New Sebi strictures on subsidiaries make accountants even more accountable

The Securities and Exchange Board of India’s (Sebi’s) new rule pertaining to reviewing the account of unlisted subsidiaries of listed entity could go a long way in preventing the reoccurrence of the IL&FS debt saga. 

The regulator last month issued guidelines on group audit making statutory auditors even more accountable while preparing audit report, mandating them to undertake a limited review of all entities accounts of which are consolidated with the listed entity.  

The new rule, effective from April 1, is in line with recommendations of the Uday Kotak committee report on corporate governance. The committee had recommended that “auditor of the holding company in case of listed entity should be made responsible for the audit opinion of all material unlisted subsidiaries”. 

Experts believe this new format would increase transparency for monitoring and reviewing an entity’s performance at a consolidated level. 

“This is to ensure that the primary auditor (auditing the listed entity) undertakes an independent review of the investee companies’ financial results of which are consolidated with that of the listed entity,” says Moin Ladha, partner, Khaitan & Co. The auditor is also required to obtain an understanding of the consolidation process to perform audit review for preparing the consolidated statements. “There have to be discussions with the auditors and management of the consolidated entities on activities which are or likely to be significant to the group,” says Ladha.

The move assumes significance in light of the huge gaps found in the various accounts of debt-laden IL&FS firms. The auditors, however, never flagged the issues in all these years until mid-last year when the infrastructure finance company defaulted on inter-corporate deposits and commercial papers. 

Subsequently, the board of IL&FS was sacked and multiple probe agencies are examining the role of the auditors and other related parties in the mismanagement of the group. According to the IL&FS annual report of 2018, the group debt stood at Rs 106, 483 crore. IL&FS has about 400 sub-companies under its ambit. This includes over two dozen direct subsidiaries, 135 indirect subsidiaries, six joint ventures, and four associate companies. 

Industry players are of the view that Sebi’s move to allow limited audit review by primary auditors would certainly help curb the illicit practice of keeping the parent company's account clean while maintaining debt in its subsidiaries. Besides, this would curtail the first line defence of statutory auditors in case of any mismatch in the subsidiaries account as they did not audit those accounts.  

Shailesh Haribhakti, chairman, Haribhakti & Co, notes that the guidelines are very useful in harmonising accounting and auditing practices so that the auditor signing off on consolidated accounts can ensure the common application of standards and processes. “High standards of disclosing sure and commonly applied standards will lead to transparency,” he adds. 

Besides, the new rule will also help the statutory auditor keep a close watch on the audit practices adopted by the component auditors. “The procedure requires the principal auditor to obtain and consider significant findings of the component auditor, and also consider the need to discuss such findings with the component auditor or the management of the component.  This will provide the principal auditor with a better lens on the transactions and audit matters across the group,” says Jamil Khatri, partner, BSR & Co.

However, there could be interpretation challenges over “limited review” of unlisted subsidiaries account. “The extent to which the auditor needs to dig deep will always be a subjective interpretation. The issue becomes even more complex in case of companies with global operations, wherein, he/she also needs to evaluate the extent of reliance he/she can place on overseas auditors,”  says Girish Vanvari, founder, Transaction Square. 

The new formats would be applicable for all listed entities equity shares and convertible securities of which are listed on stock exchanges and the statutory auditors of such entities. These procedures have replaced the earlier formats for limited review reports and audit reports issued in relation to the presentation of financial information by listed companies.

On the question of whether the presence of such procedures would have brought in transparency to multi-layered business groups like IL&FS, most chartered accountants and auditor are not willing to stick their neck out. Vanvari concedes that these procedures would bring in more transparency. However, he is quick to add that the role of the auditor is evolving.  

“The earlier processes too required auditors to reasonably detect such mishaps.  As things get more and more complex, the focus on reasonableness and negligence will become sharper,” he adds.

Key amendments

• Statutory auditors to seek limited review report on both quarterly and yearly basis
• An opinion to be expressed without any modification 
• An independent auditor’s review report on the consolidated unaudited report of subsidiary

What auditors need to do

• Identify a threshold above which misstatements in the financial statement of a subsidiary cannot be regarded as immaterial
• Get hold of accounting policies to ensure its applicability 
• The statutory auditor needs to keep a close watch on audit practices adopted by component auditors