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The Companies Act, 2013: Impact On Auditors And Audit Firms
April, 03rd 2014

When the draft rules relating to the Companies Act, 2013, were first rolled out, Zenobia Aunty’s auditor friends were shell-shocked. Typically, it is just the annual audit season that gets them down; else they are a more cheerful lot than their counterparts – those poor tax practitioners who battle it out in tax offices and tribunals.

What was the reason for their dismay? Well, rotation of auditors had been proposed not just for listed companies but for all companies, including private companies irrespective of its size. “If rotation of auditors is to ensure shareholder protection by ensuring a ‘comfort-level’ doesn’t develop between the auditor and the Company over the years, what is the logic of extending rotation to private companies?,” queried a young chartered accountant.

The chairman of a Big 4 concurred, by adding that: “Nowhere in the world is rotation prescribed for private companies.” Mind you, a loop-hole, if one could call it that was also effectively plugged in by prohibiting rotation among ‘network firms’ or associate or affiliates of an existing audit firm.

Today, all rules relating to chapter X of the Companies Act, 2013, relating to audit and auditors have been notified. Further, The Companies Act, 2013, has come into effect from April 1, 2014.

Many of the final rules are more rational, even as auditors will continue to find some new requirements challenging.

Mandatory rotation of auditors: The final rules, which were recently issued, on the eve of coming into force of the Companies Act itself, are comparatively more reasonable for the auditor community without diluting the interest of any stakeholder (say, creditors) of large private companies.

Rotation of auditors is now mandatory for all listed companies and only those unlisted and private companies which meet the prescribed criteria.

Unlisted public companies with a paid up share capital of Rs. 10 crore or more; private limited companies with a paid up share capital of Rs. 20 crore or more; and companies with public borrowings from financial institutions, banks or from the public (by way of deposits) of Rs. 50 crore or more; will need to rotate their auditors.

A press release from The Institute of Chartered Accountants of India (ICAI) quotes its President, C.A. K Raghu as saying: Rotation of Auditors which has not been accepted across the world is now only restricted to certain class of companies leaving close to 90% of the companies outside the scope of rotation. This will benefit small and medium practitioners (which means auditors) and corporates.

Last December, member countries of the European Union, approved new auditor regulations, which provide that auditor of public interest entities, be rotated every ten years – with provisions for a longer tenure when audit engagements are put out for bid or joint audits are performed. Public interest entities include banks, insurance firms and listed companies. “A point to note is that private companies continue to remain out of the ambit of auditor rotation requirement,” points out a retired auditor friend to Zenobia Aunty. Moreover, he adds: Auditor rotation isn’t yet on the legislative books in the United States of America.

Well, back home, private companies meeting the specified criteria have no choice but to rotate audit firms. One may well say that these are large firms, well equipped to bear any administrative hassles and costs that may arise owing to auditor rotation requirements.

Private companies in India which are subsidiaries of global MNCs will also have to comply with rotation requirements if they meet the prescribed thresholds. MNCs typically prefer to have a single audit firm carry out audit for its subsidiaries spread across the globe – it helps in seamless consolidation of accounts. Guess, they have to toe the line adjust to this new local requirement. Many could call it the cost of doing business in India!

Perhaps a 100% subsidiary in India of a foreign company, could have been exempted from audit rotation requirements.

Maximum tenure of an audit partner or audit firm: As regards the maximum tenure of an auditor (partner in an audit firm) and the audit firm, the term prescribed is five years and ten years respectively. Further, shareholders can at their discretion even determine that the audit partner be rotated at much shorter intervals or that there be a joint audit conducted.

The final rules clarify with an illustration, issues relating to a transitional period which is three years. Thus, if an audit partner, or audit firm is due to complete the maximum prescribed term of five and ten years respectively, the rotation requirements will apply at the end of the three year transition period starting from April 1, 2014. This transitional period is much welcome and who knows what the laws will be three years down the line – an amendment is always possible!

Rotation of auditors is in a nascent stage, be it in EU or in India. Thus, no statistical evidence would be available of whether such rotation truly meets the intended objective of ‘independence’ or whether it just results in an added administrative cost for companies.

Cap on the maximum number of audits: Surprisingly the cap on the number of audits continues. The earlier Companies Act and the Institute of Chartered Accountants of India restricted the number of auditee companies to thirty. An audit partner could not be an auditor for more than twenty public companies of which not more than ten companies could have a paid up share capital of more than Rs. 25 lakh.

The Companies Act, 2013 and the final rules do not prescribe for any restrictions on the maximum number of audits based on the size of the companies. Thus, the maximum number of audits per audit partner is now twenty – which would include audits of small private companies.

Understandably, ICAI’s President has said: “As far as the limit of twenty audits is concerned, this is likely to create practical difficulties for the profession. With the technological advancement both in accounting and auditing, chartered accountants can serve and bestow personal attention to a much larger population than the limit prescribed.”

Reporting Frauds: While challenges arising from the above points can be dealt with by the audit professionals, the biggest challenge that lies ahead is public perception. Zenobia Aunty’s favourite niece – this columnist, is a chartered accountant.

One of the things she learnt as a CA student was that the “auditor is a watch dog and not a bloodhound”. These were the famous words pronounced by Lord Justice Lopes of England’s Court of Appeals in the case of Kingston Cotton Mills, a century ago.

In other words, he or she is not meant to attack the books of accounts with a preconceived notion that a fraud exists. Alas all her dreams of playing Sherlock Holmes had promptly disappeared during her first week of internship itself! But she soon learnt what it means to be a truly independent auditor, one whom the stakeholders can rely on. The auditor, after all, is responsible for verifying whether the financial statements exhibit a true and fair view of the state of affairs of the business.

Over the years, while auditors have continued to bank upon Lord Justice Lopes’ verdict, public perception has changed. Incidents of fraud, even if ingenious and conducted by top management – such as Satyam in India have widened this perception gap.

Perhaps this change in perception is captured in the Companies Act, 2013 and notified rules. It was required under the new Act that the auditor should immediately inform the Central Government within a prescribed time frame and in the prescribed manner, if the auditor had reason to believe that an offence involving fraud is being or has been committed against the company by its officers or employees. No materiality limit was set for such reporting. The term ‘Fraud’ as defined under the Act, covers every act of omission or commission.

ICAI in its press note comments: We also understand that there are going to be practical difficulties in dealing with the requirement to report on every fraud. However, the silver lining in the final rules on reporting of fraud is that now the auditor need not report the fraud directly to the Central Government. In the first instance, the report would have to be given to the Board of Directors of the Company and the Audit Committee and within next sixty days, the report on fraud shall have to be submitted to the Central Government. We are looking at various possibilities and hope to resolve this issue in a practical manner soon”.

Now, the auditor is required at first to report the fraud to the board and the audit committee, seek their reply within a forty-five day period and within fifteen days of this reply, report the fraud to the Central Government together with the response of the board and audit committee. Well, this puts some degree of onus on the board and audit committee as well.

It remains to be seen how this new requirement pans out.

Having finished dictating her points of view, to this long suffering niece, Zenobia Aunty trundled off in search of her dog. Spot alone was loyal enough to listen to her off-tune rendition of Que-Sera-Sera, whatever will be, will be, the futures’ not ours to see, Que-Sera-Sera.

 
 
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