Consultancy / Audit – Services – Industry – The Economic Times

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View: Auditors should be made the frontline warriors of Ministry of Corporate Affairs

Regulators in Europe have issued new regulations. The Competition Commission in Britain has submitted strong recommendations to lawmakers that include rotation, ring fencing of audits, non-audit fee limitation, etc. Putting stakeholders’ interest first is now priority.

Besides auditing, international accounting firms have provided a range of services in transnational growth. They themselves have grown both organically and through acquisition of strong national firms. As economic value of corporates multiplied, the manifold impact of accounting failures is, however, greatly affecting stakeholders.

Regulators in Europe have issued new regulations. The Competition Commission in Britain has submitted strong recommendations to lawmakers that include rotation, ring fencing of audits, non-audit fee limitation, etc. Putting stakeholders’ interest first is now priority.

India’s ministry of company affairs (MCA), too, has issued a consultation paper, raising suggestions, among other things, on economic concentration, joint audits, efficiency capacity building and restricting non-audit services. It tackles threats from selfinterest, self-review, familiarity and conflict of interest. The objective is the creation of a stronger profession.

Clarity is needed on what is expected from an auditor. A position paper should be issued by MCA, jointly with the Institute of Chartered Accountants of India (ICAI), regarding whether auditors are expected to become bloodhounds, rather than the watchdogs Justice Henry Lopes described the function of auditors in 1896. Are they trained to be business forecasters as the MCA paper expects? For efficiency in regulation and investigation, we should have only one or two bodies, and not a plethora as there are now.

Competition breeds efficiency; oligopolies destroy it. Internationally, regulators are worried over the ill-effects on professional efficiency, and lack of choice arising from economic concentration. In Britain, almost all listed companies are audited by the large firms. In India, 76% are.

Introducing rotation of auditors in 2016-17 was meant partly to address this problem. But it has only resulted in a greater concentration. The MCA consultation paper asks whether there should be a cap on the number of audits, or partners.

A bolder reform is needed. If any auditor already has an aggregate audit fee equal to 10% of the audit fee of the top 100 NSE companies, then she or he should not be eligible to accept any more statutory audits. They will be free to do other non-statutory audit and consultancy work. Thus, there is no bar on their growth. India has large audit firms with foreign affiliations that can still control 60% of their audit work. In the residual space, 15-20 mid-size audit firms can emerge.

MCA has called for views on joint audit and mid-size firms’ audit capability. They use software-based audit tools; audit holding companies with operating subsidiaries in India and abroad. These capabilities can be scaled up for joint audits, providing a bulwark against conflict of interest, familiarity risk and provide protection against any oligopoly. They should be made compulsory in the top 100 NSE companies and material subsidiaries. When mid-size firms observe the ‘Big Four’ working techniques, they will further upgrade. Accounting areas to be covered should be rotated every four years.

MCA can support capacity-building. By bringing in time and cost-based fees, resources can be generated for training and staff retention. ICAI must also expedite more advanced audit software for mid-size firms. Equipment loans for upgradation, without collateral, should be available.

Also, all consultancy companies affiliated to the same accounting network must come under the National Financial Reporting Authority (NFRA) and ICAI code of ethics. In substance, but not in form, they are associates of audit firms. These companies advertise, build brands and canvas for business.

The fee received from the auditee company, or its associate, by all such affiliate network consultancy companies should be disclosed, and work should require prior approval of the audit committee. The fee received, in the aggregate, should be restricted to 50% of the audit fee. These combined measures will do away with the risk of conflict of interest.

MCA should allow firms to continue to have a tax and corporate law department, as their inputs become integral to completing audits, issuing corporate governance reports and tax matters. Familiarity risk will be sharply reduced by rotation of audit partners in four years, against the seven allowed by ICAI.

A critically sensitive area where MCA and ICAI should look at jointly is the rules for mid-size firms to join international networks without violating core ethics. Networks provide access and training in the latest audit technology, international tax law developments, management and cyber systems. The responsibility of audit committees has been expanded by law.

Their processes should be further strengthened. Auditors should be made the frontline warriors of MCA.

(The writer is managing partner, SS Kothari Mehta & Co)

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