Explained: NFRA's proposal on exemption for mandatory audit, what is industry's view

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Audit watchdog National Financial Reporting Authority (NFRA) floated a consultation paper last week, seeking comments from stakeholders and the public on whether micro, small and medium companies (MSMCs), depending on certain criteria, should be exempted from the mandatory statutory audit all companies are now subject to as stipulated by law.

This comes after NFRA carried out an analysis to understand compliance-related issues faced by MSMCs having a net worth below Rs 250 crore.

Moneycontrol looks at what NFRA is, what the findings of the analysis are, and the divided opinion of the industry for audit relaxation to MSMCs.

What is NFRA?

Set up in 2018, the National Financial Reporting Authority is an independent regulator to oversee auditing and accounting standards in India.

According to Section 132 of the 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 for up to 10 years.”

Do experts and industry favour exemption to MSMCs for mandatory statutory audit? 

The industry is divided in its views on the relaxation of statutory audit requirements to MSMCs.

MSMCs are in favour of the exemption, as it would not only help in reducing the compliance burden but also mean that audits are unnecessary as details of transactions are recorded in bank statements and goods and services tax returns.

On the other hand, sector experts believe that doing away with the mandatory audit requirement would affect the credibility of the information provided by MSMCs to investors, banks, and rating agencies among others.

Another point raised is that instead of setting the exemption limit based on net worth, it should be on the basis of a company’s turnover so that the exemption would benefit smaller firms and not dilute the regulatory oversight of larger ones.

What are the findings of NFRA’s analysis?

As per a preliminary NFRA analysis, most MSMCs have paid paltry sums to auditors, suggesting that their audits lack the requisite quality. “A very large percentage of MSMCs have reported payment to auditors of less than Rs 25,000," it said, adding that this is way below what standards of accounting would usually require.

This is the reason it sought comments from stakeholders on whether an exemption on mandatory statutory audit should be provided to MSMCs.

NFRA also pointed out that in several economies like the US, Singapore, European Union, Australia, Japan, and the UK, audit exemptions are given based on the number of employees, turnover, and balance sheet total.