Will new audit rules curb corporate misconduct?

The NFRA, RBI, Sebi and ICAI will deliberate with the government on how auditors of a parent company can have greater oversight of the work of auditors of subsidiaries and be accountable for it to make the audit framework stronger.
The NFRA, RBI, Sebi and ICAI will deliberate with the government on how auditors of a parent company can have greater oversight of the work of auditors of subsidiaries and be accountable for it to make the audit framework stronger.

Summary

  • The corporate affairs ministry is reviewing audit norms for business groups, to make parent company auditors more responsible for subsidiary audits. This involves aligning Indian norms with global standards and giving parent auditors greater access to subsidiary audits.

The norms on audit of business groups is set for an overhaul, with the corporate affairs ministry scheduled to discuss the matter on Monday with audit regulator National Financial Reporting Authority (NFRA), other financial sector regulators and India’s accounting rule maker, the Institute of Chartered Accountants of India (ICAI).

A person with knowledge of the matter said that the NFRA, Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi) and ICAI will deliberate with the ministry on how auditors of a parent company can have greater oversight of the work of auditors of subsidiaries and be accountable for it to make the audit framework stronger.

Typically, the audits of subsidiary companies, which are relied upon for certifying consolidated financial statements, are done by other auditors.

Also Read: India's audit standard loophole that has professionals in a fix

Monday’s review is expected to explore ways of giving the parent’s auditor greater access to specific aspects of subsidiaries’ audits and align Indian audit norms with international norms, the person quoted above said on condition of anonymity.

Mint reported on 21 August that the Indian standard on auditing (SA600) issued by the ICAI for audit periods starting April 2002 has come under regulatory attention after several cases of business failures and alleged audit lapses in detecting siphoning of funds. These lapses have pointed to certain inconsistencies between SA600 and comparable international standards.

Unlike the International Accounting Standard Board’s (IASB’s) ISA600 norm governing work of other auditors, the SA600 allows the parent company's auditor to rely on a subsidiary’s auditor’s work subject to safeguards, without being held responsible for it.

Queries emailed on Friday to NFRA, Sebi, RBI, ICAI, and the ministry of corporate affairs on the review of audit standard 600 remained unanswered at the time of publishing.

Also Read: Centre plans to start e-waste audit, impose penalty as environment compensation

“Auditor of consolidated financial statements needs to assume responsibility for audit opinion on those financial statements, said Ashok Haldia, a chartered accountant and a past secretary of ICAI. “In this process, he has to suitably assess risk and materiality aspects of the component (subsidiary). For this, he needs to have access to the work done by the component auditor."

Vijay Kapur, a former director at ICAI, said there is a strong case for India’s SA600 to be aligned with the ISA600.

“As per audit standard SA200, when the auditor… uses work performed by other auditors….he will continue to be responsible for forming and expressing his opinion on the financial information," said Kapur. “Thus, the principal auditor is primarily responsible for expression of opinion on financial statements of the parent as well as all other entities consolidated, and cannot get away by stating that he has no access to the working papers of other auditor or auditors."

Fund diversion often happens through loans granted by parent to subsidiaries

Often, fund diversion takes place through loans granted by the parent to subsidiaries, from where it goes to entities privately held by the major shareholders of the parent company, which otherwise may be credit unworthy.

If audits of subsidiaries are not robust and don’t question the business rationale of such loans financed by funds raised by the listed parent, it weakens the oversight, explained a second person, who is also privy to discussions among regulators.

The fear in some quarters is that smaller audit firms that get assignments for auditing subsidiaries or branches of larger firms that are audited by the Big Four, could lose their business opportunity if the principal auditor is held responsible for subsidiary audits, too. But policy makers believe that the big picture should be kept in mind while reviewing the audit framework, and that stakeholders have a right to get full information about the end use of funds that flow from the parent to the subsidiary.

“Smaller audit firms may have some apprehensions. But the question is, what is paramount—public interest or the interests of auditors?" said the first person quoted earlier. “Should the parent company’s auditor not know what is happening in the subsidiaries?"

The final pages of the 22 August Sebi order on Reliance Home Finance Ltd. (RHFL) show the several subsidiaries of the company and the flow of funds, said the person. NFRA had in April issued a disciplinary order against the auditors of RHFL for alleged professional misconduct in the company’s FY19 audit.

A spokesperson for the company’s promoter Anil D. Ambani said that Ambani had resigned from the board of directors of Reliance Infrastructure Ltd. and Reliance Power Ltd.—two group companies referred to in Sebi's latest order—pursuant to an earlier interim order in the matter of RHFL, and is in compliance with that order for the past two and a half years.

“Mr. Ambani is reviewing the final order dated 22 August 2024 passed by Sebi in the said matter, and will take appropriate next steps as legally advised," said the spokesperson.

Queries emailed to the auditors of Reliance Home Finance Ltd remained unanswered at the time of publishing.

Vijay Kapur said claims that SA600 cannot be modified because sharing of working papers is prohibited under Chartered Accountants Act 1949, was unfortunate.

“This argument is completely indefensible on two counts. First, the ICAI itself has allowed sharing of working papers under the peer review process. Second, sharing of working papers is permitted if required by any law and, thus, once standards on auditing are notified under section 143(10) of Companies Act of2013, the ICAI has no option but to adopt ISA 600," said Kapur.

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