Rotation of auditors and its side effects

The Companies Act, 2013, has introduced important audit reforms. One of the important reforms is rotation of the auditor. All listed companies; unlisted public limited companies having paid-up share capital of Rs 10 crore or more; all private limited companies having paid-up share capital of Rs 20 crore or more, and all companies having public borrowings from financial institutions, banks or public deposit of Rs 50 crore or more are required to rotate their auditor.

An individual cannot continue as an auditor for more than one term of five years and an audit firm cannot continue as an auditor for more than two terms of five years, that is a consecutive period of 10 years. The cooling off period is five years. The Companies Act allows three years for complying with the provision. Therefore, the provision must be complied by April 1, 2017. The objective is to enhance audit independence. This is expected to improve audit quality, resulting in improved financial reporting.

Traditionally, companies do not change their auditors except in exceptional circumstances. In a large number of companies that are required to rotate the auditor, auditors have already completed more than the prescribed period for providing auditing service. Those companies will change their auditors from 2017-18.

Local firms dominate the Indian audit market. However, the presence of the Big Four audit firms (Deloitte, PWC, E&Y and KPMG) cannot be ignored. The Big Four are the largest professional service network in the world. They provide audit, assurance, tax, consulting, advisory, actuarial, corporate finance and advisory services. In India, they cannot provide audit services directly.

Therefore, they provide services through a network of local firms. It is alleged that they flout rules while providing audit and assurance services. Many foreign investors put a condition that the auditor of their choice should be appointed. This helps the Big Four audit firms to grow in India. Local firms audit 62 per cent of the BSE 500 companies.

There is an apprehension that many companies that get their accounts audited by local firms will appoint one of the Big Four or another large international professional service network (e.g. BDO, RSM, Grant Thornton and Baker Tilly) as auditors. If that happens, the local firms will lose out. It is reported that 20 large local firms have written to the government to intervene to protect their interests.

On September 30, 2016, the Ministry of Corporate Affairs had notified the constitution of a three-member expert group to look into the complaint that the Big Four are circumventing rules and to find ways to help local firms. Most local firms are small and they do not face any threat from the Big Four and other international firms.

They are mostly located in tier-II and -III cities and small towns. They provide a variety of services to small companies. They lack aspiration to become big. The Big Four and other international firms engage members of the Institute of Chartered Accountants of India (ICAI) to deliver audit and assurance services. In this context, the presence of the Big Four does not hurt the auditing profession. Therefore, it is debatable whether there is a case for government's intervention to protect local audit firms.

A proposal is doing the rounds that the government should mandate a joint audit with at least one local auditor to create professional opportunities for local firms. This is unwarranted. This will increase auditing expenses. The audit committee of a company should assess the need for a joint audit and the company should decide whether it should have a joint audit. No rule should be framed to create jobs for a profession, particularly for one that is matured.

Chartered accountants are prohibited from soliciting professional work through advertisement or otherwise. But they can respond to tenders. The practice of issuing a tender for the appointment of an internal auditors is quite common among public enterprises. Such a practice is not common among private-sector companies.

Companies usually do not issue tenders for appointment of statutory auditors. Tendering is the right method to search for the right audit firm. This increases choice and reduces auditing cost through competition. Companies should not limit their choice to the Big Four and other international firms or a few large local audit firms. There are local firms that have capabilities to audit large and complex transactions. Search through tendering process would help to identify such firms.

It will be interesting to see how the new rules regarding rotation of auditors will actually impact the auditing profession.

The writer is adjunct professor in IMT-Ghaziabad & chairman, Riverside Management Academy

E-mail: asish.bhattacharyya@gmail.com