Audit Firms: The Credibility Crisis 
The shadows of pedestrians are cast on a sidewalk in Seoul, South Korea. (Photographer: SeongJoon Cho/Bloomberg)

Audit Firms: The Credibility Crisis 

Is india suffering an epidemic of audit failures? The Big 4 – PWC, EY, Deloitte and KPMG – are each facing investigation or regulatory sanctions. It’s been 10 years since the Satyam Computer Ltd. fraud and the IL&FS Ltd. investigations suggest auditors haven’t learnt any lessons in the past decade.

Resignations, deficiencies, failures – they all point to a crisis of credibility facing Indian auditors.

Also read: A Few Roads Out Of This Audit Mess

Anil Singhvi, Founder of governance advisory firm IiAS, R Narayanaswamy, professor of finance and accounting at IIM Bangalore, Amarjit Chopra, former ICAI President and PR Ramesh, former chairman at Deloitte discuss the challenges at hand with BloombergQuint’s Menaka Doshi

Also read: PwC Resignation as Auditor of Reliance Capital, Reliance Home Finance Comes Under SEBI, Government Scanner

Here is an unedited transcript of the discussion.

Is this an epidemic of audit failures? Is there now very low investor faith in the audited statements of listed companies or is that a gross exaggeration given the 2-5 audits found deficient?

Anil Singhvi: This problem is far bigger than what meets the eye, be it the Satyam case or IL&FS. Satyam happened 10 years back, but what is the learning by the big four or by PwC? Nothing. Secondly, they have taken advantage of a very lax regulatory environment and even more lax judicial system. SEBI passed an order in January 2018. They went to SAT immediately, sought for relief. When SAT did not give full relief, they went to the SC and again came back to SAT. But still, PwC has not bowed down and said that it goofed up. There is every evidence to suggest that in Satyam’s case, PWC goofed up big time. So, what is the learning? There is no learning from it.

Then comes IL&FS. You look at IL&FS situation today, it is much larger than any other frauds that have so far taken place in India. But yet they are protesting and saying that they are not involved in it. They are saying they did their job based on whatever representation was given to them. The whole profession now has to be seen in a very different light. What are they giving? Is it only the true and fair? Is it only the accounting policies, accounting standards and the role stops here? The answer is no. They are in the assurance practice.

The famous case law on this says that auditors are not greyhounds but watchdogs. But according to me, they have become pets. Once you have an auditor which becomes a pet of the management, obviously it is not going to bark. That’s what our problems are today. In fact, we have been talking more about debt, but look at the amount of equity which is lost by the minority shareholders. Even in the case of Satyam, which had not borrowed a single rupee. But the market capitalisation of Satyam, which was the third largest IT company, completely vanished from the scene. So, the amount of money which is lost by investors, be it debt or equity, on account of the auditors not doing their job is colossal. Their punishment in India for the last 10 years? Nothing. So, where is the incentive for them to put their house in order? None. Or where is the punishment to put their house in order? None.

We often talk of the Big 4, but according to me they are too big to continue. In fact, they should be broken into smaller firms. Instead of four, make them 12-15, but break them up. They got together and acquired all the local firms to become big four. So, this whole consolidation has resulted in a monopoly and the abuse of that monopoly. On one side, the audit fees have gone up, but on the other side, the quality and standards have gone down. At the receiving end, it is the investor who is providing the money.

So, this has to be seen in a very different light. The regulatory framework should not be based on a judicial process that takes its own time. This has to be done on real-time basis because audit is like an insurance. It shouldn’t be the case that I paid lesser premium so I get lesser claim. Premium may have been a competitive situation, but the claim has to be the full amount. So, this has to be seen as a very different situation and according to me the big four have to break up.

We tend to look at certain big incidents that hogged the headlines, whether it was Satyam 10 years ago or IL&FS today. We sort of broad-brush the entire profession with that - that’s one way looking at it. The other way of looking at it is that over past two years we have seen a spate of auditor resignations, we have watched firms go insolvent with few auditor red flags to warn us and then IL&FS.

