AUDITOR RESIGNATION – PRESCRIPTIONS AND RESPONSIBILITIES

INTRODUCTION

Auditing is the core area of competence of a
Chartered Accountant. Audit of financial statements of public interest entities
such as listed companies, government companies, banks and insurance companies
is an exclusive domain area entrusted to our profession. The underlying trust
in assigning this responsibility to the members and firms (referred to as
“auditor” henceforth in this article) registered with the Institute of
Chartered Accountants of India (ICAI) needs to be preserved by diligent
discharge of our duties associated with such a responsibility. Audit of a
public interest entity should be accepted not merely as a professional opportunity
but with a sense of pride in safeguarding the stakeholder’s interest by
authenticating the financial statements audited. Viewed from this perspective,
it is a matter of concern that during the year 2018 numerous mid-term
resignations by statutory auditors of listed companies (hereinafter referred to
as “auditor”) were reported. No doubt, an auditor is legally entitled to resign
as per law under certain circumstances. However, the large number of
resignations occurring in recent times has become a cause of concern among the
stakeholders. In this article, all aspects relating to an auditor’s resignation
are dealt with for assimilation of the readers of the journal of the BCAS.

CHALLENGING ENVIRONMENT

With the passage of time, business practices
are getting complicated and the environment is quite challenging. New laws
envisaging stringent compliance mechanisms are demanding more time, attention
and cost for enforcing compliance. The business methodologies and practices are
becoming vulnerable to manipulation and the individual value system is
degenerating due to greed, on account of which many frauds and scams are
occurring. Cases of mismanagement and flouting of governance norms are getting
reported in the corporate world, where it is least expected. This also leads to
widening the gap between expectations of the stakeholders as against
performance by an auditor. Beginning with the Satyam case and followed by many
other scams including Nirav Modi’s case associated with Punjab National Bank
and till the current on-going investigation in the IL&FS group cases, the
accountability of the auditor who has attested the financial statements in
those cases has been the subject matter of scrutiny. In the Satyam case, the
auditor was banned by SEBI from auditing listed entities for two years. The
Companies Act, 2013 and the Chartered Accountants Act, 1949 provide for
stringent consequences if an auditor is found guilty in discharging his onerous
task. The Companies Act, 2013 has vested the right of class action suits in favour
of the shareholders posing a threat not only to management but to the auditor
as well. Hitherto, only a signing partner was liable for any consequence for
misdeed, but now, even the firm can suffer the consequences for lapses in the
discharge of the audit function—Section147(5).

LEGISLATIVE AND REGULATORY PRESCRIPTIONS

The provisions of section 139 of the
Companies Act, 2013 deal with the appointment of auditors. Rotation of every
individual auditor after a 5-year term and audit firms after two consecutive
terms of 5 years each is stipulated. The law lays down a procedure not only for
removal but also for resignation of an Auditor. But, either of this can be done
only by adhering to the procedure laid down in The Companies Act, 2013 read
with the Companies (Audit and Auditors) Rules, 2014. According to sub-section
(2) of section 140 of the Companies Act, 2013 the auditor who has resigned from
a company shall file within a period of 30 days from the date of resignation a
statement in Form ADT-3 with the company and the Registrar of Companies. In the
case of a government company or any other company owned or controlled by any of
the governments, the auditor shall also file such a statement with the
Comptroller and Auditor-General of India. The said form, apart from seeking the
basic details about the company and the auditors, requires reasons for
resignation and any other facts relevant to the resignation. Failure to submit
such a statement attracts a levy of penalty of Rs. 50,000 or an amount equal to
the remuneration of the auditor, whichever is less, and in case of continuing
failure, with a further penalty of Rs. 500 per each day after the first during
which the failure continues, subject to a maximum of Rs. 5 lakh.

