Joint audits don't add up

In its final report on statutory audits in April this year, the Competition and Markets Authority of the UK suggested mandatory joint audits to increase choice in the market and thereby drive up audit quality. Though these are just recommendations and are yet to be accepted and legislated, the issue has become a hot topic in the Indian auditing fraternity.

The reasons are obvious. The audit profession is in the spotlight for all the wrong reasons, the latest trigger being the IL&FS fiasco and the alleged involvement of the auditing firms in the scandal. While a detailed investigation into the role of auditors is required, it may not be prudent to accept the suggestion from several quarters that India should take the cue from the UK committee’s report and make joint auditing mandatory. Here’s why.

France is the only large economy that has mandatory joint audit requirements. Most of the large economies that had such a system, such as Canada, Sweden, Denmark and South Africa, have abolished the law, primarily because of increased cost and no apparent beneficial impact on audit quality. Further, the leading economies of the world such as the US, China and the EU have not mandated joint audit.  

There have been several cases where the quality of audit has been questioned even in a joint audit scenario. For example, public sector companies and banks in India are subject to joint audits. But these banks have faced several questions around non-performing assets and some high-profile frauds.  Even in countries where joint audits are permissible, companies rarely opt for it, because they increase costs to both companies and auditors and present challenges in coordinating between two audit firms and between the auditors and the audited entity.

The moot point is that any audit reform should be driven by the objective of enhancing audit quality. There is no basis to believe that joint audits enhance quality. In fact, they create an incentive where managements could try to leverage one firm against another in seeking a preferred outcome.

Several studies have analysed the effect of joint audit regulations on audit quality. Holm and Thinggaard in 2011 examined whether joint audit impacts audit quality. Their sample comprised non-financial companies listed on the Copenhagen Stock Exchange at the time of joint audit abolishment. Their final sample for the audit quality tests included 117 companies. They found insignificant coefficients on their audit quality measures (abnormal accruals), suggesting that joint audits are not better able to constrain earnings management than single audits.  

Mandatory joint audits also lead to higher audit fees. According to estimates, joint audits lead to 20 per cent additional cost as compared to the single auditor approach. The implication on effectiveness is also not encouraging. Joint audits may in fact lead to lack of accountability as some issues may fail to be considered by any of the auditors, following the division of the work. 

Besides, mandating joint audit in combination with mandatory firm rotation would result in problems particularly in the case of specialised industries since it would be difficult for companies to appoint specialist auditors with sufficient expertise and capability to handle the audit because of their low availability. 

There are other reasons, too. In a joint audit scenario, each auditor has joint liabilities. This results in practical challenges in splitting of work evenly, reviewing each other’s work papers, joint meetings, resolving disagreements and evaluation of joint auditors’ objectivity, competence and independence. Owing to the differences in the audit firms in terms of size, resources, expertise and technology, there are practical challenges in sharing of risks and fees.   

Joint audits also lead to an increase in the workload because of duplication of audit work. Many tasks must be performed by each of the joint auditor, such as attending meetings with key members of management, audit procedures on high risk accounts, etc. A significant time of the audit partner and manager is spent in co-ordination (meetings, reviews of working papers, exchange of information etc) in a joint audit scenario. In addition, joint audits may bring additional complexity as the audited entity must choose and must communicate with two auditors instead of one. It is also possible that in the conduct of the joint audit, the work performed by one of the auditors will be subject only to a limited and superficial review by the other joint auditor and would not bring any added value.

Mandatory joint audits also do not enhance independence or objectivity, as both auditors are subject to and must comply with the same independence requirements. They just cannot counter the demand of large, complex global companies for audit firms with extensive geographical coverage and expertise to be able to perform high quality audits

These are the reasons perhaps why an expert group set up by the ministry of corporate affairs under the chairmanship of Ashok Chawla, former finance secretary, considered the issue in 2017 and recommended that there should not be mandatory joint audit and the decision must be left to the companies and their boards.