R Narayanaswamy: First of all, let me tell you that auditors are coming under scrutiny not just in India but in other countries too. For example, Carillion and Patisserie Valerie in the U.K., these were major triggers for the review of the working of audit professions in that country. We have similar incidents in U.S. and in other countries. I think it’s a big problem and is not specific to India and it’s a much bigger issue. I am not certain that has been spate of audit failures in the recent years, although it appears to seem a lot more. These failures may have been happening for many years but had gone unnoticed till the sudden tightening by the government, regulators and so on. We seem to be catching a lot more of these now. So, two or three years back these resignations possibly were not too different. But maybe these get reported because of the tightening happening around us; the tightening on shell companies, the new regulator for auditors, the NFRA and so on. So, it’s getting a lot more attention.

So, I must add that what is happening is causing me a lot of concern. I am not directly affected by this in the sense I am not auditor, I am not a corporate manager. But I study how the capital market works, how the corporate governance works, how accounting and auditing plays a part in this. So, this certainly worries me a lot. And my worry is no less because of the kind of talk that has been going on about what the auditors are supposed to be doing. There are big issues what we are supposed to do.

My worry has a lot to do with the fundamental cause of this. I certainly think that there some very basic issues which need to be addressed.

Which issues are you alluding to here? Are you agreeing that we have widespread issues with audit quality in this country? You say there is a global problem of audit quality. It exists in India as well.

R Narayanaswamy: It is of course a big issue in India. One of the mistakes which we seem to have made is that after we had Satyam and then lot of things happened like the 2013 Companies Act and so on, all of us became a bit complacent because the letter of the law was sufficient to assure us that everything else was fine. But I don’t think that is working. That is the lesson we are learning now.

I think what is happening now is also the result of a slowdown in the economy. A lot of these things might have gone unnoticed. Things might have worked differently. Things might have never become an issue at all had the economy been booming. In 2008-10 after the financial crisis, there was a lot of pumping in of money by state. But now there is a lot of tightening in the markets. Many of the things which could have worked earlier are not working. So, it has to do with the general economic condition as well.

Is it just a problem with the Big 4? They have the dominant share of the market and almost 30 percent by value of audit fees of listed companies. Or is this quality problem across all audit companies in the country?

Amarjit Chopra: I will not necessarily say that this is the problem with big four alone. This country has an NPA level of almost Rs 11 lakh crore today. If we start looking at those, then they have not been audited by the big four. I will not insist that only the big four have the fault. Overall auditing requires some kind of reform in this country. The Kingston Cotton Mills case, which I read about centuries ago, says an auditor is a watchdog. I don’t think we are watchdogs anymore. If at all the standard on auditing section 240 is to be implemented in the right spirit with regard to duties and frauds, auditors will be required to do far more than we have been doing. At least we should start throwing some indicators as to what is happening. It is a sort of an epidemic. What we have seen in the last ten years does not well reflect the auditing profession at all. It is not just one of two of the big four firms. Each one of us will have to do the self-introspection as far as this issue is concerned, smaller or bigger one. The only thing is that 30 percent of the listed values are being audited by them and so they will always remain in focus. But we need to look at the overall auditing system in country.

The other day when we saw the MCA moving applications to the NCLT to impose a 5-year ban on Deloitte Haskins and Sells, which is a network form of Deloitte and on BSR, which is a network firm of KPMG. All the Big 4 in this country are facing regulatory sanctions.

PR Ramesh: I think all the panelists have made very good points and agree with them all in that. Anil Singhvi did say that it’s an issue for the profession at large and it’s about the trust in the assurance function. The professor said a point that I don’t agree with, that it’s not about India but also about the rest of the world. All this boils down to 2-3 things.

One thing is clear that it is time for those in the profession to introspect. For us to determine what is expected from an audit function. Second, audit comes in to validate or corroborate the financial reporting data. Financial reporting itself needs to be reformed today to be able to provide those signals which one is seeking about the underlying issues. The third one is about choice and concentration. You cannot have limited number of firms. The question is whether this is an epidemic of business failures or an epidemic of audit failures.

