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  Policy & Strategy

Nowhere to hide: audit law extended

The auditing profession is poised for a major transformation in Vietnam with the release of Decree 105 by the Ministry of Finance in March this year.

This wide-ranging decree sets out required changes to the ownership structure of audit firms, greatly increases the number of enterprises that are required to have an independent audit, and introduces many international best practices into the regulation of auditors and audit firms. In developing a replacement to Decree 07/1994, the ministry has consulted with enterprises that prepare financial statements, users of these statements, especially Government departments such as tax authorities and audit firms. It has also researched international practices in regulating the auditing profession.

The result is a far-reaching decree that will have a major impact on the auditing profession and on the financial reporting of State-owned enterprises.

Implementing guidelines to the decree were issued in Circular 64, dated 29 June 2004. This Circular has given some welcome clarifications, especially on the question of auditors’ legal liability to users of financial statements.

Transforming audit firms

There is currently a range of types of audit firms in Vietnam, including State-owned companies, limited liability companies, joint stock companies and foreign-invested companies. Decree 105 takes a big step towards modernising the auditing profession by regulating that audit firms can only be one of three types: a partnership, private enterprise or foreign-invested company.

State-owned, joint stock and limited liability audit companies must transform into one of the three permitted types within three years from the issue of Decree 105. It is expected that most will adopt the partnership form. Historically, partnerships were the traditional form for audit firms in Europe and the US. The partnerships had unlimited liability. In the event of any legal action against the audit firm, the partners stood to lose everything – personal assets, home, life savings – and not just the money they invested in the firm. This exposure to potential bankruptcy if the auditor was sued by clients for damages caused by the auditor’s improper acts or negligence was seen by many in the business community as a powerful incentive for the auditor to act with integrity and extra care.

With the increase in litigation against audit firms from the 1980s onwards, the audit profession has argued that the potential exposure to partners within an unlimited liability partnership is too great, and is unreasonable given that clients and others in the business community are protected by limited liability. Where permitted by legislation in each country, audit firms have moved away from the unlimited liability partnership model, becoming limited liability partnerships or companies.

Partnerships in Vietnam are regulated by the Enterprise Law, which states that the personal liability of at least two of the individual partners is unlimited. The directors of State-owned audit firms, joint-stock companies and limited liability companies who become unlimited liability partners in the new partnerships stand to share in the profits of the audit firm, but do have exposure to the risk of loss of personal wealth.

Decree 105 requires audit firms to purchase professional liability insurance or set up a contingency fund against professional risks. Circular 64 regulates that compensation for damages to an audit client is limited to 10 times the audit fee. The circular also gives a very clear directive that for a user of financial statements to have any claim against the auditor, they must have:

(i) a direct interest in the client on the date of the audit report;

(ii) a proper knowledge of financial statements and accounting standards;

and (iii) acted carefully when relying on the financial statements.

The above insurances and limits on liability may provide a buffer against the risk of personal losses, but the audit partner with unlimited liability will still have a greater incentive to ensure the integrity and quality of work of his or her firm to avoid legal actions, as it is more than just a job that is on the line when they sign an audit opinion.

Expanding the reach of independent audit

The potential market for audit services to be delivered by the existing and transformed audit firms has been greatly expanded by Article 10 of Decree 105. This requires an audit of the annual financial statements of all State-owned enterprises (SOEs) to be performed by independent audit firms, except for those SOEs that are subject to audit by the State Auditing Department.

The aim of the Government is to improve transparency in the financial reporting of SOEs, help State management authorities to understand their performance better. Action can then be taken to improve performance or restructure or reorganise the SOEs if necessary. The discipline of an independent audit and the resulting improvements in the quality of financial reporting has many other benefits for the State-owned sector.

It will permit the State-owned commercial banks (SOCBs) to make lending decisions to SOEs based on more reliable financial data and assist the SOCBs to monitor the performance of the SOEs that they have lent to. This should have the knock-on effect of making the financial statements of SOCBs more reliable, as better information is available on the recoverability of their credit to SOEs.

