More companies seek legal views as auditor qualifications rise

MUMBAI: An increasing number of companies are seeking legal opinions after auditors have qualified their accounts wherever they were unsatisfied with the management explanations, hoping to safeguard themselves against a regulatory action.

Following aggressive regulatory action in the aftermath of the IL&FS scam, the audit firms have started following a very technical and conservative approach while making judgement calls on accounting issues compared to a pragmatic approach they followed earlier.

A few problematic areas which the auditors are running into are loans and advances to related parties, contingent liabilities and commitments, long standing trade receivables, company investment evaluations and impairments.


“With several companies including IL&FS and DHFL facing scrutiny from investigation agencies and in many cases where auditors have abruptly resigned this has become a growing trend,” said Ashish K Singh, managing partner, Capstone Legal. “In the long run, legal opinions of this nature are a good mechanism to improve corporate governance as it would lead to informed decisions being taken by the company. It also increases accountability which is much needed in the Indian context where most big companies are promoter-driven,” said Singh.

Auditors have said that qualifications are their weapon of last resort but now they have no option but to point out accounting anomalies because the regulators and agencies have been harsh on firms auditing scam-hit companies.

In the recent past, auditors have issued qualifications in case of Zee, DHFL, Vodafone Idea, Bharti Airtel, 8K Software, HDIL among others.

In the Vodafone Idea case, EY has pointed out that the company needs to settle or refinance liabilities to continue as a going concern. In Zee’s case the auditor Deloitte has flagged off a few related party concerns. In 8K software, Deloitte had said it had informed MCA about a suspected fraud.

“Giving an adverse qualification is the only way a statutory auditor can take a stand, if there is a disagreement with the company. Resignation was an easy way out earlier, but now the new SEBI disclosures on resignation, are equivalent to adverse qualifications. Often, there is a disagreement with the company over giving out adverse qualifications but at the end of the day that's an auditor’s opinion of the company’s financial health,” said Jeenendra Bhandari, partner at tax and audit firm MGB and Co LLP.

Wherever the companies are seeking legal opinion or a second opinion from an outside audit firm, it’s increasing their cost but they have no option but to defend their positions using outside opinion.

“I have to seek outside opinion to justify to the board, investors and bankers why auditors issued qualifications. Now even exchanges and SEBI want an explanation. Ironically, the lawyers fee was more than the yearly audit fee,” said a CFO of a mid-size real estate firm.

Qualified accounts often lead to a share price drop and increased scrutiny from investors.

Companies would earlier issue written assurances or management representation letters to the auditors attesting the accuracy of the financial statement and documents that a company has submitted to auditors and in turn the auditors wouldn’t issue qualifications.

Now the risk averse auditors are not taking any chances and pointing out anomalies while presenting their observations to the board. In some cases, the audit firms are doing just ‘limited reviews’ instead of full audits.

Lawyers are now being cautious while giving their opinions, after watching the accounting firms being hauled over coals in the IL&FS case. “Given the level of scrutiny and ambiguous regulations, it’s not worth taking a risk. One bad apple like IL&FS can ruin the reputation of the firm,” said a top lawyer who advises Big Four firms on a regular basis.

Increasingly, even the auditors are seeking legal counsel to determine if they can defend their judgements or resigning from the audit was the best solution. “Both the auditors and company managements want to save their backs. No one is willing to take additional business if it leads to higher risk,” said Vinayak Padwal senior partner, Mazaars India.

Experts say that both parties seek legal counsel in case somebody sues them for professional negligence.

The US audit regulator doesn’t allow qualifications in its audit reports, however, the ICAI regulations permit auditor qualifications.