Audit Rotation: Impact on Accountants, Firms & India Inc?

of 5 Friday: 10.30 pm, Saturday: 11.30 am Sunday: 9:30am & 11.00pm Home About Us Feedback Audit Rotation: Impact on Accountants, Firms & India Inc? Tweet Published on Sat, Dec 03,2011 09:46, Updated at Sat, Dec 03 at 13:59Source : CNBC-TV18 Watch Video : Two years when the parliamentary standing committee suggested the companies bill mandate auditor rotation, both corporate India and its auditors dissented. But the ministry of corporate affairs has remained steadfast in its intention helped Im sure in no small measure by the global scrutiny of the audit business. So now the companies bill 2011 is about to usher in the mandatory rotation of audit firms for listed companies. How will this impact accountants, their firms and most importantly their clients India inc? To discuss that i am joined by P R Ramesh, chairman - Deloitte India, Koushik Chatterjee group CFO TATA steel and Gautam Nayak, partner CNK India an independent audit firm. To three of you a warm welcome. Doshi: I would like to start with you Mr. Ramesh first and that is that I think the rationale behind proposing audit firm rotation has now been debated for 20-30-40 years across the world, so its not a new concept, its not on the table for the first time globally, but in India it is on the table for the first time and about to become a reality. We know the debate, the cost versus quality, the independence versus skepticism debate, all of that. What impact do you think if the Companies Bill mandates lets say a four year term or a five year term for audit firms, What impact will it have on both the fraternity as well as the companies that they audit? More Stories New Depository Receipts Scheme! De-Listing: Easier, Tougher & The K... SEBI Tightens Insider Trading Norms... Shell Victory Good News for all MNC... GST: Reality by April 2016? The Liechtenstein Story! Cartels & Claims! Tax Cheer For Private Equity! FTIL + NSEL = Public Interest? Why Switzerland Is Being Nice & Cyp... Twitter Tweets by @thefirmupdate Ramesh: Yes, I think its not right to say that it is for the first time on the table. Rotation has been there in some form or the other in the public sector in India, in the financial services sector. So there is an experience. Its in the insurance sector. Doshi: You sound you are almost for it then. Ramesh: Not really so, because its not the principle of rotation alone. When we are looking at audit firms and each of these firms or rather the profession itself should mirror the environment which it serves. Doshi: So why does mandated audit firm rotation not mirror the environment that it serves? Ramesh: I am not on the issue of whether the rotation mirrors the environment. I am saying there is a profile of a profession which should mirror the environment which it serves. There are few large firms. There are few firms having national presence. There are large number of firms having regional presence in large number of smaller firms, whereas businesses are not so. Equally today we have Indian businesses having a global footprint. Doshi: But not all you would concede? Ramesh: Yes, not all. Doshi: So if its horses for courses there are large audit firms that can service large Indian companies and medium size audit firm that can service medium size Indian companies and then the same for small within the listed universe. Ramesh: True. To use your term horses for courses the point I am driving home is they are the same horses and you are saying rotate within the horses. So you are not necessarily going to find new horses. Doshi: Are you making the argument that the Big Four today currently occupy such a large amount of the market that any rotation will just mean that you are going from one Big Four to second Big Four or worst still, from one network form of one Big Four to another network form of another Big Four, is that the case you are making against rotation at this point? Ramesh: No. If you are talking of India, the Big Four if I may use that term do not have the same market share as they have elsewhere in the world. Doshi: No, they dont, but they still dominate the market of large listed companies. Ramesh: If you take top 500 companies the Big Four will not have a share exceeding 50%. So point I am driving home is that when you are introducing rotation you have very few firms of size or geographical presence. The rotation will happen only within the few. So if

of 5 you are trying to correct the profile of the profession by introducing rotation its not going to happen. On the contrary if 50% are not audited by the Big Four it is more likely that they will move to the Big Four. Doshi: Do you agree with the argument that Mr. Ramesh is making and that is that more clients will move out from the non-big Four 50% of the market to the Big Four as opposed to give up the Big Four really? Nayak: I think its highly likely. If you look at the experience of Italy, in Italy they say that there are two parts of the market, one is the mandated audit rotation market and the other is the voluntary. If you look at the mandated audit rotation market I think its 84% whereas 78% for the voluntary audit market. Doshi: The market share for Big Four? Nayak: Big Four, thats right. Doshi: So it ends up benefiting the Big Four. So this is a change for the Big Four, not by the Big Four, but definitely benefiting the Big Four. Nayak: Absolutely. In fact there could also be a situation where one Big Four firm tells another Big Four firm, okay you take over my clients which I have to retire and I will takeover your clients. So that sort of a reciprocal swap is also something which is likely. Doshi: So you answered the question of what happens to the fact that the smaller independent firms may not really get their teeth into a larger part of the market. Thats fine. Thats the firms