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Joint Audit: A Failed Idea Whose Time Has Come In India

Don’t make joint audit the corporate governance equivalent of forcing a Covid-19 vaccine that failed to work in other countries.

<div class="paragraphs"><p>(Photo: Scott Graham/Unsplash)</p></div>
(Photo: Scott Graham/Unsplash)

The Company Law Committee, set up in 2019 to offer changes to the Companies Act, 2013, has recommended joint audits for some types of companies. In such an audit, two or more audit firms sign off the financial statements of their client. Public sector banks and other public sector undertakings have had joint audits for decades. Sadly, there’s no evidence to suggest that their audit quality has been better than that of companies that have sole auditors. Then why did the CLC propose joint audits in India?

Pros And Cons Of Joint Audit

Proponents of joint audit assert that two heads are better than one, since each of the joint auditors can apply their minds independently, and it would be harder for management to influence all the auditors. As a result, audit quality should improve. Also, the audit market for large companies is highly concentrated in favour of the ‘Big 4’ (PwC, KPMG, EY, and Deloitte) and other big audit firms. A joint audit will also reduce the audit industry concentration, increase choice for companies, strengthen resilience in the event of the collapse of a big audit firm, and help build expertise among a larger number of firms. Opponents protest that joint audits will increase audit costs, require companies to ensure proper allocation of work and coordination among auditors, and produce uncertainty in auditors’ accountability.

In theory, many or all of these are possible and even likely. A decision on whether to have a single or joint audit can be made after evaluating the various factors. Joint audit should be made mandatory only if the benefits exceed the costs.

The State Of Joint Audit

In India, last year, the Reserve Bank of India directed private banks and large non-banking financial companies to appoint joint auditors, even though public sector banks have not been the best advertisement for joint audits.

In most major jurisdictions, including the United States, and much of the European Union, a single audit is the norm, mandatory joint audit being the odd exception. In France, where it has been tried, the evidence is underwhelming.

According to a document published by the International Federation of Accountants, a grouping of national accounting industry associations, joint audit is required or permitted in 55 countries. France is the only major jurisdiction that has had mandatory joint audits since 1966, initially for listed and larger unlisted companies, and since 1984 for all companies that prepare consolidated financial statements. According to IFAC, the mandate was intended to help develop, promote, and preserve a sustainable French audit system. Following France’s lead, some francophone countries in Africa require joint audit. Then there are those that had second thoughts about it – for example, Canada, Denmark, South Africa, and Sweden. They had mandated joint audits but later abolished them.

The U.K. Position

The U.K. Competition and Markets Authority examined joint audit and shared audit (in which the statutory auditor is responsible for the audit but is assisted by a smaller firm) and decided to support joint audit by a Big 4 firm and a large non-Big 4 challenger firm. In 2019, a U.K. House of Commons committee noted it “shared the reservations about the utility and impact of joint audits but believed that they had a role to play in increasing the resilience of the market in the medium term.” The Committee recommended that joint audits involving a Big 4 firm and a challenger firm should be made mandatory for the FTSE 100 companies while maintaining audit quality.

The Evidence

In his detailed review of joint audits in many countries, Javed Siddiqui of the University of Manchester concludes:

  • Empirical studies offer very little support to the notion that the introduction of joint audits would result in better audit quality. On the other hand, recent evidence supports the established conclusion that joint audits don’t have any impact on audit quality.

  • Several studies, however, suggest that companies with joint auditors pay significantly higher audit fees as compared to companies in the single auditor regime. Also, a switch from joint audit to single audit results in cheaper audit costs but the single audit still offers the same audit quality.

  • Although a number of empirical studies confirm the lower audit market concentration in France, the audit market for the larger French listed companies is still dominated by the Big 4 audit firms.

In other words, joint audit is more costly, doesn’t offer higher quality, and doesn’t address the industry concentration problem. This should remind us of what happened after mandatory audit firm rotation was introduced by the Companies Act, 2013. Preliminary evidence from firms for the years 2014 to 2017 suggests that mandatory audit firm rotation does not appear to have improved audit quality, reduced audit costs, and increased audit market competition. A case of ‘be careful what you wish for’.

Joint Audit, For Whose Sake?

The CLC report recommends joint audit but doesn’t make a case for it. As stated in the report, the Institute of Chartered Accountants of India has been pushing for joint audits for many years. In the absence of any justification, it appears that the recommendation for joint audit is to ensure a more equitable distribution of the audit pie. It’s less about enhancing audit quality, notwithstanding that it’s included in the section titled “Strengthening the audit framework”. In other words, joint audit has little to do with the interests of investors, creditors, and other users of financial statements or the public interest, but is for the benefit of auditors, especially the mid-sized firms.

It’s hard to think of a worse abuse of public policy to advance the interests of a privileged group.

A Personal Anecdote

The author was the audit committee chair of a large bank that had six joint auditors. The auditors assured the committee that they had allocated the work among themselves. However, when a tricky issue came up, each auditor would invariably point to another. The author’s constant worry was that some things could slip through the cracks. Each of the joint auditors talked about their portion of the work. They would not take joint responsibility for the entire audit. Regardless of the legal position, this is deeply unsatisfactory for the audit committee.

There were instances where the management played one auditor against another with the result the audit committee couldn’t count on the support of the auditors on any matter.

All this despite the audit fees being multiple times the fees paid by companies of a similar size in the same industry with a single auditor. A mandatory joint audit will only make this a nationwide problem across industries.

Auditors Should Do Better

The nub of the problem is poor audit quality. The belief that joint audit quality is superior is an urban myth. Having multiple auditors all of them doing low-quality work can’t conceivably make the overall audit quality better. The government should ask for evidence of the efficacy of joint audit. Otherwise, this would become the corporate governance equivalent of forcing on people a Covid-19 vaccine that failed to work in other countries.

R Narayanaswamy is a Retired Professor of Finance and Accounting, Indian Institute of Management, Bangalore, and Chair, Technical Advisory Committee of the National Financial Reporting Authority. Views are personal.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.