Sunday, November 13, 2016

Rotation of auditors - 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 ten crore or more, all private limited companies having paid up share capital of Rs twenty crore or more, and all companies having public borrowings from financial institutions, banks or public deposit of Rs fifty crore or more are required to rotate their auditor. An individual cannot continue as an auditor for more than one term of consecutive five years and an audit firm cannot continue as an auditor for more than two terms of consecutive five years, that is a consecutive period of ten years. The cooling off period is five years. The Companies Act allows three-year time for complying with the provision. Therefore, the provision must be complied by April 1, 2017. The objective is to enhance the 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 Large number of companies that are required to rotate the auditor, auditors have already completed more than ten years/five years of providing auditing service. Those companies will change their auditor effective from 2017-18.
Local firms dominate Indian audit market. However, the presence of Big 4 audit firms (Deloitte, PWC, E&Y and KPMG) cannot be ignored. Big 4 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 network of local firms. It is alleged that they flout the rules in order to provide audit and assurance services. Many foreign investors put a condition that the auditor of their choice should be appointed. This helps the Big 4 audit firms to grow in India.
Local firms audit 62 per cent of the BSE five hundred companies. There is an apprehension that many companies that get their accounts audited by local firms will appoint one of the Big 4 or other large international professional service network (e.g. BDO, RSM, Grant Thornton and Baker Tilly) as their auditors. If that happens, the local firms will lose out. It is reported that large 20 local firms have written to the government to intervene to protect their interest. On September 30, 2016, the Ministry of Corporate Affairs has notified constitution of a three member expert group to look into the complaint that Big 4 are circumventing rules and to find ways to help local firms.
Most local firms are small and they do not face any threat from Big 4 and other international firms. They are mostly located in tier II and III cities and small towns. They provide variety of services to small companies. They lack aspiration to become big.  Big 4 and other international firms engage members of the Institute of Chartered Accountants of India (ICAI) to deliver audit and assurance services. In this context, presence of Big 4 firms 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 taking round that the government should mandate joint audit with at least one local auditor to create professional opportunities for local firms. This is unwarranted. This will increase the auditing expenses. The audit committee of a company should assess the need for the joint audit and the company should decide whether it should have 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 tender for the appointment of internal auditors is quite common among public enterprises. Such a practice is not common among private-sector companies. Companies usually do not issue tender for the appointment of statutory auditors. Tendering is the right method to search for the right audit firm. This increases the choice and reduces auditing cost through competition. Companies should not limit their choice to Big 4 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.


  1. Agreed. Why demand protection? Members of a profession which claims to be of international standards, should not be seen as surviving on life support. If the Big4 appeal to companies soliciting audit services due to their scale, local firms can jolly well tie up and form matching conglomerates to throw up the counter-challenge. The key thing to have is "an aspiration to grow" as the author rightly mentions.