problem. As far as the company is concerned do you believe that the ability or the mandate to go from one Big Four to the second Big Four will still mean some professional skepticism, will still mean some degree of independence, more than what exists right now? Nayak: It will introduce a situation where you have the perception of independence but will there really be independence, because today the audit fees are decided by the management. You have a situation where what happens typically is if you talked to any client who has got a Big Four auditor they say they always want to cross sell their services so therefore you are looking into situation where they would look at a quid pro quo that, yes I am retiring as the auditor but during my audit term if you want a favourable treatment you have got to give us this work going forward. Thats something that is the danger there. Doshi: Is this going to help improve the quality of audits because actually that is the driver for this change? I understand that maybe the fraternity itself or the profession itself is not fully ready to benefit from it. Maybe it wont help the independent audit firms as much as it will probably perpetuate the dominance of the Big Four. All thats fine. It doesnt matter. If it means that we end up with more auditor independence then fine. The fraternity figures it out on their own? Chatterjee: I think for large companies and I have seen this once globally where the transition is very critical from one firm to the other forget whether its a Big Four or Big Six or whatever. I think the capability of the audit firm whomsoever it is is very critical in a going concern to move from one audit firm to another audit firm because there is a history in a company of whats happening in that particular company and if the incoming audit firm does not have the capability to actually slip into the shoes of the earlier auditor, get an understanding of the business as well as the company, the peculiarity and complexities which are normally associated with any company there is a time. Its not that it is not possible but there is a time. Doshi: But its been done for banks isnt it as Mr. Ramesh pointed out. Its been done for banks and I would imagine fairly all right. What is it a two year term or is it a four year term or Chatterjee: Four year term, yes. Doshi: So its been done for banks and public sector undertakings and nobody seems to be complaining much. I dont know if its resulted in better audit quality. Chatterjee: Yes, thats what I was coming to. Doshi: But it is doable. Chatterjee: It is doable. Thats what I am saying. If there is an auditor who doesnt scale up to the level of the competency or the incisiveness required to do a good audit, who will judge that? Doshi: You are watching The Firm. Two years when the parliamentary standing committee suggested the companies bill mandate auditor rotation, both corporate India and its auditors dissented. But the ministry of corporate affairs has remained steadfast in its intention helped Im sure in no small measure by the global scrutiny of the audit business. So now the companies bill 2011 is about to usher in the mandatory rotation of audit firms for listed companies. How will this impact accountants, their firms and most importantly their clients India inc? To discuss that i am joined by P R Ramesh, chairman - Deloitte India, Koushik Chatterjee group CFO TATA steel and Gautam Nayak, partner CNK India an independent audit firm. To three of you a warm welcome. Copyright e-eighteen.com Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of moneycontrol.com is prohibited.

of 5 Doshi: I would like to start with you Mr. Ramesh first and that is that I think the rationale behind proposing audit firm rotation has now been debated for 20-30-40 years across the world, so its not a new concept, its not on the table for the first time globally, but in India it is on the table for the first time and about to become a reality. We know the debate, the cost versus quality, the independence versus skepticism debate, all of that. What impact do you think if the Companies Bill mandates lets say a four year term or a five year term for audit firms, What impact will it have on both the fraternity as well as the companies that they audit? Ramesh: Yes, I think its not right to say that it is for the first time on the table. Rotation has been there in some form or the other in the public sector in India, in the financial services sector. So there is an experience. Its in the insurance sector. Doshi: You sound you are almost for it then. Ramesh: Not really so, because its not the principle of rotation alone. When we are looking at audit firms and each of these firms or rather the profession itself should mirror the environment which it serves. Doshi: So why does mandated audit firm rotation not mirror the environment that it serves? Ramesh: I am not on the issue of whether the rotation mirrors the environment. I am saying there is a profile of a profession which should mirror the environment which it serves. There are few large firms. There are few firms having national presence. There are large number of firms having regional presence in large number of smaller firms, whereas businesses are not so. Equally today we have Indian businesses having a global footprint. Doshi: But not all you would concede? Ramesh: Yes, not all. Doshi: So if its horses for courses there are large audit firms that can service large Indian companies and medium size audit firm that can service medium size Indian companies and then the same for small within the listed universe. Ramesh: True. To use your term horses for courses the point I am driving home is they are the same horses and you are saying rotate within the horses. So you are not necessarily going to find new horses. Doshi: Are you making the argument that