Accounting Failure

BS OPINION

The most unfortunate part about the Institute of Chartered Accountants of India's (ICAI) vote in favour of compulsory rotation of auditors is that it was completely avoidable.

It was obvious to everyone that a body as protectionist as the ICAI would try to push for rotation of auditors since it feels that the best audit accounts are monopolised by big Indian firms affiliated to the world's Big Four audit firms.

Yet, on the day when it mattered most (and the pro-rotation gang won by a single vote) three government nominees on the 29-member ICAI central council stayed away "" this included a joint secretary from the ministry of finance.

In addition, a similar-ranked officer of the department of company affairs (which drafted the Companies Act that turned down the suggestion to rotate auditors) refused to cast his vote.

The proposal to rotate auditors "" which is now to be judged by a larger referendum amongst ICAI's 110,000 members "" could, if accepted, set back the progress India has made in its audit standards over the years.

The reason is simple: if auditors are to be simply selected by rotation, or they know a good audit is not going to get them another shot the next year, what is their incentive for doing a thorough job? What makes things worse is the increasing complexities in accounting procedures that crop up each year, with the increased use of financial mechanisms like, for instance, special purpose vehicles.

With several different methods of billing clients in the IT industry, for instance, 'revenue recognition' has become an art in itself. The ability to understand complex related-party transactions, or wade through the myriad investment firms that many Indian companies still have, gets developed only after several years of relationships between audit firms and their corporate clients.

Which is why the Naresh Chandra committee, set up to examine the issue of corporate fraud, did not recommend rotation of audit firms. Instead, it recommended rotation of partners within the firm.

Few countries anywhere in the world, Italy being the only exception that comes readily to mind, have compulsory rotation of audit firms for precisely this reason.

But how do you ensure audit firms don't cosy up to clients after years of handling their audits? The companies bill provides some safeguards.

For one, auditors are protected from getting sacked if they do a tough audit since a company's management will now have to pass a special resolution for doing so, and will have to give a convincing reason.

Auditors, in turn, will have to either certify that they have no non-audit relations with the client or specify the non-audit fee. They will also have to certify that the client firm does not represent more than a certain percentage of their annual audit income.

Other solutions lie in areas like levying strict penalties for audit fees. Reducing the audit business to a socialist divide-and-eat rule is not the way to go.