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Introduction

Offshoring of business processes has gained wide currency in recent times. From its simple beginning in the 1970’s with the movement of payroll and repetitive transaction processing, off-shoring has grown to a $65 billion market. As per the Global Financial Services Offshoring Report 2007 by Deloitte, over 75% of major financial institutions report off-shoring a portion of their operations. It is estimated by some economists that up to one-third of total U.S. employment in services may ultimately be off-shored.

Audit Quality Inspections; Annual Report 2011/12 published by the Audit Inspection Unit of Financial Reporting Council, UK had this to state about off-shoring

“A number of firms are continuing to pursue “off-shoring” strategies where certain audit procedures are performed in off-shore locations, in order to reduce costs. While the extent of offshoring remains small, generally less than 5% of core audit hours, it continues to increase at a significant rate. Firms will need to ensure that their policies and procedures evolve in order to manage effectively any risks to audit quality associated with off-shoring.”

Concept

In an audit, offshoring is when certain auditing procedures for the audit of a US based company are performed by audit firm personnel located in another country, where the US based company may or may not have operations.

Large accounting firms are increasingly performing audit work for their global clients in off-shore locations such as India, China, Pakistan, Philippines etc. This is highly advantageous as the latter provides a skilled labor pool at significantly lower costs than the global counterparts. A partner of KPMG commented at a 2007 faculty symposium that the ‘all-in’ cost of a chartered accountant at the firm’s Indian COE is approximately 25 percent that of the employee’s U.S. equivalent.

Further the Indian off-shore team of say a UK practice, typically called a captive offshore entity (COE) would offer the flexibility in work timings in order to bridge the five and a half hour time-gap between the two countries. An increasing amount of audit related number checking and tabulation is being performed remotely. Improved technology for scanning and transmitting documents to far off locations is facilitating this development

Legal Structure & Impact on Audit Responsibility

In the year 2011, James Doty- the Chairman of the Public Committee for Accounting Oversight Board (PCAOB) has stated the question marks that are being raised about off-shoring of audit function from a USA standpoint. “I am concerned about investor awareness. I have been surprised to encounter many savvy business people and senior policy makers who are unaware of the fact that an audit report that is signed by a large U.S. firm may be based, in large part, on the work of affiliated firms. Such firms are generally completely separate legal entities in other countries.” In his book No One Would Listen, Bernie Madoff whistleblower Harry Markopolos (2010) writes “What many people don’t realize is that PricewaterhouseCoopers is actually a different corporation in different countries. The corporations have the same brand name, but basically they’re franchises.”

In many instances, a significant portion of the audit may be conducted abroad—even half or more of the total audit hours. The core question here is whether the audit firm in the parent country would be completely responsible for the part of the work that has been off-shored to global networks of member firms.

Let us consider the example of Deloitte Touche Tohmatsu Limited (DTTL), that employs 193,000 people across 150+ countries and posted FY 12 revenues of $. 31.3 bn from its practice of audit, consulting, financial advisory, risk management, and tax services.

This relationship is described on Deloitte’s website as follows:

“DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable only for their own acts or omissions and not those of each other”

Through this legal structure, governing organization (such as DTTL) is apparently exonerated from liability for audit failures of other member firms, as well as member firms from liability for audit failures of other member firms. This risk is mitigated in the US where audit form which issues the report is responsible for the entire audit, including audit work done by foreign affiliates. But it is not very clear how it operates elsewhere.

Investor Perception over Quality of Audit

The off-shoring practice is also causing eyebrows to be raised in the off-shoring countries as the audit function has traditionally required the firm’s audit staff to spend a significant quantum of time on the premises of the company being audited, allowing for direct observation of its operations and documents. Critics argue that offshoring of audit by large firms is in fact a form of self-inflicted tick-box mentality, breaking down the audit into a series of mundane tasks devoid of client interaction. However, supporters maintained that in every audit there will be routine tasks requiring no judgment, and these boxes can be ticked just as well from India as the UK

As per the current regulatory framework, “If the principal auditor is able to satisfy himself as to the independence and professional reputation of the other auditor and takes steps he considered appropriate to satisfy himself as to the audit performed by the other auditor, he may be able to express an opinion on the financial statements taken as a whole without making reference in his reports to the audit of the other auditor”. It is then added with emphasis that “if the principal auditor decides to take this position, he should not state in his report that part of the audit was made by another auditor because to do so may cause a reader to misinterpret the degrees of responsibility being assumed.”