I have often heard auditors say to me that we are not in the business of doing forensic audits, we rely a lot on what is provided to us. I wonder if auditors even do the basic job well enough. I read the SFIO report and there are a couple of things that popped out to me that were surprising. For instance, the SIFO report said that RBI very clearly put limitations on use of funds raised through bank loans and NCDs by NBFC’s. Yet auditors did not verify compliance. (Instead) they relied on a CA certificate, a CA who is appointed by the management. Even when it came to the evergreening of loans by IL&FS entities, the auditors were aware. They cited emails exchanged between audit partners and said that the auditors were aware, and they had the knowledge these borrowers were being funded again and again about the repayment and yet they relied on the management representation and assurance. These are standard things that auditors should be doing, we are not asking auditors to do anything above and beyond what the basic audit job is. Why are auditors failing at these things?

PR Ramesh: I can’t comment on this specific matter. All I can tell you is that we can’t pick bits and pieces and say audit failures are happening and there is an epidemic. The reality is that businesses have failed and there have been deficiencies alleged in the audit firms in India and across the world. This is the time therefore to determine what is expected of an audit. Why would a review happen in U.K.? For this very same reason, if the public expectations have changed then the audit profession has to go beyond that.

I use these illustrations to say that these are very basic audit jobs and they are not asking auditors to be forensic investigators, but are asking auditors to verify compliance.

PR Ramesh: Coming back to the expectations, what is the compliance that an auditor has to verify on.

Q- This is not an expectation. This is the law, sir. It is not some enhanced expectation of investors or stakeholders.

PR Ramesh: I will not comment on anything specific.

Amarjit Chopra: We have been auditing the public sector banks and we have seen private sector banks also being audited. Some of the things which has happened in IL&FS, I think this should have been taken care of. Despite the fact that I have been saying that this fight is between big four and the NON-big four. But I think the kind of ever greening of accounts that happened in IL&FS could have been avoided by a mere look at the entire position. I am not getting into the position of a judge. But the way the things have been brought out by the SFIO, I think there are certain basic things missing and for that I don’t think you need to be doing a forensic audit. You don’t need to be doing a forensic audit. I strongly feel that IL&FS is a case of audit failure and business failure too. It has been an epidemic of failure of corporate governance, business failures, audit failures everything. Unfortunately, auditors are taking the flak. Where are rating agencies, valuers, directors? Where is the role of the RBI? After all RBI has been auditing IL&FS year after year. Where their inspectors have been already flagged those issues. In one of those years if the issue was flagged and they RBI did not respond, it needs to be taken care of.

PwC quit from two Anil Ambani group companies as auditor. It said that it has noted that certain transactions if not resolved satisfactorily might be significant, material and substantive to the financial statements. The company disputed it, didn’t offer substantive responses to the auditor, failed to call audit committee meeting as required and threatened them with legal proceedings including civil and criminal proceedings.

So, when auditors do speak up, promoters don’t take it very easily. It is very lovely to blame auditors. But this is also a case of business failures, entrepreneurs’ failures...

Anil Singhvi: By what process and who appoints auditors? Auditors are appointed by shareholders because the shareholders demand that auditors must give an assurance that balance sheet and annual report of the country predicts a true and fair picture. Management is very different than what we are looking at today that auditors are supposed to be giving assurance to shareholders. Some part of management can also be part of the shareholding group.

The second issue is what are the audit committees doing? Audit committees in our country have by and large failed in discharging their duties. You have audit committees and not even looked at their composition for many years. You just go by names which are very decorative pieces. They haven’t changed them.

Audit committees are supposed to look at the quality of audit which is being done, supposed to appoint auditors and fix the remuneration. I am yet to come across any company which is where auditors are appointed by audit committee, the remuneration is fixed, and quality is being checked by audit committee. Audit committees has also failed miserably in this aspect. They go by what the management says. The auditor is allowed to fix the remuneration and do whatever he wants to do. The auditor’s job is to look at the results. In 15-20 mins or half an hour, the results are approved and sent to board. When are audit committees really doing their job? It is very rare.

These problems are much larger than the audit firms or committees feel which are being failed. I think we have to look at entire things afresh. We have to look at the quality as well. It is not just accounting standards and regulations. They have to go beyond that. In the case of Satyam, receivables and cash. PwC failed even in that. Satyam did not borrow a single rupee. These two things have not checked by PwC and Satyam, IL&FS is much bigger problem at hand.

