When a Company fails, the standard of the audit is often called into
question. The Auditors are then called into question that they allowed
inappropriate accounting treatments and their independence has been compromised,
because either they have become too close to the Company they are auditing (the
familiarity threat) or, more directly, because their objectivity is
challenged by over-reliance on income from a single source. It is known to
everyone that companies choose their own Auditors and pick those with whom they
have the best cultural fit or chemistry rather than those who
offer the toughest scrutiny. Those who hold that view are of the opinion that
the only solution is for Auditors to be prevented from providing any services
other than audit, to their audit Clients.
The prime motive of introducing the provisions of Section 144 of the Companies
Act, 2013 is apparently to ensure the enhanced independence and accountability
of the Auditors. The idea is to ensure that any pecuniary relationship on
account of offering Non-Audit services do not compromise the independence of
Auditors in giving a true and fair picture of the Auditee Company’s financial
The concerns regarding such Non-Audit services are two-fold:
First, Auditors may not stand up to the management of the Auditee Company
because the Auditors wish to retain the additional income from Non-Audit
services to the Company;
Second, providing a range of services to the management may lead to the Auditor
identifying too closely with the management’s interests and lose their
Policymakers globally have responded by prohibiting Auditors from performing
some specific Non-Audit functions. Policymakers have also intensely debated the
need to impose a cap on the Non-Audit fees of audit firms. It has been
repeatedly asserted that Auditors must be independent in fact and in appearance.
Independence-in-fact is defined as the Auditor’s mental state lacking any bias,
while independence-in-appearance is a public perception that the Auditor is
objective and unaffected by a financial interest in the Client.
Institute of Chartered Accountants (ICAI)
The ICAI's Ethical Code forbids Auditors to provide Non-Audit services to audit
Clients that would present a threat to their independence for which no adequate
safeguards are available. Guidance Note on Independence of Auditors issued by
ICAI provides valuable inputs to understand the same. Para 1.9 of the said note
states that the Auditor should be straight-forward, honest and sincere in his
approach to his professional work. He must be fair and must not allow prejudice
or bias to override his objectivity.
One should maintain an impartial attitude and both be and appear to be free of
any Interest which might be regarded, whatever its actual effect, as being
incompatible with integrity and objectivity. This is not self-evident in the
exercise of the reporting function but also applies to all other professional
work. In determining whether a member in practice is or is not seen to be free
of any interest which is incompatible with objectivity, the criterion should be
whether a reasonable person, having knowledge of relevant facts and taking into
account the conduct of the member and the member’s behavior under the
circumstances, could conclude that the member has placed himself in a position
where his objectivity would or could be impaired.
Multinational Comparative Study
The European Union has introduced caps on fees from Non-Auditing services
toPublic Interest Entities (PIEs)as well as a disclosure obligation on the
total fees received from PIEs. PIEs are defined as listed companies, credit
institutions and insurance undertakings.
Member States can also designate as
PIEs, other undertakings that are of considerable public relevance, because of
the nature and the size of their business or the number of their employees. The
international practice (Australia, United Kingdom) showsprohibitionon
Non-Audit services like taxation, restructuring and valuation since they are
likely to influence the objectivity and independence of Auditors.
Consequently, India adopted a similar approach by prohibiting Auditors from
performing specific Non-Audit services in the Companies Act, 2013. This
prohibition is applicable to the audit firm, its associated entity or any entity
whatsoever, in which the firm has significant influence or control or whose
brand name is used by such audit firm or its partners. While Section 144 of the
Companies Act, 2013 provides a list of prohibited Non-Audit services, it also
authorizes the government to prescribe any other kind of services in this list.
It has been noted that there could be a risk of self-review if certain services
are allowed to be provided by the Auditor. Therefore, there is a need to review
the list keeping in mind the various kinds of services rendered by Auditors
which can possibly result in conflict of interest and threat to the
Presently, there is a cap which requires that Non-Audit services fee earned by
statutory Auditor along with its associate concern or corporate bodies must not
exceed the aggregate statutory audit fee. However, this cap was set in 2002 by
ICAI and since then the market of Non-Audit services has evolved. Therefore,
this cap on Non-Audit services also needs to be reviewed.
It is recommended that a statutory Auditor must separately disclose toNational
Financial Reporting Authority (NFRA), the audit as well as Non-Audit fees earned
from each of its Auditee Company or its holding or subsidiary companies.
Under Section 144 of the Companies Act, 2013, an Auditor has to obtain prior
approval of the audit committee or board of the directors for providing
Non-Audit services which are specifically not prohibited. Similar approvals are
required in other jurisdictions also. For instance, inU.S.A.under theSarbanes
Oxley Act, 2002, audit committee approves the types of Non-Audit services which
can be provided to the Auditee Company.
Similar practice is also followed
inUnited Kingdomunder theUK Corporate Governance Code, 2016. Therefore,
keeping in view the best international practices, it is recommended that the
approval of audit committee or board of directors given to Auditors to provide
Non-Audit services, should be separately disclosed in the annual report of the
Auditee Company along with a description of the necessary safeguards in place to
protect the independence and objectivity of the Auditors.
To get higher quality of audits, Auditors’ exclusive focus should be on audit
and not on selling consulting services. This can be best achieved by the split
up between audit and Non-Audit businesses into separate operating entities.
the proportion of Non-Audit services increases and the nature of the services
provided by the Audit firms become further removed from the core audit function,
so we need to increase the undermining focus on independent, high-quality audit.
Also,The Big Four Audit Firmsare conducting more than 50% of the audits
in the World. Such a gap between the Big Four and the rest is not healthy, and
will persist unless tackled. And choice could get worse rather than better if
left unaddressed; choice would be severely further curtailed if one of the Big
Four were to cease to operate.
Competition and Regulationshould work hand in hand to ensure that audit firms
and individuals within those audit firms have the maximum incentives to carry
out high-quality audits. Within firms, individual Auditors’ personal success
should depend to a very large extent on whether they deliver high-quality
audits. There must be set standards to review firms’ work and Auditors must be
punished for sub-standard quality.
Written by: Navin Kumar Jaggi and Aashna Suri