Big 4 thinking of keeping off risky audits
Following a series of strict regulatory actions for alleged auditing lapses, the Big Four firms have kickstarted a debate over whether to walk away from potentially risky work and limit their client roster to multinational companies, prominent Indian companies and reputable startups.
On Tuesday, PwC resigned from Reliance Capital before submitting its audit report for the financial year 2019. That came on the back of a proposal by the Ministry of Corporate Affairs to ban Deloitte Haskins & Sells and BSR & Co for five years in connection with the Infrastructure Leasing & Financial Services case, the Reserve Bank of India’s ban on SR Batliboi & Co auditing commercial banks and the market regulator banning PwC last year.
The audit firms say they are at an inflection point and must take hard calls on the business.
“We will start walking away from grey audits or rather, any shade of grey. Everyone now has to be more mindful of whom they sign or service. The question staring at us is: Is the risk worth taking?” said the audit leader of a Big Four firm.
Experts concur that more auditors will start avoiding potentially problematic clients in the next few months.
In terms of money, the audit business across the Big Four is estimated at between Rs 2,300 crore and Rs 2,600 crore and it’s not the most profitable when compared with taxation or advisory.
After audit rotation was introduced, margins shrank because the investment required to audit a new client is higher than the yearly fee an auditor earns in the case of most big companies. Now, with the risk growing exponentially, the risk-reward ratio is going awry.
Deloitte and BSR & Co will end up spending much more on litigation than the fee they made on the IL&FS Financial Services (IFIN) audit. In addition, there is collateral damage in terms of loss of reputation and other advisory business.
“Now we decide who we can audit. More than 60% of my clients will be multinationals who want quality audits, and this will come at a price,” said a senior audit partner in another Big Four firm.
After regulators questioned the quality of audits, the firms said the audit environment will change.
“We are at the end of our patience with audit committees. We are dealing with a government which doesn’t understand the meaning of professional judgement. They are bringing criminality to an auditor. The last few days have changed the profession. The risk-taking ability of the profession will reduce drastically as both the management and auditors will be perennially suspicious of each other,” said a Big Four audit partner.
According to Jeenendra Bhandari, a partner at MGB & Co LLP, looking at the swift investigation in the IL&FS case and the seriousness of the government to pursue action against auditors, and added to this the ban, penalties and class action suits, no auditor – whether a large firm or tier-2 firm – would sign off on a company’s accounts that have even the slightest potential for risk.
“I see a flurry of resignation of auditors happening in this financial year,” said Bhandari.
Recently, the UK’s Competition and Markets Authority recommended that the Big Four audit firms should split their audit and non-audit businesses to avoid conflict of interest situations and ‘concentration’ issues.
Experts said the crisis may trigger similar introspection in India.
“There is increased discussion globally about breaking up the Big Four audit and non-audit business,” said Sunil Chandiramani, former advisory head of EY. “In the UK, there are conversations by regulators to separate the assurance and consulting business.”
According to Chandiramani, PwC and EY have reportedly said they will ban consulting services to their audit customers in the UK to restore public trust.
With stakeholder confidence being impacted in several parts of the world due to financial reporting and fraud scandals – the UK, Africa and now in India – it may just hasten this separation, especially given that the firms have significantly expanded their advisory businesses, which over the next few years, could become larger than their audit businesses, he said.
Over the past few years, the Big four firms have successfully diversified into non-audit services – only 14-18% of their total revenue comes from audit. Services lines such as tax have grown into big businesses, bringing in ₹4,500 crore for the firms, while advisory services account for another ₹5,000- 5,300 crore.
Source: ET Tech