The Companies Act, 2013, has introduced important audit reforms. One of the important reforms is rotation of the auditor.
Important provisions under this reform
All listed companies; unlisted public limited companies having paid-up share capital of Rs 10 crore or more; all private limited companies having paid-up share capital of Rs 20 crore or more, and all companies having public borrowings from financial institutions, banks or public deposit of Rs 50 crore or more are required to rotate their auditor.
An individual cannot continue as an auditor for more than one term of five years and an audit firm cannot continue as an auditor for more than two terms of five years
The cooling off period is five years.
The provision must be complied by April 1, 2017.
Benefits of this reform
This is expected to improve audit quality, resulting in improved financial reporting.
Would give local auditors more leverage, if implemented properly along with some other measures.
Local auditors v/s the Big Four
Local firms dominate the Indian audit market. However, the presence of the Big Four audit firms (Deloitte, PWC, E&Y and KPMG) cannot be ignored.
The Big Four are the largest professional service network in the world. They provide audit, assurance, tax, consulting, advisory, actuarial, corporate finance and advisory services. In India, they cannot provide audit services directly.
It is alleged that they flout rules while providing audit and assurance services. Many foreign investors put a condition that the auditor of their choice should be appointed. This helps the Big Four audit firms to grow in India.
There is an apprehension that many companies that get their accounts audited by local firms will appoint one of the Big Four or another large international professional service network as auditors.
Hence, the Ministry of Corporate Affairs had notified the constitution of a three-member expert group to look into the complaint that the Big Four are circumventing rules and to find ways to help local firms.
Should the government intervene?
Local auditors are mostly present in tier 2 and tier 3 cities and audit 62 % of the companies listed on BSE 500.
They provide a variety of services to small companies. They lack aspiration to become big.
Therefore, it is debatable whether there is a case for government’s intervention to protect local audit firms
Way ahead and Conclusion
Chartered accountants are prohibited from soliciting professional work through advertisement or otherwise. But they can respond to tenders.
The practice of issuing a tender for the appointment of internal auditors is quite common among public enterprises. Such a practice is not common among private-sector companies.
Tendering is the right method to search for the right audit firm. This increases choice and reduces auditing cost through competition.
Companies should not limit their choice to the Big Four and other international firms or a few large local audit firms.
There are local firms that have capabilities to audit large and complex transactions. Search through tendering process would help to identify such firms.
It will be interesting to see how the new rules regarding rotation of auditors will actually impact the auditing profession.
In what showed a mindset shift among India’s policymakers, the government on Monday opened the floodgates for foreign direct investment (FDI) by easing the terms for nine sectors
In what showed a mindset shift among India’s policymakers, the government on Monday opened the floodgates for foreign direct investment (FDI) by easing the terms for nine sectors. Showing scant signs of legacy inhibitions, it virtually paved the way for even foreign airlines to acquire their Indian counterparts, removed the condition of domestic access to state-of-the-art technology for 100% FDI in the defence sector and put in abeyance the fractious 30% local sourcing norm for FDI in single-brand retail of advanced-technology products.
Despite the local pharma industry’s oft-expressed fear of being swamped by Big Pharma, foreign firms can now take majority (up to 74%) ownership in Indian drugmakers via the automatic route, which could again catalyse big-ticket M&A activity in the sector.
With the relaxations in the aviation sector, even a foreign airline could acquire 100% ownership in an India airline company by working in concert with a related party, according to some analysts. For example, a Qatar Airways could acquire a GoAir by directly picking up a 49% in the Indian firm and lapping up the balance equity through the West Asian nation’s sovereign wealth fund, Qatar Investment Authority.
Analysts, however, said the government seems to have tightened the sourcing rule in single-brand retailing, instead of giving a blanket exemption from such a rule for entities having “cutting-edge” technology, as was the case earlier. For instance, Apple will be exempted from the local sourcing rule for three years and have a relaxed sourcing regime for another five years if it wants to set up its own retail store, as its technology has already been described as “cutting edge” by a government panel. However, the company will still have to start local sourcing from the fourth year itself, thanks to the insistence of the finance ministry, which wanted that the Make in India programme get a boost. Similarly, Chinese company LeEco will be subjected to the same conditions if its claim of having “cutting edge” technology is endorsed by the panel headed by department of industrial policy and promotion secretary Ramesh Abhishek. However, another Chinese smartphone maker, Xiaomi, which recently withdrew its application for such a waiver, will have to comply with the mandatory 30% sourcing rule from the beginning should it wish to set up its own retail store.
