Corporate Governance-MBA-Mod-5

Corporate Governance
Module- 5: Role of Auditors
1. Independence of Auditors; Prohibition of taking non audit services; Rotation of auditors/partners; Quality
of audit report; Disclosure mechanism; Role of SEBI

Role of an Auditor

Whenever someone talks about a company and its functioning, the role of an auditor is underestimated –
whereas, the truth is that an auditor, whether internal or external, has an important role to play in the
Corporate Governance of a company. Auditors are one of the many stakeholders in a company; they are
authorized to review and verify the accuracy of financial records in order to ensure that the company
complies with the laws. A company has two types of auditors namely internal and external. Internal auditors
are those who form a part of the company as employees whereas external auditors are independent. Auditors
play the following roles:

a) Protecting Interests of Stakeholders: Auditors often have access to the key information regarding
several activities being carried out in the organisation and this makes them aware of the mismanagement
happening therein. Here, the auditor has the opportunity to inform the management about the shortcomings
in the policies while also bridging the gap between the stakeholders and the management.
b) Promoting Accountability: At times the auditors in an organisation become privy to the various
misstatements and figures that have been manipulated. This is the time when the auditor can recommend
penalties for every manipulation done by the company. This will help in bringing a sense of accountability
in every stakeholder and will also help the Board of Directors to identify people who are not depicting
professionalism in their work.
c) Crisis Management: Bigger Organisations, at some point of time, go through financial crisis. This can be
attributed to any scam or corruption within the company or any allegation that a company is subjected to
from outside. In times like these, the auditor is expected to have an action plan ready which shall include
assigning different responsibilities to different stakeholders of the administration. The objective of this
action plan is to sustain the faith of the investors in the company.
d) Mitigating Risk Factors: Auditors often carry out periodic risk assessment to ensure smooth functioning
of the company. During these risk assessments, they analyse all the risks that can potentially result in the
downfall of a company. They also look at all the measures that a company has taken to ensure there is no
corruption within the organisation.
e) Maintaining Relationship with Regulators: It is the case with most of the regulators and the
shareholders that they need transparency with the operations they are a part of. The external auditors usually
put a lot of efforts to make sure that the operations carried out by the company are transparent and which
helps the regulators in bestowing trust upon the organization.

Independence of Auditors

A vital issue which needs to be addressed here is the independence of external auditors in the execution of
their audits. They have to perform their obligation in the most independent and reliable manner to provide
investing public with the level of assurance enabling them to make their decisions on the basis of these
financial statements. The auditor independence has been defined by International Auditing Practices
Committee of the International Federation of Accountants in its I.A.G.-3, September, 1980 as 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. He 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. There is an expectation that the auditor will have performed an
audit that will have reduced the chances of a successful negligence lawsuit to a level acceptable to the

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auditor. In the language of economics, the auditor will perform auditor work until the cost of undertaking
more work is equal to the benefit the auditor derives in terms of the reduction in the risk of a successful
lawsuit being possible. This then represents the minimum amount of work that the reader can expect the
auditor to perform. However, all auditors are individuals with different attitudes to risk and return and so
one auditor's minimum standard of audit work will not necessarily be that of a colleague. Auditors must be
objective and thus remain independent from company managements. Statutory provisions, auditing
standards and professional guidance al1 aim to ensure that this principle is applied in practice. Those
concerned will keep these safeguards under close scrutiny and will bring in any improvements which are
necessary. Audit firms have very strong commercial reasons for preserving a flawless reputation for
independence. But there may be a temptation to compromise on independence where an audit firm depends
for a significant proportion of its income on a single audit client. The audit committee is an essential
safeguard of auditor independence and objectivity; it should keep under review the overall financia1
relationship between the company and the auditors. In particular, the audit committee should have a key role
where the auditors also supply a substantial volume of non-audit services to the client. There has also been
concern that directors or auditors who confirmed the effectiveness of a company’s control system may he
exposed to legal liability if unintentional misstatement or loss of any kind is found to have occurred. The
following are some of the important features of auditor independence:
a) The trustworthiness of auditor's independence depends on auditor's independence on the one hand, and
the degree of his experience, competence and knowledge, on the other.
b) The independence of the auditor is of leading importance as his report is believable and subjective in
nature. Independence is a state of mind and implies that auditors should remain firm enough to withstand
any type of influence.
c) Independence is of leading importance as wide spectrums of users are interested in his professional report
and if his independence is not maintained, expectations of users will be belied.
d) The auditor is beholden to be independent without resorting to confuse rather than enlighten the business
community by his work and report on the task entrusted to him in a clear straight forward manner.
e) Traditional view of auditor independence is that lack of independence will reduce the importance placed
on audit reports and that investment and loan decisions will be impaired.
f) There is widespread agreement by regulators, accounting practitioners, and auditing academics that
auditor independence enhances auditor credibility.
g) It is argued that independence enhances the credibility of financial statement on two grounds. First,
independent auditors increase the likelihood that financial statements conform to Public Policy and
Administration Research. Second, investors are more likely to rely on the financial statements if the auditor
is independent.
h) Under this set of arguments, auditor independence plays a central role in enhancing the credibility of
financial statements, and any threat to auditor independence has undesirable effects on capital markets.

