Cost cannot be an overwhelming consideration if joint audits lead to improvement in quality
The concept and practice of a joint audit have been piloted as a major reform in India as well as globally. Auditing failures often take centre stage in public discussions. These deliberations focus on improving the quality of audits and the healthy development of the audit market.
Unfortunately, joint audits have yet to be made mandatory by the statute or by capital market regulators; nor have they been introduced as a best practice, except for scheduled banks and public sector units.
In the past, the Institute of Chartered Accountants of India has also suggested mandating joint audits through the Companies Act. The committees set up by the government have recommended the same. It has not been introduced as a best practice by the industry either.
In recent months, three independent reviews, a parliamentary inquiry, and extensive policy proposals in the UK advocated for joint audits, among other things, as a reform measure fundamental to making the audit market competitive, which is currently dominated by the big four — namely EY, Deloitte, KPMG and PwC. The proposal came in the wake of a spate of audit failures involving the big four and concerns over quality observed by the Financial Reporting Council of UK in audits of public interest entities.
The draft Audit Reform Bill, as announced in the Queen’s speech on May 10, states that the FTSE 350 audit market is heavily dominated by the big four audit firms. It provides that these companies will be required to either appoint an auditor outside of the big four or to allocate a certain portion of their audits to smaller firms. Such shared audits are expected to bolster the competition while avoiding replication of efforts.
Joint audits incentivise smaller firms to invest in technology, organisation-building, infrastructure and expertise. This will over time give rise to a number of larger firms, enabling healthy competition in the audit market. Globally, the big four dominate the audit market with more than 70 per cent of the share. The next six in aggregate account for 10-15 per cent, and the remaining is shared by thousands of small and mid-size firms.
The situation in India is no different. The challenge is not the size of the big four. It is about a healthy audit market and the imperative to increase the number of globally competitive firms.
Joint audits improve the quality by reinforcing independence in audit and mitigating the extant audit risks of over familiarisation through rotation and of conflict of interest arising out of acceptance of non-audit services. They also act as a built-in check on each other’s audit work through reciprocal review; provide oversight following the “four eyes” principle; and add to the auditors’ ability to hold on to their viewpoint in case of disagreements with the management.
Internationally, joint audits have been in place for the last 50 years in France, leading to a less concentrated audit market, apart from other benefits. Denmark, however, mandated joint audits for 75 years but removed the requirement from 2005. Belgium, and South Africa have also mandated joint audits for financial services companies. In recent years, with the development of multinational audit firms, the preference has shifted in favour of appointing a sole auditor, except where rotation of auditor is mandatory. For example, in the UK, shared audits for financial companies was a common practice.
Opponents of joint audits argue that they divide the responsibility and thus divide and diffuse accountability. Besides, too many auditors may also spoil the broth. This may not be correct as applicable standards of auditing prescribe for proper design of joint audits with clear allocation of responsibility and a mechanism for coordination amongst them. The audit committee would also need to exercise due diligence and care in identifying and selecting joint auditors so that the overall quality of audits is not compromised and the responsibility is clearly demarcated and understood.
Another criticism of joint audits is that they entail higher costs due to multiple auditors. While there is no empirical evidence to suggest so, from a public interest perspective, cost cannot be an overwhelming consideration if joint audits lead to improvement in audit quality. Even if they do add to the cost, it may be at most 10-15 per cent of the audit fee. Joint audits in India, as stated, are in place for scheduled banks and public sector units and there has not been any contrary evidence to suggest that they have not worked well.
Overall, joint audits have merits in improving the quality of audit in public interest entities. However, in the initial years, till a large number of firms gain commensurate size and capabilities, shared audits may be considered for the relatively larger and complex entities. The regulators should promote and incentivise smaller firms to reorganise, expand across geographies, acquire multidisciplinary expertise and technological competence. Needless to mention, auditors would be required to reorient themselves to the culture of joint audits.The writer is a former secretary of ICAI. The views are personal