The National Financial Reporting Authority – Rise Of New Audit Governance

This article was written by Shachi Sawla, a student of Alliance University.

Introduction

All the major economies have independent audit regulators. These regulators hold the confidence of the people as they undertake the critical role to control the ethical code of conduct of auditing. The auditors came to public attention because of their involvement in major scams. India remained the last major economy where auditing was self-regulated until NFRA established.

The establishment of an independent regulator was one of the key changes brought in by the Companies Amendment Act, 2013. The inclusion of the provision in the Companies Act was on the specific recommendations of the Standing Committee on Finance in its 21^st report.[1] This was recommended in the wake of the Satyam Scam in 2009. Setting up an independent regulator in India was a matter of discussion for a decade and the provision for its establishment was already there in Companies Act, 2013 but until 2018, no steps were undertaken to implement it.

NFRA is a body constituted under the provisions of Section 132 of the Companies Act, 2013. This body became effective from 1^st October 2018. The aim of the Central Government in this regard appears to be:

• Setting up of a separate and independent regulatory body to assist in the framing and enforcement of legislation relating to accounting & auditing and
• Improving investor and public confidence in the financial reporting of an entity.[2]

Structure of NFRA

The Companies Act requires appointing a maximum of 15 members and they shall be headed by Chairman appointed by Central Government. Chairperson should have expertise in accountancy, auditing, finance or law. All the members including the Chairperson should not be associated with any audit firm including any related consultancy firms during their tenure and 2 years after ceasing to be a member of NFRA. They are also required to make a declaration to the Central Government regarding no conflict of interest or lack of independence.[3]

The terms and conditions relating to the appointment of the chairperson and members have not yet been prescribed. However, the NFRA rules outline the following composition of the authority:

1. Chairperson is a Chartered Accountant and a person of eminence having expertise in accountancy, auditing, finance or law;
2. Member – Accounting;
3. Member – Auditing;
4. Member – Enforcement;
5. One representative of the MCA not below the rank of Joint Secretary or equivalent (ex-officio)
6. One representative of RBI, being a member of the RBI Board is to be nominated by the RBI;
7. One representative of SEBI, being the Chairman of SEBI or whole-time member of SEBI is to be nominated by SEBI;
8. Retired chief justice of high court or a person who has been the judge of a high court for more than 5 years is to be nominated by the Central Government,
9. President of the Institute of Chartered Accountants of India (ex-officio)

The Chairman may also invite any other person to the meeting to give their expert opinion.[4]

About its Jurisdiction

NFRA has the authority to investigate Chartered Accountants and their firms under section 132 of the Companies Act which includes investigation of listed companies and large unlisted public companies.

Listed companies include listed in India as well as outside India on any stock exchange, whereas unlisted public companies having paid up-capital of Rs 500 crore or more or having turnover of Rs 1000 crore or more as on the 31st March of immediately preceding financial year. Insurance companies, banking companies, companies engaged in the generation or supply of electricity, companies governed by any special Act for the time being in force or bodies corporate incorporated by an Act in accordance with clauses in accordance with the above-mentioned requirements. It can be any entity if referred by Central Government to NFRA where the public interest is involved.[5]

The regulatory role of ICAI will not come to an end it shall be continued as prescribed in the Chartered Accountants Act, 1949 in respect of its members in general and specifically with respect to audits pertaining to private limited companies, and public unlisted companies that are below the prescribed limit. The Quality Review Board (QRB) will also continue quality audit in respect of private limited companies, public unlisted companies below the prescribed threshold and also with those companies that may be delegated to QRB by NFRA.[6]

The step to establish NFRA is an uphill task as a creation of structure and processes for delivering a range of functions like setting up standards, professional development, quality auditing and investigating a range of firms. The matter of concern comes when the government would control a profession when it should be an independent professional body. There are various institutions in this country, there is no need to increase them, and instead, the existing ones can be made more robust and efficient.

When an institution is already established 70 years ago, the government should try to fill in the gaps as per the changing needs, instead of dismantling that institution.  When the Institute of Chartered Accountancy of India was established by an act of parliament, having another body by another act of Parliament would result in jurisdictional overlap between the ICAI and the NFRA. The multiplicity of the regulators could result in more complexities in their working. There are various fundamental issues on the constitution of NFRA that should be solved, some of them are listed below:

1. Structural Misconfiguration – The qualification of the Chairperson of having 25 years of experience in the field of accounting, auditing, finance or law is not adequate. He should be a qualified Chartered Accountant with significant experience. How a lawyer chairs the Bar Council and a doctor the medical council is a norm in general, likewise, NFRA should be headed by an experienced CA. Only he will be able to serve the job well by supervising the quality of the profession, monitoring the compliance and punishing the disobeyers.

