By nature, auditors are supposed to be independent. Since independence is a state of mind and it could vary from auditor to auditor, regulators cannot thrust independence upon an auditor but can only expect that they act independently all the time. For the last couple of decades, regulators around the world have thought up two options that would act as a firewall for auditors’ to act independent — compulsory rotation of auditors and mandating companies to have joint auditors.
The former is to ensure that the auditor does not become too cosy with the client and the latter assumes that two heads are better than one, at least in the world of auditing.
The Companies Act, 2013 introduced a system of mandatory rotation of auditors for a certain class of companies. The first set of rotated auditors are due to commence their new audits from the ensuing financial year. On the ground, it has been observed that rotation of auditors is happening based on barter transactions in which audit firms mutually agree to give up and take audits amongst themselves.
In very few cases, companies have actually gone out into the market and scouted for an audit firm. Rotation of auditors cannot truly guarantee audit quality as the auditor can get cosy with the client within days.
Joint audits
When the Government announced its intention to open up the audit market to more international firms, desi audit firms felt threatened. A committee was promptly set up and the Institute of Chartered Accountants of India has recently recommended to the committee that they should mandate joint audits for large listed firms. While ‘large’ has not been defined, it is expected that it could mean a minimum net worth of ₹500 crore. There have been suggestions to mandate joint audits for all listed companies. While this would certainly provide opportunities to more audit firms, there are many listed companies that are dormant. The threshold should probably be active listed companies with a net worth in excess of ₹200 crore.
India already has a system of joint audit for banks and PSUs. The jury is still out whether there has been an improvement in audit quality due to this. In the international market, France has a system of joint audit since 1966 while South Africa mandates joint audits for companies in the financial services sector. The argument against joint audits is that it is extremely tough for any company to convince one auditor every year. Two or more would only multiply the problem as one cannot expect two auditors to see eye to eye of financial statements that are increasingly based on fair value and judgement.
Audit quality
By mandating rotation of audits and joint audits, there can only be hope that audit quality would improve. Other ways should be thought of to improve audit quality. For instance, the Audit Report today is based on a format and a checklist called CARO. In addition to this, the auditor should be free to express his opinion on any matter that he feels needs the attention of shareholders. This would enable the stakeholders to pass judgement on the judgement made by the auditors. The Companies Act has all the necessary clauses to take strict action against erring auditors. Empowering auditors to express themselves and punishing them if they don’t can well be the solution to improved audit quality.
(The writer is a chartered accountant.)