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Accounting firms: Time to redo numbers

Nandini Lakshman

On Thursday afternoon, about 25 top auditors from leading accounting and audit firms and council members of the Institute of Chartered Accountants of India, were ensconced in the ICICI Bank headquarters in suburban Mumbai's Bandra-Kurla complex.

They were meeting bureaucrat Naresh Chandra, who heads a committee, constituted by the government to thrash out issues related to auditing, accounting and, more importantly, the independence of auditors.

Such meetings have become commonplace now, as the so-called watchdogs grapple to restore the credibility of the auditing profession, which has seen its brand equity battered in recent times, both at home and in the US.

The accounting debacles at Enron, WorldCom and now the controversy shrouding Tata Finance, have focused the limelight on the role of the auditor. In fact, in the last one week, the ICAI suspended three auditors from A F Ferguson and C C Chokshi & Co.

Now, from this fiscal, ICAI's new directive brings yet another paradigm shift for both audit firms and their clients. According to the directive, the non-audit remuneration of firms cannot exceed its audit business for a client.

"This is to ensure the independence of auditors, as many firms also do consultancy work for the same clients," says Kamlesh Vikhamsey, central council member, ICAI. Adds an independent auditor, "When you are doling out other services to clients, there is a tendency to go soft on the audit."

This is in step with the Sarabanes-Oxley Act 2002 implemented in the US. American audit firms are banned from doing any consulting work, and if there are assignments, they have to be approved by the Securities Exchange Commission.

These issues have been debated in India, for over two decades, but auditors say that accounting firm Arthur Andersen's role in the Enron fiasco, has quickened the pace of developments.

Andersen is said to have had audit revenues of $25 million while its consulting income exceeded that, resulting in a conflict of interest.

Over the years, economic forces have seen Indian clients rely on their accounting firms for more than audits. "The jam for auditing firms came from consulting," says an auditor. From taxation and transfer pricing to handling US GAAP issues, audit firms have been doing it all.

Says the head of a leading accounting firm, "We have become one-stop shops for our clients."

Adds the finance head of a leading public sector undertaking, "Since we work closely with our auditors, it makes sense to use them for other requirements."

Consider Reliance Industries. In 2000-01, while its audit fees were Rs 1.16 crore (Rs 11.6 million), its taxation and other services fee was Rs 1.36 crore (Rs 13.6 million).

Or take Hindustan Lever. Of its Rs 5.09 crore (Rs 50.9 million) fees paid in the year ending December 2001, audit fees were a mere Rs 1.41 crore (Rs 14.1 million).

Now look at some of the big audit firms in India - PricewaterhouseCoopers, C C Chokshi Deloitte Haskins & Sell, S R Batliboi (Ernst & Young) and Bharat Raut & Co (KPMG). Most claim that half or more than half of their revenues come from the audit business.

N V Iyer, partner Deloitte is more candid. He reveals that audit, taxation and consultancy each account for one-third of his firm's revenues. "It is logical for an audit firm to also do taxation and other services as long as there is no conflict of interest," he says.

Is it? The ICAI doesn't think so. "Earlier, the big five accounting firms tightened the client's accounts so that they could get US-GAAP assignments," says a council member. He claims that this was largely due to the fees which were 10 to 20 times more than vanilla auditing.

This pressure on margins has also forced audit outfits to spread their wings. "There is a definite pressure to generate fees amongst organisations," says Ketan Dalal, partner at RSM & Co, a Mumbai-based audit firm.

So while other services earlier meant largely taxation, today an audit firm has no qualms advising on mergers & acquisitions transactions, putting information technology systems in place, and even helping corporates hire a chief financial officer.

At Bharat Raut & Co, the services also include fraud detection and prevention, systems review, ERP and export taxation. And the margins? Auditors obviously don't want to go on record. They say that the hard core audit work attracts around 25 per cent margins, and the non-audit business has margins of anywhere from 40 per cent to 70 per cent, depending on the firm's size. For many, the other services account for almost 70 per cent of business.

That's why, not everybody is enthusiastic about the new directive. "If I am advising a client on M&A and also doing his audit, then I'm sitting on judgement on my advice. That shouldn't be allowed," says Bhavna Doshi, partner at Bharat Raut & Co.

Responses like these highlight the subjective nature of the issue. But what is certain is that it'll make the audit business even more competitive.

"Firms will try and pitch for work which others are doing. There will be cross-pollination amongst the big firms. Earlier, transfer pricing was the auditor's domain. Now, there's a greater chance of other consulting firms coming in," says Dalal.

The transition, in fact, is likely to benefit smaller firms. "Now we will get a chance in the non-audit business," says the head of a small audit firm.

And what about the client? They have to search for other service providers, if their service reimbursements exceed that of the audit fees. "It is a headache as we will have to go to different service providers," says the CEO of a company.

Not only that, they will have to pay more. So far, audit fees have been reasonable and billed on the basis of man hours.. If audit firms lose out on non-audit work, they will try to recover it elsewhere. Some auditors claim that audit fees might rise by 25 per cent.

Will these measures make both auditors and corporates more accountable? Definitely, says Pankaj Jain, an ICAI council member. He believes it will also help to change companies' perception that auditors are a necessary evil. "One mistake, and not just the company's management, but the auditor too will be hauled up," he says.

Adds Vikhamsey, "It will definitely cleanse and strengthen the independence of the auditor. If they don't get consulting fees, then there is no axe to grind."

That may be. But the frequency with which skeletons are rolling out of corporate cupboards, it'll be a while before the auditors' image can undergo a facelift.

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