The Indian economy is going through a
tumultuous time. Rs. 1 trillion1were wiped out of the markets due to various causes. A more distinctive
feature is that several pillars of the economy are in the news for the wrong
reasons. From NBFC2s, Reserve Bank of India3, SEBI4,
Credit Rating Agencies5, to Stock Exchanges, bankers6,
National Clearing Corporation, NSDL7 and auditors.
However, the reports on audits and auditors
are most distressing. The central banker banned a top audit firm; criminal
charge sheets lodged against two other top firms and partners in the IL&FS
case; MCA seeking a five-year ban; reports of an auditor leaking
price-sensitive information; MCA approving the removal of an audit firm;
auditor resignations; blaming the auditors for the stock price fall, and more.
Before we look more deeply at the audit
framework in India, auditors have been implicated in many other parts of the
world and much of this seems symptomatic. An FRC (UK) report8has dealt with a number of aspects of the
audit market, including audit quality and audit failures. Notable reasons given
by the report are: a. Failure to exercise sufficient professional
scepticism or challenging the management, b. Failure to obtain
sufficient appropriate evidence, and c. Loss of independence. The FRC
report also points out perils of the precarious audit market structure with
‘too few to fail’ firms which make up the audit market (97% and 99% in the UK
and the US securities markets are audited by only four auditors). India hasn’t
reached there yet but it seems like it is on its way, ignoring structural problems
and treating symptoms superficially. The report also states that each of the
top four ‘audit’ firms reported three-fourths of their revenue from ‘non-audit’
services and faster growth in ‘non-audit’ revenue. The ‘auditors’ are actually
doing more ‘non-audit’ work and suspected of getting audit work in order to get
more lucrative ‘non-audit’ work. Coming back to India, the MCA should have done
much more and much better in presenting data on the above lines rather than
bringing out a rather hasty and flawed report9 last year.
1 Bloomberg Quint report published June 23, 2019
– Eleven Stocks, $14 billion erased
2IL&FS, DHFL etc.
3 It was expected to keep an eye on systemically
important NBFC, SFIO pointing out that it should have acted faster
4 Reported to be the most powerful market
regulator in the world who could have done more in ‘algo’ scam
5 Giving credit ratings that turned out to be
worthless, ICRA CEO and MD asked to go on leave
6 PSB NPAs at Rs. 806,412 crores in March, 2019
or Rs. 8.1 billion (per PIB release of 24th June,.2019)
7Allegations of shares moving out of pool
account of a broker in allied matter
Audit Services Market Study, 18th April, 2019
The root causes within the auditing
framework need examination. The problems and surrounding questions are many and
complex but not impossible to overcome if dealt with in right earnest. The
problems are written on the wall – i. Appointment of auditors (mostly by
a common management and ownership), ii. increasing concentration in the
audit market (oligopolistic audit market where market leaders begin to convey a
sense that they are the market – too big and too few to fail types), iii.
multiple regulators (SEBI, MCA, NFRA, ICAI, RBI, etc.), iv.
misunderstanding about audit (what it can do and what it cannot do), v. conflict
of interest and independence issues (audit firms are connected with group
entities looking for non-audit work), and vi. a misty reporting framework
(changing and difficult to fathom) to name a few.
The expectation and delivery gaps are
widening and blurred. Auditors, regulators and the public do not understand
them in the same sense. It seems that an auditor today is neither a watchdog
nor a bloodhound, but rather a sniffer dog. So long as an auditor has done what
the auditing standards ask of him, he cannot be sent to a doghouse. All the
same we have more questions than answers, and we need to flip that fast –
before it’s too late.