Mohan Lavi

NFRA is right, scrap statutory audit for small firms

Mohan Lavi | Updated on October 07, 2021

In most small, medium firms the owners and managers are same, so audits serve no purpose

After its establishment in 2018, the National Financial Reporting Authority (NFRA) spent its initial period looking at the work done by the auditors of IL&FS. Over the last few months, there has been a flurry of activity from the NFRA — it issued an audit quality review report on the auditors of Jaiprakash Associates Ltd, a report on the financial reporting done by Kudremukh Iron Ore Company Ltd, a consultation paper on statutory audit and auditing standards for micro, small and medium companies (MSMCs) and a long list of audit firms that had not filed a return with the NFRA.

The Consultation paper on MSMCs raises three questions. Should a certain set of MSMCs (based on some criteria) be exempt from statutory audit? Should SMCs have a separate set of auditing standards? Should the current threshold limits for CARO, ICFR and statutory audit need to be standardised and made uniform?

One of the reasons the NFRA asked the first and second questions was its analysis of the audit fees that was paid to auditors of MSMCs. The analysis showed that the fees paid was paltry. NFRA inferred that the audit being carried out was a sham.

In many small companies, the owners and managers are the same, therefore have limited third-party users of general-purpose financial statement. A majority of these MSMCs are essentially family-owned enterprises formed as companies for the sake of limited liability, or to get bank loans, bus route permits, mining licences, and the like. They are effectively glorified proprietorships or partnerships. There is no public interest in foisting external audit on them.

Questions over audit quality

It is also clear that such audit as is being carried out cannot boast of any quality. Banks or external investors, if any, can direct them to have an audit as a condition for giving them loans, but that can be a private matter. Other countries have exempted MSMCs from audit based on certain threshold limits. Based on these reasons, NFRA makes a case for exempting MSMCs from statutory audit, CARO and ICFR.

While the data regarding audit fees used by NFRA may not be entirely accurate, the fact that the audit fees being paid to audit firms is paltry cannot be refuted. One need not look to other countries to make out a case for exempting MSMCs from audit. Since GST laws are turning out to be the go-to place for collection of information, a cue can be taken from those laws and a blanket exemption from statutory audit, and auditing standards can be provided to every entity whose turnover is below ₹5 crore in a financial year.

A higher threshold limit could be counter-productive to other allied legislation such as the Insolvency and Bankruptcy Code and certain provisions of the Banking Regulation Act. This threshold can be reviewed once every three years and increased if necessary.

Over the last few months, NFRA has showed that it means business. One cause for concern is that the NFRA is being run as a government organisation — filling up of vacancies get delayed and the Ministry of Corporate Affairs has the power to veto appointments.

As on date, the office of the Chairman is vacant and has been filled temporarily. NFRA can do much better if it is run as a professional organisation and without restrictive covenants. If this does happen, the accounting fraternity in India would be the biggest beneficiaries — the Institute of Chartered Accountants of India would ensure that only quality Chartered Accountants qualify and the NFRA would ensure that they maintain their quality in the discharge of their duties.

The writer is a chartered accountant

Published on October 07, 2021

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