'Audit Business Set To Change'

The Companies Bill, 2012 will change how large audit firms work. Audit firm rotation after two consecutive terms of five years each, prohibition on providing non-audit services to an audit client, class action suits against auditors- CNBC TV18's Menaka Doshi spoke to Grant Thornton’s Global CEO Ed Nusbaum on how these changes will impact the audit business in India.

Edward Nusbaum, Global CEO, Grant Thornton International
There is more scrutiny already on the auditing profession. There are reforms being discussed in Europe certainly- reforms proposed by the European Commission, the Companies Bill here impacts auditors and there are proposals in the United States (US) and China- everywhere in the world people are looking at the role of the auditors- how you improve independence, how you constantly improve quality. So, I think the auditors are already under more scrutiny to make sure that we are doing high-quality work and increase the quality coming out of the crisis.
 
Doshi: Let me get down to some of the specific India-related questions that I have. As you know we have a Companies Bill that has been passed or voted on in the Lower House of Parliament and will hopefully be voted on in the Upper House in a few weeks to come from now – that Bill recommends or proposes that there be rotation of audit firms, not just audit partners, but audit firms. Now this is a concept that has been gaining currency across the world. We have seen the European Union (EU) study this to great depth. We have seen the Public Company Accounting Oversight Board (PCAOB) put out discussion paper last year. What do you make will be the impact of audit rotation?
 
Nusbaum: It is clearly a trend throughout the world. The regulators throughout the world are moving towards audit firm rotation. There is a feeling that if the auditor has been the same auditor, in some cases for 50 or 100 years – that’s too long a relationship and that it has become too cozy and there is a perception certainly, if not reality, that the auditor is too close to the companies that they are auditing and so mandatory audit firm rotation has been discussed or proposed almost everywhere in the world. I think it is something that is a reality of where the regulators are going. I think it makes sense to test it- as the rules are developed or maybe try with some of the larger companies first, see the lessons that we learn. It is only being applied to listed companies. In some cases only the largest of listed companies, but I think mandatory firm rotation does have an impact on the relationship and certainly the perceived independence and objectivity of the accounting firm.

PCAOB
Issued a Concept Paper in 2011 on Auditor Independence & Audit Firm Rotation
 
EU Green Paper
Suggests mandatory audit firm rotation after every 6 years with a 4-year cooling off period before the same firm is appointed
 
PCAOB Concept Paper
Suggests mandatory audit firm rotation every 10 years
 
Companies Bill, 2012
Mandates compulsory rotation of individual auditors every 5 years
Mandates audit firm rotation every 10 years
 
Doshi: You keep making the point that it could potentially fix the perception that there is a lack of scrutiny or skepticism when it comes to audit or a lack of independence. Do you think that in reality it will not go the required distance in enhancing both audit independence as well as audit skepticism?
 
Nusbaum: I think it can create more independence. I think there is a time period after some period of years where the auditors, in some cases, not in every case, and hopefully not in too many cases get too close to the companies. I think each audit is unique, each situation is unique. So in some cases I think audit firm rotation will not impact independence and objectivity, but other cases it may.
 
Doshi: The other proposal in the Companies Bill 2012 that has irked auditors is the limit that it places on the number of companies that an audit partner can audit and that limit it has proposed be at 20 inclusive of all kinds of companies. Now that’s going to clearly change how audit firms approach clients, how many clients they can take on and the number of people they will need depending on the number of clients they have- your views on this proposal?
 
Nusbaum: This is not something we see in a lot of jurisdictions around the world, but certainly it is in the Companies Bill and again I am sure it will be passed. Overall, the concept makes sense to put some limits around the number of companies in audit, but it can’t be a one-size-fits-all solution. But again if I were writing the rules, as you implement it, I would put some size restrictions on it. So, let’s say a limit of 20 companies over a certain size.
 
I don’t know what the right size is, whether it is 1 billion or some other number, but it is a complicated situation because some companies have multiple subsidiaries and how it gets applied to the subsidiaries and all the related entities could cause some problems because obviously you would have a single partner do all of those audits even though they maybe quite a statutory audits in many countries around the world. So how it gets applied is critical. The rules that get established and rules and regulations under the Companies Bill will make a huge difference, but the concept makes a lot of sense.