Today when you look at Satyam which was a simplistic fraud to a very complex fraud like in IL&FS, auditors have simply not risen to that situation. Why you want to take audit of a company if you think you cannot deliver a good quality report at a cost at which company wants to have it. It is the cost versus revenue. If you think you have to spend many more hours in that (then you should do it). You cannot rely solely on management representation but actually deep dive. You have to go deep dive. You cannot absolve yourself of your responsibility by saying that it is not my role and function. It is your role and function to see to it that accounts represent a true and fair picture. You can’t just rely upon representation, accounting standards and accounting policies.

I think audit practice needs to really change. This will change when the concentration of audits gets disbursed. When you have multiple firms that compete for the quality of work rather than just the quantum of the fee which they are getting today.

Our Institute (ICAI) failed miserably in disciplining the members. The Institute’s track record for the last 50 years is dismal. The whole structure of the Institute is elected bodies. They did not have disciplinary committee which consists of outsiders rather than elected bodies. Let the Institute of CA have the CEO, not just the president-elect. Also let’s have a disciplinary committee which consists of some elected members and many more members drawn from society. It could be a cop, ex-CBI person to have a very forensic way of looking at disciplinary action against the errant auditors. But nothing has been done. For years, disciplinary committee doesn’t meet to punish the chartered accountants.

Lastly, there has to be several and joint responsibility of making all firms into LLPs. Government failed miserably on it. They shouldn’t have been allowed to make limited liability partnerships. This liability has to have unlimited liability on it. it can’t be just partner because when you have a brand and if you go to PwC, Envoy or Deloitte, you are basically opting the brand. You buy a brand because there is assurance and guarantee behind it. Thereafter, you cannot say that the partner has done it. When you want to pitch, it is PwC, when something goes wrong, it is XYZ partner. This has to change. There has to be a complete overhaul into the system in audit practices in terms of what these big four are. These big four has to be broken up into at least 10-12 companies.

The ICAI has not proved to be a very effective regulator but let’s look at the role of other regulators. They’ve done very little to instill confidence in audit quality or to enforce standards.

For instance, last year the MCA promised that they will look into all the audit resignations that happened and we had dozens of resignations. I don’t think that we heard anything on what that investigation found, if there was an investigation.

Just a couple of weeks ago RBI when they said that SR Batliboi cannot audit any bank for one year - it was such an oddly worded statement. It says, “on account of the lapses identified in the statutory audit assignment, it has been decided that the RBI will not approve the said firm for carrying out statutory audit assignments in commercial banks”. RBI offers no detail about what those lapses were. I am assuming they were material lapses otherwise there would not have been a one-year bar on this firm. But if they are material lapses and they have impacted financial statements, then RBI has made no disclosure to that count. So, we have some ham-handed regulating.

The ICAI is not very effective and the NFRA which should have been set up five years ago is still in the process of being set up.

R Narayanaswamy: I will put the blame squarely on the doorstep of the ICAI, because ICAI is responsible for regulating its members. The ICAI’s job is to regulate its members’ professional conduct. I think it has failed miserably. It is a club of CA’s, a club-only function for the benefit of its members. So, outsiders are not welcomed in the club at all. They keep claiming that there are government representatives and so on. Government representatives are full-time employee and they have a lot of things to do. So that is more like a governance or monitoring work.

But we have known ICAI’s failure a lot time ago. A super regulator was supposed to be set up in the form of NFRA and both ICAI and politicians, hand in glove with them managed to delay the setting up that super regulator by several months.

R Narayanaswamy: The ICAI not only mismanaged the situation by doing nothing, but also blocked the section setting up the NFRA from coming into effect for five years. They fought in parliament, they fought in committees, they fought on the corridors of Shastri government and they blocked the NFRA from happening. So, not only they failed to do anything, but they don’t also want anyone to come. So, if NFRA comes now. I think 1st October was the date chairman has been appointed, now it’s too early for them to do anything before six months. Just about 6 months.

They really are working very hard to do their best, they have limited resources. They need people, they need time. So, NFRA I think is the way to go. I have a lot of faith in the NFRA because it’s an independent body, its body consists of people who are highly accomplished and the current chairman and member. There is a lot they are going to do. I am sure we are going to see a lot of action in the NFRA, including in the IL&FS case. Of course, they need a lot of help, they need significant technical support, they need financial support, they need human resource and so on, but NFRA is the one I would set store by.

