NFRA Consultation Paper - Emerging Views and Response

It goes back to 2009 when Satyam scandal took place, raising questions on the quality of its audited financial statements and in response, in its 21st report, the Standing Committee on Finance proposed concept of National Financial Reporting Authority (NFRA). Thereafter, it was given shape in Companies Act, 2013 which came in force from April 1, 2014 but still the setting up of the NFRA, a key recommendation, was delayed.

But when Rs.12,636 crore Punjab National Bank fraud hit the headlines in January 2018, it inevitably raised the eyebrow of regulators and that's when Union Cabinet approved creation of NFRA on March 1, 2018. It was October, 2018 when NFRA came into existence by appointment of Mr. Rangachari Sridharan, former IAS officer. According to Section 132 of Companies Act 2013:

"NFRA is responsible for recommending accounting and auditing policies and standards in the country, undertaking investigations, and imposing sanctions against defaulting auditors and audit firms in the form of monetary penalties and debarment from practice”.

The Institute of Chartered Accountants of India (ICAI) had initially voiced its discontent with the idea of a regulator for the sector, saying the existing structure was adequate but the government has clarified that the role of the new regulator and those of ICAI will not overlap.

But overlapping came apparent when ICAI came is loggerhead with NFRA over the March 2021 report of Technical Advisory Committee (TAC) of NFRA, which the ICAI has outright rejected and rather raised serious concern over "one sided surrealism". It was the case of ICAI that it was based on the views of a miniscule set of stakeholders who responded to a questionnaire and the report has to be redrafted based on the views of a large sample set of stakeholders. It was further stated that inferences made in the report were far from the ground reality in many matters.

While the concerns still remained to be addressed, NFRA recently published a Consultation Paper on dt.Sept.29, 2021 on Statutory Audit and Auditing Standards for Micro, Small and Medium Companies (MSMCs), asking for comment by November 10, 2021. This probably is the hottest topic in practicing CA fraternity, as in long run it may even raise question on existence of many small practicing firms.

With this article, assessment of object and fundamental premise of conclusion drawn in the consultation paper is assessed and also whether some more study to be done while having a relook at important aspects. So let us first look at on what points NFRA has requested comments or views:

Now on these specific questions on which comments from public is drawn comes with the following background:

Payment to auditors: in para 3.1.2, NFRA had discussed the payment which is being made to auditors of the company.

The above data is taken from table 1.6 placed at bottom of the paper on page 36 and it shows payment to auditors which is based on the filing of the companies with Ministry of Company Affairs (MCA):

It may be seen that payment to auditor is not stated on the basis of turnover or the net worth but only on scale of remuneration. In contrast, the study on cost of audit which may be incurred by MSMCs have been made on the basis of turnover of the companies which is coming later in the article. After this there is discussion of the turnover, indebtedness of the companies and present compliances position by the companies. Para 3.2 is relevant in between:

So one of the issue is that there are limited public users of General Purpose Financial Statements (GPFSs) given there is very low or nil indebtedness. There is also discussion on the threshold given in other laws like Income Tax Act .

Further, present scenario on audit as prevalent in other global jurisdictions has been discussed at para 3.3.3 of the paper on page 18 and the same is discussed in detail in annexure I on page 32 onwards.

And after all above discussions, the following observation is made in para 4.1:

So the important point to note is that it is nothing to do with quality of audit done by the CAs but on altogether different parameters. Though there is observation made in para 4.1 that “audit presently being carried is a sham”, but its more like a passing remark on the basis of presumption that it might be so just because it’s a private affair and there appears no effective foundation for this conclusion. This becomes quite clear from para 4.2 in which paper discusses about ease of doing business and not the quality of audit. Notably, this para is just before the para in which comments have been requested from public and therefore, it carries much more significance:

Linking ease of doing business, possible cost of audit for such companies is also calculated in the paper which is on the scale of turnover. This calculation appears on page 38 and 39 of the paper and some excerpts from the table 1.7 given is as below:

In the table the report take into consideration the complete cost structure of a practicing CA firm for which calculation is also given in the paper itself. From table it would be seen that the estimated cost of audit is taken as high as Rs.4.57 lacs even for a company with nil turnover and this is in sharp contrast of the fee which is being charged at present.

