NFRA suggests on removing compulsory statutory audit for small and medium companies | Consultation Paper on Statutory Audit and Auditing Standards by NFRA

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About NFRA

National Financial Reporting Authority (NFRA) was established by the Central Government in October 2018 under Section 132(1) of the Companies Act, 2013. An important function of NFRA under section 132(2)(a) of the Companies Act, 2013 is to make recommendation to Central Government on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or class of companies or their auditors.

India is unique among the big economies of the world in statutorily mandating compulsory audit for all companies, irrespective of their size and characteristics. In view of the significant role played by companies in India in the economic growth and development of the Nation, it is essential that the regulatory environment is conducive to support, and not burden, the growth in business and economic activities of these entities.

A preliminary analysis has been done by National Financial Reporting Authority (NFRA) on the key financial parameters of the companies registered in India from their MCA-21 filings and it is found that the fees paid to auditors by a large majority of Micro, Small and Medium Companies (MSMCs) are way below what an audit, when performed in compliance with the letter and spirit of the Standards of Auditing, would require.

Major economies of the world require statutory audit for small companies only in case some minimum criteria of public interest are satisfied. Even in India, income tax audit is now not compulsory where the turnover is Rs. 10 crore or less provided not more than 5% of the transactions are in cash. GST audit has also been completely done away with.

It is, therefore, appropriate to revisit the requirement of compulsory statutory audit for all companies irrespective of their size and/or public interest. NFRA has prepared a Consultation Paper explaining the issues involved and providing the data and information required for responding to the questions raised in an informed manner, with the objective to seek the comments/suggestions of the wider stakeholder group and the public at large on questions raised. The last date for receipt of comments is 10^th November, 2021. The comments may be submitted by email at: comments-tac.paper@nfra.gov.in

NFRA’s Consultation Paper on Statutory Audit and Auditing Standards for Micro, Small and Medium Companies (MSMCs) can be accessed on NFRA’s website at:

https://nfra.gov.in/sites/default/files/NFRAConsultationPaperMSMCs.pdf

The focus of the analysis is companies with Net worth below Rs. 250 crores. These companies are referred to as Micro, Small and Medium companies (MSMCs) for the purpose of this Consultation Paper.

Questions related to Issues about the Auditing Areas of MSMCs

Question No. 1 – Do you think that Micro, Small and Medium Companies (MSMCs) depending upon some criteria and threshold should be exempted from the mandatory statutory audit under Companies Act, 2013? If not, why not and if yes, what would be the criteria and thresholds for exemption?

Question No. 2 – Do you think there is a requirement for a separate set of auditing standards for MSMCs as it exists for accounting standards? If no, why not and if yes, what should be the basis for the same?

Question No. 3 – The cost of conducting an audit as per the prescribed standards is an important input for the responses to Questions 1 and 2. Do you agree with the approach for estimating standard cost of audit computed by NFRA? If not, which areas/ assumptions need changes?

Question No. 4 – Do you think the current exemption thresholds for CARO, ICFR and statutory audit applicability need to be standardised and made uniform? If no, why not and if yes, what would be the criteria and thresholds?

In the study Key data parameters viz. payment to auditors, turnover, net worth, and indebtedness of companies with net worth below Rs. 250 crore were analysed by NFRA to understand the nature and size of such companies and the related public interest involved. The payment to auditors made by the Companies as reported in their filings is compared with the estimated standard cost of audit for a reasonably good quality audit, performed in compliance with the letter and spirit of the SAs.

Of the total number of companies as per Table 1 in Para 2.6.1 above, only 52.48% (6,03,055 Companies) of the total number of active companies have filed their AFSs and MGT -7 for the financial year (FY) 2018-1910 as of June 2021 (Refer Table 1.1 in Annexure 2 for details). Such a low percentage of compliance with a critical statutory filing even after two years from the end of the reporting period indicates perhaps a lack of adequate accounting professionals with many of these companies.

Data about Payment to auditors by such companies:

(i) Payments to Auditors12 ((Refer Table 1.6 in Annexure 2 and Annexure 3)

There are a large number of Companies (1,81,392 Companies, nearly 30.26%) that have reported NIL Payments to Auditors. This perhaps could be data input error indicating lack of adequate accounting professionals with many of these companies.

