As a part of its mandate under Section 132 of the Companies Act, 2013, the National Financial Reporting Authority (NFRA) undertook a quality inspection of four major audit firms over the past year and has published 24 of their observations. These are the first set of quality inspections done and published by NFRA.

In the case of one firm, NFRA observed that the firm’s control over the creation, changes, and review of audit work papers was inadequate since the software they used allows for the working papers to be modified even after they have been signed and closed by the partner in charge of the engagement.

The software also does not require a sign-off on the papers that were modified. NFRA observed that this was a defect in documentation since it would allow for the inclusion of blank audit working papers which is non-compliant with the auditing standards on documentation and quality control.

For another firm, NFRA observed that confirmations that the members were independent of the audit were not obtained for some members. In the case of this firm, NFRA observed that they did not reassess and recategorise audit risk in one engagement as required by auditing standards and the firm’s own policy manual.

During the inspection of another firm, NFRA observed that the audit firm as part of its internal quality monitoring policy and process, performs inspection of a sample of individual audit engagement files and the inspection teams select certain audit areas for review.

However, there is no document explaining the rationale or criteria for selection of these specific audit areas for review by the inspection team. NFRA also ruled that the firms policies and procedures for ensuring the integrity of audit documentation could do with improvement.

In another audit firm also, the NFRA team observed that the finalised and signed off audit documentation is editable at any time before archival without affecting the sign-offs. The copy of the archived audit file used for various practical purposes such as inspections lacks integrity as it is fully editable by any engagement team member.

The individual audit firms have acknowledged that they would incorporate the observation of the NFRA in their forthcoming audit assignments.

Carrot and stick

From October 2018 onwards, NFRA has been wielding the stick against errant auditors and companies. Penalties have been imposed, restrictions on accepting audits were ordered, and suggestions on compliance with different auditing standards have been suggested.

Though the NFRA’s objective to improve audit quality is laudable, auditing errors can only be minimised and not totally eliminated. NFRA can also nudge audit firms and companies to encourage them to improve audit quality. For audit firms, NFRA can mandate a generous increase in audit fees particularly in the case of listed companies. Audit firms could use the increased fees to invest in their technology, and quality and documentation processes. For companies, NFRA can offer rewards by recognising their compliance with laws and regulations.

As NFRA inspects firms that are outside the top 10 category, they could find more observations some of which could be significant. With the amount of data in their possession, NFRA should publish audit manuals on sample audit files which could contain details of the minimum documentation that regulators could look for.

Mid-sized audit firms could use this document as a reference point for their audit documentation. If NFRA could collaborate with the ICAI on this project, the end-result could incorporate the wealth of data that both these organisations possess. If audit quality is a journey, it is important to ensure that the auditor, auditee and regulators travel together.

The writer is a chartered accountant

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