The new guidelines by SEBI, along with revised formats of audit reports, will sharpen focus on responsibilities of principal auditor.
By Jamil Khatri & S Sethuraman
Pursuant to recommendations of Kotak Committee, SEBI amended Regulation 33 of the SEBI Listing Obligations and Disclosure Requirements by requiring that “the statutory auditor of a listed entity shall undertake a limited review of the audit of all the entities/companies whose accounts are to be consolidated with the listed entity as per AS 21 in accordance with the guidelines issued by the Board on this matter.” This change was intended to ensure that, in relation to financial statements of subsidiaries and associates (referred to as ‘components’) that may be audited by other auditors, the principal auditor (auditor of the parent company) has exercised appropriate diligence before concluding that reliance can be placed on the work of such other auditors.
Globally, most jurisdictions require the principal auditor to perform certain minimum procedures that would enable the auditor to either assume responsibility for the work done by such component auditors (for example, International Standards on Auditing), or to ensure auditor obtains additional comfort before making a reference to the other auditor in the main report (for example, US Auditing Standards).
While the SEBI amendment was a step in the right direction, there was lack of clarity on the level of procedures to be performed by the principal auditor since the term ‘limited review of the audit’ was subject to multiple interpretations. Also, it was unclear how this requirement was aligned to existing guidance for auditors included in Standard on Auditing SA 600 ‘Using the work of Another Auditor’ (SA 600) and principles set out in the Guidance Note on Audit of Consolidated Financial Statements (Revised 2016) issued by the ICAI (GN on Audit of CFS). SEBI has now issued guidelines to provide clarity on the procedures to be performed by principal auditors to meet the requirements of the amended Regulation 33. The guidelines also provide updated formats of reports to be issued by the principal auditor.
The procedures are intended to enable the principal auditor to obtain sufficient audit evidence to ensure that the work of the other auditor is adequate for principal auditor’s purposes. These cover aspects relating to determination of the scope of work in the context of audit/review of consolidated financial statements, addressing significant findings of the other auditor and related reporting considerations. The guidelines set out key matters that may be included in audit or review instructions given by the principal auditor to other auditor. Such instructions provide a structure to the communication between the principal auditor and the other auditor, and seek to cover ethical and independence considerations, timelines for reporting, compliance with laws and regulations, listing of uncorrected misstatements, and other matters relevant to the audit.
The updated report formats specifically require the principal auditor to assert that audit/review of components has been performed by the auditor of the component, and that the principal auditor has performed the procedures under the guidelines, while relying upon the work of the component auditor. Such specific reference to the guidelines and procedures in the report of the principal auditor seeks to reinforce the diligence that needs to be exercised by the principal auditor to comply with SA 600 and GN on Audit of CFS.
The guidelines acknowledge the exclusion of audit/review of certain components by the parent auditor that may not be material in the context of consolidated financial statements. The principal auditor is required to determine ‘significant components’ and ‘non-significant components’ to develop an overall audit/review plan. Such determination should be made by the principal auditor based upon their understanding of the risks associated with consolidated financial statements, materiality and exercise of professional judgement. As a minimum, significant components selected by the principal auditor would represent those components that together with the parent company would, in the aggregate, represent at least 80% each of the consolidated revenue, assets and profits.
The new SEBI guidelines, along with revised formats of audit reports, will sharpen the focus on responsibilities of the principal auditor enshrined in SA 600 and GN on Audit of CFS. This will improve overall audit quality and governance environment. The guidelines may result in change in practice for principal auditors in terms of performing prescribed procedures, and for component auditors in terms of more detailed reporting to principal auditors. Companies and auditors need to consider the impact of the guidelines on the audit, and plan for any changes that may be required.
(Authors are partners with BSR & Co)