The recent observations of the chairman of National Financial Reporting Authority (NFRA) that the “audit panel of companies cannot escape blame by citing audit failures” has shifted the spotlight from auditors to the audit committee. It is clearly a wake-up call for all audit committees and time for serious stocktaking on their increasing roles and responsibilities.

The entire ecosystem of audit entails that the combined role of various stakeholders ensures reliability of the financial statements and that proper practices and procedures are followed, giving the required comfort to the regulators that all is well in governance and compliance. The key players in the ecosystem are: statutory auditors; internal auditors; IT and systems auditors; and audit committee. While it is mandatory to expect the audit committee to play the role enshrined in the regulations, the expectation of NFRA seems to be that it should go beyond that and, if need be, serve as a watchdog and bloodhound rolled into one — and maybe more of the latter than former.

Increasing use of analytics and sophisticated sampling techniques have made audit — both statutory and internal — highly technology oriented. The expectation is that audit committees should now focus on the methodology adopted by auditors and appropriately capture the same in the minutes. They should question the audit process more deeply and satisfy themselves that all angles are well covered.

Proper documentation

Before the quarterly meetings, the audit committee chairman is expected to spend quality time with the statutory auditors to understand how the limited review or audit was carried out and be satisfied on the process adopted. One relevant question generally put across is whether there were any contentious accounting related issues discussed with the management and how were they resolved. The questions should now be more on the audit process and methodology, including the tools used. The next step now is to get this properly documented as part of notes or minutes of the audit committee meetings.

Likewise, the scope of internal audit, which is finalised at the beginning of the year, should no longer be a box-ticking affair but an elaborate exercise covering transactions and adherence to regulations and nimble footed enough to make mid-course corrections. There is an increasing trend now to have exclusive audit committee meetings along with with the statutory auditor just to discuss the scope of internal audit.

On related-party transactions (RPT) the role of the committee is to ensure compliance with regulations, arm’s length pricing and adequacy of documents. The key issue is whether the audit committee should ask the relevant questions, get the answers and move on or should it actually be verifying each transaction for correctness and go through every document with a fine-tooth comb?

In reality every audit committee chairman brings in the relevant accumulated knowledge and experience gathered over the years to test the veracity and reasonableness of RPTs and steers the discussion on those lines. If the expectations of the NFRA is for the audit committee to go beyond this, then it is clearly a new ask and has to be reckoned in the context of the company and the industry in which it operates. The other major issue is to identify transactions with unrelated parties which could indirectly benefit a related party. Use of technology does help in achieving this but the audit committee is saddled with the onerous responsibility of ensuring that nothing is left out in the RPT landscape at the meetings. The problem of multiple subsidiaries and multiple layers leading to constant movement of funds from one entity to another and attendant RPT implications is a separate subject for discussion.

With the recent developments around NFRA’s expectations, the need of the hour is clear guidelines to audit committees on audit methodology and RPT. The endeavour should be to prevent mishaps through a process of education and thought leadership publications rather than wait for an incident to happen and then do a post mortem on how and why things went wrong. Further, in the zest to shift the onus from auditors to audit committees, one should not end up in a paradoxical situation of audit committees playing the bloodhound role and auditors, the watchdog role.

The writer is a chartered accountant