Further, the composition of NFRA includes members being ex officio, i.e., people holding senior positions in government. The primary issue that is raised here is, finding the time to address NFRA issues is highly unlikely and moreover running a body like this with just four full-time members including the chairman, that too them being qualified from the profession is also not assured.

2. Limitation to Infrastructure and Technical expertise – NFRA will have to monitor the compliance of a large number of companies, as well as the audit firms. Assigning all the tasks in bringing the standards in setting process, quality control, and maintaining the decorum in the profession can’t go simultaneously. The estimate suggests that only performing a task of monitoring compliance and disciplining the erring members could go beyond 50 crores per annum which includes the cost of experts as well as infrastructure.

If NFRA conducts a single quality review or investigation, it might require at least 4-5 technical experts working exclusively for 2-4 months to work on multiple compliances in hand and if such company is listed in any stock exchange then it will be an additional burden on those experts as there are various listing obligations on that company.

3. Overburdening Jurisdiction – NFRA has a very wide jurisdiction. Initially, it was restricted to include only audit firms that were handling more than 20 listed company audits or 200 audits of all types of companies to deal with the cases referred to it by other regulators or government under its purview. This was more of a selective control of significant firms. Lack of efficient technical and infrastructural resources might render the objectives

CONCLUSION

Auditors were regulating themselves worldwide until this custom ended in the US in the wake of the Enron case and in many countries after the Leman crisis. In India as well ICAI was a self-regulator until recently when Government took the decision of establishing NFRA.  The step to introduce NFRA will help in regaining the lost faith of stakeholders and regulators thereby shooting up investors as well as public trust in India.

Setting up of Independent body now would be more advantageous to the Indian economy as there exist shreds of evidence as to the functioning of this kind of regulators at the global level which have set up as a result of huge audit failures, ignorance in reporting and realizing the weakness in self-regulation. The NFRA can outperform global best practices and further enhance its effectiveness by dodging the mistakes done by these bodies in other countries.

But still, NFRA carries some structural deficiency which can be reduced be making certain alterations. For instance, they can make three committees – one handling accounting standards, other auditing standards and the last one for taking disciplinary actions, monitoring and investigation to which NFRA acts as a board of all the committees.

Further, if NFRA is constituted in the public interest and the objective as per companies act is to increase the transparency, then the present reporting rules stating just writing the reasons for not publishing would only contribute to bureaucracy. As is the practice abroad, it would have been appropriate to segregate the report into public and confidential portions and make the publication of the non-confidential section mandatory.[7]

In summation, NFRA could result in a successful attempt in strengthening the regulatory oversight over CAs and detect the loopholes. This move would result in an overlook of auditing under an intense scrutiny of both CAs and their firms which would prevent financial frauds in the corporate and banking sectors. NFRA carries a commendable objective; with support of technical experts, allocation of adequate budget and balance between its jurisdiction and access to the resources it will be able to serve its purpose for which it was formed.

[1] Press Information Bureau Government of India Ministry of Corporate Affairs,  <https://pib.gov.in/newsite/PrintRelease.aspx?relid=176919> last accessed on 11/04/2020

[2] https://cleartax.in/s/nfra

[3] CA Ankush Aggarawal, caclubindia.com/articles/nfra-section-132-of-companies-act-2013-22405.asp last accessed on 12/04/2020

[4] National Financial Reporting Authority ( NFRA ) <https://cleartax.in/s/nfra> last accessed on 14/04.2020

[5] Rule 3 of National Financial Reporting Authority Rules, 2018

[6] Monisha, All you need to know about NFRA, <http://www.legalserviceindia.com/legal/article-444-all-you-need-to-know-about-nfra.html> last accessed on 12/04/2020

[7] Santhankrishnan S, Is A Deformed National Financial Reporting Authority The Answer To ICAI’s Flaws?, <https://www.bloombergquint.com/opinion/is-a-deformed-national-financial-reporting-authority-the-answer-to-icais-flaws> last accessed on 12/04/2020