Hazy start to auditor rotation Shyamak Tata There is a need to make auditor rotation prospective, as it is for independent directors. Today’s auditor is required to meet the expectations of varied stakeholders. However, the profession often draws attention when adversity strikes: Enron, WorldCom, Lehman Brothers, Satyam Computer Services are examples. Like in many parts of the world, in India too, auditors are appointed by shareholders at the recommendation of the management. Questions often arise around independence, ‘other services’, tenure and, overall, the need to ‘relook’ at the system. On ‘other services’, regulators have had diverse views — proscribing some and establishing monetary limits around an auditor’s ‘other fees’. The accompanying table gives a comparison. On tenure too, auditors are guided by country-specific regulations. In India, the appointment has so far been annual, where auditors most often get reappointed, although larger firms have their own internal stipulations around partner or key team member rotation. Companies Act, 2013 changes that to make the auditors’ term of appointment a five-year one and mandates auditor rotation after two terms — with a five -year cooling period. The proposed Rules (currently under discussion) suggest retroactive applicability — that is, considers the auditor’s tenure prior to the new Act in determining eligibility for reappointment. Also, the draft Rules are wide and stipulate auditor rotation for most companies — running into lakhs! Only a few standalone, small companies would be excluded. The argument in favour of auditor rotation is often around audit quality — where ‘over-familiarity’ impedes professional scepticism. Yet, in the short run it could impair audit quality, until a good understanding of the business, industry, sector and so on is achieved. The global position on this has been varied. The US House of Representatives has prohibited the regulator from mandating auditor rotation. In Canada, South Korea, Spain, Turkey and Pakistan, auditor rotation was mandated to be rolled back. The European Union is currently deliberating. Italy and Brazil have mandated auditor rotation, while in the Netherlands this is a recent requirement effective 2016. So the jury is still out! What does this mean for companies in India? The rotation covering lakhs of companies — over a relatively short period — could prove challenging, particularly for geographical, size and skill considerations. Remember, auditors too will need to choose their clients with diligence. Additionally, the five-year term may make a midway divorce onerous (requiring Central Government approval). What does this mean for auditors? Auditors, too, would undergo disruption, as many (if not most) clients will be ‘up for rotation’, especially for those with a relatively stable client base. Mid-sized and smaller audit firms will be most affected, with a need to replenish their portfolio within geographical and industry constraints. Larger firms would likely weather this somewhat better. What does it mean for the audit process? Gaining an understanding of the business, industry/ sector, internal control processes and so on is often best done over time and after repeated audits. Initial years will require greater efforts. Multinational companies with subsidiaries in and outside India would need to consolidate, and would value seamlessness, accountability and good communication. Mandatory rotation in India would disrupt that and increase costs. India is yet to implement Internal Controls over Financial Reporting (ICFR) as in, say, the US. As India adopts Indian Accounting Standards (Ind ASs) — within the IFRS reporting framework — there would be additional challenges too. Audit firms understand their client’s businesses and are best positioned to assist in such transitions, and a new auditor may often have to struggle. Notwithstanding the merits of auditor rotation, there are two significant challenges: Retrospective rotation — and covering a large number of companies; Implementation of ICFR and Ind As on the anvil. This begs the question on the timing of the proposed changes. A potential large-scale disruption would be ill-advised. Hence the need to make the auditor rotation provisions prospective — as it is for independent directors. (The author is Partner, Deloitte Haskins & Sells)
Posted on: Tue, 15 Oct 2013 17:37:28 +0000
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