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January 17, 2021

NFRA “Auditor is a watchdog and not a bloodhound” is a serious misconception

by CA Shivam Jaiswal in Income Tax

NFRA “Auditor is a watchdog and not a bloodhound” is a serious misconception

Audit regulator National Financial Reporting Authority (NFRA) has urged the audit fraternity to refrain from taking shelter under the adulated description of the auditor “being only a watchdog and not a bloodhound”.

What is the role of NFRA?

The NFRA is a body constituted under the provisions of Section 132 of the Companies Act, 2013. The NFRA has the following responsibilities:

  • Make recommendations on the foundation and laying down of accounting and auditing policies and standards
  • Monitor and enforce the compliance of the accounting standards and auditing standards
  • Oversee the quality of service of the professionals (such as auditors, CFOs, etc) and suggest measures required for improvement in the quality of service
  • Perform such other functions related to the above

What do you mean by the phrase that the “auditor is a watchdog and not a bloodhound”?

  • The perception of auditor’s duty with regards to detection and prevention of frauds and errors was initially based on the decision given in Kingston Cotton Mills Co. (1896) case.
  • The judge summed up auditor’s duty by stating, “Auditor is a watchdog, not a bloodhound.”
  • It was noted that the auditors were to be appointed by the shareholders, and were to report to them directly, and not to or through the directors.
  • The object was to ensure that the shareholders received “independent and reliable information respecting the true financial position of the company at the time of the audit.”
  • The duty of the auditor is to be honest i.e., he must not certify what he does not believe to be true, and he must take reasonable care and skill before he believes that what he certifies is true.
  • What is reasonable care in any particular case must depend upon the circumstances of that case.
  • Where there is nothing to excite suspicion very little inquiry will be reasonably sufficient.
  • Where suspicion is aroused more care is obviously necessary; but still an auditor is not bound to exercise more than reasonable care and skill, even in a case of suspicion, and he is perfectly justified in acting on the opinion of an expert where special knowledge is required.
  • An auditor is not bound to be a detective, or, as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong.
  • He is a watchdog, but not a bloodhound. He is justified in believing tried servants of the company in whom confidence is placed by the company.
  • He is entitled to assume that they are honest, and to rely upon their representations, provided he takes reasonable care.

Comments by NFRA Chairman

  • NFRA Chairman R Sridharan stated that the phrase that the “auditor is a watchdog and not a bloodhound” is a serious misconception.
  • The same is needed to be exorcised from everyone’s mind and the same has very far-reaching consequences.
  • Clearly, what was a common law understanding of the auditor’s duty in the absence of any statute to govern the same would not at all be applicable today.
  • The Companies Act, 2013, was built in substantive provisions regarding audit and auditors into the statute.
  • All accounting and auditing standards were now part of subordinate legislation. The auditor’s duties were now comprehensively detailed in the law.
  • This includes responsibilities to obtain reasonable assurance (defined as a high, but not absolute, level of assurance) that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error (SA 240).
  • SA 240 says that when obtaining reasonable assurance, the auditor is responsible for maintaining professional skepticism throughout the audit, considering the potential for management override of controls and recognizing the fact that audit procedures that are effective for detecting error may not be effective in detecting fraud.

The NFRA Chairman said the point that needs emphasis is that good audit quality starts from getting the very elementary basics right. “If this is not taken care of, any talk of nuanced professional judgments in arcane business and financial matters would have to be regarded only as smokescreens meant to mislead. The foundation of good audit quality is independence,” he said.

Sridharan also highlighted that India has already built into law the separation of audit and non-audit services that other countries are only now attempting to achieve. The separation of audit and non-audit services being undertaken in developed countries is expected to boost auditor independence around the world.

In conclusion, the Chairman said that we need to forget the watchdog and not bloodhound description. For those who would nevertheless recall the watchdog metaphor with something like nostalgia, he recommended a read of the Sherlock Holmes short story Silver Blaze, where Holmes drew attention to the curious incident of the dog in the night time, a dog that did nothing, because of the identity of the criminal

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