Auditing is an age-old profession - what is in the future?

The Securities and Exchange Board of India (Sebi) vide its order dated Janaury10, 2018, has placed a two-year ban on PricewaterhouseCoopers (PwC) in India. The penal action arises from PwC’s failure to detect accounting fraud in the erstwhile Satyam Computer Services Limited. The fraud was committed over several years and PWC could not detect it, as it failed to bring ‘professional skepticism’ and apply audit procedures stipulated in auditing standards. The order said, “There can be only two reasons for such a casual approach to statutory audit – either complacency or complicity." Thus, it held that PwC was guilty of complicity in the fraud. Many consider that the ban (plus disgorgement of fees) of the firms in the PwC network is unexpected and unprecedented, while others are of the view that it is appropriate. PWC has appealed against the order. The Sebi’s order has brought back focus on the auditing profession.

 
Auditing is an age-old profession. But, the context of auditing has changed over the last 50 years, particularly with the growth of the capital market and number of investors, increase in the size of companies and increase in the complexity of business models. Earlier it was considered an individualised service. Chartered Accountants (CAs) were not allowed to advertise.
 
In 2006, the Chartered Accountants Act, 1949, was amended, permitting CAs to advertise, subject to guidelines framed by the Council of the Institute of Chartered accountants of India (ICAI). Now, CAs can advertise in mass media. Audit not being an individualised service any more, the audit-firm’s reputation has become more important than personal reputation individual CAs. Earlier, the audit partner used to consider himself/herself as a friend, philosopher and guide of the promoter or controlling shareholder. That profile is fading away. Now, the audit partner is expected to be a hard core professional whose primarily responsibility is to protect non-controlling shareholders by ensuring that the financial statements provide a true and fair view. The auditing profession has emerged as the most important player in the economy, which has a huge responsibility to ensure that the capital market is operating efficiently and the nation’s economic resources are allocated optimally by providing credibility to financial statements.

 

Some fundamentals have not changed. De-facto, the management appoints the auditor, although dejure, it is appointed by shareholders, to whom it reports. Therefore, the auditor is continuously under subtle pressure to compromise its independence. On the other hand, the gap between expectations of what auditors should do and what they can do is expanding rather than getting narrowed. In the changed context, globally, regulators are experimenting with ideas to address the challenge for improving audit quality. 
 
Traditionally, regulators endeavoured to protect the independence of auditors by incorporating stringent provisions in the Companies Act regarding the appointment and removal of the auditor. But, audit failures could not be avoided. Therefore, regulators are experimenting with new ideas, such as, rotation of auditors or rotation of audit partner in order to reduce familiarity risks and bring in new eyes; and debar the auditor from providing most non-audit services in order to minimise the risks that the auditor would compromise with independence to protect its income and the possibility that the management would bribe the auditor to get a favourable report.

 
Research fails to provide conclusive evidence that these measures improve audit quality significantly. Therefore, the need is felt to impose exemplary punishment on auditors who fail to perform audit diligently or who collude with the management in perpetrating fraud. The trend is to establish a separate regulatory body to regulate the auditing profession. This is a clear departure from the conventional practice of self-regulation.
 
Regulatory bodies exist in many countries, such as Australia, Japan, the UK and the USA. In India, the Companies Act 2013 empowers the government to establish the National Financial Reporting Authority (NFRA), which will regulate the auditing profession. Although, the government could not establish the NFRA in four years, now it is keen to establish the same.

 
The moot question is whether all these measures will improve audit quality. It is not clear. Only time will tell. One thing is clear that human greed for wealth accumulation will continue and so long as corruption will remain in the business environment and unethical practices will be rewarded, even in short-term, a market will continue to exist for unscrupulous auditors. The downside of new measures is that as the expectation gap widens and the auditor’s performance is microscopically reviewed, the profession will become less attractive and there might be a talent shortage. As the professional risks increase, the cost to investors, who hold diversified portfolio, will also increase without commensurate benefits.  The author is mentor faculty, Institute of Management Technology Ghaziabad

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