It’s not to say that SEBI and RBI has not done anything. We should really say this is the effectiveness of the lobbying of the ICAI all these years. Its lobbying has been so strong that all those agencies have not been allowed to function.

Do you think NFRA will change audit quality?

Amarjit Chopra: ICAI has been taking the flak for certain number of years. Probably it could have been certain years that things have not happened but there are many years where things have happened. People have been debarred even for lifetime in this very council itself. So far NFRA is concern, it is government’s choice and I don’t want to comment on it. NFRA has already come into existence. Let it take its own shape. Probably, things will start happening.

We have got 5 benches. In every disciplinary bank, we have got 2 government nominees. Without government nominees, we cannot have the quorum. I can quote a recent incidence where the institute has debarred a particular member and SEBI has given only given him caution. It is not that only ICAI is lax, but there are also other regulators who are far more lax than the ICAI. I don’t want to get into criticism of any of the regulators.

Theoretically, Mr. Singhvi said that shareholders appoint the auditors. We know practically who is appointing the auditors. Let’s start talking about who should be appointing the auditors and whether there should be a single auditors and or a joint auditor. Let there be debate which will make them improve in periods to come.

Are you suggesting that there should be a mandatory joint audit

Amarjit Chopra: Yes, there should be a joint audit.

Is this because you believe that will help scale the smaller, independent firms? Their abilities and opportunities will improve if they were to become joint auditorss along with the Big 4 and other big firms?

Amarjit Chopra: You look at the auditors of ONGC, Indian Oil and all public sector banks. They are all joint auditors. Then there are questions among themselves. They actually debate over some of these issues. If there are conflicting views, then these are taken care off.

The other thing is who should be appointing the auditor. Is it the management appointing the auditor? Theoretically, it should be the management appointing the auditors. I don’t agree with that notion. It is always the management which has been appointing the auditors. So, let’s start debating on fundamental points of where is the independence of the auditor. We may call it independent audit report. Whether it is really independent or not is the question to me. Monopoly in any profession and any field is bad and so is the monopoly in auditing profession.

Let’s break up these big four firms into smaller firms and lets 2-4 firms not dominate any profession. The wisdom of no profession can lie in 4-5 firms. This lies at a much, much larger levels. To me, this profession had got its strength. But we need to take measures.

So far as the disciplinary mechanism is concerned, let somebody conduct a research on how many cases the justice was delayed only because of stay is granted by various courts. Whether it was ICAI at fault or whether courts which have granted the stay on those cases and the ICAI couldn’t move along with those cases.

Q- What is the answer to this? Is it that we take away the dominance or concentration of the big four?

PR Ramesh: There is a larger issue and it is not about finger pointing. Fixing the concentration is not the answer. We are veering away from the fact that we are trying to enhance the quality of audit, trying to get more assurance out of this whole thing.

That is exactly what U.K. is doing. The Brydon review is a very comprehensive review of all players in the ecosystem and we need to look at it. it is not just about breaking the large and making them small. You need many more large. If businesses are large, you will need matching service providers. I concede that concentration is not good. We need 8-12 large firms.

The U.K. CMA proposes an operational split of the Big 4 and has recommended mandatory joint audits to increase the capacity of challengers. And that, regulators should hold audit committees more vigorously to account. Do these sound like good prescriptions for India?

PR Ramesh: It is to not make big small but to provide them opportunities. I am in favor of creating more large firms.

So, break up super large firms into smaller large firms? Organically, for some of the smaller independent firms to become of that size will take a long time.

PR Ramesh: One of the ways to recommend is to that all new audits which come up are not necessarily taken up by the larger firms.

Q- You are saying there should be rules to take new business away from the Big 4?

PR Ramesh: It is not to take business away from Big 4 but an issue of incremental business. The big four may have to cede space to the others. There is no issue there.

The other change is for regulators to understand ways to mitigate business complexity. For instance, recently SEBI  directed that the auditor for the parent company will also do a review of subsidiary accounts. It gives an auditor more visibility of the subsidiaries.

PR Ramesh: It is also a path towards ensuring accountability on the parent auditor on a consolidated basis.

