RAJIV GANDHI NATIONAL UNIVERSITY OF LAW

PROJECT ROUGH DRAFT - SEMESTER 10

Topic​:
Regulating the Auditors - A Critical Analysis of National FInancial Reporting Authority

Date​:
11th March, 2020

Submitted To:
Dr. Vipan Kumar
Associate Professor of Law
RGNUL, Punjab.

Submitted By:
Rohit Jacob Varghese
15058
RGNUL, Punjab
 Statement of the Problem

Till October 2019, the auditing process for public companies in India was self regulated
under peer review. The Institute of Chartered Accountants of India (ICAI) has established a
Peer Review Board and a Quality Review Board to conduct limited reviews of the auditing
services provided to Public companies in the Country.

Such a mechanism of self regulation is not in line with practises adopted elsewhere in the
developed world. This project examines the state of auditing service providers and other
stakeholders on the subject of regulating auditors. Moreover, it also seeks to analyse the
National Financial Reporting Authority - its justification, vulnerabilities; its supporters,
opponent ​etc.

Regulation of Auditors - Overview

USA
In 1988, the American Institute of Certified Public Accountants (AICPA) made periodic
quality peer review of public accounting firms compulsory. Erosion of the credibility of
auditors following the collapse of big corporations in the US- Enron and WorldCom at the
turn of this century mounted pressure on the federal government to regulate the auditors more
stringently. Public Company Accounting Oversight Board (PCAOB) was established in 2002
by Sarbanes-Oxley Act (SOX) to review the audits of public companies.

UK
Financial Reporting Council (FRC) is the independent regulator in the UK to promote high
quality corporate governance and reporting. FRC sets codes and standards for governance,
accounting and auditing; reviews reports of public interest entities; and has the power to
investigate misconduct by professional accountants. While FRC has direct statutory powers
in relation to audit regulations, some of the functions of FRC have no statutory backing but
have been derived from widespread support of the professional bodies in the UK. FRC is
funded by the audit profession who are required to contribute under the provisions of the
Companies Act 2006.

Australia
In Australia, Financial Reporting Council (FRC) set up under the Australian Securities and
Investments Commission Act 2000 oversees the effectiveness of the financial reporting
framework and provides strategic advice in relation to the quality of audits conducted by the
auditors in Australia.

Audit Review Mechanism in India

For nearly 16 years, auditors in India are only self-regulated under peer review. The
professional body of accountants in India – Institute of Chartered Accountants of India
(ICAI) has established Peer Review Board and Quality Review Board to conduct limited
reviews of audit services.

Peer Review Board was established in year 2002 by ICAI to ensure that in carrying out the
assurance service assignments applicable technical, professional and ethical standards are
followed. The objective being educative to enhance quality of professional work and
transparency in audit standards, peer review has no connection with any disciplinary or any
other regulatory mechanism. Its domain is limited to organising training programmes
imparting training to the reviewers and issuing Peer Review Certificates to firms reviewed.

Quality Review Board (QRB) seemingly is more powerful peer-review body in India as it
consists of half of the members nominated by the government and others by the ICAI. The
first Quality Review Board was constituted in 2007 and then in 2011, 2012, 2014, 2015 and
2016. During the period 2012-15, the Board could only review 216 statutory audit
assignments and in 74 cases advisories were issued to the audit firms for improvement in
their services. QRB, however has never been an effective body as it does not have
disciplinary or investigation power over the auditors.

Need for NFRA

In the midst of intense debate in India to regulate the public accountants in the aftermath of
the Punjab National Bank heist of more than $ 2 billion, the Government of India established
National Financial Reporting Authority (NFRA), an independent review body over the
auditors and auditing firms with a view to improve the audit quality while retaining
self-regulation mechanism by the professional body of auditors. As per section 132(2) of the
Indian Companies Act, 2013, the National Financial Reporting Authority (NFRA) shall make
recommendations to the government on formulation of accounting and auditing policies and
standards. Most importantly NFRA will oversee the quality of service of the professions
associated with ensuring compliance with accounting and auditing standards, and suggest
measures for improvement in quality of service. NFRA has the twin powers of investigation
and judicial powers of a civil court of summoning including imposing penalty and debarring
the public accountant or the firm from engaging in practice as chartered accountant.