Based on the
recommendations of the Kotak Committee on Corporate Governance many changes
have been made to the Listing Obligations and Disclosure Requirements (LODR)
and these have been made effective in a phased manner from 2018 onwards. The
changes encompass matters that relate to disclosure of auditor credentials,
audit fee, reasons for resignation of auditors as indicated below:

“The notice being sent to shareholders for
an annual general meeting, where the statutory auditor(s) is/are proposed to be
appointed/re-appointed shall include the following disclosures as a part of the
explanatory statement to the notice:

(a)   Proposed fees payable to the statutory
auditor(s) along with terms of appointment and in case of a new auditor, any
material changes in the fee payable to such auditor from that paid to the
outgoing auditor along with the rationale for such change

(b)   Basis of recommendation for appointment
including the details in relation to and credentials of the statutory
auditor(s) proposed to be appointed.

In case of resignation of the auditor of the
listed entity, detailed reasons for resignation of auditor, as given by the
said auditor, shall be disclosed by the listed entities to the stock exchanges
as soon as possible but not later than twenty-four hours of receipt of such reasons
from the auditor.”

CIRCUMSTANCES WHEN A RESIGNATION IS WARRANTED

Before accepting an engagement as auditor to
an entity, the auditor is expected to evaluate diligently about the entity, the
scope of the mandate, the resources (time, manpower and competence) available
to execute the audit and then take a conscious call to accept or not to accept
the engagement. After accepting an audit engagement, it is generally perceived
that the auditor would carry out the mandate adhering to the Standards and Ethical
framework governing the profession and issue an audit report with or without
modification. Resigning or withdrawing from an engagement to perform audit of
financial statements without issuing an audit report is an exceptional
situation and therefore needs to be backed by justifiable reasons and should
not be based on flimsy grounds.

An auditor entrusted with the engagement to
perform audit is required to comply with the requirements of SQC 1 in
performing audits, reviews of historical financial information and for other
assurance and related services engagements. As part of this responsibility, an
auditor should establish policies and procedures designed to provide reasonable
assurance that independence can be maintained. The auditor needs to evaluate
circumstances and relationships that pose threats to independence and to take
appropriate action to eliminate those threats or, reduce them to an acceptable
level by applying safeguards or if considered appropriate, to withdraw from the
engagement (Paras 18 & 22). Where the auditor obtains information that
would have caused to decline an engagement if that information would have been
available earlier: In such a situation, the auditor may examine if withdrawal
from the engagement or both from the engagement and the client relationship is
appropriate (Paras 34 & 35).

The overall objectives of the independent
auditor and the conduct of an audit in accordance with Standards on Auditing
are dealt with in SA 200. In case reasonable assurance cannot be obtained and a
qualified opinion in the auditor’s report is insufficient in the circumstances
for the purposes of reporting to the intended users of the financial
statements, the SAs require to disclaim an opinion or withdraw from the
engagement, where withdrawal is legally permitted (Para 12). If an objective in
a relevant SA cannot be achieved, the auditor shall evaluate whether it
prevents him from achieving the overall objective of the audit and then decide
either to modify the auditor’s opinion or to withdraw from the engagement (Para
24).

According to SA 210, agreeing to the Terms
of Audit Engagements, if the auditor is unable to agree to a change in the
terms of the audit engagement and is not permitted by the management to
continue the original audit engagement, the auditor shall withdraw from the
audit engagement where permissible as per law or regulation (Para 17). SA 220
on Quality Control for an Audit of Financial Statements provides that if the
engagement partner is unable to resolve the threat to independence with
reference to the policies and procedures that apply to the audit engagement, if
considered appropriate, the auditor can withdraw from the audit engagement
(Para 11 and A6). Where the applicable law or regulation does not permit
withdrawal of the auditor from the engagement, disclosure shall be made through
a public report of circumstances that have arisen that would have otherwise led
to the auditor to withdraw (Para A7).