Prohibition of taking non audit services

The auditor is prohibited from providing the following non-audit services to an audit client including its
affiliates:
a) Bookkeeping
b) Financial information systems design and implementation
c) Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
d) Actuarial services
e) Internal audit outsourcing services
f) Management functions or human resources
g) Broker-dealer, investment adviser, or investment banking services
h) Legal services and expert services unrelated to the audit
In addition to the specific prohibited services, audit committees should consider whether any service
provided by the audit firm may impair the firm's independence in fact or appearance.
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Rotation of auditors/partners

Every Company incorporated in terms of the provisions of Companies Act, 2013 requires to get their
financial records reviewed and verified by qualified professionals. Thus, after incorporation companies shall
ensure appointment of a qualified auditor in terms of the provisions of Companies Act, 2013. Every
company appoint its first auditor by Board within 30 days from Incorporation and if Board fails to do so
then members of Company appoint first auditor at Extra-ordinary general meeting within 90 days till the
conclusion of First Annual General Meeting. At first Annual General Meeting an auditor appointed who
shall be an individual or hold office from the conclusion of that meeting till the conclusion of its sixth
annual general meeting and thereafter till the conclusion of every sixth meeting.
Rotation of Auditor is appointing a new auditor when:
a) an individual had been appointed as an auditor for more than one term of five consecutive years
b) an audit firm had been appointed as an auditor for more than two terms of five consecutive years.
For the purpose of the rotation of auditors means following class of companies but small companies and one
person companies not included:
a) Every Listed Company
b) Unlisted Public Companies having share capital of Rupees 10 crore or more
c) All private limited companies having paid up share capital of rupees 50 crore or more
d) Companies having paid up share capital of below threshold limit mentioned above, but having public
borrowings from financial institutions, banks or public deposits of rupees 50 crores or more

Mandatory Requirements for Rotation

For the purpose of the rotation of auditors
a) in case of an auditor (whether an individual or audit firm), the period for which the individual or the firm
has held office as auditor prior to the commencement of the Companies Act, 2013 shall be taken into
account for calculating the period of five consecutive years or ten consecutive years.
b) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the
outgoing auditor or audit firm under the same network of audit firms.
The term “same network” includes the firms operating or functioning, hitherto or in future, under the same
brand name, trade name or common control.
c) a break in the term for a continuous period of five years shall be considered as fulfilling the requirement
of rotation.
d) if a partner, who is in charge of an audit firm and also certifies the financial statements of the company,
retires from the said firm and joins another firm of chartered accountants, such other firm shall also be
ineligible to be appointed for a period of five years.

Quality of Audit Report

The purpose of the audit report is to summarize the findings in a way that management can readily
understand and see the impact of these findings. The audit report represents the end result of weeks of
reviews, analyses, interviews and discussions. It provides important information to audit clients about the
area reviewed by internal audit.
More importantly, it provides details to management about significant issues that need to be addressed. How
well internal auditors communicate that information is critical to getting their client’s acceptance of findings
and their agreement with audit recommendations.
Quality reports require thought and effort. Auditors should consider who will read the report, what they will
do with it, what level of detail is necessary, what the organization’s culture and norms call for, and if
industry-specific language is necessary. Every effort should be made to ensure the report is kept at a
reasonable length and conveys a balanced summary of the status of the areas audited.

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The audit report needs to be issued as soon as possible after the audit is completed. If, for any reason, it
cannot be issued by the deadline set in the audit plan, an explanation for the delay should be provided to the
auditee and a revised issue date established.
 