Commenting on the new FDI policy for airlines, Amber Dubey, partner and India head of aerospace and defence at KPMG in India, said: “The avoidable controversies on settling ‘ownership and control’ issue is now over. Foreign airlines can now focus on the customers and competition rather than wasting time on legal and regulatory issues.”
“The likely increase in competition will bring down prices and enhance air penetration in India, both international and domestic. Indian carriers can now look for enhanced valuations in case they wish to raise funds or go for partial or complete divestment,” he added.
Calling the new norms a “bit tricky”, Amrit Pandurangi, senior director, Deloitte Touche Tohmatsu India, said, “Foreign airline investment is restricted to 49% and FDI investment in this sector has been opened up to 100%, so if the beyond the portion of the equity is by a related entity, then that needs to be tested.”
Among domestic airlines, the Rahul Bhatia-controlled Interglobe Enterprises holds close to 43% in IndiGo, Ajay Singh has a 60% stake in SpiceJet and Naresh Goyal holds 51% in Jet Airways. While Tata Sons holds 51% in both Vistara Airlines and AirAsia India, GoAir is wholly owned by the Wadia Group.
In defence, the decision to scrap the condition of access to “state-of-the-art technology” for FDI beyond 49% (through government route) will make it easier for foreign investors to invest in India. Already, Russian firm Kalashnikov is reportedly looking for local partners for manufacturing in India. Similarly, Swedish defence major Saab is learnt to be looking at more than 49% FDI in defence in its joint venture with a local partner to make the Gripen aircraft in India.
The government’s move to allow 100% FDI through the automatic route (earlier it was up to just 49%) in the broadcast carriage industry, comprising teleports, cable, direct-to-home (DTH) players, HITS (head-end-in-the sky) and mobile TV operators will provide a breather to the cable industry which has been struggling with the process of digitalisation of cable TV. The government has also allowed 74% FDI (49% under automatic route and through government approval beyond this ceiling) in private security agencies. Earlier, only 49% of FDI through government route was allowed.
Also allowed now is 100% FDI in animal husbandry (including breeding of dogs), pisciculture, aquaculture and apiculture under the automatic route under controlled conditions. It has been decided to do away with this requirement of ‘controlled conditions’ for FDI in these activities.
“For establishment of branch office, liaison office or project office or any other place of business in India if the principal business of the applicant is Defence, Telecom, Private Security or Information and Broadcasting, it has been decided that approval of Reserve Bank of India or separate security clearance would not be required in cases where FIPB approval or license/permission by the concerned Ministry/Regulator has already been granted,” a PMO statement said..
Monday’s is the second largest FDI liberalisation initiative by the Modi government, after the steps taken in November 2015. Prime Minister Narendra Modi tweeted: “In two years, Govt brings major FDI policy reforms in several key sectors… India now the most open economy in the world for FDI; most sectors under automatic approval route.” He added: “Today’s FDI reforms will give a boost to employment, job creation & benefit the economy.”
In what seemed to indicate that the government’s intention was indeed to let foreign airlines acquire Indian firms and thereby augment their capital and fleet strength for the benefit of air travellers, economic affairs secretary Shaktikanta Das said that Monday’s reforms in the sector were a “game changer”.
India’s FDI inflows increased to $55.5 billion in FY16 from $36 billion in FY14. Net FDI inflows stood at $36 billion in FY16 compared with $32.6 billion in FY15.
Commerce and industry minister Nirmala Sitharaman, however, rejected assumptions that the government decided to announce so many FDI policy reforms in one go to divert public attention from RBI governor Raghuram Rajan’s decision to not continue at the central bank after his current tenure ends on September 4. The reforms are a result of months of deliberations among various departments and are not announced in a hurry to divert attention, she affirmed.
Giving some clarity to companies switching to the new accounting standards, an expert Committee of Finance Ministry has said that there may not be any rise in tax burden for them.
The committee, led by retired Indian Revenue Service Officer MP Lohia, has concluded that corporates will not have to make any adjustments to net profits while computing book profits to pay minimum alternate tax (MAT).
“…considering the implicit relation between distributable profits which is available for payment of dividend distribution tax, no further adjustments are required to be made to the net profits (Excluding net other comprehensive income) of India AS compliant companies, other than those already specified…,” the Committee report said.
The government had set up the expert panel in June last year to resolve the differences arising in the computation of MAT when companies with a turnover of over Rs. 500 crore adopt the Indian Accounting Standards (IndAS) from 2016-17.
A number of firms had expressed concerns over their tax liabilities rising significantly due to the new system of accounting.