If, as a result of a misstatement resulting
from fraud or suspected fraud, the auditor encounters exceptional circumstances
that bring into question the auditor’s ability to the perform the audit, the
Standard suggests the withdrawal from the engagement as one of the options,
subject to following certain procedures and measures — SA 240, the Auditor’s
Responsibilities relating to Fraud in an Audit of Financial Statements (Paras
38, A53, to A56). Again, when management or those charged with governance do
not take the remedial action that the auditor considers appropriate in the
circumstances, even when the non-compliance is not material to the financial
statements, the auditor can consider withdrawal from the engagement if
necessary. If such withdrawal is prohibited, the auditor may consider
alternative actions, including describing the non-compliance in the “Other
Matters” paragraph in the auditor’s report — SA 250, Consideration of Laws and
Regulations in an Audit of Financial Statements (Para A18). In a situation
where the two-way communication between the auditor and those charged with
governance is not adequate and the situation cannot be resolved, one of the
options available to the auditor is to withdraw from the engagement, if not
prohibited under the applicable law or regulation — SA 260 (Revised),
Communication with those charged with Governance (Para A53).

SA 705, dealing with “Modifications to the
Opinion in the Independent Auditor’s Report”, establishes requirements and
provides guidance in determining whether there is a need for the auditor to
consider a qualification or disclaimer of opinion or, as may be required in
some cases, to withdraw from the engagement where it is legally permissible –
SA 315, Identifying and Assessing the Risks of Material Misstatements Through
Understanding the Entity and its Environment (Para A108). Concerns about the
competence, integrity, ethical values or diligence of management, or about its
commitment to or enforcement of these, may cause the auditor to conclude that
the risk of management misrepresentation in the financial statements is such
that an audit cannot be conducted. In such a case, the auditor may consider,
where possible, withdrawing from the engagement, unless those charged with
governance put in place appropriate corrective measures — SA 580, Written
Representations (Para A24).If the auditor is unable to obtain sufficient
appropriate audit evidence, then the auditor is expected to determine the
implications thereof to decide whether to qualify the opinion or to resign. If
the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be both material and pervasive and a
qualification of the opinion would be inadequate to communicate the gravity of
the situation, the auditor shall resign if not prohibited by law or regulation.
In the event of resignation not being practicable or possible, the auditor
shall disclaim an opinion on the financial statements —SA 705, Modifications to
the Opinion in the Independent Auditor’s Report (Paras 13, 14, A13 to A15).

In a rare circumstance where the auditor is
unable to withdraw from an engagement even though the possible effect of an
inability to obtain sufficient audit evidence due to limitation on the scope of
the audit is pervasive, the auditor may consider it necessary to include in
“other matter paragraph” in the auditor’s report a statement  to explain why it is not possible for the
auditor to withdraw from the engagement — SA 706, Emphasis of Matter Paragraphs
and Other Matter Paragraphs in the Independent Auditor’s Report (Para A10).
Similarly, if the auditor concludes that a material misstatement exists in
other information obtained prior to the date of the auditor’s report and the
other information is not corrected after communicating with those charged with
governance, the auditor shall take appropriate action. One option in such a
situation is withdrawing from the engagement, especially when the circumstances
surrounding the refusal to correct the material misstatement of the other
information casts such doubt on the integrity of the management and those
charged with governance as to call into question the reliability of
representations obtained from them during the audit. In case of certain
entities, such as Central or State governments and related government entities,
withdrawal from the engagement may not be possible. In such cases, the auditor
may issue a report to the legislature providing details of the matter or may
take other appropriate actions.

The Code of Ethics requires an auditor to
consider resigning/withdrawing from an engagement when the auditor is able to
conclude that the expectation or requirement envisaged by the Code of Ethics
cannot be fulfilled and there is no other option but to resign. It is also
possible that an auditor expresses inability to continue as statutory auditor
due to overdue past audit fees and disagreement on fees for future services. In
case the auditor cannot legally continue as auditor, then withdrawal becomes
inevitable. There could also be an unavoidable circumstance beyond the control
of the auditor due to which continuing the engagement is ruled out. 