So more competition, more oversight of complex, large business groups and the third way to enhance audit quality is more enforcement. Let’s say an NFRA kind of body will make it tougher for audit firms and partners to get away with poor quality?

PR Ramesh: I can’t say that NFRA is the solution. First, work with the profession to develop the quality of profession and you need oversight, which is essential. The principal across the world has independent oversight which is why the NFRA is came into the Companies Act. It is as Nani Palkhivala once said - who shaves the barber? We need a far more comprehensive review of the entire system.

I get how grave the deficiencies or failures may be, but is banning the entire firm the right answer?

Anil Singhvi: Banning is the right answer. Or how do you break this monopoly of the four? They will again get into splinter groups. Most of them have become big four as they have amalgamated smaller firms. There was a consolidation for the last 15-20 years. This has come as a blessing as these firms are banned and splinter brands can come back onto the scene and do good quality jobs.

I don’t think joint auditor will be remedy. This could be divided responsibility. Instead of one auditor. A blame game will go on and shareholder will lose more than what they have lost today.

Disciplinary actions taken today by regulators by banning the firm, whether it is RBI, or EY or whether Deloitte or BSR on account of IL&FS is according to me exactly the right thing. Section 144 was prescribed for the very same reason that they must know that they have committed such big fraud. They have been partly to this fraud because they did not do their job well. It is assurance business in, and they can’t rely on just management representation.

This is law, not just in theory. That it is not practiced is a different manner, but auditors are appointed by the shareholders. Audit committees should examine who are the auditors and appointed for the company. Call a couple of firms to see their competence of the audit and then recommend to shareholders out of 3-4 firms and they interview those 4 firms and select one. Also, they should be answerable to set of shareholders as they are the one who are recommending.

It is the audit committee’s prerogative and the responsibility to appoint auditors and fix the remuneration. Why are they giving those jobs to the management? And the law requires them to do it. According to me, the audit committee should be held responsible. SEBI should make it clear. Look at certain cases where audit committee chairman should be called for, along with the auditor, to see where he lost oversight of the responsible job. Most of the audit committee chairman are not even qualified to be in that position. We have examined 500 companies and they do not possess even the knowledge of accounting standards and practices unfortunately. For first 100-500 companies, audit committee should be CA with at least 10 years of experience as a CA. How can you have someone else who has not even gone through regulations, rules, standards, policies and looking at the oversight of the auditors?

While we are discussing ways to cut the Big 4 down to size, that will not automatically improve audit quality as there’s no guarantee other firms have excellent audit quality.

Anil Singhvi: I agree. But Big 4 are making that impact as they are the one having large firms. They either have large market cap or very large borrowed funds. If you look at enterprise value of company audited by them, it is reaching to 60-70 percent of the enterprise value, because the market cap might not be right barometer to judge audit firms. In case of IL&FS, it was a traded company and the market cap would not be more than Rs 1,000 crore. Whereas there was Rs 1 lakh crore of borrowing.

Going forward, if we have these bans then they will break as for five years they can’t remain and keep partner payment of salaries on monthly basis. So, it will be very good idea that there will be ban on these firms and get into these smaller firms. These kinds of regulatory framework will ensure that auditors do not mess up. I am not in debate of smaller and bigger firms. Debate is that there should be good competition and it will be there where there are 30-40 firms to look at and choose from.

According to me, the audit committee should be held responsible for the appointment and recommendation of auditors to the body of shareholders. They should ask to look at where auditors have failed and have, they done their job in view of audit committee. The chairman of the audit committee has to be a qualified CA with at least 10 years of experience otherwise it is difficult for chair of audit committee to decide his/her obligation.

We need to look at how this assurance practice, how shareholders and lenders have to rely on company’s balance sheet and whether they are representing a true and fair view.

When you have brands like Deloitte, KPMG, E&Y, they work from cradle to grave. They were doing the law practice too. Before the bar council came heavily on it, most of the firms had a legal arm also. So, it was one shop providing all answers. They have appointed Resolution Professionals. In most of the cases these big four has appointed even on RPs. So, you first take company to liquidation process and then you get appointed on it to see what they salvage out of this. This is a joke. We need to get out of this. A complete overhauling needs to be done. They cannot get down to do every job, be it consulting, law, being RP.

