The Hindu Business Line : Peer review, peel by peel

THE Institute of Chartered Accountants of India (ICAI), by the powers vested by Section 15 of the Chartered Accounts Act, 1949, issued a Statement on Peer Review in April 2002 that effectively serves as a wake-up call to the profession. Professional firms will be subjected to peer review (PR) and those which meet the prescribed criteria will be issued a PR certificate.

PR is basically a review by one's equals and is part of self-regulation procedures for ensuring quality in audits. This is another concept that has been imported. While there may be detractors of it, one must admit that the time has come (even if imposed by events of the last two years) for the profession to demonstrate its efficacy if it is to retain its credibility. The underlying concept of a PR is the same as ISO certification, that is, if one controls the input in terms of quality the output is bound to be of quality. The statement, therefore, concentrates more on the internal systems by which a firm of chartered accountants is driven.

The statement is silent about the consequences of not obtaining a PR certificate. A practice unit (PU) — a sole practitioner or a firm as defined in paragraph 3 of the statement — will still be entitled to carry on its practice. However, one can hazard a guess as to what can happen if a PU does not obtain a PR certificate. For a start, there is the adverse publicity the PU will attract. Probably in the foreseeable future the Comptroller & Auditor General of India, the RBI, the IRDA and other regulators may insist on PUs obtaining a PR certificate as a condition precedent for being appointed as auditors of entities within their jurisdiction.

Added to this, potential clients and audit committees may not be willing to consider appointment of a PU unless it obtained a PR certificate. A PR certificate will, therefore, become a must for survival. Considering these issues, the accounting fraternity should immediately wake up to the new challenges posed by the statement. It is no longer enough if one does a good audit. One must also appear to have done a good audit.

The statement goes into details of what is entailed in a PR. The procedure prescribed is rather detailed — probably because of the ICAI's anxiety to give more than one chance to PUs to acquit themselves well. The avowed objectives of the statement are to ensure that PUs comply with the technical standards issued by the ICAI and have in place proper systems, including documentation, for maintaining the quality of attestation services. The actual definition of technical standards (paragraph 3) is wider and includes provisions of various relevant statutes and regulations that are applicable in the conduct of an attestation service.

PR, as stated in paragraph 7, will focus on: i) compliance with technical standards, ii) quality of reporting, iii) office systems and procedures with reference to conduct of attestation services; and iv) training programmes for staff who are involved in attestation functions.

Paragraph 3 defines what attestation services are. Essentially, these involve audit and verification functions. According to the definition, attestation services do not include management consultancy, tax representation, and so on. Preparation of financial statements is included in the definition of attestation services; this could only be an error that has crept in.

Technical standards are defined as Statements on Standard Auditing Practices, Accounting Standards, Guidance notes and other statements and notifications, and so on, issued by the ICAI, and also the applicable statutes concerning the attestation engagements and those that regulate the attestation client. The ICAI Council will establish a Peer Review Board (Board) to oversee the programme. A reviewer is defined as a member who is appointed by the Board to carry out a review.

The Board will have 11 members, of whom, six are council members and, of the six, at least two-thirds have to be members in practice. The council will appoint another five from amongst (but not limited to) the public, including eminent persons, the regulatory authorities, bankers, chartered accountants, and so on. Theoretically, therefore, four more chartered accountants can be appointed to the Board. The Council will appoint the chairman and the vice-chairman from the council members. However, members of the Disciplinary Committee and the Committee for Ethical Standards and Unjustified Removal of Auditors are not eligible to be appointed to the board.

Also, at no stage can a reviewer name any person in his report. Thus, there is a Chinese wall between the Board and these committees, which is well conceived to afford protection to PUs being reviewed. Obviously, the members of these committees should not be privy to what goes on in the PR procedure, as any knowledge of PUs facing problems would force them to act to the detriment of the PUs. A question to be considered is whether the wall is thick or strong enough in view of the procedure that has been prescribed, whereby the Board has to submit reports to the council from time to time.

Paragraph 8 empowers the Board to prescribe practices and procedures to be followed in the conduct of PR and paragraph 9 makes it mandatory for PUs to comply with the provisions of the statement. Those who fail will be required to undergo appropriate review of their quality control systems as may be directed by the Board.

A reviewer is required to have at least 15 years' audit experience and should currently be active in the practice of accounting and audit profession. What is not stated in the statement is whether a member who has not obtained a PR certificate or who is subjected to further reviews can be a reviewer. It stands to reason that a PU that is not good enough to obtain PR certificate should not be allowed to sit in judgment over others. The ICAI should address this issue immediately. While this may not be an issue in the initial years, as everyone is starting with a blank slate, it is bound to come up later.

The cost of review is to be borne by the PU. The statement also provides for an attestation client to apply for its auditor to be reviewed, in which case the attestation client will pay the fee. It is in the interest of a PU to complete the review as early as possible, as the fee of the reviewer is time-based. Where the PU is not comfortable with a reviewer coming from the same city or town in which the PU is practising, the PU can ask for an outstation reviewer, in which case, the PU will have to pay for the TA and DA as well. The statement also takes into account the convenience of the PU for the timing of review to ensure that PUs are not put to inconvenience.

PUs are divided into three categories, and PR will commence in three stages. Those that fall in stage 1 will face a review after April 1, 2003, those in stage 2 after April 1, 2004, and those in stage 3 after April 1, 2005. Normally, a review will include a verification of attestation records for the previous three years. However, the Statement prescribes that no accounting year commencing prior to April 1, 2002, will be subjected to review.

Stage 1 includes those PUs that are the statutory central auditors of public sector, private sector and foreign banks, public sector undertakings, insurance companies, and so on. PUs that conduct audits of companies with Rs 5 crore or more of paid-up capital and with turnover of Rs 50 crore or more (and such other criteria that may be fixed), asset management companies, mutual fund trusts, and so on, will also be covered. In the case of stage 1 PUs, they will be reviewed at least once in a block of three years. Since a review normally includes verification of the attestation records for the three preceding years, a stage 1 PU will effectively be monitored continuously.

Stage 2 includes those PUs that audit branches of banks, regional rural banks, co-operative banks, NBFC (based on criteria to be prescribed), companies with Rs 5 crore paid-up capital or less and such other criteria as regards the turnover as may be fixed by the Board. PUs that have attestation clients, which have accessed funds in excess of Rs 1 crore from the market or financial institutions will also fall in stage 2.

All other PUs will fall in stage 3. Any PU that has not been reviewed may apply for a review. While a tax-audit may not trigger a PR in the case of Stage 1 and Stage 2 PUs, once a PU is chosen for review, tax-audits may also come under scrutiny of the reviewer, if they are included in the sample.

In terms of paragraph 12, the reviewer has access to documents that are in the possession of the PUs. PUs have an obligation to provide information to the reviewers with regard to those documents which the reviewers believe is of relevance in their review. In addition, where the information is not in a legible form, the PUs have an obligation to produce it in a legible form as also provide an English translation of documents which are not in English. The reviewer is also entitled to take any abstract of any document that may be required by the reviewer. It may be noted that the obligation to produce documents and information is restricted to what is in possession of the PU. Attestation clients however, are not bound by it.

As discussed, the actual procedure for PR is very detailed. It is in the interest of every PU to complete the PR as quickly as possible as a matter of enlightened self-interest, as any delays can be expensive in terms of fee payable to the reviewer not to mention the dislocation one has to put up in cases of further reviews.

(To be concluded)

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