Watchdogs and certifiers: why auditors are critical for listed companies

The Satyam and PNB scandals underlined the dangers of lax auditing. What does recent wave of auditor resignations portend?

Written by Sandeep Singh | New Delhi | Published: July 25, 2018 12:36:17 am
Watchdogs and certifiers: why auditors are critical for listed companies Watchdogs and certifiers: why auditors are critical for listed companies

Auditors in as many as 204 listed companies have resigned between January 1 and July 17 this year, an unusual average of a resignation a day, data from the Registrar of Companies show. Why is this significant?

Holders of trust

An auditor has an especially important role in a listed entity, which has numerous stakeholders, including minority shareholders, whose interests have to be protected, experts say. “No one other than the auditor has the permission to go through the accounts of the company. Their role is fundamental and unparalleled,” Prithvi Haldea, chairman of Prime Database, said.

It is said that the trust of around 3.2 crore active demat account holders in capital markets is primarily on account of auditors — the only outsiders in a company who can verify and certify the books. Among shareholders in most of India’s top 10 companies by market capitalisation, over 60 lakh hold up to 500 shares; all these retail investors, as well as institutional investors, rely heavily on auditor’s certification, experts say.

“What the judiciary is for politics, the auditor is for the corporate world and capital markets,” the head of a leading mutual fund company said. “In the absence of an auditor, capital markets would collapse. They are the watchdogs who keep an eye on the management, and certify the balance sheet. Without the auditor’s certification, the balance sheet would mean nothing.”

Said another fund manager, “Since it (auditing) is a highly specialised job that not every one can do, investors rely on the auditor’s report and certification before investing in a company. Auditors are the most visible and reliable gatekeepers of accounts.”

Some auditors who have resigned recently have complained that company managements did not share crucial data with them. Given that several auditors in the past have failed to perform their duty and have, in some cases, been seen to play along with the management, the industry is aware that they are under scrutiny and auditors are, therefore, keen to play safe.

Section 132 of the Companies Act, 2013, talks about the constitution of a National Financial Reporting Authority (NAFRA) to look into accounting and auditing standards, and the government has in the past expressed its intention to strengthen the system. The proposed NAFRA will have the powers to investigate misconduct by any member or firm of chartered accountants, and some recent activity suggesting imminent action on the proposal may have contributed to auditors seeking to appear extra diligent, experts said.

Also read | Alarm bells in India Inc as auditors of 204 listed firms quit this year

Watershed moment

The 2009 Satyam Computer Services episode, which resulted in big losses for shareholders, marked a turning point in corporate governance practices in India. While Satyam’s promoter admitted to reporting inflated, and sometimes non-existent, cash and bank balances for several years, responsibility was also fixed on the auditor, PricewaterhouseCoopers, for having failed to perform its gatekeeping duty and detect or report the accounting fraud. In January this year, markets regulator Sebi passed an order barring PwC from auditing any Indian listed company for two years, and slapped a penalty of Rs 13 crore, along with interest at 12% every year since January 2009, on two partners of the auditing firm.

More recently, the Rs 13,000 crore PNB fraud has spotlighted the role of auditors. The chartered accountants’ body ICAI issued showcause notices to the auditors of both the bank and Nirav Modi’s Gitanjali Gems, and set up a high-power group to study the case and suggest remedial measures.

Prescription in law

Among the changes in audit rules that the new Companies Act, 2013, introduced is that beginning April 1, 2014, listed companies can’t appoint or re-appoint “an individual as auditor for more than one term of five consecutive years”, and “an audit firm as auditor for more than two terms of five consecutive years”. The Act gives the auditor the right to access all records of the company, and enjoins upon the auditor to report any reservations about the maintenance of accounts, and state whether the company has adequate internal financial controls in place.

The Act puts the onus of reporting fraud on the auditor, and removes the distinction between “material” and “immaterial” fraud. The auditor must report the matter to the central government within 60 days of becoming aware of the fraud; wilful non-compliance will attract a fine of between Rs 1 lakh and Rs 25 lakh.

The auditor is required to forward his report to the Board or the Audit Committee immediately after the knowledge of the fraud, and seek their reply within 45 days. On receipt of the reply, the auditor has to forward his report with his comments on the reply to the central government within 15 days.

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