Where SOEs are in the process of equitisation, they need to be valued so the State can obtain a fair price for their disposal. The audited financial statements will assist in the valuation process, by giving more reliable figures for past performance and balance sheet position.

If the management at the SOE knows it is to be rewarded based on performance, and if the independent audit can lead to more transparent and robust reporting of performance, there will be a greater drive to improve efficiency and effectiveness of operations. The majority of SOE managements will not previously have been subject to an independent audit. They may not understand the audit process and this lack of understanding or uncertainty can cause difficulties for the auditor. They will need briefing or training on the audit process to explain its aims and the benefits that should arise.

The implementation date for the audit requirement for SOEs is not given in Decree 105 or Circular 64 and will need to be set out in subsequent regulations. There are currently nearly 5,000 SOEs in Vietnam while on 31 December 2003, there were 61 audit companies. You don’t need to be an accountant to work out that when it does become a reality, the audit requirement for SOEs will cause an explosion in demand for audit services, presenting a considerable challenge to the auditing profession.

An expansion in the number of audit firms and in the size of existing firms is required to meet this new demand. Auditors need training and good work experience to perform effectively, which cannot be obtained overnight.

A concerted effort is needed from the Ministry of Finance, audit firms, independent training-providers and other interested parties to increase the quantity and improve the quality of accountancy and audit training available in Vietnam. More needs to be done to attract smart, educated people into a career as an auditor; and then once they are in, the quality of training needs to progress.

Modernising the audit profession

Throughout the process of drafting Decree 105, the Ministry of Finance has been very aware of the debacles involving Enron and other corporate failures, and the role of the auditor in these corporate failures. In the US, the release of the Sarbanes-Oxley Act in 2002 was a response to the wave of corporate failures. This act sets out new requirements for companies listed on the US Securities and Exchange Commission and their auditors.

Certain of these requirements are aimed at ensuring the independence and objectivity of the auditor, including greater restrictions on non-audit work that can be provided by the audit firm to its client and the mandatory removal of the audit partner from the audit engagement after serving 5 consecutive years.

The ministry has tracked the developments in the US and adopted rules on auditor independence in Decree 105 that are similar or even more hard-line than the Sarbanes- Oxley Act. These include restrictions on the audit firm performing services such as book-keeping, internal audit or management consultancy for the audit client, and the auditor partner is to be rotated off the engagement after only three years. There are other strong rules in the decree aimed at maintaining the independence of the auditor, including a restriction on the auditor holding any shares or other investments in the client and performing an audit when they are closely related to the management of the client. These rules bring the audit profession in Vietnam in line with international best practice.

Decree 105 also spells out new requirements for auditors to participate in an annual programme of continuing professional education to develop their knowledge and skills. This is in line with international best practice. However, the requirement in Circular 64 for auditors to pass an examination each year before they can register to practice the following year introduces an excessive amount of regulation, and raises practical issues on how this requirement can be implemented consistently and justly across the range of audit firms.

Article 9 of Decree 105 appears to be relatively weak in that it only encourages enterprises to have their financial statements audited before submission to the State authorities or being released to the public. Enterprises should be required (not just encouraged) to have the audit performed and finalised before the official announcement of results.

However, this is already covered by the Law on Accounting, issued by the National Assembly in June 2003, which requires enterprises to have financial statements audited before they are submitted to the State authorities (Article 34) and any published financial statements must be accompanied by an audit report (Article 32).

Changes on the way

Decree 105 is a comprehensive regulation that represents a big step forward in the modernisation of the audit profession in Vietnam. It presents specific challenges to the State-owned audit companies, joint-stock companies and limited liability companies that will need to convert to another form. At the same time, the requirement for independent audit of State-owned enterprises presents significant opportunities and challenges to all audit firms in Vietnam. The objectives of this initiative are clear and laudable. The setting out of the course of action to deliver these objectives is still a work in progress.

Vietnam Investment Review - (03/08/2004)

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