So the conclusions drawn by NFRA is not based on the existing quality of reporting done by the auditors but based on the probable cost of audit in accordance with the revised set of ASs while comparing it with low scale of fee charged by the auditors and also on parameter of ease of doing business for MSMCs. Although getting away with compliances may be a welcome step but there appears some contradiction in paper as ease of doing business is seen in perspective of cost of audit and not strictly on parameter of easing of compliance burden itself and further compromising on various risk parameters which may come into picture in case financial statement not being audited.

Some of the gaps which appears in the discussion paper based on overall understanding and apparent circumstances (not based on research, plz note):

1.?????At para 3.3.1, threshold limit given in Income Tax is discussed in the paper so as to support some threshold limit for compulsory audit under the Companies Act, 2013. But one important point which is missed here that the company is a creation by Statute with limited liability and any error in the financial statement may bring in significant risk to the users or third parties.

2.?????Undoubtedly, most of the small companies are glorified proprietorship or partnership as stated in the paper but still in the eyes of law, it’s a separate entity with its own right and responsibilities and therefore, merely being extended private affair do not give a sound rationale for deciding on the issue of compulsory audit.

3.?????The paper essentially deals with two parameters i.e. turnover and indebtedness as the basis of relaxation from statutory audit but there may be concerns beyond these thresholds of turnover, indebtedness and net-worth. For example, if a company takes share application money and show it as creditor or say company start taking donations even if not authorised and show it in some different head, how the same would come to light?

4.?????Public at large including those less educated and more humble background, show more trust and confidence on the companies and this also reflect in most of the bank defaults and manipulation with public, which came from the entities with company format. Getting away from compulsory audit is set to increase such instances manifold.

5.??? Amount of audit fess may depend on number of assignments with the group or other parameters but charging of lower fees certainly do not essentially imply with compromising with the quality of audit.

6.?????The consultation paper at para 3.1 itself discusses the failure of compliances by the companies. So how getting away from compulsory audit will help in meeting those compliances? and why not getting away from unnecessary returns?

7.?????Ease of doing business is certainly a welcome step but it may be better addressed with reducing the requirement in filing of number of returns instead of getting away from compulsory audit which is way more comprehensive and cover vast no. of compliances by the companies.

8.?????Putting a presumption that with the revised set of SAs, there will be huge cost of audit of companies and thereafter concluding that the MSMCs cannot afford such cost of audit appears to be going too far. Rather study need to be done with the stakeholders that whether they find the scale of fee charged by the auditor too high or too low? and also have consultation with ICAI on the issue

9.?????It is unclear that where is concern:

a.?????is it lower fees charged? Then logical step should be to mandate audit fee in the law itself on the parameters reached after discussion with stakeholders

b.?????is it higher fees charged? Then logical step would be to work with ICAI to reach to a reasonable fee structure

c.?????is it quality of audit? Then logical step would be to work with ICAI with stringent monitoring of audited GPFSs which I believe already going on

d.?????is it ease of doing business? Then logical step would be to eliminate number of returns to be filed by companies as the paper itself discusses that the companies are finding it difficult to make compliances

Further:

e.?????can ease of doing business be extended to an extent where it become risk for users?

f.??????should not promoters of MSMCs be well prepared to pay the cost of running a company instead government freeing them from the mandatory audit which is way more essential than anything else? ?

g.?????if the small practicing firms are able to manage their affairs while maintaining quality of audit, should there be any issue?

h.?????are not world over there is trend in service sector, where different entities in same field charges fee with vast difference in scale for same work

We don’t find any answer on above points and it appears that possibly much more study is required before reaching to any conclusion. Hope that the Authority will possibly have a relook at the paper presented for comment.

The views presented are purely personal in nature and I request you to bring to my notice any error which may have crept in due to limited research.

Your comments are welcome.

Thanks and regards

Nikhilesh Kataria