NFRA has its task cut out to bring in more accountability in audit services

A report prepared by a group of British academic experts (Reforming the Auditing Industry, December 2018) for the UK’s Labour Party has suggested that the state should consider offering statutory audit services to the financial sector. The proposal to ‘nationalise’ audit services to fix the increasing instances of audit failures across countries is debatable. However, the watchdog role of auditors has come under scrutiny after every instance when a business goes under due to financial stress or fraud. The ongoing crisis at IL&FS is no different and has put the spotlight on the role of present and previous auditors of the group.    

“There is a problem with audits at every level, including education,” says Prem Sikka, professor of Accounting and Finance, University of Sheffield, who led the group of academic experts looking at measures to fix UK’s audit industry.

Sikka says governments have to follow a multi-pronged approach for reforming audit practices and make audit industry more accountable.

“The two most important factors causing audit failures are lack of independence and of course, human greed,” says Amarjit Chopra, former president of Institute of Chartered Accountants of India (ICAI).

The concept of an auditor being a mere watchdog appears to be outdated, say experts. “There is a need to move in a direction where auditors provide alerts in time, much before the collapse occurs,” says Chopra.

However, for that to happen, accounting experts say, the approach to statutory audit has to change. Auditors have to apply increased professional scepticism when auditing management estimates and that would require companies to provide more granular disclosures on estimates and assumptions made, they add. Similarly, regulators, too, are required to provide guidance on early warning indicators around going concern, say auditors.

Independence of auditors has been the subject matter of debate given the pressure on accounting firms to increase non-audit revenues.

“Firms of every size have failed to maintain desirable levels of independence,” says Chopra. However, this becomes all the more glaring in case of the Big Four given that their financial relationships run deep through firms under the same network as well, he adds.

Most experts agree that the way forward for the accounting profession is to create structurally divided firms for audit and consultancy services. 

“Separating audit and consulting should be a first-order priority for regulators. 

Consulting shifts the mindset of auditors from scrutiniser to friend. This is not useful to capital markets,” says Karthik Ramanna, professor of Business and Public Policy at the University of Oxford.

But in the Indian context that may not be easy to practise. “Almost 75 per cent of Indian firms have less than three partners,” points out Chopra. Further, in smaller towns and cities, there has been a proliferation of audit firms that also offer multiple services to clients, including tax-related services.

“This impairs the independence of an auditor to an extent. There is an urgent need to propagate the concept of specialised services,” Chopra.

There is also the issue of attracting talent and technology into audit practices.

“A multi-disciplinary firm provides the auditor access to specialised skills such as technology and analytics that are needed to audit in a complex business environment.  A standalone audit firm will not be able to attract talent with these skill sets,” says Sudhir Soni, national director & partner, assurance services at SR Batliboi & Co.

For improvement in audit quality, corporate India, too, has to become more accountable to its auditors for business decisions.

Many auditors highlight the dichotomy in audit practices. Auditors who resign for an audit account are supposed to give reasons for doing so, but the management of such companies are not put through the same level of scrutiny.

“The management of companies whose auditors resign also need to be questioned,” says Chopra. There have been several instances of auditor resignation over the last two-three years following differences of opinion between auditors and management.

Clearly, the National Financial Reporting Authority, the newly appointed regulator for audit services, has its task cut out to give teeth to the auditor.