PR Ramesh: The landscape in the corporate world has very large companies with global footprint, medium size companies and small companies. Do you believe that the profession should have a matching profile? You are a service provider. Do you want a small service provider and then you have very large companies? Those companies are not being broken down into smaller sizes. They will continue to grow.

The second is, technology will be the disruptor. How will you deal with technology in audit, if you are not addressing the issue of size? It is issue of audit quality so technology has an important role to play. One of the issues of audit quality is the auditor’s tool kit. There are complex technologically run business.

It’s not just the large firms which will have the money to run this. Do you only have firms which are audit without any technology? If you have to be able to audit something which is highly sophisticated in technology, then you need firms to invest in technology and that will require funds.

If you break the size of the large today, it is not going to solve problem of matching service providers. You need to create consolidation in the others to get many more large firms. Why aren’t 10 others not coming together to become one large firm? Over the 15 years, the large firms have become large over consolidation. So why are the other non-big 4 firms also consolidating?

We found two issues here that can potentially be part of the solution, one is to find a way of getting rid of the conflicts that the audit firms face, this is a global debate that has been going on, but the other is to critically introduce more competition in the Indian market place. How does one go about doing that

R Narayanaswamy: It’s a difficult thing. About 25 years back there were more firms so there was natural competition but because of the mergers and acquisitions that has happened, there are fewer firms. So, now we have situation where there are firms which are too big to fail, they are also too big to regulate

and also to jail. So, if they fail then there is big problem in economy as a whole. I would actually like the response to this being completely independent of IL&FS situation.

The partner is making money for the firm, the partner is the part of the firm. So, Firm gets to benefit from the partners work. Suddenly if the partner does something wrong or the audit goes to toss, they say no the partner is different from me. They ought to say that minus partner we are okay. I find it difficult to accept this point.

On joint audits, there have not seem to be a lot of observation but I can tell you as an audit committee chairman of bank, I wouldn’t say a victim of joint audit because the joint auditors will never agree on anything by themselves and in fact management will use joint auditors to set them against each other and do what they wanted. One more thing if joint auditing would have such a great solution to all these problems, why the NPAs of all this public sector banks was so much higher than the private sector banks. They all had joint auditors and they always had joint auditors. And outside countries like in France where the joint audits were made mandatory, have not worked at all. So, I don’t think so there is simple solution to this at all.

Since there are many issues already, I think we also need to focus very carefully on the cultural and business practices for accounting firms. My understanding is with talking with accounting firms and so on, I think the targets are very steep. They have to get new businesses all the time, they also have to earn non audit income and they get remunerated and promoted based on this. So, is there too much emphasis on profit at the cost of independence and quality. Could that be the cause of conflict and compromise resulting in lower quality? Is the atmosphere of open debate and questioning within these firms? Is their effective whistleblower arrangement within this firm? If it is there, then how they are working? Is there protection for whistleblower? I think there are lots of things to worry about because audit quality is not a textbook based thing. It is something that is practiced, and the practice happens because of the culture within which we practice. So, I think we have to raise many issues here.

I am actually very deeply interested in the working of the accounting firms which is in fact the black boxs to lot of us. I think those working in hospitals, in law firms but working of accounting firms nobody knows. I think they should also open themselves to the outside scrutiny. So they should consider setting up a supervisory board to which this entire firm reports on the quarterly or half year basis and audit quality governance and remuneration matters. I think more importantly they should also publish a annual report, detailed report setting out the activities with detailed financial statement showing performance separately of audit and non- audit businesses until they are separated.

I am in favor of a pure audit firm. So, you decide. Do you want to do audit resign or something else? you know audit is not a very profitable thing, so you don’t want to audit and want to do something else that is the start of the problem. You pitch your audit very low until once you are in, you start getting non-audit business. I think this should stop. If this stops a whole lot of problems will be solved. This is way the bigger firms have bigger issues because they use audit to raise income from non-audit businesses. Smaller firms don’t have opportunities to do this kind of things, but bigger firms have more opportunities. So, I think this is something we should seriously figure out, splitting the firm into audit and non-audit then supply of audit firms will come down and then the audit fee will go up. And the main complaint of these people is that audit firms don’t feel adequately remunerated because you price it low and you expect to get something else. Do only audit in which case you will do full costing of the audit and full prices of the audit services. So, I definitely feel that audit and non-audit should separate and that should be the transmission time alone and it should not be 10 years. I think in next three years also the split has to happen.

