CA T. N. CA T. N. ManoharanManoharan
6th June, 20146th June, 2014
Bombay Chartered Accountants’ Society
A 2-Day Summit on Networking Within and Across ProfessionsA 2-Day Summit on Networking Within and Across Professions
Why is Audit Rotation considered
Audit Rotation - Statutory provisions
Audit Rotation – Global Scenario
Arguments against Mandatory Audit Rotation
Alternatives to Mandatory Audit Rotation
Way forward
Over familiarity with the management can result in loss of professional skepticism
Pressure to maintain a commercial relationship may undermine the quality of the audit
Fresh Eyes are more likely to spot issues than an incumbent audit firm
Would help in opening up and eliminating concentration in the upper part of the market
Auditors with Long Tenures in India
Company Auditor/Audit Network Tenure (in years)
Hindalco Industries Singhi and Co. >50
Reliance Industries Chaturvedi and Shah, Rajendra and Co., Deloitte*
>35
Larsen & Turbo Sharp and Tannan >30
Jaiprakash Associates M.P.Singh & Associates >25
Grasim Indsutries GP Kapadia and Co; Deloitte (joint statutory auditor since 2009)
>20
Tata Power Deloitte/ AF Ferguson & Co >15
Tata Steel Deloitte/ AF Ferguson & Co >15
*Deloitte has been an auditor since 2005Source: IIAS Analysis
Statutory provisions governing the Rotation of Auditors
Chapter X of the
Companies Act, 2013
The Companies (Audit and
Auditors) Rules, 2014 w.e.f 01.04.2014
Section 139(2) of the Companies Act, 2013
Audit being done byIndividual
AuditorAudit Firm
One term of 5 consecutive
years
Two terms of 5 consecutive
years
Includes LLPs, incorporated under
Includes LLPs, incorporated under
LLP Act, 2008
Cooling period - 5 years after completing the tenure
Transition Period from1.04.20143 years
Transition Period from1.04.20143 years
Class of companies Covered
as per Rule 5 of The Companies (Audit and Auditors) Rules, 2014 r/w S. 139(2):
All Unlisted public companies having
Paid up Share Capital of
Rs. 10 Crore or more
All private limited companies having
Paid up Share Capital of
Rs. 20 Crore or more
Other companies having public borrowings from
financial institutions, banks or public deposits of Rs 50 crore or more.
“One Person Company” and “Small Company” as defined under Section 2(62) and 2(85) respectively are excluded from this provision
Section 139(3) of the Companies Act, 2013
Members of the Company may resolve to provide that:
In the firm appointed:
Audit partner and team must be rotated at intervals as resolved by members
The audit must be
conducted by more than one auditor
Nothing contained inSection shallaffect• the
an
• auditor
Nothing contained inSection 139(2) shallaffect :• the right of the
company to remove anauditor or
• the right of the auditorto resign
Mr. A
Joint AuditorJoint Auditor
Mr. B
Joint AuditorJoint Auditor
Sub rule 4 of Rule 6:T ofauditors thejoint notcomplete their term in the same year.
Sub rule 4 of Rule 6:The company may follow the rotation ofauditors in such a manner that both or all of thejoint auditors, as the case may be, do notcomplete their term in the same year.
Does it mean Joint auditors will need to be appointed in different years or successive years?Does it mean Joint auditors will need to be appointed in different years or successive years?
What happens in case of Existing Joint Auditors who have been appointed on the same date earlier? Who’s tenure will end first?
What happens in case of Existing Joint Auditors who have been appointed on the same date earlier? Who’s tenure will end first?
DEF Ltd.
European UnionEuropean Union
November 2011 Crisis” proposed a requirement for audit firm rotation.November 2011 - Green paper “Audit Policy: Lessons from the Crisis” proposed a requirement for audit firm rotation.
European Parliament voted in favor of this recentlyEuropean Parliament voted in favor of this recently
Europeanmust appoint a new auditor European-listed companies, banks and financial institutions must appoint a new auditor every 10 years
Extension of Tenure : If companies put their audit contract up for bid at the decade mark (10 more years) or in case of a jointaudit (14 more years).
Extension of Tenure : If companies put their audit contract up for bid at the decade mark (10 more years) or in case of a joint-audit (14 more years).
U.S.AU.S.A
November 2003 - The U.S Government Accountability Office issued its study – “Public Accounting Firms: Required Study on the Potential Effects of Mandatory Audit Firm Rotation”
November 2003 - The U.S Government Accountability Office issued its study – “Public Accounting Firms: Required Study on the Potential Effects of Mandatory Audit Firm Rotation” - as part of the Sarbanes-Oxley Act.
Congress dismissed Mandatory Auditor rotation in favor of mandatory engagement partner rotationCongress dismissed Mandatory Auditor rotation in favor of mandatory engagement partner rotation
Public Company Accounting Oversight Board (PCAOB) encountered fierce resistance to the mandatory auditor rotation idea, which never got beyond the concept release stage.
Public Company Accounting Oversight Board (PCAOB) encountered fierce resistance to the mandatory auditor rotation idea, which never got beyond the concept release stage.
At present, lead audit partners are rotated At present, lead audit partners are rotated every 5 years.
The US is of the view that this system captures substantially all the benefits of mandatory auditThe US is of the view that this system captures substantially all the benefits of mandatory audit-firm rotation in a cost-effective manner.
