Independence is the bedrock of audit profession. Only an independent auditor can expected to be skeptical, objective & unbiased. To strengthen the independence of auditors, new Companies Act, 2013 contains provisions related to Auditor Rotation. Only time will tell how much it improves the independence of auditor, but it is in no case expected to radically improve it.
The underlying fact still remains as it was. The auditor will still be appointed mostly on recommendation of management. The auditor remains dependent on management for fixing of fees and re-appointment in subsequent years, and like all other professionals, auditor is also concerned about his revenues & profits.
The provisions of Auditor rotation can be easily beaten by a tacit understanding between two or more audit firms. It would also not be much difficult for a wicked management to collude with two wicked auditors, who can be rotated again & again. So, auditor rotation is unlikely to make significant improvement in auditor independence or audit quality.
What we need instead is management having lesser or no say in appointment of auditor & proper oversight of the audit work carried out. Coming to the first point made above, while shareholders appointing watchdog of their own wealth looks fine for small & medium companies, where there is direct contact between shareholder & auditor, same is not case in big listed companies.
In listed companies, wealth of public at large is involved. The appointment of auditor is in substance made by large shareholders or management, while minority, whose numbers may run into lakhs, have no say in it. They simply have to put their faith in the watchdog appointed by large shareholders or management. The solution here could be SEBI appointing auditors of listed companies & rotating them as per provisions of new Companies Act or in any other appropriate manner.
This is not something completely new. Auditors of Banks are already appointed by RBI. To make it more acceptable to companies, SEBI may give a panel of 3-5 auditors, from which the management can choose their auditor. This will substantially increase independence of auditors, as they won't be dependent on management for re-appointment in subsequent periods. However, even an independent auditor can indulge in wrong doings for a consideration, monetary or non-monetary. Here we need proper oversight of audit performed. Currently, to ensure quality of audit work, ICAI is having procedures like peer review, which is clearly inadequate. There needs to be put in place more comprehensive, independent & effective system of review of audit work. Just the auditor himself, the oversight body of audit also needs to be independent.
More & more countries are going for independent auditing oversight bodies. India will also join in as the Companies Act, 2013 has mandated formation of National Financial Reporting Authority in this regard. NFRA will be an independent reviewer, whose oversight would be limited to few hundred large companies & their auditors. For other companies & auditors, ICAI will continue to exercise its powers. Only time will tell how much trust can NFRA instill in signature of the auditor. We can only hope that it will perform its functions perfectly, so that I won't have to write this type of article again.
(Suggestions & constructive criticism is most welcome)