The effectiveness of the statutory audit has been in question for decades but nothing worthwhile has been done to stem the rot.
Dual audit, the audit by two separate audit firms as a remedy to improve the credibility of statutory audit, is worse than the disease.
The independence of auditors or directors cannot be inculcated but it should be encouraged. Honesty cannot be mandated but must be built into the system.
Mandatory rotation of an audit firm itself, and not just the partner, is a powerful weapon. If an auditor closes his eyes to the management’s wrongdoings, he is seldom caught and this is one factor that encourages dishonesty, as brought to the fore in the case frauds perpetrated at Punjab National Bank.
The statutory audit is, inter alia, to assure minority shareholders that the statement of accounts reflects a true and fair view.
Statutory auditors are de facto appointed by the same management that appoints the internal auditors, since the management controls sufficient portion of shareholding to make such appointments. The statutory audit is planned and executed after a significant time gap, thereby affecting its efficacy and usefulness.
Two alternatives
There are two alternatives. The first would be to discard the statutory audit. This may sound too revolutionary an idea but it is the best solution to the problem. Instead, we have to put in place other checks and balances, as follows:
Shift the total responsibility for true and fair view of accounts and relevant disclosures to the Board, the CFO, Chief Internal Auditor and the Company Secretary, jointly and severally.
Widen and deepen disclosure mandates by including disclosures of internal budget estimates versus actuals with explanations for any variation.
Privatise tax assessments and the Registrar of Companies by handing over clearly defined functions to qualified professionals, with government holding overall control.
Evolve a system for the Department of Company Affairs to order a complete and total audit of accounts of any company by a CA firm to be appointed by it after receiving the annual reports from companies, by selecting, say about 10 % of the companies in a year using a computerised random sampling method. Making companies to close accounts every half year and hold HGMs is a step in right direction.
Make mandatory provisions in the Companies Act for Right to Information for shareholders and lenders regarding companies accounting and audit information and records, including inspection, survey or seizure by government authorities.
Make it difficult to remove a CFO or Chief Internal Auditor (CIA) or a Company Secretary (CS) by making their resignation or removal subject to scrutiny or enquiry by the Department of Company Affairs. Their emoluments need to be protected.
Prescribe stringent punishment to all board members, CFO, CIA, CS for irregularities, fraud and violations of laws relating to accounts. Make the ICAI responsible for developing a suitable grading system for CA firms and for redefining the disciplinary action mechanism with stringent minimum credible punishment for erring members in employment and in practice.
The grading system is essential as, under the present Companies Act, a CA qualified yesterday and a CA qualified a decade ago are treated at par for audit of even giant enterprises.
Grading CA firms and prescribing audits of companies, based on the grade of a firm vis-a-vis net worth and other parameters, strengthens the audit system.
Mandatory rotation
The other alternative is to adopt all the measures outlined above and to continue with the existing statutory audit with a mandatory rotation of audit firms at least once in three years and not to reappoint the same firm at least for the subsequent 10 years. The statutory auditors of a company shall be prohibited from accepting any other assignment from the same entity or its sister and associated concerns.
Limiting the number of companies that can be audited within the same group by the same audit firm, would also be welcome. These steps would act as a disincentive for auditors to collude with the auditee.
(The writer is CEO, Right India Consultancy House)
