Independence of Auditors in Private Sector

Since Satyam scandal has exposed one of the biggest audit failures in India. However considering our tendency to undertake institutional changes only when forced to, we could use it as a blessing in disguise. It should force us to ask what caused such a massive audit failure and what are the after-effects on the credibility of audit as an institution?

It should make us look at the fundamental issues in which accountability system works in India and particularly in the private sector.

Presently our focus is on punishing the guilty, particularly in the audit profession, who were found either negligent or in worse case scenario with hand in gloves situation. However meting out punishment to guilty should not obscure us from undertaking institutional changes for enhancing the credibility of audit process. As we all are aware the credibility of an audit is determined by the level of independence that auditor has, from management. In theory shareholders appoint the auditors, but in practice they hardly have a choice, and auditors are always handpicked by the managements. For bringing real independence in the appointment of auditors, one needs to look beyond the legal processes, and ensure that choice of auditors is independent in real sense and not in the hands of the management. Even the rotation of audit is not a solution, where organisations routinely alternate between two sets of audit firms.

While examining various available models, perhaps our instantaneous reactions till now of always looking towards western systems may not be so appropriate now, particularly after massive frauds like Enron & Madoff, and the current scenario where auditors’ have been unable to bring out the impending financial precariousness of financial behemoths like AIG, Lehman Brothers and many other similar financial institutions, in any meaningful way.

If we look at the Indian models, the appointment of auditors to PSUs /Public sector banks by CAG /RBI has been in place for a long time and seems to be working relatively well, with reasonable credibility in ensuring some form of credibility of independence in appointments of auditors. Notwithstanding ill-advised recent amendment by RBI in appointment of statutory auditors, so far the system of appointment of statutory auditors by RBI and CAG has ensured a good level of independence at least in the appointments of auditors.

Perhaps time has come when we need to look at that model for large private sector corporates (at least the listed ones), where some independent body appoints auditors based on evolved criteria out of a panel of eligible auditors.