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Policy | If the ‘market knows’, why doesn’t the auditor?

Does the audit industry consider its responsibility towards a company’s stakeholders while writing out scripted audit reports? There needs to be a systemic focus on improving audit quality standards.

May 11, 2020 / 02:36 PM IST
Representative Image

Representative Image

Auditors are considered market fiduciaries, because they validate the fairness of financial statements. Resignation of auditors and frequent changes in auditors are considered early warning signals by most investors. The market frustration over the lack of accountability of the audit industry led to SEBI using its discretionary powers over market fiduciaries to regulate auditors. SAT overturning SEBI’s ban of PriceWaterhouse, legally tenable no doubt, misreads market expectations and leaves open the question of their accountability yet again.

Recently, the market has been raising pertinent questions over auditors given the recent controversies. IL&FS, CG Power and Industrial Solutions Limited, and Dewan Housing Finance Limited (DHFL) are just some of these instances. In these and in others as well, investors question the role of auditors in not being able to highlight financial shenanigans, which (post-facto) seemed obvious in some cases. Another frequent comment from investors is that audit reports are scripted, and most read similar to each other. Put differently, it is that audit reports don’t really differentiate between companies.

The audit industry argues that the failures are isolated instances and that in aggregate, these ‘mishaps’ account for a very small share of the financial statements reviews by auditors. This no longer appears to hold. The financial implications of these ‘mishaps’ has been material starting from the Satyam fiasco — the first material event that raised questions on the role of the auditors — to IL&FS, to Vakrangee, to DHFL, to Fortis, to CG Power and to several more. These have impacted both banks and the average citizen: either through an overall impact on the economy or through the erosion of personal wealth.

In most instances, investors seemed to sniff out that something is amiss, well before a company’s auditors. This was being reflected in either a steadfast deterioration in the company’s stock price, or a systematic contraction in the company’s access to debt. Therefore, if the ‘market knows’ based on largely publicly available information, why are auditors — who have access to much better quality of internal information — unable to see the writing on the wall? Can what the ‘market knows’ be embedded into the audit process?

Some of the issues raised above (and more) were discussed at the NSE-IiAS round table discussion held a few weeks ago between audit firms (the big four and some domestic firms) and some institutional investors.

One of the questions raised during this round table was whether audit firms did a ‘look-back’ to see what they missed to catch in these failures. The firms reiterated the claim that they have strong processes in place that ensure appropriate level of oversight of each individual audit. This includes measuring partner hours per audit, monitoring of workload of the audit team, use of technology to scan through reams of data, leveraging the forensic practice to examine critical areas, a committee-based escalation matrix for tricky issues (this is essential as more judgement-based accounting seeps into the financial statements) and internal independent reviews on quality of work.

If this is indeed the case and audit review processes are strong, the answer may be that auditors have limited themselves to form, rather than the substance in audit reports.

Auditors describe their role as expressing an opinion on the financial statements, whose preparation is the responsibility of the management. In expressing this opinion, they appear to limit their role to what is prescribed by the accounting and auditing standards. If so, there still exists one contradiction: Indian accounting standards are closer to International Financial Reporting Standards (IFRS), yet there is little confidence that they offer a truer picture.

This is the first of a two-part series on the state of the Indian audit industry. In Part II, we will discuss the issues of regulatory oversight, conflict of interest, capabilities beyond the big four, auditor resignations, and what the future holds for the industry.

Hetal Dalal works at Institutional Investor Advisory Services India Limited (IiAS) and is a member of The Institute of Chartered Accountants of India. Twitter: @hetal_dalal. Views are personal.

Hetal Dalal
first published: Oct 29, 2019 12:09 pm