Making auditors accountable

The MCA's proposals will address the conflict of interest issue

The role of auditors has come under significant scrutiny in recent years with the emergence of high-profile corporate frauds. The auditors are expected to protect the interests of stakeholders of the companies they audit. To plug the gaps, the Ministry of Corporate Affairs has put out a consultation paper, inviting suggestions on enhancing the independence and accountability of auditors. While the paper talks about a number of issues, some of the possible interventions can significantly affect the auditing business.

One of the proposals is to prohibit non-audit services to audit clients so that revenue considerations from other services do not stop an audit firm from fulfilling its obligations to the shareholders. This is a good idea, because it is expected to substantially reduce the risk of a damaging conflict of interest, where the commercial interests of an auditor are perceived to be the most important factor in an audit relationship rather than the focus on high-quality work. There is no doubt that several audit firms tend to bid aggressively for the audit work and compensate it with revenues from other services. Section 144 of the Companies Act, 2013, does not allow an auditor to offer certain services to its audit clients. The list includes accounting and book-keeping services; investment advisory and investment banking services; outsourced financial services; and management services. Anticipating the impending changes, Price Waterhouse India and Deloitte have decided not to offer non-audit services to audit clients. In June last year, Grant Thornton, too, had said that it would not provide non-audit services such as consulting and transaction advice to listed companies audited by it. The proposed expansion of the list is a prudent move even though it has been argued that such a measure will affect smaller firms more than big auditing outfits. Also, the concern is that audit firms will push up fees in order to keep the business viable. 

The other proposal is to cap the number of companies the big auditing firms can serve. Under the present rule, an audit firm cannot audit more than 20 companies, excluding small and private limited companies with paid-up capital of less than Rs 100 crore. But big audit firms in India work with local chartered accountant firms and allow them to use their brand names. Consequently, as noted in the discussion paper, 70 per cent of companies listed on the National Stock Exchange are audited by the audit firms affiliated to the Big Four. This has resulted in concentration of business and lack of competition. However, it will not be easy to put a blanket restriction as the way to address concentration is not to make the big small. The discussion paper also talks about joint audit with two firms preparing the audit report. This would help reduce one kind of risk, but can make audit firms less accountable.

While some of the ideas have both pluses and minuses, the government should be commended for following a consultative approach in reviewing the rules. On balance, the objective of regulation should be to enhance the level of competition. Also, since auditors play a critical role in the functioning of the modern market economy, India needs a strong legal framework which can swiftly bring offenders to justice. This will deter both auditors and company executives from compromising shareholder interests. Changing regulation alone may not inspire enough trust.