The auditing landscape in India is about to undergo a potential changes as the government considers implementing eligibility standards for appointment of auditors/ audit firms in the case of large companies and public interest entities. With investor interests at risk due to inadequate audit quality/standards, the government aims to strike a balance between audit quality and the firm size. This article discusses the ongoing deliberations, the concerns surrounding smaller audit firms and the need for transparency reports to boost investor confidence.
Setting Eligibility Standards for Large Audits
Recent news reports indicate that the government is exploring the possibility of reserving the auditing of large companies and public interest entities for audit firms of a certain size, reputation and technological capability. This move comes in response to growing concerns about the adequacy of audit quality/standards and their potential impact on investor interests. Reportedly, the discussions are still in their early stages and center around a graded approach to addressing this issue.
One of the options being considered is the establishment of eligibility standards for audit firms responsible for overseeing the financial accounts of large listed companies. This could involve setting a threshold size for these firms.
Concerns of Smaller Audit Firms and Investor Confidence
In recent months, several cases have emerged where companies with significant public investment and facing financial reporting or audit quality issues, have had their accounts audited by small, lesser-known audit firms. This has raised doubts among investors about the quality of the resulting reports. One notable example is the Hindenberg Research report, which revealed that the independent auditor for Adani Enterprises and Adani Total Gas appeared to be ill-equipped for large and complex audit assignments.
On the other side, smaller audit firms whcih are already at a disadvantage when compared to the Big Four firms, they will be further marginalised with this likely move of the Government. It is to be seen how the interests of the smaller audit firms is taken into account and protected.
Balancing Audit Quality and Firm Size
News reports have quoted ICAI President Aniket Talatiarguing that audit quality should be the primary consideration and not the firm size. He stated that believing only larger firms can provide better services is unfair to all the professions, including chartered accountancy. The move is in early stategs and is likely to be subjected to further deliberations before any final decision to balance the interests of smaller audit firms.
Transparency Reports to Boost Investor Confidence
The government’s latest initiative comes at a time when auditors of 1,000 large listed companies in India are required to file transparency reports with the National Financial Reporting Authority (NFRA) in a specified format starting from the current financial year 2023-24. These new regulations aim to enhance the credibility of auditors and bolster investor confidence in their services. As a result, audited entities and their shareholders will gain insight into the management, ownership structure and governance of audit firms, as well as their internal policy frameworks.
The government’s move to set eligibility standards for audit firms seeking large audits is still in its early stages, with various factors to be considered in order to maintain a balance between audit quality and the audit firm size. This move should take into consideration the fact that auditors of large listed companies in India are already required to file transparency reports with the NFRA, which could potentially improve the credibility of auditors, enhance investor confidence and ensure a more transparent auditing landscape in the country. NFRA seems to have already taken the initiative to balance the situation and the results will be manifested in due course of time only.
When we talk about the audit quality, only the size of the audit firm should not matter! History is replete with the examples of failures of large audit firms as well.
Reference: Financial Express dated 26/04/2023
To improve audit quality, ICAI has made the ‘peer review’ system (phase II) mandatory for even unlisted entities beginning July 1, 2023, as opposed to the existing norms of peer review of only listed entities.
As you know, under the peer review process, an independent auditor/ peer reviewer verifies an audit firm’s audit processes and documentation framework before issuing a report which assures certain requirements as well as serves as an excellent check-and-balance system.
Further, my suggestion to ICAI is that please make joint audit mandatory for such large private or unlisted companies, similar to what MCA/RBI does for PSUs, banks and insurance companies. Perhaps balancing can keep Big-4 or any other firm in check, to ensure better audit quality and investor’s protection.