Rotation resets audit firm order

The churn raises concerns on fee undercutting and its impact on quality of inspection

Rotation of audit firms mandated by the company law that took effect three years earlier has played out in full force this financial year — around 980 listed companies have changed their incumbents in favour of a new auditor.

The massive churn has snapped some decades-old ties, particularly hitting small firms which are dependent on a handful of clients. It has had a mixed effect on mid-size audit entities, depending on factors such as location and type of clientele. The process has also made the ‘Big Four’ audit networks — Deloitte, EY, KPMG and PwC — more aggressive, reflected in a slight improvement in their combined market share.

However, the pecking order has also been reorganised.  The rotation process has altered the market shares in terms of numbers of listed companies audited by each of the ‘Big Four’ (BF) networks. Sector experts believe the best data point for calculating audit market share is the number of listed companies, as other numbers (such as a number of unlisted companies) are not easily verifiable. The notices of annual general meetings (AGMs) of listed companies show the details of new auditors appointed, as these are put up for shareholder approval.

An analysis of these notices shows the churn has made the BF more aggressive in getting new business, reflecting in a higher market share. “The BF, between them, shall handle 461 assignments of the 1,583 companies for which auditor details are available for 2017-18,” notes Pranav Haldea, managing director, Prime Database. This means their share goes up to 29 per cent, from 26 per cent in 2016-17.

Their dominance will be even stronger in the Nifty-500 subset, wherein they handle 274 of the 451 (around 60 per cent) audits. The impact of these rotations on the fees earned will be clear at the end of the financial year. As of 2016-17, Deloitte, with audit fees of Rs 220 crore, earned almost twice as much as EY (Rs 120 crore) and KPMG (Rs 110 crore).

For smaller companies, the impact has been nuanced. According to Nilesh Vikamsey, president of The Institute of Chartered Accountants of India, experiences have been different. “Small firms have been impacted. I nurture a client for 40-50 years. Rotation comes and the client is taken away,” he observed. For mid-size audit entities, it has been a mixed bag, depending on how they built their businesses, he adds.

BF mechanics

Among the BF, the KPMG network (comprising firms such as BSR & Associates LLP, BSR & Co LLP, BSR & Company, BSR & Associates, BSR & Co, BSR & Company) has emerged the biggest gainer of the process, almost doubling the number of companies under its watch. EY and PwC have also gained companies, maintaining their second and fourth position in the league table. Deloitte, market leader before the process began, has been rotated out of several large companies and settled for the third position.

According to analyses of notices for AGMs, at which companies appoint their statutory auditors, the KPMG network has gone from third place last year with 84 firms to the top position, with 135 companies. Among its big catches are Tata Motors, Tata Consultancy Services and HDFC.

If one adds new companies at the bourses this year, the BSR firms have nearly doubled the number of listed companies it audited from the time the rotation process began in 2014. The group has ramped up capacity by adding headcount and modernising of operations. 

EY has also gained significantly, with the number of companies audited by the network (comprising SRBC & Co LLP, SR Batliboi & Associates LLP, SR Batliboi & Co LLP, SV Ghatalia & Associates LLP), raising its tally to 133 companies, from 117 the previous year. It now has biggies such as Reliance Industries, Sun Pharmaceutical and Bajaj Auto. After adding companies that have had an Initial Public Offer of equity this year, the number goes up to 145, sources said. “We had also increased our headcount in preparation for the transition and are deploying project management and analytical tools more extensively,” says Sudhir Soni, national director and partner, SR Batliboi & Associates.

Deloitte saw its company count fall to 121, from 162 the previous year, according to analysis of AGM notices. It has been rotated out of Eicher, Hero MotoCorp, HDFC and Mahindra & Mahindra. A spokesperson declined to comment on the changes. According to sources, the writing was on the wall for Deloitte and the impact here was expected to be the biggest, as they were the largest and perhaps the oldest. Its share of the top 500 was almost equal to the other three put together. The silver lining for Deloitte is that it has won some large companies such as Adani Ports, Infosys, Wipro and Bharti Airtel. “In every sector, we were auditing the largest,” notes a Deloitte source. 

PricewaterhouseCoopers (PwC) showed a marginal improvement to 74, from 73, companies. It won Tata Steel from Deloitte and Hindalco from Singhi and Co. A spokesperson did not respond to an e-mail seeking comment.

Falling fees

While rotation of audit firms addresses the issues of fading independence and cosy relationships among auditors and managements, there are concerns that this could lead to undercutting of fees and a fall in quality of audits. Rachel Grimes, president, International Federation of Accountants, notes that Bra the il and Argentina moved to five-year rotation and then shifted back. “My belief is that the partnership should rotate, not necessarily the firm,” she adds.

Companies will need to change their auditor every 10 years, by the company law provisions. The change is making audit firms look at newer ways to add value to their clients. According to Jamil Khatri, head of audit at BSR, rotation has enabled companies and their auditors to have a fresh look at disclosures in the financial statements and focus on what is material information for the users. Firms are increasingly using data analytics in the audit process, he adds.