Public comments sought
The Finance Ministry has now sought public comments on the report by May 10, before it finalises the guidelines.
“The Committee submitted its report on 18 March, 2016 after having consultation with the Ministry of Corporate Affairs (MCA),” it said in a statement on Thursday.
“The net profits under Ind AS may include a sizeable amount of notional or unrealised gains or losses. If the MCA prescribes any further adjustments to the current year profits for computation of distributable profits, the requirement for any additional adjustments to the book profit under section 115JB may be examined,” said the Committee in its report.
It also recommended that items that are a part of the net other comprehensive income should be included in book profits for MAT purposes at an appropriate point of time. These include changes in revaluation surplus, re-measurements of defined benefit plans, gains and losses from investments in equity instruments designated at fair value.
It further said those adjustments recorded in reserves and which would subsequently be reclassified to the profit and loss account, should be included in book profits in the year in which these are classified to the profit and loss account.
Positive response
Experts welcomed the report and said it is in harmony with the current structure.
“Industry can now start preparing themselves for the accounting standards. It has indicated that the same treatment would be carried forward,” said Vikas Gupta, Partner, Nangia & Co.
Sunil Shah, Partner, Deloitte, concurred, saying: “The usual adjustments will continue to be made.
But, there could be an impact in cases where unrealised gains and losses on fair value accounting are recorded in the profit and loss account, which is permissible under IndAS.”
Some of world’s top auditing firms, including Price Waterhouse, Grant Thornton, Deloitte LLP and Walker Chandiok & Co, are under scrutiny with a slew of regulators seeking answers on their valuation, auditing and due diligence of UB Group companies over the last few years.
Deloitte LLP conducted the financial and tax due diligence for Diageo of United Spirits Ltd (USL) which led to the $2.1 billion acquisition of the company, but could not detect the problems in annual accounts. These accounts, in turn, were prepared by PW, which was the auditor for USL between 2010 and 2011, and later by Walker & Chandiok & Co.
The accounts were disputed by Diageo in April 2015 after it found a Rs 2,100 crore hole and sought Vijay Mallya’s ouster from the USL board. Questions have also been raised by lenders on what basis Grant Thornton valued the Kingfisher brand at Rs 4,100 crore. This is now being probed by the Serious Fraud Investigation office (SFIO).
When contacted, a Grant Thornton spokesperson said the firm fully stood by its brand valuation report on Kingfisher. “We believe it was appropriate in the context of when it was done and the purpose for which it was done,” the spokesperson said.
PW declined comment but an external spokesperson said the firm had not received any communication from either the Securities and Exchange Board of India or the Enforcement Directorate. “Deloitte does not comment on client confidential matters,” its spokesperson said.
Diageo had invested in USL after the British company was given express representations that all of the receivables from Mallya entities were recoverable in full. The fund diversion worth Rs 2,100 crore from USL was later raised when KPMG, the new auditor appointed by Diageo, discovered discrepancies when it was finalising USL’s 2014 accounts. All the three years’ accounts will now have to be re-stated, according to listing norms.
In the same year, the new USL management called in PW UK for a forensic audit of the previous three years (which included auditing by its own India unit) and passed on the reports to the regulators including the Sebi, the ministry of corporate affairs and the Institute of Chartered Accountants of India.
The ICAI, sources said, had asked both PW and Walker Chandiok to explain the discrepancy. An ED official said it was surprising that none of the auditors or valuers for Diageo raised flags over the accounts manipulation or the Rs 4,000 crore diversion by USL to the British Virgin Islands in 2007.
While the auditors of USL are in the dock for cooking accounts, another marquee auditing firm — Grant Thornton is under investigation by the SFIO for its Rs 4,100 crore brand valuation of Kingfisher Airlines. It was based on this brand valuation in 2011 that Mallya raised Rs 9,100 crore from government-owned banks by offering the brand as collateral. The lenders are now holding a dud Kingfisher brand, which is finding no takers.
Sources in the ICAI said it was a redux of the Satyam scam, when some of the world’s top auditors overvalued assets before the Maytas and Satyam merger, which led to the unravelling of the scam. In the Satyam case, the ICAI had debarred two auditors from Price Waterhouse who were found guilty of professional misconduct. S Gopalakrishnan and T Srinivas were struck off the ICAI’s rolls and fined Rs 5 lakh each. A Central Bureau of Investigation court later convicted them of fraud.
The Companies Act, 2013, has introduced important audit reforms. One of the important reforms is rotation of the auditor.
