The role of an auditor has developed significantly over the years. With globalisation and increasing cross-border transactions, the stakeholders interested in the financial statements are no longer restricted to a specific country. A recent survey of investment professionals by a large accounting firm in the UK has shown that ‘a clean audit report' is a one of the significant factors considered while making investment decisions.

Given the state of the financial markets and the need for stronger financial reporting, it is the right time to explore the possibilities of improving the transparency of the scope, process and decision-making involved in an audit.

The Companies Bill, 2011(Bill) has made significant strides in this area by making changes to existing provisions and incorporating new requirements which are sure to go a long way in shaping the future of the audit profession in the country.

Auditor Independence

Independence of an auditor from the company that he is appointed in is of crucial importance in ensuring that there is objectivity and credibility in the auditors' reporting. The Bill has now introduced the concept of rotation of auditors — in case of listed companies it would be mandatory to rotate auditors — every five years in case of an individual and every 10 years in case of a firm with a uniform cooling off period of five years in both cases.

Rotation of audit firms and audit partners is currently a topic which is being discussed around the world, particularly in the light of the proposed legislation being considered by the European Commission and Concept Release on Auditor Independence and Audit Firm Rotation by Public Company Accounting Oversight Board (PCAOB ) in the US.

However, while almost all the existing regulations require audit partner rotation, there are hardly a few jurisdictions (the EU and the US, not being one of them), which have implemented audit firm rotation.

There are stringent requirements with regard to appointment of an auditor even currently both under the ICAI requirements as well as the Companies Act, 1956, with the guidance of the Institute of Chartered Accountants of India (ICAI) already pegged to international standards since it is on the lines of the Code of Ethics issued by the International Federation of Accountants.

Audit firm rotation, if implemented, has several far-reaching implications, in particular increasing the burden on the company by going through the exercise of evaluating and hiring a new auditor/audit firm every few years.

Additionally, where a company has global operations, including an Indian company with overseas operations, this could lead to an operational nightmare if there are different auditors auditing different components owing to varying audit firm rotation policies across territories.

Regulating the auditors

This brings us to the next issue of how are the auditors regulated and who regulates them. Audit has always been a highly regulated profession and primarily regulated by the ICAI. The Bill now seeks to introduce a new regulator — the National Regulatory and Financial Authority (NFRA) as well as provide substantial powers to the Tribunal. The powers and responsibilities of the NFRA are currently exercised by the ICAI.

Creating newer and more stringent laws will essentially require enforcing and monitoring measures to be implemented.

While the rationale of creating a new body to meet this end could be argued either ways, the fact that the roles and powers of the regulators should be rationalised such that there are no conflicts, cannot be ignored.

Extent of responsibility

The layman's inference of an audit is more often that a sign off by an auditor is proof enough of the company's ‘all round' well being.

This mindset has been fostered over the years and is one that is hard to let go off. It may, in fact, surprise many that the auditor only looks at 12 months from the date of the financial statements to assess the ‘going concern' assumption of the company.

Certain provisions of the Bill seem to further endorse this view by making the auditor responsible for reporting any and every aspect that could potentially go wrong with the company.

Another significant aspect of the Bill is that the scope and extent of auditor's liability has been substantially enhanced. The auditor is not only exposed to various new forms of liabilities, but the existing ones have been made much harsher.

The provisions of the Bill imply that irrespective of the nature of contravention, all contraventions by an auditor are liable for penalty.

There is no defence of default not being committing willfully, as in the existing Companies Act, 1956. Further, the liability of the auditor has been extended to any person who reads the financial statements of the company. The drastic repercussions proposed in the Bill appear to be clearly disproportionate to the duties of an auditor.

What the future holds

The reforms proposed reflect the deliberations across the world around audit policy. Apart from the ‘regulatory' debates, there are also discussions relating to the need of the investor community requiring auditors to report on newer aspects such as non-GAAP measures, industry metrics, and so on.

While such debates are still a long way off in India, the proposals in the Bill are significant enough to change the face of the auditing profession in the coming years.

However, the law makers and the regulators should ensure that they do not lose sight of the fact that an auditor never was nor will he ever be responsible for the functioning or the ‘good' performance of the company.

Having said that, the laws (and enforcement) relating to auditor independence and unambiguous and credible reporting by the auditor, are of paramount importance.

Given the relevance of the auditing profession and the fact that audit and auditors are an indispensable part of the corporate world, regulators must think of providing stimulus to the audit profession to empower them to face the ever increasing challenges rather than stifling them with extreme and excessive consequences.

(The author is Partner, Price Waterhouse. With inputs from Madhuri Ravi, Price Waterhouse.)

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