Independence of statutory auditors has received attention of researchers and regulators for ages because independence is the cornerstone of statutory audit. Stakeholders rely on auditor’s opinion because it is unbiased and based on professional judgement of someone who is capable of forming a judgement on the issues covered in the audit report. Therefore, laws are formulated to protect the independence of statutory auditors. Oversight and disciplinary mechanisms are strengthened, penalties are imposed for audit failures, environment is created to reduce subtle pressure on audit independence by introducing mechanisms such as rotation of the auditor and prohibition on offering non-audit services, and mechanisms are created to protect audit independence by creating institutions like the audit committee. Even after introduction of such elaborate mechanisms, the concern for audit independence persists. This is so because, as shown by research, monitoring and penalizing independent auditors’ behavior reduce the frequency of independence violations when the probability of losing a client is small, but the frequency of violations is not reduced when the probability of the loss of a client is high. Another research finding is that auditors with low moral development scores violate independence more frequently than those who have higher scores. Some researchers observed that levels of moral development were inversely related to increases in rank within accounting firms. Auditors’ levels of moral development increase until reaching the supervisory level, at which time they decrease through the partner level.
Relying on the research findings, it may be argued that auditors are tempted to compromise with audit independence because they are de-facto appointed by the management. Therefore, the appointment and removal of auditors should not be left to the company. The regulators should appoint auditors. This might be a new model for private sector enterprises. But this practice is being followed in the case of government companies. Government companies appoint the auditor on the recommendation of the CAG. Until 2005, the RBI was directly involved in the appointment of auditors in public sector banks. Currently, public sector banks appoint auditors under the supervision of RBI. The accounting profession generally believes that auditors enjoy a higher level of independence when regulators appoint auditors. In October 2011, the then President of the Institute of Chartered Accountants of India, Mr. Ramaswamy, argued in favour of appointment of auditors of public sector banks directly by the RBI.
Appointment of auditors by regulators might be ineffective if they apply certain objective parameters in selecting the auditor for appointment in order to avoid charges for corruption in the appointment of auditors. The criteria could be the age of the firm, the size of the firm, number of fellow members, the average earning per fellow member, audit experience and similar parameters, which can be used objectively, or rather mechanically. Appointment of auditors by using such criteria might enhance the level of independence but might not necessarily improve the audit quality. Audit quality, like excellence in any other field of management, depends on attitude and internal governance. The death of Arthur Anderson, one of the big five audit firms, has established that audit quality depends a lot on the internal governance of the firm. It is difficult to find an objective parameter, which evaluates the quality of audit being performed by a firm or the quality of its internal governance of an audit firm.
The issue can be addressed by strengthening the oversight of audit firms before entrusting regulators with the task of appointment of auditors of companies. The effectiveness of the peer review system and other oversight mechanisms that are currently being used to enhance audit quality is questionable.
The Companies Bill 2011 requires the government to constitute a National Financial Reporting Authority (NFRA) with wide powers. It will replace the National Advisory Committee on Accounting Standards (NACAS). NFRA, among other things, will monitor and enforce the compliance with accounting and auditing standards and will oversee the quality of service of the professions associated with ensuring compliance with such standards. It has the power to investigate professional miscount and penalise those who are found guilty of professional misconduct. In certain matters, it shall have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908.
We may expect that the new institution (NFRA) will strengthen the oversight and will address the issue of audit quality. The government should seriously consider the appointment of auditors in listed companies by regulators after the establishment of NFRA.
E-mail id: asish.bhattacharyya@gmail.com
Affiliation: Director, International Management Institute - Kolkata
