Financial Market In Sri Lanka Accounting Essay

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The intention of this chapter is to set the stage and review the financial market in Sri Lanka and to discuss the audit market with special emphasis on the Big 4 audit firms. The demand and supply of companies and the general audit practices used by companies are discussed later. The background to the research further explains the regulations on external audits while highlighting both professional and legislative guidelines. Some features of the external audit fees are discussed subsequently.

Financial market in Sri Lanka

Sri Lanka's financial system continues to remain stable and resilient underpinned by strong domestic economic growth in the face of increased risks from the global macro-financial environment. This stability is instrumental in creating a favourable environment for depositors and investors, while encouraging financial institutions and markets to function effectively and efficiently, promoting investment and economic growth. Financial system stability requires a stable financial and economic environment within an effective regulatory framework and a safe and robust payment and settlement system.

The local financial landscape can be divided into the Money Market and the Capital Market respectively. The Money Market where short-term interest- bearing assets with maturities of less than one year, such as treasury bills, commercial paper, and certificates of deposits are traded and facilitate the liquidity management in the economy. The Capital Market on the other hand is the market for trading in assets for maturities longer than one year, such as treasury bonds, private debt securities (bonds and debentures) and equities (shares). Its purpose is to facilitate the raising of long-term funds.

The Financial Market can be also be classified according to instruments, such as the debt market and the equity market.

The debt market is also known as the Fixed Income Securities Market and its segments are the Government Securities Market (treasury bills and bonds) and the Private Debt Securities Market (commercial paper, private bonds and debentures).

The financial system consists of the Central Bank, as the apex financial institution, regulatory authority, financial institution, a payment and settlement system and a legal framework. The financial system carries out the vital financial intermediation function of borrowing from surplus units and lending to deficit units.

The Central Bank through its conduct of monetary policy influences the different segments of the Financial Market in varying degrees. The Central Bank's policy interest rates have the greatest impact on a segment of the Money Market called the inter-bank call money market and a segment of the Fixed Income Securities Market, i.e. the Government Securities Market. The Central Bank may also intervene in the inter-bank Foreign Exchange Market, which is closely connected to the Money Market.

One of the most important functions of the financial system is to ensure safety and efficiency in payments and security transactions. Financial infrastructure refers to the different systems that provide for the execution of both large-value and small-value payments. Payment and settlement systems enable the transfer of money in the accounts of financial institutions to settle financial obligations between individuals and institutions. (Financial System Stability Review - Central Bank 2011)

Audit market in Sri Lanka

The Institute of Chartered Accountants of Sri Lanka (CA) plays a vital role as the country's sole authority in formulating Accounting and Auditing Standards while adhering to the International Financial Reporting Standards (IFRS).

The Sri Lankan audit landscape is mainly dominated by the Big 3 audit firms which are Pricewaterhouse Coopers, Ernst & Young and KMPG. These audit giants account for the majority of audit services across the listed companies.

In addition to these major players BDO Partners, B. R. De Silva & Company, Amerasekera & Company, SMJS Associates, De Zoysa Associates, R N Associates, Nandimuttu & Co, Ranwatta & Co are some of the other auditing firms that compete in the general audit industry of Sri Lanka. These players mostly are involved in auditing companies that are not listed on the Colombo Stock Exchange.

The game of Big 4 & Non Big 4 audit firms

The largest network for accountancy professional services identifies the Big 4 audit firms as the 'Final four' which is responsible for a majority of audits for publicly traded companies. This is mostly due to the market share of those four firms where other small firms could not compete with the top end work and also that they are not reliable as auditors to large organisations.

However in Sri Lanka it is noted that Deloitte Touche Tohmatsu is not a prominent player and only the other three audit firms are significant within the industry. The stability, credibility and global presence that these companies offer are in fact substantial. In a Sri Lankan context these companies have an edge and become a formidable contender for almost all the listed companies.

Firm

Revenue

Employees

Fiscal Year

Headquarters

Pricewaterhouse Coopers

$29.2bn

169,000

2011

United Kingdom

Deloitte Touche Tohmatsu

28.8bn

182,000

2011

United States

Ernst & Young

22.9bn

152,000

2011

United Kingdom

KMPG

22.7bn

145,000

2011

Netherlands

Table : Financials of the Big 4 Audit Firms

Reference: Company Financials (PWC 2011, E&Y2011, KMPG 2011, Deloitte 2011)

Demand and Supply

In terms of geography, the American region accounts for a 40% and declining share of global combined revenues. From 2010 to 2011 however, the American region had a strong performance growth of 9.9%. Europe has 44% of combined firm revenues and increased 5.4% from 2010 to 2011, growing the slowest due to regional uncertainty. Asian revenues have more than doubled from $7 billion in 2004 to $17 billion in 2011, and grew a spectacular 17.4% from 2010 to 2011.(The 2011 Big Four Firm Performance Analysis)

According to employee statistics, indicated in the Big 4 Performance analysis report for year 2011 the four firms collectively employ staff of more than 65,000 across the globe with 35,000 partners. It also indicates that the net employment increased by 36,000 from 2010 to 2011. This gives an indication of how significant these companies are and to what extent they dominate the entire audit landscape.

