Corruption hides truth in audit reports

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.