Overstepping limits of auditing

The Delhi High Court’s judgment upholding the decision to allow the Comptroller and Auditor General of India (CAG) to audit private firms is fraught with irreconcilable problems.

The CAG is the official auditor of the government. Under an activist CAG, the functions of the institution were pushed outside of auditing and many of the observations of the last CAG were in fact commentaries on government policies. When an accountant’s viewpoint is imposed on economic or other policy-making, the broader objectives of policy- making risk getting lost.

Thus, for example, a marginal loss of government revenue by deliberate policy might be justified in the interest of a developing country’s domestic energy sources. As a matter of fact, all government incentive schemes for attracting investments in certain sectors are based on this principle.

For an auditor, this might be indefensible. He might just as well impute motives to these moves.

Such an approach will not take into account the development aspirations or requirements in public policy. This is,  of course, not to say that deliberate and selective concessions for lining selective pockets are excusable. These, when detected, must be adequately punished. But such suspicions should not be generally applied to all, resulting in a general stalemate. The latest court decision has to be seen against this background.

When government revenues are linked ad valorem to the turnover of a company, there might be some justification in allowing a public auditor to examine whether the revenues have been reported correctly. Any under-reporting of revenues will mean a lower revenue for the government that is tantamount to short-changing.

However, a correct evaluation of revenue cannot be limited to examining only the revenue receipts.

Such auditing will eventually mean auditing the entire operations to ascertain whether revenues have been correctly computed, and all receipts recorded, so on and so forth. This actually happened last year in the petroleum sector with the ministry of petroleum insisting on private companies handing over their papers to the CAG. 

It inevitably results in overstepping the limits of auditing. And in many cases of other industries as well, government take is related to the turnover or price of a product. Will the CAG be ever widening its ambit?

The better approach should be to adopt a formula for computing government dues which bypasses all these points and is computed on clearly spelt-out norms.

A similar issue had cropped up in case of the oil and gas industry post NELP award of oil and gas acreages to private companies. These contracts were framed on the basis of a cost-sharing formula. Since oil or gas explorations were highly risky and involved huge outlays on uncertain explorations, it is an established international practice for these exploration and production contracts to factor in an element of cost sharing. That is, the costs of exploration and production are shared between the operator and the government and the surplus above that is shared between the contractor and the government. Inherently, if the costs are not correctly reported then the sharing of the profits will get skewed in favour of one or the other party to the contract.

The cost-sharing formula thus inevitably brought in government auditing of costs. It resulted in long drawn out and protracted legal and other battles between petroleum and gas-producing companies and the government, and the attendant allegations and counter-allegations.  These then take on the character of political battles where the government and private firms are ranged against each other.

Such perpetual sparring between the government and oil companies hurts the public purpose of opening up the industry to develop indigenous energy resources. When the country was importing petroleum and its products to the tune of $160 billion and facing acute current account deficit, petroleum products being the single largest import item, domestic production was lost in course of bitter fights between the ministry and private oil and gas producers.

The chances of inherent conflict and litigation in such a contract were realised by a committee on future production sharing contracts (PSCs) under Dr C Rangarajan, chairman of Prime Minister’s Economic Advisory Council (PMEC). The Rangarajan Committee suggested scrapping of the current PSC structure and introduction of a new revenue-sharing formula.

The new formula also follows some other globally accepted practices. This is to move over to a royalty payments system along with production-linked payments. Under this system, royalty is paid by the producer on the basis of a price cleared by the government. Royalty is thus paid on the basis on the government approved well head price. This obviates the need to examine in details the costs incurred by the contractor or whether these have been ingenuously inflated.

Instead of adopting ad valorem revenue share, the licence fee can be specific and independent of revenue turnover — a practice followed earlier. Other revenue model options could also be evolved on the basis of industry-government dialogues. The best global practices are a good guide in this field.

In fact, the petroleum ministry has taken welcome initiatives in, so to say, codifying the global best practices in the exploration and production (E&P) sector. These norms could help improve efficiency of the industry as well as minimise the friction points between government and industry.

Development of the telecom industry is vital for India. Telecom is important for both the rich and poor.  Equally important is IT industry and business process outsourcing.

An accountant’s approach and examination of revenue sharing may be a good idea for hair-splitting evaluations of competing takes. But these are not the top priorities. No one should short-change the public. But inevitable and interminable quarrels over these should not stall natural growth — a process through which we are passing currently.

The author is a Delhi-based analyst and commentator