kwik Kian Gie discusses the reasons behind the disparity.

JAKARTA (JP): Corporate financial reports that have been audited by public accountants, particularly ones submitted by international networks such as Arthur Anderson, Arthur Young, Price Waterhouse and KPMG, usually reflect the real conditions of the audited companies.

Such reports are generally used by banks to assess the credibility of audited companies and by investors to decide whether or not they will cooperate with them. If such reports do not reflect the truth, bad luck will follow for the banks and investors. Can audit reports by public accountants be trusted?

Something very strange has happened in the country: the Indonesian Bank Restructuring Agency (IBRA) distrusted the audit reports of major international public accountants and assigned two giant finance companies -- Lehman Brothers and J.P. Morgan -- to reaudit Indonesian banks. The two firms use a different method of auditing called due diligence, which can be interpreted as an assessment of serious scrutiny.

As is widely known, most Indonesian banks cannot repay their huge debts to Bank Indonesia, the central bank. The government, therefore, confiscated the banks' assets, including assets put up as collateral by bank borrowers who failed to repay their debts. Assigned by the government to restructure the banking industry, IBRA appointed the two finance companies to carry out the due diligence.

The due diligence produced extremely different results, some of which indicate that the real value of certain banks is only about 20 percent of the value recognized by public accountants. Who is right, Lehman Brothers and J.P. Morgan, or the public accountants?

The two companies determined the value of the assets on their real prices, crosschecked at market places or at factories. The public accountants, who work in accordance with the Indonesian Accounting Standard, set the asset values based on financial reports prepared by the audited companies. A public accountant, for example, will believe an audited company's report that it procured a building at Rp 100 billion (US$11.5 million) as long as the report is supported by basic documentation or receipts, even if its real price is only Rp 50 billion. Company executives keep the other Rp 50 billion.

Are public accountants operating in Indonesia not required to carry out serious auditing in the due diligence manner of Lehman Brothers and J.P. Morgan? No, because the scope and sophistication of their auditing jobs are determined by their fee amounts.

How about responsibility for their reports? Public accountants operating in the country are protected by representation letters which declare that the truth of the documents accompanying the reports is the responsibility of the audited companies.

If that is the case, can financial reports in Indonesia be trusted? Not at all. But facts show that creditor banks, the Capital Market Supervisory Agency (Bapepam) and the Jakarta Stock Exchange regard public accountants' audit reports as true and appropriate. That is one of the causes resulting in the current financial disaster facing the banking industry and the capital market.

Investors in the capital market, for example, lost a lot of money because when they valued stocks they relied on audited financial reports, the figures of which turned out to have been marked up significantly. As a consequence, the Jakarta Stock Exchange lost its good reputation. Many of its stocks are traded at prices far lower than costs for the production of share certificates.

In other countries public accountants also rely on documents produced by audited companies to determine asset values. But no one there would produce a Rp 100 billion receipt if they sold a building for Rp 50 billion. Otherwise they would have to pay income tax on the false profit. So, formal truth -- based on documents -- is the same as material truth in those countries. In Indonesia, income tax on false profits can be evaded through bribery. Formal truth, therefore, is extremely different from material truth.

Now that a new government will be established soon after the June 7 general election, it will have to take necessary measures relating to public accountants' methods and the standardization of Indonesian accounting. Will the new government continue to allow public accountants to relay "the truth" merely by the verification of documents or will it suggest they adopt principles used by J.P. Morgan and Lehman Brothers in their due diligence?

As long as collusive and corrupt practices prevail among tax officials and taxpayers, the Indonesian Accounting Standard will continue to reveal false formal truths. It will be up to the new government to revise these standards.