 "Shyamak R Tata")
Shyamak R Tata is a partner with Deloitte Haskins & Sells, Mumbai, and a chartered accountant with about 20 years of experience in the sector. He has been tracking the emergence of the Indian economy since 1991, primarily from the consumer business side. In an interaction with Sudipto Dey, he talks about the implications of the auditor rotation policy on the audit business and on companies. Edited excerpts:
Recently, the US House of Representatives shot down the mandatory rotation of auditors. But our Companies Act still has this. Is India adopting a practice that does not have global acceptance?
The choices of countries to mandate rotation of auditors or have a mandatory tendering process or have no regulation around rotation are independent. For most of these choices, the pros and the cons are evaluated with regard to a country's environment. After the discovery of financial irregularities, regulators have raised the question of audit rotation. Countries such as Brazil, Belgium and Italy have mandatory rotation. However, recently, the US House of Representatives approved a Bill that prohibited the US regulator from mandating audit rotation. There is insufficient evidence to suggest mandatory audit firm rotation would significantly enhance auditors' objectivity and, consequently, audit quality.
Indian regulators, however, believe audit rotation is a positive step and will enhance audit quality. However, given the polarity of views by regulators, India needs to be careful and cautious in determining how the implementation should be achieved. This needs to be implemented in a phased and calibrated manner, in a way that does not completely disrupt the business environment or enhance audit risk. I am not in favour of a big-bang approach.
What is the implication of this move on the audit business?
The current [draft] rules require virtually every company - exceptions being one-person companies and small companies - to rotate their auditors over a specific term, not exceeding two terms.
This could impact thousands of companies, probably many more than in other countries where rotation has been introduced. Initially, it is likely to be highly disruptive. Mid-sized and small audit firms would need to replenish their portfolio of clients, which may be difficult in small-town geographies and for specialised industry auditors. Business models of some of the small- and medium-sized audit firms would get challenged.
For larger firms, the reach is wider, and the ability to service clients from more than one office is a real possibility. Companies, too, are likely to undertake a careful evaluation of the audit firm it would choose. This may actually reduce the population of available and capacity-capable auditors significantly. It is, therefore, highly unlikely the aggregate churned portfolio would have a number of new entrants at the top.
What does this mean for companies?
Though there is a three-year time frame for implementation from the time the Act is notified, I expect a scramble among companies to get a new set of auditors. We are advising many of our clients to undertake a dipstick impact analysis on the potential impact on their financial statements and operating factors.
Enhanced reporting, both by the board and the auditor, on the internal financial controls will mean added work for the auditor. The Act has also made consolidation mandatory, against just listed enterprises currently.
Both auditors and managements of companies would have to invest more time for effective audit output. From a company perspective, I expect auditing costs to increase.
Do you expect a change in the 'coziness' equation between companies and their auditors?
The fact that a company has been audited by the same firm of auditors for many years has often been interpreted as resulting in 'coziness' and, therefore, 'independence-impairing'. This is too sweeping a statement. But ensuring independence does remain an important priority in enhancing stakeholders' reliability on financial statements and, therefore, financial markets. However, it must be remembered a key component of an audit is to 'understand the business' which, in some cases, could take two-three years for a new auditor.
NFRA is the regulator for both accounting and auditing policies and standards, with a right to monitor and enforce compliance with the standards. While countries such as the United States have separate accounting and auditing regulators, it may be a good starting point to have a regulator.
To be able to perform its role, it is critical to ensure the fifteen members of NFRA are chosen with care and they are considered in good standing and of high eminence, with the ability to drive the desired change in the economy and enhance investor confidence.
How do you assess the impact of changes in the depreciation rates on balance sheets of companies?
The current Schedule XIV to the Companies Act, 1956, was largely a rates-provided regime. We have moved to a useful-lives regime in which specified entities have the freedom to determine fairly the useful lives.
This, in itself, is a good concept in a mature economy, as it establishes the principle on which depreciation is charged to the statement of profit and loss. However, rather than leave useful lives to be determined by all companies these lives have been prescribed by the schedule.
Having said this, there is a significant decrease in the useful life and, therefore, an increase in the deemed rates of depreciation for, say, continuous process plants. Here, the total charge for depreciation is more than double the amount provided earlier.
Also, it is expected in the short term, there would be significant volatility in the charge for depreciation, as the unamortised cost is to be depreciated over the revised balance life, as determined under the schedule.
Depreciation is required to be computed and provided by companies before declaration of dividend and is, therefore, likely to impact the dividend policies of some companies.
The Act has a wider definition of related-party transactions, which now includes immovable property. What is the likely impact of this move on the way businesses are run?
Definition of related parties per se has seen a sea change. The (draft) rules have widened the net further. Audit committees are now responsible for the approval of related-party transactions. Transactions that are not at arm’s length need to be blessed by the board and, in certain cases, also by shareholders, excluding related parties. These additional requirements would put a lot of stress on audit committees and boards, as the determination of ‘arm’s length’ is neither precise nor quantitatively measureable in all cases.
My assessment is independent directors would err on the side of caution. It would not be out of place for audit committees and boards to push such matter to the company shareholders for approval.
Do you expect the Act to make a perceptible change in the ease of doing business in India?
The intent has been to make companies transparent and accountable to stakeholders. On an overall basis, the Companies Act, 2013, focuses on investor protection, particularly of minority shareholders, aims at stricter enforcement and adopts self-regulation. Given the widespread changes, it is likely before things eventually settle, there would be more pain in the short term.
In certain areas, it is unclear how the regulation, in the current form, may be enforceable. Implemented well, the law would make a perceptible positive change in the way corporate businesses are run today.