the Big Four today currently occupy such a large amount of the market that any rotation will just mean that you are going from one Big Four to second Big Four or worst still, from one network form of one Big Four to another network form of another Big Four, is that the case you are making against rotation at this point? Ramesh: No. If you are talking of India, the Big Four if I may use that term do not have the same market share as they have elsewhere in the world. Doshi: No, they dont, but they still dominate the market of large listed companies. Ramesh: If you take top 500 companies the Big Four will not have a share exceeding 50%. So point I am driving home is that when you are introducing rotation you have very few firms of size or geographical presence. The rotation will happen only within the few. So if you are trying to correct the profile of the profession by introducing rotation its not going to happen. On the contrary if 50% are not audited by the Big Four it is more likely that they will move to the Big Four. Doshi: Do you agree with the argument that Mr. Ramesh is making and that is that more clients will move out from the non-big Four 50% of the market to the Big Four as opposed to give up the Big Four really? Nayak: I think its highly likely. If you look at the experience of Italy, in Italy they say that there are two parts of the market, one is the mandated audit rotation market and the other is the voluntary. If you look at the mandated audit rotation market I think its 84% whereas 78% for the voluntary audit market. Doshi: The market share for Big Four? Nayak: Big Four, thats right. Doshi: So it ends up benefiting the Big Four. So this is a change for the Big Four, not by the Big Four, but definitely benefiting the Big Four. Nayak: Absolutely. In fact there could also be a situation where one Big Four firm tells another Big Four firm, okay you take over my clients which I have to retire and I will takeover your clients. So that sort of a reciprocal swap is also something which is likely. Doshi: So you answered the question of what happens to the fact that the smaller independent firms may not really get their teeth into a larger part of the market. Thats fine. Thats the firms problem. As far as the company is concerned do you believe that the ability or the mandate to go from one Big Four to the second Big Four will still mean some professional skepticism, will still mean some degree of independence, more than what exists right now? Nayak: It will introduce a situation where you have the perception of independence but will

of 5 there really be independence, because today the audit fees are decided by the management. You have a situation where what happens typically is if you talked to any client who has got a Big Four auditor they say they always want to cross sell their services so therefore you are looking into situation where they would look at a quid pro quo that, yes I am retiring as the auditor but during my audit term if you want a favourable treatment you have got to give us this work going forward. Thats something that is the danger there. Doshi: Is this going to help improve the quality of audits because actually that is the driver for this change? I understand that maybe the fraternity itself or the profession itself is not fully ready to benefit from it. Maybe it wont help the independent audit firms as much as it will probably perpetuate the dominance of the Big Four. All thats fine. It doesnt matter. If it means that we end up with more auditor independence then fine. The fraternity figures it out on their own? Chatterjee: I think for large companies and I have seen this once globally where the transition is very critical from one firm to the other forget whether its a Big Four or Big Six or whatever. I think the capability of the audit firm whomsoever it is is very critical in a going concern to move from one audit firm to another audit firm because there is a history in a company of whats happening in that particular company and if the incoming audit firm does not have the capability to actually slip into the shoes of the earlier auditor, get an understanding of the business as well as the company, the peculiarity and complexities which are normally associated with any company there is a time. Its not that it is not possible but there is a time. Doshi: But its been done for banks isnt it as Mr. Ramesh pointed out. Its been done for banks and I would imagine fairly all right. What is it a two year term or is it a four year term or Chatterjee: Four year term, yes. Doshi: So its been done for banks and public sector undertakings and nobody seems to be complaining much. I dont know if its resulted in better audit quality. Chatterjee: Yes, thats what I was coming to. Doshi: But it is doable. Chatterjee: It is doable. Thats what I am saying. If there is an auditor who doesnt scale up to the level of the competency or the incisiveness required to do a good audit, who will judge that? Doshi: But if you go from one Big Four to another Big Four considering that in this country right now they are all national etc. etc. So lets for a moment forget the audit fraternity, forget the firms, forget what impact it has on them and lets just focus on companies. You go from one good auditor, national presence etc. to another good auditor national presence, you should manage. We havent seen an improvement in audit quality recorded by virtue of the rotation that already takes place in this country but nor have we have seen a deterioration, I dont know. Chatterjee: No, it is going to be fairly standardized as far as an outcome is concerned. Doshi: Mr. Ramesh has a secretive smile on his face. Do you believe the mandated rotation that we currently experienced has improved audit quality or not? Ramesh: Yes, let me put in this way. It has not deteriorated audit