The Naresh Chandra Committee has laid down stringent guidelines defining the relationship between an auditor and its client.

In a move that could impact many smaller audit firms, the committee has recommended that along with its subsidiary, associates or affiliated entities, an audit firm should not derive more than 25 per cent of its business from a single corporate client. Existing rules put a cap of 25 per cent on each auditing entity.

Thus, along with its associates, an audit firm, can derive more than 25 per cent of its business from a single corporate entity. This, the committee has said, would improve the independence of audit firms.

While turning down the proposal for a compulsory rotation of audit firms, the committee has said that the partners and at least 50 per cent of the audit team working on the accounts of a ompany need to be rotated by a frim every five years.

However, some of the leading audit firms are already moving towards such a norm. PricewaterhouseCoopers, for instance, is reducing the rotation period from seven years to five years.

"And this will be applicable to managers as well, apart from partners. But both won't be changed in the same year in order to maintain our relationship with the client," PricewaterhouseCoopers partner Deepak Kapoor said.

Ravi Sood, vice-president, finance, of Hero Honda Motors, the country's largest motorcycle manufacturer, added: "The management of a company is comfortable with the partner who has been around for five years, and vice-versa. The partner knows the clients in and out and is the best judge about the company's performance. Also, since the relationship with the audit firm is time-bound, this will lead to further confusion."

Said M.R. Rajaram, executive director and chief financial officer of ICI India: “Though it establishes some independence, it still remains inferior to rotation of auditors.”

In addition, the chief executive officer and the chief financial officer will also have to certify the accounts of a company whose paid up capital and free reserves exceeded Rs 10 crore (Rs 100 million) or which has a turnover of at least Rs 50 crore (Rs 500 million).

The auditors, it has been recommended by the committee, should highlight their views on the management's description of the material liabilities in the significant accounting policies, notes on accounts as well as the auditor's report, where necessary.

While the committee has said that it has no objections to an audit firm having subsidiaries or associate companies engaged in consulting or other specialised business, it has drawn up a list of prohibited non-audit services.