I will give two more examples. Tax audit and tax consulting are not among the list of prohibited items under Companies Act. The companies that has banned list of services that audit firms can provide, tax audit is not there. Tax advising services is not there. I think this should be included in the list immediately and also manage

So, all of this if included there will be a lot more independence for auditors. May be in the short-term supply of audit services might come down eventually claimed prove. But there could be better audit quality for everyone.

We have seen Indian firms consolidate under various foreign brands and that has not produced very high quality. So how does consolidation answer the core problem?

PR Ramesh: We are talking about larger choice of large firms. You need to facilitate consolidation and incentivise. We are mixing size and quality. Audit quality is a different subject and need to be dealt differently from size. Size is one component and in some way enabler, but it is not the reflection of the quality. More larger firms are required and therefore you need to incentivise that.

Q- So, you are in the favor of the big four audit firms being broken up into audit-only firms and maybe even being curtailed in size?

PR Ramesh: Pure audit-only firms is not the solution. If the issue is of conflict, the conflict is to ensure that audit firms do not render other services to the clients they audit.

What are the three things that any policy action should focus on?

PR Ramesh: Clearly, consolidation of firms. We need a comprehensive review to address audit quality and what need to be done in terms of the entire ecosystem. Introspection is not by picking up one item and saying here is the solution. I have done it— joint audit is the solution. So again, we move forward and few years later we came back to same situation. That is why today, across the world, a comprehensive review is being done. Even though they have been through similar situations in the past. Why even the regulator in the U.K. being reviewed, looked at and restructured, why?

Amarjit Chopra: I would like to tell Ramesh, despite Section 144 of the Company’s Act people have been able to circumvent it. That is why the concept of pure audit firm may be more relevant. Because the moment you allow the consultancy to be there, through one route or the other, it definitely takes place here or there. I think this concept of pure audit firm or non-audit firm may be looked at; I am not passing on any judgment. We all are talking only about the auditing profession unfortunately—as to why auditing profession has failed or where they have failed. What about the various other regulators? What about the valuers? We depend on the work of the valuers, whether these are actuaries or others. What happens to the work of the rating agencies? After all, the rating agencies have also failed. Even if I have to fix a rate of interest in a bank, these are the rating agencies, which play a very significant part.

Nobody today is talking about those agencies, valuers, and other regulators. We definitely need to come to that because then only the audits can be made effective. I am very clear that the regulators have to play— whether it is the accounting regulators or other regulators, which have to play a very effective role. Join audit could improve the things. Nobody is discussing who should be appointing the auditors. Audit committees have failed to discharge the function that they were supposed to discharge. If you look at review of board—of independent directors, and look at the forms which they fill in, I don’t think that’s the spirit. Even if the law came in—of appointment of women director on board and if I bring my wife and say that I have complied with— then the spirit of it has not been complied with. It is only the law, which has been complied with. Whether it is auditing or the other way around, we need to look at the spirit. The auditors’ reports have to undergo a change under all circumstances. SA 240 has to undergo a change and it must be made far more effective than what it has been. SA 240 cannot be used as a shield— that only if the auditor stumbles upon some information, you will be looking at the fraud. To a large extent, certain things have to be looked at by the auditor to find out some information which may not be found out today. Auditor’s reports must throw some indication about what is likely to happen. The way it has been handled over the years needs to be taken care of. We have revised the standard of auditing 570 and we need to move ahead with those times.The things are bound to improve.

Whatever has happened in last 10 years, does not augur well for the audit profession. Unless we change radically, this may not be good for the profession. I am sure that the institute and regulators will improve. We will do lot of introspection. The Indian firms will have to consolidate. We must give up charm for the name— what will be the name of the firm and who will head the organisation. All this charm must go away. We must consolidate.

So far as technological investment is concern, that is one ground on which the concentration should not be there. Technology can be adopted by anybody. It is one tool, which can be used by smaller firms—investments can come in. Technology makes the audit easier and more reliable. What is needed is the analysis, interpretation, and reporting.

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