quality, if you are looking at the banking sector for instance. Banking sector not only has rotation of auditors most nationalized banks have joint audits and multiple auditors. You have to recognize that in the banking sector there is a very active regulator, a very responsible regulator. The regulatory inspections are very intense. Their own regulatory inspections are very intense and the financial services sector is always under a spotlight. So to say that audit has therefore caused stability in the banking sector I think would be giving far too much credit to audit. When we come to audit quality, in effect what we are saying by introducing rotation is that the audit committees are not independent. They are the ones who see the auditor closely. They are the ones who would see how the auditor presents, what is he carrying out? What are the issues he brings to the table? So if they are truly independent they would be the first ones to recommend a change and they are required by law to evaluate the performance of the auditor. Nayak: If you look at worldwide they are looking at first partner rotation, they are looking at joint audits. Doshi: We already have partner rotation in the country. Partner rotation is pretty common in most jurisdictions isnt it? I dont think that, that is yet to be introduced anywhere. Nayak: No, along with joint audits. Chatterjee: We used to have joint audits in our company for many decades. We had two firms who use to rotate between their scope of work every half year. So, one firm use to do the closing for the half year and the other firm use to do the closing for second half and it use to work very well. Doshi: So if you are faced with a 4 or a 5 year term. May be 2 terms of 4 or 5 years consecutively before there is a cooling off period, then you think that its fairly alright?

of 5 Because there are arguments made, studies done, research that seems to support the claim that in the first few years of a limited term engagement, the learning curve s very steep for the audit firm and therefore the quality of the audit is low and then more recently some researchers pointed out that in the last few years of the term the audit quality drops off because the lack of engagement, saying anyways we are going to quit this company 2 years down the line or one year down the line does it really matter? Chatterjee: This issue comes in specifically if you have fixed term. This issue does not come if you are having the option to rotate out every year which is currently the case. Doshi: I want you to visualize for me assuming that this has now become effective; we are going to go into a 4 year or a 5 year audit firm rotation period. How is it going to change the way small, medium sized firms work? How is it going to change the big 4 work and how is it ultimately going to change the way companies interact or engage with their audit firms? Nayak: If you look at the position, I think the big four firms, their real superiority is in their marketing. They have good systems but marketing is where they score and thats the point that, there small and medium sized firms could be at a disadvantage because frankly I think most small and medium sized firms have grown from a situation where they look at this as a profession and not as a business. So, marketing is something which they are not really into and thats where I think you are likely to lose clients at the time of rotation. Doshi: How will you prepare as chairman of one of the Big Four to deal with this and the impact and implication of all of this? Ramesh: As a large firm Gautam is right, clearly large firms are at advantageous position A. because they have scale, they can deploy resources depending on the size of the entity. B. they have industry experience because they would have some client or the other in that industry to be able to showcase their industry norms and third is their geographical spread whether its national or international. Doshi: Thats a pitch now yes, nice. Ramesh: But thats the reality. So if these are some of the facts, if these are placed before audit committees as opposed to another firm which cannot demonstrate scale, which will say yes give me the audit and I will build up scale as I go along because of the audit and say I dont have experience, I learn at your cost and say I dont have a national presence or a international presence but I will do so as time goes by, logically an audit committee will chose which has those credentials. Chatterjee: I think the key issue from a companys perspective is to understand how do they transit every four years or five years or ten years whatever it is. What would happen also implicitly because of this rotation the cost of audit will also go up? Doshi: Do you think so? Substantially? Chatterjee: Yes, it will go up. End of the day when people knowing that this client is going to give me audit for the next two years, three years, four years, there is a certain build-up I am sure that the audit firms will be doing on a projected basis. The moment that is not there and you said this is only for three years then if you have to hire people or if you have to man people or train people in understanding that company or that sector etc. I think the cost will go up. So thats a reality also from a companys perspective Nayak: This point about cost, the US General Accounting Office had estimated in 2003, they said that audit fees will go up by almost 20% that was their estimate. Chatterjee: So you have the statistics. Doshi: Alright gentlemen. Well wait to see what exactly the bill spells out and have you visit us again to get into some of the details once we do have the fine print. For the complete show, watch the accompanying videos... Rate this article Rating : Not yet rated Comments Have an opinion on this news? Post your comment here. Type your message here