MCA's proposal to curb non-audit services will affect small firms: Experts

Illustration by Binay Sinha
On February 7, Institute of Chartered Accountants of India (ICAI), the self-regulatory body for audit profession, had its 70th Annual Day bash at a five-star hotel in the national capital which was attended by hundreds of its members and students from across the country. The same day, the ministry of corporate affairs (MCA), the presiding ministry of ICAI, uploaded on its website a consultation paper, seeking views of stakeholders on measures to enhance audit independence and accountability. 

Over the last three-four years, auditors have been under scrutiny for their role in financially stressed and fraud-hit companies. Several expert groups over the years have suggested measures to raise the accountability bar for auditors. 

This time, the consultation paper drives its point hard: “Recently various instances of failure of auditors have been noticed, such as (in the) IL&FS case, and it also has been seen that the quality of audit reports have been compromised. In most of the cases, the auditor appears to be hand in glove with the management and, therefore, the question on their independence and accountability have been arisen.”

“What is worrisome is the tone of the consultation paper. The language is accusatory,” says a senior executive from one of the ‘Big Four’ audit firms. While ICAI has welcomed the latest move by the government, it has appointed a high-level committee to prepare its responses.  

However, arriving at commonly accepted recommendations will not be easy for the audit fraternity. Among several proposals in the discussion paper, two suggestions have riled both big and small players offering audit and advisory services.

One, putting a cap on the number of clients a ‘Big 4’ audit firm can take. And the other, putting a blanket ban on offering non-audit services to audit clients.

Globally audit and accounting firms have come under scrutiny because of their size, influence, and disproportionate levels of accountability. High profile corporate failures have only increased the regulatory gaze on them. The MCA, through its consultation paper, has also highlighted its concerns on the economic concentration of audit work in the domestic market and an “inadequate degree of competition” because of the oligopoly of the Big 4 audit and accounting firms. The paper suggests two ways of combating the situation -- one, through putting a cap on the number of audit firms a group can have; two, through fostering growth of domestic audit firms to decrease the industry’s reliance on the Big 4.

Under the present system, an auditor cannot undertake the audit of more than 20 companies. However, large audit firms partner with local firms and license the use of their name to undertake more audits. As a result, over 70 per cent of the firms on the Nifty are audited by firms related to the Big 4, according to PRIME Database (a statistic, which the MCA cites in its paper). The paper states that because of the aforesaid situation, the quality of the audit becomes “compromised”, which may signal the need for putting a cap on the number of audit firms a group may have, and the number of partners in a firm be fixed to a certain limit (to allow better allocation of resources and improve quality of auditing).     

While there are concerns in the audit fraternity about the size and influence that the Big 4 have on the market and on their clients, the general feeling is that is unfair to punish "size".

“To correct the economic concentration, what you need is many large audit firms, and not to make the large firm small,” says a former head of one of the Big 4 audit and accounting firms. A cap, if put, could only be a transitory measure, he adds.

However, one thing most professionals agree on is that the best course going forward is to incentivise small and mid-sized firms to grow. ICAI, too, is looking upgrade the network guidelines for audit firms so as to encourage small and medium-sized firms to work with each other, and eventually merge, says a senior council member of ICAI.

“We want to spread the message that the days of proprietorship auditor firms are numbered and that they should move towards an LLP structure to offer multiple services to clients,” he adds. A corpus of Rs 30 crore has been put in place by ICAI to help capacity building among small audit firms. The plan is to have post-qualification training programmes, and build audit tools and database for small firms.

Many members of the audit fraternity feel the proposal to put a blanket ban on offering non-audit services to audit clients will hit small firms the most. Most proprietorship audit firm package audit services, along with tax advisory services and their client’s compliance-related requirements.

Taking a cue, already two large audit firms -- Grant Thornton India and PW India -- have decided not to partake in non-attest work with their audit clients. Globally, no country, other than the UK, bars offering non-audit services to audit clients.

Already, Section 144 of the Companies Act prohibits auditors from providing certain specific non-audit services to companies. However, there are many services, such as consultation and transaction advisory, which are allowed to be undertaken simultaneously under the present laws. Many companies avail such services from the same firms that undertake their audit.

Sriram S L, corporate lawyer, suggests that the MCA should ideally mandate parameters of quality for audits, and even implement a minimum number of employees to be staffed on each audit mandate. “This can ensure that personal oversight on audit mandates is at an optimal level,” he adds.
The challenges

  • Self-interest threat because of auditors' reliance on the fees from their clients
  • Self-review affects the independence of the auditor if he/she is auditing own work or work done by others in the same firm
  • When an auditor promotes the client to the point in which their objectivity is potentially compromised, resulting in advocacy threat
  • A familiarity threat exists if the auditor is either too familiar with employees, officers, and directors, or keeps a long-standing relationship with the client
  • An intimidation threat to independency exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively
Source: MCA’s consultation paper to enhance audit independence and accountability

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