Regulations on external auditing

All listed companies should establish formal and transparent arrangements with respect to the business monitoring practices, typically overseen by the audit committee, and involves the application of accounting policies, financial reporting practices, monitoring guidelines, build relationships with the company auditors.

Once this is finalised a listed company should obtain the services of a professional audit firm. To this effect the company must reach out to the framework on Sri Lankan Auditing standards. The Companies Act of 2007 also has a series of regulations that need to be adhered to when selecting and commissioning the services or an external auditor. This is also applicable in the event of changing the existing audit firm.

It is obligatory for listed companies to comply with the Sri Lankan Accounting Standards as well as the Listing Rules of the Colombo Stock Exchange when preparing audited financial statements which are included in their Annual Report. Accordingly, annual reports usually include audited financial statements of the Company, Director's report and the disclosures required by rule 7.6 of the Listing Rules and must be circulated to shareholders before the expiry of five (5) months from the end of the financial year.

This is one of the main considerations that the listed companies must meet in order to comply with the requirements mandated by the Securities and Exchange Commission and the Colombo Stock Exchange.

Professional guidelines

The Sri Lankan Auditing Standards are created on the International Standards on Auditing (ISA) published by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC), with slight modifications to meet local conditions and needs. It sets out the basic principles and related practices and procedures that apply to audits of financial statements. Hence this confirms compliance in all materials respect to the International Standards on Auditing.

Under the Sri Lanka Accounting & Auditing Standards Act No. 15 of 1995, compliance with these Standards is unavoidable when carrying out the audits of entities specified in the said Act. This Act not only places the responsibility of complying with these Standards on the Auditors alone, but also places a corresponding responsibility on the entity's management to take all reasonable steps to ensure that these Standards are complied with in the conduct of the audits of their accounts.

Legislative guidelines

When analysing the legislative framework for the listed companies, it is the responsibility of the audit committees of listed companies to determine the audit process both internal and external. Audit committee responsibilities in companies are to be enriched according to the Sri Lanka branch of the Association of Chartered Certified Accountants which will create an additional layer of governance and accountability. This will ensure that appointing audit firms to conduct external audits will now rest in the hands of these audit committees which will monitor and provide transparency to the audit process.

Steps are taken to ensure that all listed companies provide information publicly on auditor independence. This corporate disclosure has enabled more transparency into the audit process. Therefore auditors are bound to deliver comprehensive information on their independent report and risk and internal control reviews.

In the wake of significant discrepancies in corporate disclosures in listed companies it is important to note that auditors only give an opinion of the true and fair view of the financial statements taken as a whole, in terms of materiality, which is termed as a reasonable assurance and not an absolute assurance, in accordance with the international accounting standards.

Features of external audit services

An external audit is a review of the financial statements or reports of an entity, usually a government or business, by someone not affiliated with the company or an agency. External audits play a key role in identifying financial errors of businesses and governments because they are conducted by outside individuals and therefore provide an impartial judgment. External audits are commonly performed at regular intervals by businesses, and are typically required yearly by law for governments.

External audits are performed to substantiate that the financial statements of an entity are correctly presented with a true and fair view. They do not involve an actual accounting of a business' financial accounts, but rather external audits are an independent evaluation of financial documents provided to the party, that carries out the audit.

For a private-sector business, an external audit will typically include a review of the company's quarterly or monthly financial reports as well as statements on revenues and expenditures to ensure they are correctly presented. For governments, an external audit will include a review of the budget, the distribution of funds and the expenses to ensure the budgeted revenues and expenses were correctly compiled and used.

An external audit will feature a report outlining the auditor's findings. This will generally be a summary of the overall validity of the financial statements and documents as presented by the company or government which is usually presented as the Statement of Auditors in the Annual Reports. Should the external auditor uncover discrepancies between the statements presented by the company and his findings, these will be noted in the report as well. The audit will often include financial suggestions for the entity as ways to improve its overall financial standing and accounting practices.

The more important feature of an external audit is the conclusion of the auditor. A favourable conclusion is unbiased evidence that the entity is reporting financial data correctly while a negative conclusion is a red flag for poor accounting practices.

Summary

The stability of the financial market in Sri Lanka is a key driver of economic growth and sustenance. Similarly the capital markets provide a gateway for foreign investment and stimulate growth trajectories. The Sri Lankan Auditing Standards board and the Institute of Charted Accountants are the top governing bodies that ensure good practices and transparency in the industry.

In summary it was revealed that in Sri Lanka a majority of the listed companies prefer to seek the services of three of the Big4 audit firms, namely, Ernst & Young, KMPG and Pricewaterhouse Coopers. There are some smaller audit firms that are not so significant in providing services to the listed companies. This chapter discusses the regulations on external audits while stressing the importance of both professional and legislative guidelines. Estimation of the external audit fees, its composition and services offered have been discussed from a Sri Lankan perspective.

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