TIMING OF RESIGNATION

As the resignation of an auditor from an
audit engagement is not a matter of routine and since it is not a recurring
act, it is difficult to suggest as to when is the appropriate time for
resignation. But considering the immense faith that the various stakeholders
including the regulators and shareholders have reposed on the profession, an
auditor must be abundantly cautious not to exercise this right in a casual
manner and that, too, when the audit is almost complete. Unless the situation
is grave and the circumstances adequately justify it, the resignation option
should be avoided. Instead, a disclaimer of opinion and adequate disclosures on
the circumstances that have resulted in such a disclaimer can be reported.

The ICAI has issued “Implementation Guide on
Resignation/Withdrawal” wherein the following guidance is given in this regard:

“16. The auditor is therefore advised,
particularly in case of listed entities, to comply as below:

(a) In case an
auditor has signed all the quarters (either limited review or audit) of a
financial year, except the last quarter, then the auditor has to finalise the
audit report for the said financial year before resignation.

(b) In other cases, the auditor should resign after
issuing limited review/audit report for the previous quarter with respect to
the date of resignation.

(c) To the extent information is
not provided to the auditor or the management imposes a scope limitation, the
auditor should provide an appropriate disclaimer in the audit report.”

DISCIPLINARY/ REGULATORY PROCEEDINGS AGAINST AN AUDITOR

Even when called in for questioning in a
later proceeding, the auditor should be able to defend with the proper documentation
done and with the audit evidence gathered and maintained prior to issuing the
audit report. It is possible that an auditor is called in the disciplinary
proceedings of the ICAI or in an appropriate proceeding by a regulator such as
SEBI or RBI. The auditor is required to respond and submit in a systematic
manner all the working papers that would explain the execution of the audit
engagement stage by stage, strictly adhering to the SQC 1, SAs and Code of
Ethics. An auditor must demonstrate that in a given situation how a
professional judgement was made based on proper reasoning and prudence and that
any other auditor in the same set of facts and circumstances could not have
reached a different conclusion. In my experience as Chairman of the Disciplinary
Committee of ICAI and subsequently as a member of the Appellate authority, I
have come across cases with simple charges wherein the auditor was held guilty
for want of proper working papers and documentation. On the other hand, there
have been complex cases with serious charges levelled but finally the auditor
was acquitted on the strength of the working papers, audit evidence and proper
documentation which demonstrated that the standard auditing procedure was
meticulously followed and professional scepticism and judgement were duly
exercised.

Even those who sit in judgment on the
professional conduct of an auditor must not judge the conduct based on
subsequent developments pertaining to the entity that have taken place post
signing of the audit report. They must evaluate the case based on the circumstances,
facts and records as were available to the auditor at the time of signing the
audit report and by verifying whether the applicable SAs and Ethical framework
were followed and due professional judgement was exercised. It is easy to hold
anyone guilty in hindsight but that would defeat the very purpose of fairness
and justice while reaching a conclusion on the performance of a professional.
It must also be appreciated that audit is not an investigation and an audit
cannot unearth all kinds of frauds that have been perpetrated upon an entity.
At the same time, an auditor cannot claim protection on this general premise in
all cases of fraud because, if proper audit process is planned and executed
with professional scepticism it is possible to find out certain types of
misstatements arising out of frauds. If a fraud, which could have been
unearthed by following standard audit procedures and exercise of professional
scepticism, was not detected on account of gross negligence or dereliction of
duty, then an auditor cannot defend on the generic ground that audit is not an
investigation. On the other hand, if there are instances of fraud which could
not have been detected even after proper conduct of audit procedure and best
practices then the auditor cannot be held guilty in such a case and needs to be
exonerated.

COMMUNICATION AND DOCUMENTATION

When
circumstances compel an auditor to contemplate resignation from an audit
engagement, he must communicate with the appropriate level of management and,
where appropriate, with those charged with the governance, and, where
considered necessary, inform the circumstances, evaluation on the implications
thereof and the conclusions drawn. The auditor may even seek time from the
Audit Committee Chairman and explain to him the circumstances and seek his
intervention either directly or through the Audit Committee. Once a
communication is so given by the auditor, the management and, where
appropriate, those charged with the governance should respond to the said
communication within a reasonable period of time. Management and those charged
with the governance that are put on notice should also take necessary steps to
remedy the situation and communicate the same to the auditor. The auditor
should evaluate the response received and then review his earlier conclusions
impacting the decision of resignation. Thereafter, either he may drop the
decision to resign and continue with the engagement in accordance with the
Standards and Ethical Code or he may persist with his earlier decision to
resign, in which case he must comply with the procedure prescribed by filing
the relevant Form ADT 3 as indicated above.

