Lead auditors to face the heat for group lapses. Small audit firms are fretting
New Delhi, Sep 1, 2024
Summary
India’s audit watchdog is revising rules to enhance lead auditors’ accountability for conglomerates’ financial statements, more closely aligning with international standards. But this could disadvantage smaller audit firms.
India’s audit watchdog is set to plug a regulatory leak that had allowed business groups to get away with fund diversions by subsidiaries, by holding the lead auditors of conglomerates chiefly accountable for such lapses. However, experts are divided on the likely impact of the move on the profession.
At the root of the issue is a clause in India’s accounting rules—standard of accounting 600, or SA600 — that allows a parent company’s auditor to rely on the work of a subsidiary’s auditor without being held responsible for it, subject to safeguards. But any lapses such as diversion of funds from the subsidiary to, say, the group’s promoters could go unnoticed as a result.
India’s National Financial Reporting Authority is now set to issue a draft of revamped rules for the audit of business conglomerates to plug the loophole, two persons with direct knowledge of the matter said. The audit watchdog will issue its revised framework in a few days, they said, declining to be identified.
The proposed rules seek to make the lead auditors of a business group — typically large audit firms — more accountable for the consolidated financial statements of the conglomerate, more closely aligning with international standards.
But the proposal will include carveouts to ensure that smaller audit firms — which are typically assigned to the subsidiaries — do not get edged out of the market.
The carveouts leave a part of the audit market comprising unlisted companies, public sector entities, state-run banks and their branches from the proposed SA600 changes, so a subsidiary’s auditor will continue to be relied upon by the lead auditor.
This is because public sector companies are already subject to the additional oversight of the Comptroller and Auditor General of India while state-run lenders have the Reserve Bank of India looking over them.
Ved Jain, former president of the Institute of Chartered Accountants of India, said NFRA should keep in mind the social and development aspects of the audit industry while revising the audit standard. The ICAI is the country’s accounting and auditing rulemaker.
“There may be a regulatory case for harmonisation, but it will have an impact on the audit profession," Jain said. “The upgradation and confidence of smaller audit firms depends on their opportunity to audit subsidiaries. If big audit firms cannot rely on the work of another audit professional, they may insist on auditing the subsidiaries as well and it could lead to the dominance of big audit firms."
Mohandas Pai, a chartered accountant, entrepreneur, and chairman of private equity company Aarin Capital, thinks otherwise.
“The lead auditor should take full responsibility to ensure proper audit of all material subsidiaries and subsidiaries that account for more than 5% of a group’s revenue or profit," he said. “This is important to ensure the integrity and credibility of the financial statements of large companies."
But in the case of companies that have a large number of subsidiaries that do nominal business or are just investment vehicles, such units can be excluded from the lead auditor’s responsibility to avoid the audit becoming too cumbersome without benefits, said Pai, who has served on the board of the Securities and Exchange Board of India and on various regulatory and consultative committees.
No statutory obligation or liability
NFRA has slapped disciplinary orders on BSR & Associates LLP, the principal auditor of Coffee Day Enterprises Ltd, stating that it had not ensured compliance with SA600 in letter and spirit though “a substantial portion of financial information of the consolidated financial statement was audited by the other auditors".
The audit authority has taken similar action against Dewan Housing Finance Ltd, where the principal auditor had no access to the audit working papers of the subsidiary.
The proposed revision in the audit standard of business groups is aimed at preventing lead auditors from washing their hands off such lapses on account of the subsidiaries being audited by other firms.
Under the international standard of accounting 600, or ISA600, the principal auditor takes full responsibility of a group’s audit and has the right to review the working papers of a component auditor.
India’s Companies Act grants a lead auditor the right to examine the books of accounts and other records of the company, subject to the law and audit standards. But there is no statutory obligation or liability on the lead auditor to formally verify and confirm the truthfulness and fairness of accounts of subsidiary companies, the Company Law Review Committee noted in its March 2022 report while recommending amendments to the audit standard. The committee was led by Rajesh Verma, former secretary in the ministry of corporate affairs.
Queries emailed to NFRA, ICAI and the ministry of corporate affairs on Thursday seeking comments remained unanswered.
A big no to the US model
NFRA rejected suggestions for adopting the US model that in certain “relatively uncommon" circumstances allows a lead auditor of a business group to divide responsibility with one or more audit firms, said one of the persons mentioned above.
The second person, who is also privy to the discussions among NFRA, RBI, Sebi, and ICAI, said that in recent years only in about 40 cases in the US had the auditor of a parent company shared responsibility with other auditors, and mostly in instances such as late-year acquisition of a company.
Besides, the lead auditor of a US business group has to audit at least 50% of its assets or revenues if he relies upon other auditors’ work for subsidiaries, as per the rules of the US Public Company Accounting Oversight Board.
India has about 400,000 chartered accountants, the Big Four—firms with links to Deloitte, EY, KPMG, and PwC—and several small audit firms. If the audit authority decides to align SA600 with international rules, smaller firms will get impacted, said Jain, the former ICAI president.
“I do appreciate the regulatory expectations. We can frame stricter criteria for appointing auditors for the subsidiaries, in terms of expertise and experience," said Jain. “But saying that only the lead auditor will be responsible for the group’s audit could mean that second level audit firms will never get the opportunity to audit subsidiaries."
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