Regulators must provide more oversight to improve overall quality of audit

An audit firm dealing with a listed company wrote to it recently for clarification on certain items. They followed up numerous times over the course of the next few weeks. But the replies they received either didn’t answer the questions or raised new ones. The discomfort grew.

They met with senior management and said they would resign. After some more back and forth, they finally did.

The above is a story that played out in one firm but may have been repeated in others in recent weeks. Such actions are said to serve as a warning on dodgy accounting practices. However, there are some issues. For example, a senior industry accountant who applauded the actions of a major audit firm had one complaint.

“(They) could have been more explicit in their reasons of resignation,” said the person.

Others too agree on the need for clear reasons, rather than a hasty exit.

“Auditors should not resign in an abrupt manner unless they provide adequate reasons and detail the true issues for their resignation,” added Virendra Jain, founder of investor association Midas Touch.

What the auditors who quit said 

Manpansand Beverages: Significant information requested from company at various points in time was not provided

Atlanta:  Absence of adequate and relevant information and explanations on observations made by tax authorities

Vakarangee:  The management’s responses to queries raised were inadequate or contradicted earlier explanations

Investor wealth has evaporated in recent cases. Construction and engineering company Atlanta was locked in the lower circuit after their auditor exited. This means the shares fell as much as is permissible, subject to exchange limits on daily price movements. The share price of Manpasand Beverages has halved. Others too have seen sharp falls in share prices.

This may suggest the need for a system to standardise such exits.

For example, the Securities and Exchange Board of India (Sebi) has moved against abrupt withdrawals of ratings by credit rating agencies. If there are issues with non-cooperation, rating agencies have been told to not withdraw abruptly but instead disclose that their rating is based on limited information. They should also say that the issuer did not cooperate with the rating exercise.

While acting on partial information may not be feasible for auditors, they should make more disclosures feel experts. That said, their actions are an improvement over previous years.

“For the first time they are realising that the fee they earn may not be worth the reputation risk,” said Shriram Subramanian, founder and managing director at proxy advisory firm InGovern.

The current crop of resignations can also be seen as ushering in an era where dodgy accounting is more difficult to pass off.

“Resignations in three companies namely Manpasand, Vakrangee and Atlanta by the auditors and that too just a few days before the closing of the year heralds a new era in auditing… The auditors are trying to highlight that there are a lot of corporate governance issues and need to be tackled accordingly, and they are no more willing to be made scapegoats,” said Amarjit Chopra, former president, Institute of Chartered Accountants of India (ICAI).

He said a number of recent developments have resulted in auditors becoming more cautious about their liability. The stock market regulator barred Price Waterhouse (PW) from auditing listed companies for two years. There has also been activism over bad loans, the Reserve Bank of India has increased scrutiny and the Companies Act provides for class action suits where affected parties (including shareholders) can come together to sue against wrongdoing. The National Financial Reporting Authority is also set to be established as a separate regulator for auditors and audit firms. The recent spate of resignations may also be a function of more companies being audited by bigger audit firms with higher compliance requirements. 

The top five audit firms covered 484 firms in 2016-17, show Prime Database numbers. This changed to 547 in 2017-18. The top five auditors account for more than four times the number of clients as the bottom five, show the 2017-18 numbers. 

While investor wealth may erode in the short-term, ShaileshHaribhakti, chairman, Haribhakti & Co said such actions will ultimately help enhance shareholder value.

“With the entire atmosphere being cleaned up, there is no more room for shady and non-transparent practices. This will ultimately reduce the cost of capital, enhance shareholder value and bring in a better atmosphere for investment, FDI (Foreign Direct Investment) flows, better regulation and excellence in all forms of auditing,” he said.

Hetal Dalal, Chief Operating Officer, Institutional Investors Advisory Services (IiAS), said regulators should encourage auditors to take strong measures. But they should also ensure that audit quality is uniformly good.

“…regulators must also provide greater oversight to the audit industry in an effort to improve the overall quality of audit,” she said.

This can help avoid situations where a new audit firm discovers issues which the previous auditor has ignored, leading to resignations, as has happened in recent times.

This is especially important considering a large number of audit rotations now taking place. Over a hundred companies are set to see audit rotations this year, show Prime database numbers. A total 1292 firms will see changes in auditors because of term expiry in the next five years.

This figure could well increase if there are more resignations ahead.