Will new audit rules help curb corporate misconduct?

A person aware of the matter said the NFRA, Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi) and ICAI will deliberate with the ministry on how auditors of a parent company can have better oversight of the work of auditors of subsidiaries and be held accountable for them to strengthen the audit framework.

Typically, audits of subsidiaries, on which the certification of the consolidated financial statements is based, are performed by other auditors.

Monday's review is expected to explore ways to give the parent company's auditor better access to specific aspects of subsidiary audits and to align Indian auditing standards with international standards, the person cited above said on condition of anonymity.

Mint On August 21, the ICAI announced that the Indian Standard on Auditing (SA600) issued by the ICAI for audit periods beginning April 2002 had come under regulatory scrutiny following several cases of corporate failures and alleged audit failures in detecting misappropriation of funds. These failures have highlighted certain inconsistencies between SA600 and comparable international standards.

Unlike the International Accounting Standards Board's (IASB) ISA600, which governs the work of other auditors, SA600 allows the parent company's auditor to rely on the work of a subsidiary's auditor, subject to safeguards, without being held liable for it.

Emailed queries to NFRA, Sebi, RBI, ICAI and Ministry of Corporate Affairs on Friday on the review of Auditing Standard 600 remained unanswered at the time of publication.

“The auditor of the consolidated financial statements has to take responsibility for the audit opinion on those financial statements,” said Ashok Haldia, a chartered accountant and former secretary of ICAI. “In this process, he has to properly assess the risk and materiality aspects of the component (subsidiary). For this, he needs to have access to the work done by the component auditor.”

Vijay Kapur, former director of ICAI, said there is a strong case for India's SA600 standard to be aligned with ISA600.

“Under the SA200 auditing standard, when the auditor…uses the work done by other auditors…the auditor remains responsible for formulating and expressing his opinion on the financial information,” Kapur said. “Thus, the principal auditor is primarily responsible for expressing his opinion on the financial statements of the parent company as well as all other consolidated entities, and cannot afford to state that he does not have access to the working papers of one or more other auditors.”

Embezzlement often occurs through loans made by the parent company to its subsidiaries.

Often, the embezzlement of funds is done through loans made by the parent company to its subsidiaries, from where they are transferred to entities privately owned by the parent company's major shareholders, who might otherwise not be solvent.

If audits of subsidiaries are not rigorous and do not question the business logic of these loans financed by funds raised by the listed parent company, this weakens oversight, said a second person, who is also aware of the discussions between regulators.

Some fear that small audit firms, which are tasked with auditing subsidiaries or branches of large firms audited by the Big Four, will lose their business opportunity if the lead auditor is also held responsible for auditing subsidiaries. But policymakers believe that the bigger picture must be kept in mind when reviewing the audit framework and that stakeholders have a right to obtain full information on the end use of funds transferred from the parent company to the subsidiary.

“Small audit firms may have some apprehensions. But the question is, what comes first: the public interest or the auditors' interest?” said the first person quoted above. “Shouldn't the auditor of the parent company know what's going on in the subsidiaries?”

The last few pages of Sebi’s August 22 order on Reliance Home Finance Ltd. (RHFL) show the company’s various subsidiaries and the flow of funds, the person said. In April, the NFRA had issued a disciplinary order against RHFL’s auditors for alleged professional misconduct during the company’s audit for the 2019 financial year.

A spokesperson for the company's promoter Anil D. Ambani said Ambani had resigned from the board of Reliance Infrastructure Ltd. and Reliance Power Ltd. – two group companies mentioned in the latest Sebi order – in accordance with an earlier interim order in the RHFL case, and had been complying with that order for the past two-and-a-half years.

“Mr Ambani is reviewing the final order dated August 22, 2024 passed by Sebi in this matter and will take appropriate next steps as legally advised,” the spokesperson said.

Emailed questions to Reliance Home Finance Ltd auditors remained unanswered at the time of publication.

Vijay Kapur said claims that SA600 cannot be amended because sharing of working papers is prohibited under the Chartered Accountants Act, 1949 were unfortunate.

“This argument is totally untenable for two reasons. First, the ICAI itself has allowed sharing of working papers as part of the peer review process. Second, sharing of working papers is permissible if required by law and therefore, once the auditing standards are notified under section 143(10) of the Companies Act, 2013, the ICAI has no option but to adopt ISA 600,” Kapur said.