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Non-audit services: Is the ban justified?

Mohan R Lavi November 10, 2022, 19:33:33 IST

Independence being a state of mind, cannot be enforced through legislation such as banning some services. Instead, it should be encouraged through general supervision

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Non-audit services: Is the ban justified?

“It has been noticed that some of the audit firms are following the self- regulation and taken decisions to not to take up non-attest work such as consulting and transaction advisory services from listed companies that are being audited by them. Such move that comes amid auditors facing heat in high profile corporate scams appears to be a welcome move. Section 144 of the Companies Act, 2013 provides that an auditor shall not provide the following services directly or indirectly to the company or its holding company or its subsidiary company:- (a) accounting and book keeping services; (b) internal audit; (c) design and implementation of any financial information system; (d) actuarial services; (e) investment advisory services; (f) investment banking services; (g) rendering of outsourced financial services; (h) management services; and (i) any other kind of services as may be prescribed. Considering the present scenario and several media reports stating that the auditors have failed to report material issues with respect to auditee companies and in order to avoid conflict of interest and maintain the independence of the Statutory Auditors, it is inter-alia suggested to include/prescribe more prohibited services in the list of section 144 of the Companies Act by making an amendment to the Companies (Audit and Auditors), Rules 2014. It may also be noted that Section 144 already provides 08 services which are prohibited for the auditor and further clause (i) of Section 144, empowers the Central Government to prescribe more services by way of Rules” The above are the provisions regarding banning of non-audit services from the Consultation Paper issued by the Ministry of Corporate Affairs (MCA) on the 6th February 2020 on improving audit independence and accountability. Since then, discussions have been going around on what additional services should be banned. Some discussions have also questioned whether there should be a ban at all. By definition, a ban is a legal prohibition. Usually, bans are enforced as a disciplinary action to ensure that laws are not broken at will. In the case of auditors, the ban on provision of non-audit services is being contemplated with a view to ensure that auditors remain independent at all times. Prohibited services Out of the nine services that have been prohibited as per Section 144 of the Companies Act, the first seven are unambiguous. The eighth one, “management services” is too broad-based and can be interpreted in any manner one deems fit. The last entry in Section 144 is a residual entry and has been inserted only to accommodate any other services that may be contemplated later. On their part, the Institute of Chartered Accountants of India (ICAI) have issued a laundry list of what could be considered to be “management consultancy services”. These include financial management planning and financial policy determination, capital structure planning, working capital management, preparation of project reports and feasibility studies, preparing cash budgets and other budgets, cash flow statements, profitability statements etc., inventory management, price fixation and other management decision making, personnel recruitment and selection, management and operational audit, advise regarding mergers and amalgamations; and systems analysis and computer related services. It could be argued that there is no difference between management services and management consulting services. However, if at all a difference could be drawn, it could be that the auditor is not supposed to provide consulting services to the management. Invariably, such consulting services should not result in the issue of a report. A good example of this could be valuation services- while the auditor is free to express his opinion on valuation, this should not result in his issuing a valuation report. Auditors would not want to reject any non-audit services that come their way due to two reasons- these services are less risky and more lucrative. Despite having enough paras in the audit report to express their views, some auditors tend to hold back from saying things in their report as they are because they are dependent on the client for their fees. Adding a few other services to the nine already present in Section 144 of the Companies Act is not going to be a guarantee that audit quality would improve. It is going to be a near-impossible task to identify such services. Even if identified, it would be difficult to define them. Auditors normally provide such service through another arm and maintain that Chinese walls exist between the audit arm and the consulting arm. Regulations in other jurisdictions In Europe, the EU Audit Directive and Regulation as well as the 2016 FRC Revised Ethical Standards have regulations regarding provision of non-audit services by auditors. These regulations provide that the Audit Committee should not agree to the audit firm providing a service which may compromise their independence or violate any laws or regulations affecting their appointment as auditors. In considering whether to give approval the Committee should not agree to the audit firm providing a service if the result is that the external auditor audits its own firm’s work, the external auditor makes management decisions for the Company, a mutuality of interest is created or the external auditor is put in the role of advocate for the Company. The Directives provide that the audit firm can provide non-audit services (such as preparation of tax returns), if some conditions are met. Some of these conditions are • they have no direct or, in the view of an objective, reasonable and informed third party, would have an inconsequential effect, separately or in the aggregate on the audited financial statements; • the estimation of the effect on the audited financial statements is comprehensively documented and explained in the additional report to the audit committee; • the principles of independence are complied with; and • for the purposes of the statutory audit of the financial statements, the audit firm would not place significant reliance on the work performed by the audit firm in performing these services. AQMM The ICAI has introduced an Audit Quality Maturity Model (AQMM) which is effective from 1st April 2023. This is a self-certification model in which auditors rate themselves on various parameters one of which is the percentage of audit revenue to total revenue. The rating would be a part of the Peer Review Certificate that audit firms are rated on. Instead of picking and choosing non-audit services that could be performed by auditors, a better solution would be to leave the decision on whether certain services can be performed by the auditor to the Audit Committee. One of the points that the Audit Committee could consider while deciding this could be the AQMM rating. Independence being a state of mind, cannot be enforced through legislation such as banning some services. Instead, it should be encouraged through general supervision. The writer is an author and partner, K P Rao & Co. Views are personal. Read all the Latest News , Trending News Cricket News , Bollywood News , India News and Entertainment News here. Follow us on Facebook , Twitter and Instagram .

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