Suggestions on NFRA paper recommending Statutory Audit removal
Bhartiya Vitta Salahkar Samiti
Date: 9th October, 2021
National Financial Reporting Authority (NFRA)
7th – 8th Hindustan Times House, 18-20, Kasturba Gandhi Marg,
New Delhi – 110001
Subject: Suggestions/Comments on the consultation paper – September-2021 “Statutory Audit and Auditing Standards for micro, small and medium companies (MSMCs)” issued by National Financial Reporting Authority “NFRA“
Bhartiya Vitta Salahkar Samiti “BVSS” is a registered society under the Societies Registration Act, 1860, and has over a thousand professionals consisting of Independent Directors of Public Sector undertakings / Banks, Chartered Accountants, Economists, Company Secretaries, Cost Accountants, Capital Market Experts, Bankers, Lawyers working in financial/ fiscal domain, and other financial consultants as its members. Our aim is to contribute towards nation building through constructive discussions, thought leadership and continuous research.
In view of the consultation paper – September-2021 “Statutory Audit and Auditing Standards for Micro, Small and Medium Companies (MSMCs)” issued by National Financial Reporting Authority (NFRA) wherein comments have been sought from the stakeholders, we are submitting our brief comments/suggestions as per Annexu re-A attached to this letter.
We are thankful to you for giving the stakeholders an opportunity to present their views/comments/suggestions in respect of the captioned subject. If needed, officials of BVSS would be available to make oral representation to further elaborate on the issues raised above.
For Bhartiya Vitta Salahkar Samiti
Annexure-A: Comments / Responses
Chairman: Sh. Subhash Agrawal
General Secretary: Sh. Puneet Agrawal
President: Sh. Vipan Aggarwal
Organizing Secretary: I Sh. Sandeep Sharma
Responses by BVSS
Part 1: Preliminary comments
NFRA’s mandate is given in sub-section (2) of Section 132 of the Companies Act, 2013 (“the Act”) which consist of (a) make recommendations to the Central Government on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or class of companies or their auditors, as the case may be;
(c) monitor and enforce the compliance with accounting standards and auditing standards in such manner as may be prescribed;
(d) oversee the quality of service of the professions associated with ensuring compliance with such standards, and suggest measures required for improvement in quality of service and such other related matters as may be prescribed; and
(d) perform such other functions relating to clauses (a), (b) and (c) as may be prescribed.
Section 139 of the Act requires every company to appoint an auditor to carry out audit of the financial statement of the company.
It is quite clear that to recommend abolition of audit for certain companies is not covered u/s 132(2) and therefore not within the scope of NFRA. So, any recommendation by NFRA to abolish of audit for certain companies is ultra-virus. NFRA should not have included this aspect in its Consultation paper at all.
Part 2: Answer to specific questions raised in the Consultation paper on Statutory Audit and Auditing Standards’ for Micro, Small and Medium Companies (MSMCs)
Without prejudice to the submissions made in the Part 1: Preliminary comments,
Question No. 1 : Do you think that Micro, Small and Medium Companies (MSMCs) depending upon some criteria and threshold should be exempted from the mandatory statutory audit under Companies Act, 2013? If not, why not and if yes, what would be the criteria and thresholds for exemption?
Answer: No. In our view, statutory audit is the basic requirement for maintaining the authenticity of financial statements of the incorporated limited liability companies. The proposal to do away with audit would put at stake the interests of government, public exchequer, and interests of the stakeholders.
It is important to underscore that the subject matter is extremely sensitive as it involves the integrity of financial statements and to say the least, such a consultation paper should have been issued only after intensive consultation with the primary stakeholders such as the MCA and the ICAI. The issuance of the consultation paper without even discussing the same within NFRA, has caused avoidable shock waves and has created a lot of confusion in the entire corporate and professional world.
Furthermore, and without prejudice to above, it is to be considered that the provisions of the Act and other legal provisions applicable to companies, such as the tax laws, ESI, PF payments, Labour Cess, etc. which in themselves are quite complicated, are also verified for their compliance in course of company’s audit. In that capacity, auditors perform a function of providing professional capacity to the clients, and at the same time safeguarding the national interest by ensuring that the legal provisions are complied with.
Various stakeholders such as lenders, government, investors, banks, creditors and employees rely upon the audited financial statements. Removal of requirement- of auditing the financial statements by statutory auditors would create insecurity in the minds of various stake holders affecting the normal business operations, such as:
a. problems in obtaining loans from the banks and FIs,
b. problems in getting credit from suppliers,
c. government will be unable to rely upon the financial statements for confirming the tax liability or statutory liabilities such as PF, ESI, Labour cess, etc.
The above aspects clearly highlight that rather than bringing any ease in doing business, abolition of audit would hamper in growth of business. It is a long standing and accepted practice for all the stakeholders to safely rely upon the audited financial statements, and in absence thereof the stake holders would be at loss to evaluate and verify the veracity of the status of an entity,
Even the “Doing Business 2020” Report issued by the World Bank provide for criteria such as paying taxes, getting credit, protecting minority investors and resolving insolvency, which can be relied upon buoyantly only if the financial statements are professionally audited.
It is also to be understood that audit is not a compliance, but a verification of the compliances provided in law. For ease of doing business, it has to be the endeavour of the law makers and the regulators to reduce and ease the statutory compliances; removal of audit would be counter-productive if the statutory compliances remain as it is.
