The Expert's Corner- Edition 33

Joint Audits: Working together for greater competition and quality in auditing

Financial reporting and corporate governance have been under constant scrutiny in recent years, with an increasing demand for transparency and accountability. In this context, the concept of joint audit has emerged as a powerful tool to enhance the integrity of financial statements and restore trust in the corporate sector. Joint audits involve two or more audit firms working together to scrutinise a company's financial records, offering a fresh perspective, and reducing the risk of errors or fraud.

In India, joint audits are generally optional, except for banks and public-sector entities, where they are mandatory. However, in 2021, the Reserve Bank of India mandated that financial institutions with assets totaling INR 15,000 crore or more to undertake joint audits.

The practice of joint audits

Notably, there isn't a specific International Standards on Auditing (ISA) that governs joint audits. However, recognising the increasing prevalence of joint audits globally, the International Auditing and Assurance Standards Board (IAASB) has identified joint audits as a new topic in their work plan for 2022-2023. This recognition highlights the growing need for clear guidance on conducting joint audits to promote consistency in auditor procedures.

Given the evolving corporate landscape, the Ministry of Corporate Affairs in India had also formed a committee that recommended a mandatory joint audit rule for public interest companies in the country. It's important to note that this proposal is yet to make significant progress.

France introduced mandatory joint audits more than 50 years ago. They are compulsory for companies listed on the stock exchange. As a result, the French audit market is more diverse than any other national economy in the EU. In France, auditing firms from outside the Big Four, participate in the audit of more than 50% of the 100 largest listed companies.

To navigate this landscape effectively, an initial step can be to assess the feasibility of globally applicable guidance for joint audits, considering their diverse requirements in different regions. This assessment will guide our approach to addressing the challenges and demands.

Political objectives and stakeholder goals

The ostensible reason given for mandating joint audits is that two pairs of eyes are better than one. Consequently, joint audits mitigate the risk of overreliance on a single audit firm, reducing the possibility of collusion or complacency between auditors and clients.

Improved audit quality: Joint audits enhance audit quality and auditor’s independence, and consequently strengthen the quality of the financial information. Moreover, the risk of an auditing firm and the company to be audited becoming excessively familiar is greatly reduced.

Diversity: Joint audits reduce concentration in the audit market and improve market supply and its diversity. The company to be audited also has the advantage of being able to utilise the expertise and strengths of two auditing firms. This raises the diversity of governance in general, which is increasingly becoming a focus in many countries. The prevalence of the Big four firms dominating the audit market is a pertinent issue that warrants discussion, as addressing this concentration can lead to a more diverse perspective. Ultimately, this diversification can have a positive impact on the best interests of stakeholders and shareholders.

Innovation: Joint audits facilitate market entry for new players in the large multinational audit sector, promoting increased competition among a wider array of audit firms. This enhanced market diversity fosters innovation among newcomers, leading to more effective responses to market demands.

Joint audits – India dynamics

In the context of India's dynamics in joint audits, it's crucial to understand that the increasing involvement of auditing firms, including the Big Four, in consultancy services can create conflicts of interest. Many countries have regulations in place to address this issue, but these regulations, while robust, can hinder competition. When large auditing firms like the Big Four also serve as consultants, they may become ineligible candidates for audit mandates, leaving fewer options for companies seeking new auditors.

The connection to joint audits lies in the need for more audit firms in India's growing economy. Joint audits can help address this issue by promoting competition and diversifying the audit market. As India's economy is predicted to become the third largest by 2028, the demand for a greater number of sizable audit firms becomes evident. Joint audits can be a means to ensure a wider pool of auditors is available to serve the diverse needs of the Indian market while maintaining the necessary standards and independence.

Conclusion

Joint audits represent a significant shift in the auditing landscape aimed at restoring trust in corporate reporting and governance. The impact of joint audits is felt across various sectors, from businesses enjoying improved credibility to regulators strengthening their oversight mechanisms.

The implementation of the "four-eyes principle" and the shared responsibility among auditors in a joint audit not only enhances the overall quality of the audit process but also serves as a continuous mechanism for ensuring rigorous quality control. This collaborative approach provides an additional incentive to promptly detect and address any irregularities, effectively contributing to ongoing and proactive quality assurance in auditing procedures.

Achieving real market diversification will take time and joint audits alone will not be sufficient to equip the audit market for the challenges of the future. However, they are a key element of a sustainable reform with the objective of stimulating competition and diversity and fostering the innovation required.