A large majority of Companies (2,48,218 Companies accounting for 41.41%) have reported small amounts of Payments to Auditors i.e., below ₹25 Thousand. Of these Companies, 40,708 Companies have reported extremely small amounts of payments to Auditors i.e., below ₹5 Thousand. The estimated standard cost to perform a reasonably good quality audit, in compliance with the letter and spirit of the SAs, for an MSMC, with Turnover below 50 Crores, is in the range of ₹1.50 lakhs to ₹ 8.43 lakhs (Refer Annexure 3). This estimated audit cost is several multiples higher as compared to the presently reported audit fee ranges i.e., a very large percentage of MSMCs have reported Payment to Auditors of less than ₹ 25 thousand.

(ii)Turnover (Refer Table 1.4 in Annexure 2):

Of the total number of 5,99,487 MSMCs considered in NFRA’s preliminary research, there are a large number of Companies (2,09,122 Companies accounting for 34.88%) that have reported Nil Turnover (in some cases, there could be data input errors in MCA21).

Among the MSMCs that have reported Turnover, a large number of Companies (3,67,019) i.e., nearly 61.22% have very low turnover i.e., below ₹ 50 Crores.

Needless to say, the above analysis clearly brings out that a preponderant majority of these companies is very small in size in terms of key financial parameters. Payment to auditors by such companies is miniscule and far below the minimum standard audit fees cost estimates.

ISSUES RELATED TO AUDIT OF MSMCs:

The above analysis clearly brings out the mismatch between the current payment made to auditors as reported by the companies and the estimated cost for conducting an audit in compliance with the letter and true spirit of SAs. The inference that is inescapable is that such audit as is being carried out is perhaps only a sham. In many small companies, the same persons are both owners and managers (as also pointed out by EU Directive mentioned in Annexure 1) and, therefore, have limited third-party users of GPFSs. A majority of these MSMCs is 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. In any event, it is clear that such audit as is being carried out cannot boast of any quality at all.

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. In the above circumstances, questions would naturally arise whether compulsory statutory audit of GPFSs is necessary, or even desirable in the case of the vast majority of companies who do not seem to be able to afford such an audit.

Exempting small companies from mandatory audit would result in furthering ease of doing business for MSMCs and reducing the compliance burden and costs on such enterprises.

Thus, based on above details we could conclude on the below mentioned points:

1. NFRA is suggesting to exempt small companies from compulsory statutory audit.
2. Internationally also various class of companies are exempt from doing compulsory audit.
3. The fees being paid to the auditors is very less as compared to the standard.

However, members of the ICAI are taking all this in a negative fashion wherein it is being told that this is a threat to the profession and NFRA is reducing the worth of the profession.

Also, people are alleging that without compulsory audit it will reduce the accountability of the companies and will in turn help them window dress the financials and hence this will lead to great number of NPA’s.

Further, it is also being said by the professionals that the figures mentioned in the data are incorrect and projections of the earning and expenses of a Chartered accountant are not accurate.

Also, blaming a professional that since he is taking less fees, the quality of audit would not be great is also not correct.

Do you agree with the above thought?

Instead of blaming NFRA, what we should think is who is responsible for such a move?

NFRA has mentioned in it’s report that it could see very less fees being paid to auditors for conducting audit and thus the standards of audit cannot be maintained.

So, who is at the fault here, is it the auditor who is doing audit at a very low cost so as to retain client and because of which the prices of the hard work of the professional is going down or is it the client who is not ready to value the hard work of professional.

Also, do you think in the current fees that professionals are charging, are they doing quality audit which could stop companies from manipulating books and thus turning into NPA?

Further, we all know that now people are making software’s to conduct audit after which auditor will only be required to sign the report, so is it really fair to complaint about the steps taken by NFRA.

Looking at the pace at which technology is growing, in the near future all the traditional practices of Chartered accountant will be abolished and taken over by machines and hence, professionals should look beyond traditional practice.

What could be the opportunities?

One could think of various new opportunities like after implementing this the people who would want to get their accounts voluntarily audit would hire good quality Chartered Accountants and would also pay a great fees in return.

Further, one could expect getting audit from banks for the entities which come for loans and hence there would not be an increase in NPA and Banks might pay a good fees.

Hence, this could only affect people who were stuck in traditional practice of audit but people who really want to do something with their profession would look at this like a new opportunity and this might also remove some players from the market who were not adding value to their profession.

We are not against the professionals but if we want to improve our image it is on us, because the major point taken up by NFRA is fees charged by professionals for audit and before commenting on NFRA we should again rethink about the quality of services being provided and how we value ourselves and our services.

What are your thoughts now?

To read the press Release CLICK HERE.

To read full consultation paper by NFRA CLICK HERE.

Disclaimer: The views presented in the above article are personal views of our team and has no legal binding. For any legal opinion consult a tax professional.

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