ChinaChina
China adopted mandatory auditor rotation rules in 2010China adopted mandatory auditor rotation rules in 2010
Global dominance of the Big Four has been broken hereGlobal dominance of the Big Four has been broken here
Financial institutions and stateundertake an audit tender process every 3 yearsFinancial institutions and state-owned enterprises must undertake an audit tender process every 3 years
An auditor cannot serve the same client for more than 5 consecutive years.An auditor cannot serve the same client for more than 5 consecutive years.
What’s happening in the Other Countries?What’s happening in the Other Countries?
Audit firm rotation only forcompanies areassuchlisted financialinstitutions, insurancecompanies governmentcompanies
Audit firm rotation only forcompanies in specific areassuch aslisted companies, financialinstitutions, banks, insurancecompanies and governmentcompanies.
Pakistan, Italy, Paraguay, Pakistan, Italy, Paraguay, Peru, Poland, Portugal and
Oman
Previously implementedbut abolishedmandatory auditorrotation
Previously implementedbut have now abolishedmandatory auditorrotation.
Canada, Czech Republic, Korea, Latvia, and Slovak
Canada, Czech Republic, Korea, Latvia, Singapore and Slovak Republic
Audit Quality
• Experience and credibilitydevelop over longer tenure
• Knowledge and understanding of company developed over long term - leads to increase in audit quality
• Longer tenure results in greater respect for auditors judgment while challenging management decisions
Cumulative Knowledge
• Removing experienced professionals from the audit team results in loss of knowledge and expertise, accumulated over the years
Concentration of Audits will persistConcentration of Audits will persist
• Few firms have the resources to take up large sophisticated clients
• Internal Company Policies - require Audit to be carried out by the Big 4 firms only
Industry Industry Specialization
• Audit firms with industry specific audit assignments might be displaced
• Considerable time and resources invested in order to gain expertise might be under utilised
• In some cases good quality maybe scarce to select
Competition in Competition in the audit industry
• Audit rotation may not necessarily provide small and medium sized firms with the opportunity to compete with large firms.
• Rotation policy may lead to collusive behavior between large audit firms
Cost and TimingCost and Timing
• Audits are less efficient at the time of commencement
• Higher costs and time utilization
• Catastrophic impact of changing the auditor during an important transaction, for eg. A merger.
• Discouragment to invest in the audit development process due to lack of long term commitment
Global Environment
• For Multinational companies using a single audit network for all their branches- rotation would cause hardship and complexities.
• Variances in the time limit as well as the category of companies to which such policies would apply would be difficult to cope with and comply
Undermines corporate governance structureUndermines corporate governance structure
• Independent audit committees - best placed to determine whether the current auditor is acting with independence and producing a high-quality audit or should be replaced.
• Rotation diminishes this role.
Adverse Effects on the audit professionAdverse Effects on the audit profession
• Increase in costs of recruiting and retaining quality audit personnel
• Partners would have to switch engagements regularly
• Firms would face significant capacity and utilization challenges
Public Company Accounting Oversight Board
(PCAOB)
Public Company Accounting Oversight Board
(PCAOB)
Average audit failure rate is three times higher in the first years.Average audit failure rate is three times higher in the first years.
• No evidence of auditor
Average tenure for Fortune 1000 companies is 22 years,
• No evidence of auditor rotation guaranteeing better audits.
• 99% of Fortune 1000 companies do not have policy on auditor rotation.
• Average tenure for Fortune 1000 companies is 22 years, 10% with 50 years of audit with the same auditor.
Higher costs for auditor and auditee.
• Rotation has an adverse effect on competition rather than improving it.
• Higher costs for auditor and auditee.• Rotation decreases the quality of
services in the early years.• Rotation adversely affects
shareholders and share values
Bocconi University Study (Milan)Bocconi University Study (Milan)
US General Accounting Office
(GAO)/
US General Accounting Office
(GAO)/
Year COP No COP Total
200065,843(71%)
27,137(29%)
92,980
200578,158(63%)
45,388(37%)
1,23,546
201184,618(49.6%)
85,992(50.4%)
1,70,610
20141,12,034(48.6%)
1,18,656(51.4%)
2,30,690
Partners 2003 2013 2014
Proprietary 33,561 40,903 41,022
2 Partners 7,464 8,742 8,981
3 to 5 3,629 6,579 6,941
6 to 9 824 1,322 1,414
10 to 15 104 291 316
16 to 20 25 56 57
Total 45,607 57,893 58,731
Audit Partner RotationAudit Partner Rotation
Natural turnover of personnel at companies for which audit work isperformedNatural turnover of personnel at companies for which audit work isperformed ensures the relationship is not too cozy
Effective Audit Committees And Greater Transparency Of Their AuditorOversightEffective Audit Committees And Greater Transparency Of Their AuditorOversight
External auditor oversight regimesExternal auditor oversight regimes
Globally consistent auditor independence requirementsGlobally consistent auditor independence requirements
Prohibition of certain non audit consulting services/cap on such fee Prohibition of certain non audit consulting services/cap on such fee
Cap in terms of % of fee from any auditee to the total income of the AuditorCap in terms of % of fee from any auditee to the total income of the Auditor
Appointment of joint auditors – rotation of scope of workAppointment of joint auditors – rotation of scope of work