Opinion
Audit quality is a bigger concern than market concentration
Summary
- The NFRA’s proposal to revise accounting rule SA600 to make a parent company’s auditor responsible for the work of the auditor of a subsidiary, in line with the global norm, is well intended. It might make the Big Four even bigger, but this challenge must be addressed separately.
The National Financial Reporting Authority (NFRA) has proposed a revision of accounting rule SA600 so that a parent company’s auditor would be held responsible for the work of the auditor of a subsidiary. The idea has met with resistance.
The Institute of Chartered Accountants of India (ICAI) has flagged its concern that it could weaken smaller chartered accountancy firms and lead to greater market dominance by a few big ones.
While the intent of the NFRA is to tighten regulation and ensure accountability so that governance lapses are minimized, some practical challenges do stand in the way.
Vesting all responsibility with the lead auditor of a business that uses many auditors would give the lead one an incentive to ask its management for the entire roster of work, including that of subsidiaries, so that it can examine all the books to its own satisfaction.
Also read: Lead auditors to face the heat for group lapses. Small audit firms are fretting.
Without its own staff carrying out all audits, the lead auditor might be unwilling to bear responsibility for the accounts of these units. This could result in big firms landing the assignments that smaller auditors often get and the latter getting edged out of this space would increase the heft of the so-called Big Four: Deloitte, PwC, EY and KPMG.
Arrangements of trust between big and small audit firms are hard to conceive. Even if some sort of arrangement could be reached for shared work, with audits of subsidiaries to be done under the oversight of the lead auditing team, the scope for professional clashes will probably make it impractical.
Regardless of whether individual auditors work for a large firm or small, each one is an independent professional certified by the ICAI and is therefore equally qualified to carry out the work. The authority vested in each does not depend on the scale of business operations.
This implies that any structure for audit processes that involves a hierarchy with power gaps between auditors would be antithetical to the flat architecture of this profession. Since a problem of market concentration has been observed in this field, the ICAI does have a valid worry.
That said, auditing is a service that is vital to the health of formal enterprises in an economy, so we need to take a larger view of the scenario. To the NFRA’s credit, it has made it its mission to close regulatory gaps that allow lapses of governance.
Instances have been detected of transactions between subsidiaries and parent companies that may have let promoters siphon off funds but fell through the audit cracks of split assignments. Under SA600 as it currently stands, the lead auditor can use subsidiary audit data without being answerable for another firm’s work.
Also read: Will new audit rules curb corporate misconduct?
Making it liable for checks all the way down would raise its accountability and align that rule with the norm followed in advanced economies. At the end, it would serve the discipline well. A series of audit failures in detecting big frauds over the years has hurt the credibility of the profession.
While auditors must act as watchdogs and not bloodhounds, nobody should lose sight of why the audit exercise exists: to assure all stakeholders that the books of a business are in order. Investors must not be left wondering if the process is faulty.
Hence, for the sake of audit quality, the ICAI should take a close look at the rulebook for loopholes that can be exploited. Now that SA600 has been identified as one, its overhaul should not be resisted. Audit integrity comes first. Other ways must be found to secure the interests of small audit firms.
