Health check for healers: The big audit firms are under the NFRA lens

In recent times, more and more audit firms have challenged company ma­nagements, some going to the extent of resigning on the ground of incompatibility with what the manage­ment wanted or was doing.

This, said Ajay Bhushan Pandey, chairman of the Nat­io­n­al Financial Regulatory Authority (NFRA), in a media interview, was a good sign.

Now, the national accounting watch­dog has turned the spotlight on audit firms themselves.

These firms are perceived to be the eyes and ears of non-promoter investors.

The NFRA on December 22 released the inspection reports for audit firms BSR & Co, Deloitte Haskins & Sells, SRBC & Co, and Price Waterhouse Chartered Accoun­tants.

This was followed by a report on Walker Chandiok & Co.

BSR is part of the KPMG network. SRBC part of the EY network, and DHSL is part of the Deloitte network.

Walker Chandiok & Co’s affiliation could not be established.

As a result, the firms, including those that are part of the Big Four network, so called because they handle the bulk of the audit business in India as well as around the world, are taking stock of the recent inspection report by the NFRA to make their systems more compliant with the norms.

However, on the authority’s concerns over offering non-audit services to audit clients, the audit firms have clarified their position and stated that they have not violated the law.

“The overall findings dealt with the potential improvements to be adopted in the future and were not in the nature of negative assessments of the audit work inspected.

"The inspection provides an opportunity for the firm to review and evaluate its policies and procedures to further enhance the system of quality control,” says a partner at Deloitte, who does not want to be named.

Deloitte plans to make its indepen­d­ence confirmation completely electronic and do away with manual document­at­ion, as the issue was raised in the inspection report.

Though this inspection report was the first such exercise by the NFRA, it could go on to hold more such inspections for other firms as well, say industry sources.

While pointing to the several gaps acr­oss audit firms related to document­a­tion and violation of Standards on Audit­ing, the NFRA stated in a report that the areas of weak­nesses should be treated as areas of pote­n­tial improvement and not as a ne­ga­t­ive assessment of the work of the firm unless specifically indicated otherwise.

“We welcome the observations made in the NFRA report, and there are certain efforts being made to further enhance audit processes and documentation, which have also been acknowledged in the NFRA report,” a Walker Chandiok spokesperson said.

Conflict of interest

One of the more serious issues raised by the NFRA in its report is about violation of section 144 of the Companies Act, which prohibits firms from providing certain non-audit services to audit clients.

The firms, for their part, deny any such violation. Deloitte and EY, for instance, have stated that the non-audit services were being provided before they got on board as auditors and were discontinued as soon as the audit engagement began.

But, with respect to networking arran­gements of these firms with the respect­ive Big Four entities, there seems to be more scope for work.

The financial reporting authority has recommended that SRBC, an EY member firm, should make the necessary changes to its India policy to recognise the direct or indirect relationship between the member firms of their international network.

“It should also review all its ongoing engagements considering EY Network entities as directly or indirectly related to SRBA Entities,” NFRA said.

EY, according to sources, is examining internally if it needs to make any changes to its India policy with respect to its net­working arrangements, as suggested by the NFRA.

Deloitte, too, say sources, is studying the matter related to its networ­k­ing agreement to see if it needs reworking.

“The NFRA in its report has asked that the firm follow the network agreement in force,” the Deloitte partner adds.

In its firm-wide review of audit control systems of BSR & Co, the watchdog found that the firm’s claim of being indepen­d­e­nt from KPMG India entities was unacc­e­pta­ble.

The NFRA said BSR did not prov­i­­de details of its leadership structure, KPMG network entities, and non-audit ser­vices provided by those entities to aud­it clients of the firm during the inspection.

In an email response, BSR & Co said it had invested considerable effort in build­ing a robust system of quality con­t­rol to support compliance and applicable au­d­iting standards.

“We appreciate the re­c­o­mmendations and observations in the in­s­pection report and will construct­i­vely en­gage with Hon’ble NFRA in evalu­a­ting and implementing further improve­men­ts to our policies and practices,” it said.

Network effect

In case of Walker Chandiok, the NFRA stated in its inspection report: “We observe that there is ‘direct or indirect’ relationship amongst WCCL, GTBL, GTAPL and GTIL, as per Explanation (ii) to Section 144 and that these entities are also part of a ‘Network.”

Refuting the NFRA’s interpretation, Walker Chandiok stressed that it does not provide any of the prohibited non-audit services to audit clients.

“We believe that we are compliant with the auditor inde­pendence related requirements under the applicable laws and regulations,” the firm’s spokesperson said.

A senior executive of the auditing ind­ustry, however, says there is need for grea­ter clarity about the finer aspects of the Section 144, which does not allow non-audit services to audit clients to avoid a conflict of interest, one of which is management services.

In the European Union, Australia and the United Kingdom, auditors are not all­o­wed to provide non-audit services such as taxation, restructuring, and valuation to protect objectivity of the audit.

India, according to the current rules, allows these services to be given by auditors.

“There is a need to define, for instance, what managerial services are, so it is not open to interpretation.

"Some guidance may be useful,” the senior industry executive says.

Industry sources say inspections such as these are useful as they help the firms understand the expectations of the regu­lator and also help the regulator interact with the audit firms constructively.