The Implementation Guide issued by ICAI
further delineates the effective mode of communication of the resignation and
the relevant portion is given herein below:

“19 Further, the auditor is also advised to
include the following in the letter of resignation, as applicable:

(a) If the withdrawal or resignation results from
an inability to obtain sufficient appropriate audit evidence, the reasons for
that inability;

(b)        The possible effects on the financial
statements of undetected misstatements, if any, could be both material and
pervasive;

(c) If the matter is related to a material
misstatement of the financial statements that relates to specific amounts in
the financial statements (including quantitative disclosures), the auditor
should include a description and qualification of the financial effects of the
misstatement, unless impracticable

(d)        If the withdrawal or resignation results
from the inability of the auditor/the firm to complete the engagement due to bona
fide reasons;

(e) The fact that the circumstances leading to
withdrawal or resignation from the engagement were communicated to an
appropriate level of management and, where appropriate, to those charged with
governance;

(f) The response from the management or those
charged with governance on the written communication made by the auditor. If
response is not received, state the fact

(g)        Prior to resignation, the last
audit/limited review report issued by the auditor.”

According to the Code of Ethics, any auditor
newly appointed by an entity, prior to accepting the position as auditor, is
required to communicate with the previous auditor (clause 8 of Part I of the First
Schedule to the Chartered Accountants, Act, 1949).The objective behind such a
pre-requisite is that the incoming auditor will have an opportunity to know
from his predecessor the circumstances that resulted in the change so that he
can take necessary steps to protect his independence and professional dignity,
besides adopting caution in safeguarding the interest of the stakeholders. In
view of this, the auditor who has resigned should respond to the communication
received from the new auditor promptly, furnishing the reasons that caused his
resignation. The auditor should share a copy of the resignation letter stating
the reasons as submitted to the Registrar of Companies.

The
auditor who has resigned should maintain the relevant documentation in order to
demonstrate compliance with the requirements of the Implementation Guide issued
by ICAI, SAs, SQC 1 and the Code of Ethics for a period of 7 years from the
date of resignation.

Conclusion

No doubt, the present business environment
is transforming into a VUCA world, implying that there is Volatility,
Uncertainty, Complexity and Ambiguity (VUCA)! In such an environment, it is
truly a challenge for an auditor to discharge the duties associated with
assurance and to  function by upholding
standards and values as the risk matrix is escalating. Nevertheless, we must
believe that challenges are given only to those who have the ability to handle
them. We must also remember that if one auditor resigns without signing a
financial statement, such financial statement will be ultimately signed by
another auditor, of course, after taking necessary measures and steps to
complete the audit engagement in accordance with the Standards and Ethical
Framework. Therefore, before exercising the right to resign, an auditor should
explore the possibility of due discussion/communication with the management and
those charged with governance so as to secure their support and co-operation
for the smooth conduct of the audit without compromising on independence. An
auditor should also examine the possibility of giving a modified report with a
qualified opinion or adverse opinion or disclaimer of opinion instead of
resigning.

As discussed above the right to resign by following proper
procedures, is vested with the auditor under the law. At the same time, an
auditor’s resignation should not give an impression to the society that there
is an abdication of the duties attached to an audit responsibility. Needless to
say, audit should not be perceived as just an opportunity but it should be
viewed as a challenging responsibility and handled with due care and
caution.  A profession like ours owes it
to society to possess the courage of conviction to perform our role as an
auditor in the best interest of the stakeholders in order to establish an
unblemished track record for posterity to inherit.