The National Financial Reporting Authority (NFRA) will not brook any related-party transactions by audit firms, which compromises their independence, its chairman Ajay Bhushan Prasad Pandey said on Monday. He cited instances where audit firms or their associates render management and consultancy services to firms they audit, and draw incomes much higher than from audit fees. Such practices, he said, will definitely undermine the independence of audit functions.
“One has to see whether the auditor is providing any kind of management services, which are prohibited under the Companies Act for auditors, or are in conflict with audit functions,” he said. The NFRA is mandated to recommend on accounting and auditing policies, enforce compliance of the rules and ensure quality of audit services.
Pandey, however, said the question whether to exclude micro, small and medium companies (MSMCs) above a threshold from the requirement of statutory audit will be resolved by the government in consultation with all stakeholders.
The Institute of Chartered Accountants of India (ICAI) had opposed the proposal made by a technical advisory committee of the NFRA in September last year to exempt certain sections of MSMEs from statutory audit requirements. The CAs’ body called for re-drafting of the report after wider consultations with stakeholders.
On independence of audit, the official said: “If revenue earned from non-audit services, even if these are not in prohibition list are, say, 100 times more than the audit fee, the auditor will see a threat to her independence. The fundamental principle is no one should judge her own case,” Pandey said.
On June 22, the NFRA in an order pointed out several gaping holes in the audit of Infrastructure Leasing & Financial Services by SRBC & Co for the year 2017-18. It said Ernst & Young Global (EYG) entities have been earning significant non-audit revenues from IL&FS, which is audited by one of its network firms — SRBC. SRBC, too, has directly earned non-audit revenue from IL&FS group entities.
The NFRA’s consultation paper stirred a hornet’s nest when it made a case for exempting MSMCs from statutory audit, Company Auditor’s Report Order (CARO) and Internal Controls over Financial Reporting (ICFR) in line with global practices. The NFRA’s technical paper showed that the audit fees paid to auditors of MSMCs were very low and suggested that the audit in such cases were not very reliable. The audit of smaller companies is under the domain of ICAI. “Our domain is largely limited to the large or listed companies. In such matters, before taking any decision by the competent authority, views will have to be taken from all stakeholders like ICAI, the ministry of corporate affairs and the MSME ministry. A collective decision will have to be taken,” Pandey said.
The NFRA, which was set up in 2018, is tasked with keeping a watch on the audit and accounting standards of more than 8,000 listed and other companies. To detect the early warning signals of corporate failures, corporate misgovernance and frauds, it is gradually increasing internal capacity to take up more and more cases for review, by using data analytics and artificial intelligence tools.
“While examining any violations of auditing standards, we also see how similar violations are dealt with by the international regulators such as PCAOB (Public Company Accounting Oversight Board) of the US or FRC (Financial Reporting Council) of the UK as our standards of audit and accounting are mostly the same. Therefore, the yardsticks with which the audit firms or the companies are to be judged would be similar and so would be the consequences,” Pandey cautioned.
The NFRA has come across several cases where related-party transactions have not been done at arm’s length and at proper valuation by audit firms. Also, the process which needs to be followed for approval of such transactions under the Companies Act has not been followed in all cases. “In many cases, NFRA has found that the audit firms either directly or through their network firms or associates take up non-audit works such as consultancy, etc in the same companies which they are auditing or their group companies or their subsidiaries,” Pandey said.