Two years when the parliamentary standing committee suggested the
companies bill mandate auditor rotation, both corporate India and it’s
auditors dissented. But the ministry of corporate affairs has remained
steadfast in its intention helped I’m 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 it’s not a
new concept, it’s 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 let’s 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 it’s 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. It’s in the insurance sector.
Doshi: You sound you are almost for it then.
Ramesh: Not really so, because it’s 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 don’t, 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 it’s 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 it’s 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 it’s 84%
whereas 78% for the voluntary audit market.
Doshi: The market share for Big Four?
Nayak: Big Four, that’s 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. That’s fine. That’s the firm’s 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. That’s 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 won’t help the independent audit firms as
much as it will probably perpetuate the dominance of the Big Four. All
that’s fine. It doesn’t 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 it’s 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 what’s 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. It’s not that it is not possible but there is
a time.
Doshi: But it’s been done for banks isn’t it as Mr. Ramesh pointed
out. It’s 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 it’s been done for banks and public sector undertakings and
nobody seems to be complaining much. I don’t know if it’s resulted in
better audit quality.
Chatterjee: Yes, that’s what I was coming to.
Doshi: But it is doable.
Chatterjee: It is doable. That’s what I am saying. If there is an
auditor who doesn’t 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 it’s auditors dissented. But the
ministry of corporate affairs has remained steadfast in its intention
helped I’m 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 it’s not a
new concept, it’s 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 let’s 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 it’s 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. It’s in the insurance sector.
Doshi: You sound you are almost for it then.
Ramesh: Not really so, because it’s 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 don’t, 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 it’s 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 it’s 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 it’s 84%
whereas 78% for the voluntary audit market.
Doshi: The market share for Big Four?
Nayak: Big Four, that’s 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. That’s fine. That’s the firm’s 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. That’s 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 won’t help the independent audit firms as
much as it will probably perpetuate the dominance of the Big Four. All
that’s fine. It doesn’t 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 it’s 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 what’s 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. It’s not that it is not possible but there is
a time.
Doshi: But it’s been done for banks isn’t it as Mr. Ramesh pointed
out. It’s 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 it’s been done for banks and public sector undertakings and
nobody seems to be complaining much. I don’t know if it’s resulted in
better audit quality.
Chatterjee: Yes, that’s what I was coming to.
Doshi: But it is doable.
Chatterjee: It is doable. That’s what I am saying. If there is an
auditor who doesn’t 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
let’s for a moment forget the audit fraternity, forget the firms,
forget what impact it has on them and let’s just focus on companies.
You go from one good auditor, national presence etc. to another good
auditor national presence, you should manage. We haven’t 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 don’t 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 isn’t it? I don’t
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 it’s fairly alright? 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 that’s 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 that’s 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 it’s national or international.
Doshi: That’s a pitch now yes, nice.
Ramesh: But that’s 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
don’t have experience, I learn at your cost and say I don’t 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 company’s 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 that’s a reality also from a company’s 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. We’ll 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.
--
CA Ramachandran Mahadevan,M.Com.,F.C.A.,
companies bill mandate auditor rotation, both corporate India and it’s
auditors dissented. But the ministry of corporate affairs has remained
steadfast in its intention helped I’m 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 it’s not a
new concept, it’s 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 let’s 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 it’s 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. It’s in the insurance sector.
Doshi: You sound you are almost for it then.
Ramesh: Not really so, because it’s 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 don’t, 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 it’s 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 it’s 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 it’s 84%
whereas 78% for the voluntary audit market.
Doshi: The market share for Big Four?
Nayak: Big Four, that’s 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. That’s fine. That’s the firm’s 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. That’s 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 won’t help the independent audit firms as
much as it will probably perpetuate the dominance of the Big Four. All
that’s fine. It doesn’t 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 it’s 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 what’s 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. It’s not that it is not possible but there is
a time.
Doshi: But it’s been done for banks isn’t it as Mr. Ramesh pointed
out. It’s 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 it’s been done for banks and public sector undertakings and
nobody seems to be complaining much. I don’t know if it’s resulted in
better audit quality.
Chatterjee: Yes, that’s what I was coming to.
Doshi: But it is doable.
Chatterjee: It is doable. That’s what I am saying. If there is an
auditor who doesn’t 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 it’s auditors dissented. But the
ministry of corporate affairs has remained steadfast in its intention
helped I’m 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 it’s not a
new concept, it’s 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 let’s 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 it’s 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. It’s in the insurance sector.
Doshi: You sound you are almost for it then.
Ramesh: Not really so, because it’s 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 don’t, 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 it’s 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 it’s 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 it’s 84%
whereas 78% for the voluntary audit market.
Doshi: The market share for Big Four?
Nayak: Big Four, that’s 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. That’s fine. That’s the firm’s 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. That’s 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 won’t help the independent audit firms as
much as it will probably perpetuate the dominance of the Big Four. All
that’s fine. It doesn’t 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 it’s 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 what’s 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. It’s not that it is not possible but there is
a time.
Doshi: But it’s been done for banks isn’t it as Mr. Ramesh pointed
out. It’s 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 it’s been done for banks and public sector undertakings and
nobody seems to be complaining much. I don’t know if it’s resulted in
better audit quality.
Chatterjee: Yes, that’s what I was coming to.
Doshi: But it is doable.
Chatterjee: It is doable. That’s what I am saying. If there is an
auditor who doesn’t 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
let’s for a moment forget the audit fraternity, forget the firms,
forget what impact it has on them and let’s just focus on companies.
You go from one good auditor, national presence etc. to another good
auditor national presence, you should manage. We haven’t 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 don’t 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 isn’t it? I don’t
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 it’s fairly alright? 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 that’s 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 that’s 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 it’s national or international.
Doshi: That’s a pitch now yes, nice.
Ramesh: But that’s 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
don’t have experience, I learn at your cost and say I don’t 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 company’s 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 that’s a reality also from a company’s 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. We’ll 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.
--
CA Ramachandran Mahadevan,M.Com.,F.C.A.,
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