Expert view: New Companies Act puts an end to crony auditing

In three years, India's biggest corporate houses - Reliance Industries, Tata Sons, Aditya Birla Group and Infosys - will have to bring in a new set of chartered accountants firms to audit their books.

This is because the Companies Act, 2013 - parts of which came into effect on 1 April 2014 - makes mandatory for companies to rotate their auditors every few years. Individual auditors can audit a company's accounts for a maximum of five consecutive years, and audit firms for a maximum of 10 consecutive years. Reappointment of the same auditor or audit firm can made only after a break of five years.

The government expects to end cosy relationships that companies shared with their auditors thus far with these new rules and bring more objectivity to the audit process and reduce instances of accounting frauds.  Essentially, it hopes to prevent another Satyam-like fraud, where promoters siphoned out large sums of money from the company as their auditors looked the other way.

Disappointingly for Corporate India, the new requirement applies with retrospective effect. So, if a firm was auditing the accounts of a company for the past 10 years or more, it can continue auditing the books of the company for another three years only. The Companies Act provides for a three year transition period to companies to become compliant with the new requirements.

Similarly, if a firm was a company's auditor for the past seven years, then too the firm can continue for another three years - allowing engagement period of 10 years.

Effectively, new auditors will have to be appointed in both these instances in financial year beginning 1 April 2017.

However, if a firm was auditing the accounts of a company of six years or less, it can continue that engagement till it has completed 10 years.

Rules also forbid companies from appointing a new auditor who may have some association with the outgoing auditor. That is to say, audit cannot be handed over from one firm of a network to another firm of the same network. For example, a company that had Deloitte, Haskins and Sells as its auditor cannot appoint SB Billimoria as its incoming auditor when the former's term ends. This is because both these firms are part of the Deloitte network of firms in India.

Many large companies have more than one set of auditors - and they may be the ones that face greater difficulty with the new rules of rotation coupled with bar on appointing firms of same network for successive terms.

If companies hoped to continue its relationship with an individual audit partner by engineering his move from the existing firm to another, that too will not be possible. Rules notified by the ministry of corporate affairs recently says a firm that such a partner joins or sets up cannot be appointed as the auditor of the company for a period of five years.

The new rules apply to thousands of companies, not just all listed companies but also many small ones. As per law, all unlisted public companies with share capital of Rs 10 crore or more, private limited companies with  share capital of Rs 20 crore or more as well as companies that have public borrowings from financial institutions, banks and public too are required to rotate their auditors.  

Companies and auditors complain the new law will increase compliance cost and quality of audit may actually deteriorate. They argue that any new auditor requires about 2-3 years to understand a company and the complexity of  its business, and till then audit process may suffer. Another big concern is the small number of large firms in India, with large talent pool capable of auditing complex companies.  

India has become part of a small group of countries that require mandatory rotation of auditors. The European Union had proposed such rotation, but it is yet to implement it.