Meanwhile in a keynote address in 2012, James Doty- the Chairman of the Public Committee for Accounting Oversight Board (PCAOB) stated that Board is developing a standard to require audit firms to disclose in their audit reports the names of other public accounting firms, including a firm's own affiliates (COEs), as well as individual accountants not employed by the principal audit firm, who contributed to the audit.

It could so happen that if there is an audit failure due to inadequacy of off-shoring unit’s personnel, juries may attribute a disproportionate share of the blame to outsourcing. The principal audit form might to able to comply fully with the standards on Audit Documentation if they do not maintain work-papers on procedures performed at AOEs

Thus it becomes onerous on part of the principal auditor to exercise control over the work executed by foreign affiliates. The risk of quality should be addressed in a strategic manner by the audit partner deciding on the optimum mix between off-shoring of judgemental and non-judgmental areas. Also the credentials of the personnel employed in the COE need to be checked via interviews before initiating them on a project. A host of measures can be taken to ensure seamlessness in the quality of work done globally on the project.

Confidentiality

A member in practice shall not disclose any confidential client information without the specific consent of the clients. They may not be uncomfortable with the idea that their confidential information is being passed onto an individual in a foreign COE that they have never met or established a working relationship with, in-spite of the fact that the professionals are the firm’s employees. In fact legislation had been proposed in the US - Personal Data Offshoring Protection Act of 2004 to mitigate such concerns. In the UK, The EU’s Data Protection Act served as the basis for a lawsuit against Lloyds TSB, which transferred certain customer information to its Indian processing center.

Audit firms will have to reinforce their assurances to clients that procedures are in place to appropriately safeguard the confidentiality of off-shored client information during and after completion of the audit

Cultural Diversity

Again there are major challenges inherent in the off-shoring process as the engagement team would comprise of individuals from diverse cultural backgrounds who mostly communicate over phone and rarely get to see each other face to face. Audit requires an auditor to be able to demonstrate control of their working papers and supervision and control of the audit work used in arriving at their conclusions. This limitation is overcome if there staff exchanges with the offices providing the offshore services.

Future increase in costs

Even though the offshore provider’s location may presently offer pay and tax advantages over time, these costs might rise and may well start to match local costs. Historically, locations such as Singapore and Taiwan provided cheap labour but that is no longer the case. With currency appreciation and rapid growth in their economies, the story might be repeated for India, China, Philippines etc. This underscores the imperative that corporations that make global location decisions ought to focus less on short-term cost considerations, and more on long-term projections of talent supply and operating effectiveness. Off-shoring would need to be cost competitive even after factoring in costs for maintenance, monitoring, and quality control processes

Conclusion

The offshoring of audit procedures presents auditing firms with unique opportunities and challenges. While off-shoring allows firms to reap benefits from economies of scale and the cost arbitrage, the management of such practices would also need to have adequate mitigation strategies for the real risks and hidden costs. However provided that audit quality is maintained, and appropriate levels of supervision and review are employed to ensure compliance with local regulations of the parent audit firm/expectations of stakeholders; there lie tremendous opportunities where off-shoring could expand into areas requiring judgment as well.

References

About Deloitte; Retrieved from http://www.deloitte.com/view/en_GX/global/about/index.htm

Audit Quality Inspections, Annual Report 2011/12; Retrieved from http://www.frc.org.uk/getattachment/98e3e7dd-cdbe-4e45-9078-14e07bf0d7d8/Audit-Quality-Inspections-Annual-Report-2011-12.aspx

Doty, J. 2011. “Statement on Proposed Amendments to Improve Transparency through Disclosure of Engagement Partner and Certain Other Participants in Audits.” Speech, PCAOB Open Board Meeting, October 11. Washington DC.

U.S. House of Representatives, Subcommittee on Commerce, Trade and Consumer Protection, 2004; H.R. 4366: Personal Data Offshoring Protection Act of 2004.   


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Category Audit, Other Articles by - Anurag 



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