New NFRA rules face opposition from smaller CA firms

Under the current rules, the principal auditor is not responsible for the accuracy of accounts that are reviewed by component auditor. Generally, companies appoint large audit firm

Tweaks to the audit standards of large firms proposed by the National Financial Reporting Authority (NFRA) are facing stiff opposition from small and medium-sized audit firms that constitute the bulk of India’s chartered accountancy (CA) firms. In a discussion paper floated earlier this week, NFRA proposed to make the group auditor of a firm responsible for the entire financial statements of the company. This is part of the ISA 600 standards proposed to be implemented by NFRA.

Currently, large companies appoint a principal auditor who looks at the parent company and is responsible for only the financial statements of the parent company. The subsidiaries are audited by so-called component auditors who conduct audits limited to a particular subsidiary. The principal auditor, while auditing the group financials, relies upon certificates given by the component auditor.

Under the current rules, the principal auditor is not responsible for the accuracy of accounts that are reviewed by a component auditor. Generally, companies appoint large audit firms including the big four consultants as the principal auditor while component auditors are small and local firms.

An email sent to NFRA remained unanswered.

The statutory body for auditors, the Institute of Chartered Accountants in India (ICAI), has already submitted its feedback to NFRA.

“ISA 600 if implemented, will be detrimental to the auditing and CA profession in India, particularly for Small and Medium Practices (SMPs).  For taking responsibility of entire group financial statements, a group auditor may pressurise the group management to replace the component auditors by group auditors. For that purpose, they may also cite the reasons such as overall savings in audit fees and uniformity in the quality of audit,” said a person close to ICAI.

The new standards will apply to all large firms as defined in rule 3 of NFRA. However public sector companies have been exempt from the requirement. As per the NFRA act, all listed companies and unlisted companies with more than Rs 500 crore paid-up capital or turnover of over Rs 1,000 crore will be covered under the rules. Also, any unlisted company with over Rs 500 crore worth outstanding loans, as well as all insurance, banking and power companies will fall under the purview of the proposed rules.

“The impact of ISA 600 on small auditors, particularly component auditors would be more. Current practice relies on component auditors' reports, but ISA 600 requires principal auditors to review their work. This could lead to a loss of work for component auditors, potentially benefiting larger firms,” said Amarjit Chopra, former ICAI President. “A more appropriate thing would be that a principal auditor and component auditor should equally share the division of work and with that, responsibilities and accountability,” Chopra added.

New standards aimed to curb corporate frauds

The new rules were proposed by NFRA to curb accounting and corporate frauds that happen at the subsidiary level of large groups. In some of the high-profile cases, including IL&FS and Coffee Day Enterprises, it was observed that the parent company had advanced money via loans to the subsidiaries which were then diverted. Since the Principal Auditor was not required to track these loans, they simply went ahead with the group audit based on reports given by component CAs. In order to curb this loophole and increase the accountability of principal auditors, NFRA has decided to tweak the rules.

"Globally, the idea is that the auditor of the consolidated financial statement should take responsibility for such financial statements," said Parveen Kumar, Partner, National Head Assurance, ASA & Associates. "Global standards will eventually be adopted, and all firms need to accept the change and work in line with global practices."

Market participants can provide feedback to the consultation paper by October 30.