It is also important to note that the companies have limited liability, and the only source for determining the financial standing are the financial statements, added with credibility that is offered by the same being professionally audited. No cause would be served by deleting audit, albeit whosoever feels that he do not wish to take benefit of limited liability may convert the business and carry out the same as a proprietorship or partnership entity.
Reference to international position may also not significantly further the argument of NFRA, since the compliance culture and systems in India are still at a very nascent stage and cannot be compared with advanced and developed countries. It is an admitted position in the consultation paper that the accounts of companies are even unable to barely present the state of affairs properly. In this wake, it is all the more important to continue with professional audits.
We would also like to bring your kind attention to the fact that the companies constitute a large proportion of taxpayers whereas in case of non-corporate assesses, the proportion of tax payers is very small. This is because of the authenticity offered by the audit function which ensures that the tax payments are duly made by the corporate assessees. Thus, if even non corporate assessees are subjected to audit based upon some criteria, it would lead to greater transparency, higher tax collection and more authenticity of the financial statements.
The consultation paper seems to suggest that smaller companies have no public stake involved. Whereas this aspect can be understood with a simple example.
If a company has a very small turnover of say just Rs. 1 Crore, then it is being suggested that there is no need for corporate audit. However, even in this magnitude of turnover, at least the following may be at stake which needs independent verification by way of statutory audit:
a. GST of Rs. 18,00,000 (@18%)
b. Income tax @ 22% on net profit
c. TDS deposit in respect of payment made to vendors, ranging from 1% – 10%
d. ESI @ 4% & PF @ 24%
All the above aspects have, if left unaudited would be counter-productive since the government revenue and public money is being left unchecked.
Question No. 2 : Do you think there is a requirement for a separate set of auditing standards for MSMCs as it exists for accounting standards? If no, why not and if yes, what should be the basis for the same?
Answer: No separate set of auditing standards are required since auditing standards are applicable universally. These are audit quality standards provided for under section 143(10), and cannot be varied with the size of the company. We elaborate as under.
Auditing function comprises mainly of:
- Accounting standards
- Risk analysis
- Sampling, and
- Internal control monitoring
The aforesaid four aspects lead to uniform presentation and disclosures in the financial statements.
These are technical issues which are to be studied in depth and applied practically, and when applied the stakeholders interests are safeguarded. As such audit function is being seen as if it is abrogating the ease of doing business, while the reality is that these aspects are crucial for strengthening the free flow of businesses.
To illustrate, recently schedule III of the Act have been revised rightly requiring more stringent standardised formats and disclosures to be made by each company without any discrimination. When the Act is itself providing for such stringent requirements in the interest of stakeholders, the argument in the consultation paper that audit is adding to a compliance, is incorrect.
That NFRA has clearly noted in Para 3.1.1 and 3.1.2(i) that the Companies do not have enough accounting infrastructure and manpower to record the transactions properly. Despite noting this, the suggestion in the consultation paper to do away with audit is clearly going to be counter-productive and we are of the strong view that it shall lead to financial instability.
Question No. 3: The cost of conducting an audit as per the prescribed standards is an important input for the responses to Questions 1 and 2. Do you agree with the approach for estimating standard cost of audit computed by NFRA? If not, which areas/ assumptions need changes?
Answer: It is important to highlight that unlike goods, in services, the fee charged can never be benchmarked against the cost incurred.
To illustrate, it would be idle to suggest that if a doctor charges (say Rs. 50) per consultation, he will be less effective and would devote lesser seriousness than a doctor who charges Rs. 1000 per consultation. Are these aspects not purely matters of professional decision making?, and can the supervisory body like NFRA can have anything to do with these aspects? In our humble opinion, the answer is clearly in the negative.
To give another illustration, many times, professionals agree to do audits purely for academic, philanthropic and for knowledge purposes, which are the real bed rocks for the professional community where fee, to say the least, is only an incidence and not an end in itself.
Even otherwise, determination of fee is purely a matter of commercial consideration between the parties, in respect of which NFRA may be well advised not to enter.
If still NFRA feels that fee has anything to do with audit quality, NFRA may first have the fee of bank and PSU audits allotted by RBI and CAG to be increased as per the criteria suggested in the consultation paper, which may pave way for the same in the private sector as well.
The comparison of chartered accountancy profession, audit in particular, has to be with the doctor’s or lawyer’s profession, and not with businesses of say traders, manufacturers or brokers. The factors for determination of consideration in the case of the former would be wholly different from the latter which are purely commercial in nature.
It is well understood by all the chartered accountants that lower fee can never be a justification for compromise in quality of audit. The Institute of Chartered Accountants of India through their Peer Review Board and Financial Reports Review Board verify this aspect very carefully and any adverse observation is taken very seriously.
Question No. 4: Do you think the current exemption thresholds for CARO, ICFR and statutory audit applicability need to be standardised and made uniform? If no, why not and if yes, what would be the criteria and thresholds?
Answer: The current exemption threshold for CARO, ICFR and Statutory Audit applicability can neither be standardised and nor made uniform as the purpose behind these promulgations is different. In fact, through these exemptions on selective basis is to reduce the compliance burden on smaller companies. These are in line with the concept of various exemptions to small companies and private companies from specific compliances under the Companies Act, 2013.