Attributes of a Quality Audit Report
a) Precise Modifiers - A modifier is a word or phrase that alters the meaning of another word. Generally,
the modifying word should be as close as possible to the word it is modifying. Otherwise, the modifying
word could attach itself to a word that was not intended to be modified. This can subtly alter the meaning of
the sentence or make it ambiguous.
b) Usage of clear Technical Terms - Auditors should consider spelling out acronyms, replacing technical
terms with nontechnical words, and embedding definitions within the sentence.
c) Documentation of nonconformities: When documenting findings, it is important to be clear and precise.
What is the actual nonconformity and why is it a nonconformity? What standard has been violated? What is
the objective evidence used to determine that a nonconformity exists? The statement of nonconformity needs
to be well written, clear and precise with enough detail.
d) Conciseness - Readers always appreciate conciseness, but it should not mean cutting down on
information. It means using fewer words to convey the same information. For example, if there are findings
in three different areas regarding document control, combine them into one finding that indicates where the
non-conformities were noted. 
e) Constructiveness - Constructiveness primarily refers to the audit recommendations, which should give
audit clients information to correct the current problem and also address the root cause so as to mitigate
future occurrences.
f) Completeness - Everything the reader needs to make an informed decision should be included in the
report, and no significant information should be left out. The auditor must not omit valid information
because it does not support his or her points. Present all the facts and allow the reader to decide.
g) Timeliness - Auditors should complete and issue reports as soon as possible to give the audit client a
chance to address the issues timely. Timeliness may vary based on things like the audit resources needed to
complete the audit, the complexity and significance of the audit, the report review process, and other factors.
If serious issues need to be communicated before the report is completed the auditor should immediately
issue an interim report or memo to allow the client the opportunity to address the problems as soon as
possible.
h) Distribution list - For internal audits, the audit report distribution tends to be much larger, but is typically
specified in an internal procedure governed by the audit group management. 
An audit report must be accurate and objective; flexible enough to communicate sometimes complex
information to various levels of people; and able to withstand the scrutiny of peer reviews and other
assessments, depending on the industry. A quality audit report aids audit client in making informed
decisions, so taking the time and effort to put it together benefits the audit client and auditor

Disclosure Mechanism

Financial Reporting & disclosures are generally influenced by the regulatory requirements prescribed by
various statues.
a) Companies Act, 2013
i) The format of Balance sheet, P&L must be in accordance to Schedule III of the act
ii) The financial statement must be approved by BoDs & signed by at least two directors
iii) The financial statements shall be filed to the concerned Registrar of Companies.

b) Reserve Bank of India (RBI)

i) The financial statement of banking companies shall be conformity with Banking Regulations
ii) The format of Balance sheet and Profit & Loss Statement to be followed by the banking companies has
been prescribed by the Banking Regulations
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c) Insurance Regulatory and Development Authority (IRDA)

i) The financial statement of Insurance companies must be in conformity with IRDA Regulations
ii) A Receipts and Payments Account is also required to be prepared.

d) Securities and Exchange Board of India (SEBI) for listed companies

i) Prepare consolidated statements in addition to Individual financial statements
ii) Disclose their quarterly results in format prescribed by SEBI
iii) The quarterly statement shall be audited one or may limited review by the auditors

Other Disclosures:
1. Annual Report under Companies Act, 2013
a) Chairman’s Statement
b) Key Financial and non-financial indicators
c) Management discussion and Analysis report
d) Directors' Report
e) Secretarial Audit Report
f) Corporate Governance Audit Report
g) Business Responsibility Report
h) Segment Reporting
i) Human Resource Disclosure
j) Auditors' Report
k) Financial Statements
l) Related Party Disclosures
m) Joint Ventures Details
n) Contingent Liability Disclosure

2. Disclosure under SEBI Regulations

a) BoD of listed entity shall authorize one or more KMPs to determine materiality of an event or information
and for the purpose of making disclosures to stock exchange(s)
b) Disclosure of Shareholding Pattern
c) Corporate Governance Disclosure
d) Financial Statement Disclosure
e) Fair Disclosure of Unpublished Price Sensitive Information
f) Trading by Promoters
g) Encumbrance of Shares by Promoters
h) Share re- reconciliation audit report
i) Transfer & Transmission of Shares Certificate
j) Fraud/Default Reporting and Disclosure

Role of SEBI
SBI caters to the requirement of three parties that operate in the Indian Capital Market. It was founded to
improve the financial market of India, hence to obtain its purpose it takes care of the most vital financial
market participants:
a) The issuer of Securities- Any firm that issue securities should be listed on the stock exchange. Issuers
are entities that help in raising funds from the financial market. The function of SEBI is to confirm that the
issue of IPO’s and FPO’s takes place healthily.
b) Investor- They help in keeping the market alive as the capital market functions because the traders exist.
Investors earn money from the market, so SEBI assures that no malpractices happen against them in the
market. Thus, it’s the role of SEBI to safeguard the interest of investors and prevent them from any unfair
trade practice.

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c) Financial Intermediaries- They are the mediators in the financial market, and they take care that the
stock market transactions happen seamlessly and securely. The role of SEBI is to monitor each activity of
financial intermediaries like NBFC’s, broker, sub-broker, etc.

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