The new Companies Act and the draft rules are heavily skewed against the auditor. The restriction on the number of audits an auditor can do in the existing Companies Act is 20 public companies. Though the restriction has been retained at 20, the limit under the new Act will also include private companies. No major country or professional body imposes such a restriction, and this is perhaps very unique to India. It is also unique within India, since similar restrictions do not exist in the legal, medical and many other professions. Imposing an unreasonable restriction on doing business perhaps may not be constitutionally valid. Restricting the number of audits would also have a negative effect on audit quality, since typically none of the audit firms will be able to invest in talents and technology, critical for a good audit.
Under the new Act rotation of auditors will be mandatory for all companies, other than a one man company and a small company. Conceded that rotation brings about independence of auditors, but it also increases audit cost, burden for companies and in the initial years of the incumbent auditor, increases the risk of non-detection of frauds and errors. Therefore in balance the rotation requirements should not be extended to companies other than listed companies, as public interest in non-listed companies is minimal.
An auditor cannot be appointed as auditor of a company if he or his relative holds investment in a company exceeding Rs. 1 lakh. Relatives have been defined in the rules and include a long list which includes brothers and sisters. In today’s world, it would be difficult to know in which companies the brother or sister has invested in; leave aside telling them not to invest in those companies. A disgruntled brother or sister of the auditor may actually invest in various companies, rendering the auditor jobless. Therefore. the term relative needs to be redefined to include only spouse and children and other people who are financially dependent on the auditor.
The rules also prohibit the auditor from having any business relationship with the company, even if those are at arm’s length. Thus, an auditor of a telecom operator cannot use the network facility of the operator, even if the pricing is the same as any other customer. Needless to say, any transaction carried out on arms length basis must be permitted, as otherwise, it will pose serious practical problems for not only the auditors but also the companies they audit.
The reporting requirements for the auditor have been made very onerous. He is supposed to be a super human who will not only detect and report to the Central Government all frauds that have been committed against a company but also frauds that are in the process of being committed. He is also required to second guess management’s business decision and propriety of transactions. All this will require him to step into management’s shoes, which is completely against the requirement of auditing standards. Besides, if the auditor is good at doing business, why have entrepreneurs; maybe, auditors should run businesses. Given the onerous nature of the auditing profession under the new Act, this may actually be a good idea!
Interestingly, the auditor is also required to report on foreseeable losses on derivative contracts. One can understand mark to market losses, but it is difficult to understand foreseeable losses. Never mind, an auditor is not only supposed to be a super human but also one with extra sensory powers. If only the auditor knew what foreseeable losses and profits are on derivative contracts, why would he choose to be an auditor, why not a derivative trader?
After all this, if the auditor is found to be lacking in his super human and extra sensory skills, there is a lot of stringent punishment waiting for him. There could be class action suit, long years of imprisonment and debarment of the audit firm for a period of 10 years. Even if the professional misconduct was attributed to a single partner, an entire firm comprising of several thousand people, could be in trouble.
Which parent would like his children to join a profession with so many imperilments? The provisions of the Act seem to be a knee jerk reaction to the Satyam fraud and in the long run will destroy the audit profession and audit quality and will be actually counter-intuitive to the very reason why these laws were framed. One can relate this experience to an attempt at VCR repair.
One day I tore into my VCR with the intention of freeing a jammed tape. I took the VCR apart, but failed to free the jammed tape. Then, when I tried to put the VCR back together, I failed again. The tape was still jammed, and now the VCR was in pieces. If I had counted the cost before looking for a screwdriver, I would have taken the VCR to a repair shop rather than destroying it. When will we learn that, “The Road to Hell is paved with Good Intentions!”
