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NFRA’s review of BSR’s IFIN audit: An overhaul of the audit process on the cards

Vivek Ananth BL Research Bureau | Updated on August 18, 2020

BSR was the joint auditor of IL&FS Financial Services (IFIN) for 2017-18. The IL&FS Group crumbled under a debt burden of ₹90,000 crore, and the Centre had to take over the group to ward off a financial contagion

After completing the review of the work done, and taking action against current and former partners of Deloitte Haskins and Sells in the IL&FS case, India’s new audit regulator — National Financial Reporting Authority — has recently released its review report on the audit work done by BSR and Associates LLP (BSR).

The findings in the Audit Quality Review report or AQR give a glimpse on the manner in which NFRA wants to regulate the auditors. Some of these salient points might change the way audit firms function through their associates, affiliates, and network firms.

Auditor’s independence

On a reading of the AQR, it appears that the way audit firms assessed their independence vis-à-vis audit engagements, will have to change. The NFRA says in the AQR that BSR and Associates LLP cannot claim to be independent of KPMG merely by claiming that these are two different entities. BSR is officially a member firm of KPMG International’s audit firm network and also has its offices in the same buildings as KPMG, apart from its employees identifying themselves as part of the KPMG group.

The NFRA has tried to link the prohibition of non-audit services to even related entities of BSR, which are part of the larger KPMG network in India. So, any consulting, management, accounting, or other services (as a whole non-audit services) provided by any entity related to BSR in the larger KPMG Group has also been considered by the NFRA. Using this, the NFRA has tried to establish that BSR as an auditor failed to be independent because its related entities were providing non-audit services.

Another new element related to independence that NFRA has tried to establish in the AQR of BSR’s audit of IFIN is a “business relationship” with any related entities of the audit firm. Using ICAI’s Code of Ethics, NFRA has made the case that prior business relationship with a client company, its subsidiaries, holding company or associates should have also been considered by BSR and its partners to assess its independence. This may include any such engagements even prior to the commencement of an audit engagement.

Materiality & audit procedures

Most audits of general-purpose financial statements are conducted based on a level of materiality of financial transactions that an auditor decides. Using this financial threshold for transactions, an auditor goes about designing and conducting audit procedures.

The NFRA has raised a basic question in its AQR of BSR’s IFIN audit for 2017-18 with respect to materiality. It called BSR’s setting of materiality level arbitrary and without any basis. This goes at the heart of any audit engagement because materiality is one of the primary filters auditors use to evaluate transactions.

From the NFRA’s conclusions in the AQR, it appears that the regulator wants audit firms to have a substantive basis for setting materiality level for auditing transactions, while rejecting BSR’s method for setting the materiality level.

NFRA also found BSR guilty of not complying with auditing standards that say that auditors should also look for special classes of transactions which might not strictly fall within the ambit of the financial materiality level set before commencing an audit.

Also, the NFRA has found faults with the audit procedures conducted by BSR in the IFIN audit engagement and found them not up to the mark for such a complicated audit engagement. The regulator has used the Institute of Chartered Accountants of India’s auditing standards to conclude that some of the audit procedures employed by BSR were not appropriate in the IFIN audit engagement.

Based on the findings of the NFRA in the AQR of BSR, audit firms might have to redesign their audit manuals and procedures in the future to make sure that they are far more substantive.

As of now, NFRA has not issued an order related to the wrongdoings it has found committed by BSR’s engagement team, the audit quality control review team or the partners who were in supervisory roles in the IFIN audit engagement. But going by the findings of the AQR, it seems a similar action by NFRA like those taken in the case of Deloitte Haskins and Sells LLP might be imminent.

Published on August 18, 2020

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