Audit opinions and auditor resignations

The auditor's report is the first page to read in any annual report. It is the only part of the accounts written by an outsider who has looked at the books and is legally responsible for what they say.

Most audit reports are clean. That is why the exceptions matter so much. A qualified opinion, a doubt about the company's ability to continue, or an auditor quitting in the middle of its term often comes months before the market fully understands that something is wrong.

India's largest accounting fraud, at Satyam, and the collapse of IL&FS both led to action against auditors. Since then, regulators have tightened the rules on what auditors must report and on how they can resign.

Audit opinion types

Indian auditing standards (SA 700, 705 and 706) allow five broad outcomes:

Other parts of the report worth reading

• Key audit matters (SA 701): the areas the auditor found most difficult, required for listed companies. Revenue recognition, loan recoverability and inventory valuation show up often.
• CARO 2020 report: an annexure covering loans to related parties, defaults on borrowings, frauds noticed and use of short-term funds for long-term purposes.
• Internal financial controls: a separate opinion on whether the company's controls over financial reporting work. A modified opinion here often comes a year before a modified opinion on the accounts.

Auditor appointment and rotation

Auditors are appointed by shareholders for a five-year term. Under Section 139 of the Companies Act, a listed company cannot keep an individual auditor for more than one five-year term, or an audit firm for more than two five-year terms in a row. After that, a five-year cooling-off period applies. A planned rotation at the end of a term is normal, not a warning sign.

Fraud reporting

Under Section 143(12), an auditor who suspects a fraud of ₹1 crore or more by officers or employees must report it to the central government. Smaller frauds are reported to the audit committee or board and disclosed in the board's report.

SEBI's rules on auditor resignations

Auditors quitting mid-term used to leave investors in the dark. SEBI's circular of 18 October 2019 set conditions for listed companies and their material subsidiaries:

• An auditor resigning within 45 days of a quarter-end must still issue the audit or review report for that quarter.
• An auditor who has signed reports for the first three quarters of a year must also issue the report for the last quarter and the full year.
• Any concerns behind the resignation must be placed before the audit committee with supporting documents.
• The company must collect the auditor's details and detailed reasons for leaving in a set format, and disclose the resignation to the stock exchanges as a material event.