How to improve the quality of audit in Indian companies

In December 2020, National Financial Reporting Authority (NFRA) Chairman R Sridharan described the view expressed in 1896 by Judge Henry Lopes that the auditor is ‘a watchdog, but not a bloodhound’ to be a ‘serious misconception’. He said the statement was outdated, and that there have been fundamental changes in the role of — and expectations from — the auditing profession. In March 2021, Institute of Chartered Accountants of India (ICAI) President Nihar Jambusaria stated that auditors should be watchdogs, ‘at most, sniffer dogs’.Lopes had said that the auditor is responsible for protecting the interest of those who appointed him, but he would presume that the servants of the company are honest and would rely on their statements. The auditor should investigate thoroughly, but is also not expected to be of suspicious mind.Take the Smell Test‘Audit’ is derived from the Latin word ‘audire’, or ‘to hear’. Recently, it is not the hearing ability but the smell test and the ability to observe that have been more in focus. The only common point of agreement among all stakeholders appears to be that the quality of audit must improve. Even auditors agree. So, how can auditing quality be improved?First, clearly understand the role of audit. The canine world is populated with bloodhounds, watchdogs, sniffer dogs, lapdogs, poodles, etc. Activists baying for blood would obviously prefer bloodhounds. The auditing profession would be happy with watchdogs — hopefully remembering that even watchdogs are, on occasion, required to bark, if not bite. Managements that expect stakeholders to unquestioningly eat out of their hands would opt for lapdogs. Those that wear the name of auditor as a badge of pride, would have no problem with poodles. In all of this, what can shareholders and other stakeholders legitimately expect of auditors?Statutory provisions require the auditor to present his or her report to company shareholders, who — as the auditor’s clients — are the ones who finally endorse the appointment of auditors, even though in practice, such a decision seems to hardly take up any time in annual general meetings (AGMs). Next comes the role of the audit committee (AC). This often experiences existential confusion, as it’s unclear on which side it should bat — the auditors’ or the managements’.That the auditor and auditing exercise are instruments in enabling the AC to keep the management, the board and the company on the straight and narrow is often lost sight of. The (now rare) practice of ACs pleading with auditors not to include a qualification or a modification in the latter’s report is the best example of such confusion creating problems of its own.The chair of the AC has an especially important role. He or she has to commit several hours of quality time in engaging with auditors. This is not only to understand their concerns and set in motion corrective measures, but also to put pressure on auditors not to pull their punches and to tell it as it is. In some companies, the chair has very perfunctory and infrequent conversations with auditors, immediately preceding an AC meeting. This is value-destroying, since one expects that the chair would have engaged in a meaningful conversation with the auditor.Talking of QualityIn seeking to uphold the quality of audit, the board also has an important role. It should not only get confidence from the AC chair that what is being presented is the outcome of a constructive engagement, but also should study the management notes and the auditor’s comments seriously. This is to understand whether the auditor, aided by the AC, has used language to conceal his or her thoughts. Shareholders are not blameless in the matter. The quality of questions asked on the accounts, and the inability (hopefully, not unwillingness) of auditors to point them out, should figure in shareholders’ conversations in AGMs.Not to be ignored is the significant role an internal audit (IA) should play in enhancing the quality of audit. If an IA sees itself as a disempowered entity, it will affect the quality of statutory audit, which counts on IA as a necessary complimentary function. If IA drops its guard, risk management would also be suboptimal.Left to itself, auditing will ensure that the rest of us live in the shrinking space between disclaimers and disclosures. The standardisation of sentences in the annual reports of auditors is evidence that defence mechanisms have been, and continue to be, erected by the profession to justify its inability to have identified any major lapse or transgression. It is readily conceded that year-end or halfyearly audits cannot be an all-encompassing exercise. That said, their experience and professional scepticism should, more often than not, point auditors in the right direction.Minus high-quality audit, there could be a tendency among some corporate entities to go in for questionable acts or omissions. In the ultimate analysis, the highest audit quality standards will invest companies with higher levels of credibility, translating to higher investor confidence and rewards for all stakeholders. Plaudits are in store for good quality audits.The writer is former chairperson, Securities and Exchange Board of India (Sebi)
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