Companies Bill, 2012
An auditor cannot audit more than 20 companies
In case of a firm, limit is applicable to each Partner

Doshi: You are right in that. The rules are eagerly awaited and they could very well narrow the impact of this specific proposal, but let me tell you what the audit head of Deloitte told me. He said that this is going to lead to audit dispersal, would you agree with that?
 
Nusbaum: Again, I think to the point that you made when you look at a group of companies and let’s say Grant Thornton audits a group of companies- it is how the rule and regulations are applied. If that group of companies is treated as one company, which may operate as within this rule is not a problem. If that group of companies is treated as 20 or 30 companies to break up that audit amongst different partners may not make any sense. It might actually reduce the quality of the audit. So a lot will depend on how the rules get written and how the regulations get applied. There are some auditors that have very small clients, I am not talking Grant Thornton, but some smaller practitioners, smaller firms, and sometimes small practitioners have extremely small clients and you won’t want to apply those limits to those very small clients, it would a tremendous burden on those firms.
 
Doshi: I must ask you this regarding the liability of auditors because that in a sense is again something that this Bill enhances. It introduces for the first time class action suits in this country and it includes in the list of those that shareholders can sort of file those class actions against auditors. It is or will result in a substantial enhancement of audit liability. I would like your view on what you make of this?
 
Nusbaum: The audit business model is constantly evolving and I think the limitation on non-audit services for audit clients has the biggest impact in many ways and our model. If that provision is limited….(interrupted…).
 
Doshi: That’s right. It is interesting that you brought that up. I should have brought that issue in as well. The fact that you can’t offer certain services now to an audit client will also restrict your business model?
 
Nusbaum: Yes and that provision, if it is applied just to listed companies and depending on how it is applied, it will change the business model- if it is applied to all companies including private companies and again that will hurt the smaller and mid-size enterprises that most regulators are trying to protect. So, it should only be applied to listed companies, but we saw provisions of that in Sarbanes-Oxley, which we have now been dealing with for a long time over 10 years and it has worked out fine.
 
It did change the business model within the US for the accounting firms. They no longer could sell the big main information technology (IT) projects to their audit clients, but then they started selling and we started selling projects, to not our audit clients, to other people’s clients. So overall, I don’t think that is as bad as some people make it out to be as long as it is applied in the right way. So, the limitation has worked in the US. There are proposals in Europe from the European Commission again to limit non-audit services for audit clients- it seems to be the way the world is moving and again I don’t think it’s necessarily bad.

Companies Bill, 2012
A class of investors can claim damages for unlawful or wrongful acts from or against the company, its directors, auditors, experts, advisors etc.

Companies Bill, 2012
Prohibits auditors to render non-audit services to an audit client or its holding company or its subsidiary

Companies Bill, 2012
Non-audit services include investment banking services, actuarial services, investment advisory services etc
 
Sarbanes-Oxley Act, 2002
Prohibited audit firms from providing certain non-audit services to audited companies
 
Sarbanes-Oxley Act, 2002
Required audit committee pre-approval of all audit and non-audit services
 
EU Green Paper
Suggests audit firms cannot provide non-audit services to audit clients
 
EU Green Paper
Conflict of interest when a statutory auditor is also responsible for non-audit work like tax advisory services, valuation, actuarial & legal services

Doshi: Let me club all these issues. So audit firm rotation will hurt your long-term client relationships. The limitation of companies regarding an audit partner- that could again reduce productivity to some extent and then you has got the limitation on non-audit services. Now clubbed together, this Bill is going to have a substantial impact on audit firm profitability in India. Could you talk a little bit about how you see the audit business model change in the country?
 
Nusbaum: I am glad that you are worried about our profits as a profession. I don’t know that there will necessarily be less profit, but I think it changes the business model and we have to be flexible enough to change. So if there is 10 year rotation for some of the largest companies or for listed companies, whatever it maybe, we will have to be more adaptive, issuing proposals and working in the market to get the proposals. We are not thrilled with having that every 10 years, but if that’s the reality, that’s the reality. With respect to the partner limitations, as you pointed out, it might reduce the productivity- if it is applied correctly just for larger companies then I think it will be okay and the limitation on non-audit services like I said it is just a matter of us being able to change our model to sell to other companies in the market place.