NFRA is to consist of government appointee chairperson, three full-time, and nine part-time
members with a term of three-years each. To make NFRA a wide participating body, it will
have representation from different bodies and regulators in the field of accountancy, auditing,
law and capital market through their nominees as part time members. The functions of NFRA
include the standard setting; monitoring, compliance, review and overseeing quality of
service; and enforcement. NFRA is given a mandate to undertake investigation or conduct
quality review of audit of following class of companies:
● Listed Companies
● Unlisted companies with net worth equal or more than Indian Rupees (INR) 500
crores or paid up capital equal or more than INR 500 crores or annual turnover equal
 or more than INR 1 000 crores as on 31st March of immediately preceding financial
year; or
● Companies having securities listed outside India

The inherent regulatory role of ICAI shall continue in respect of its members in general and
specifically with respect to audits of private companies and public unlisted companies below
the threshold limit. Quality Review Board (QRB) will also continue to review the audits of
private limited companies and public unlisted companies below prescribed threshold.

NFRA vs. ICAI

The National Financial Reporting Authority Rules, 2018 (NFRA Rules) were published in the
official gazette on 14th November, 2018. As per Rule 3 (1), the NFRA shall have the power
to monitor and enforce compliance with accounting standards and auditing standards, oversee
the quality of service or investigate the auditors of the following classes of companies:

Rule 3(1) -
(a) companies whose securities are listed on any stock exchange in India or outside
India;
(b) unlisted public companies having paid-up capital of not less than rupees five
hundred crores or having annual turnover of not less than rupees one thousand crores
or having, in aggregate, outstanding loans, debentures and deposits of not less than
rupees five hundred crores as on the 31st March of immediately preceding financial
year;
(c) 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 (b), (c),
(d), (e) and (f) of sub-section (4) of section 1 of the Act;
 (d) any body corporate or company or person, or any class of bodies corporate or
companies or persons, on a reference made to the Authority by the Central
Government in public interest; and
(e) a body corporate incorporated or registered outside India, which is a subsidiary or
associate company of any company or body corporate incorporated or registered in
India as referred to in clauses (a) to (d), if the income or net worth of such subsidiary
or associate company exceeds twenty per cent of the consolidated income or
consolidated net worth of such company or the body corporate, as the case may be,
referred to in clauses (a) to (d).

Interestingly, the ICAI will continue to regulate auditors of private companies and unlisted
public companies below the threshold limits under Rule 3 (1)(b). Similarly, the Quality
Review Board (QRB) will continue to oversee the quality of services of auditors of such
private companies and unlisted public companies.

However, such private companies and unlisted public companies are still required to inform
the NFRA of the particulars of their auditors, as per Rules 3 (2) and 3 (3). This will enable
the NFRA to notify companies when their auditors are penalised or debarred in disciplinary
proceedings by the NFRA. Additionally, the NFRA is empowered to refer cases to the QRB
relating to the quality of services of auditors of companies which are specified under Rule 3
(1).

On 1st July, 2019, the MCA issued a notification requiring all body corporates not governed
by the NFRA Rules to fill Form NFRA-1 regarding the particulars of the auditor appointed
by such body corporates. The last date for such a filing is 31st July, 2019.

A crucial distinction is found in the major function of the NFRA, which is to protect the
public interest and the interests of investors, creditors and others associated with the
companies or bodies corporate governed under Rule 3 (1) (supra) by establishing high quality
standards of accounting and auditing and exercising effective oversight of accounting
functions performed by the companies and bodies corporate and auditing functions performed
by auditors.
While Rule 6 of the NFRA Rules provides that ICAI shall give recommendations to the
NFRA in relation to accounting and auditing standards, it appears that the NFRA is expected
to relieve ICAI of its power sof regulating and establishing standards for accounting and
auditing in India.

If the auditing profession is expected to return to the position of integrity on which it was
built, the NFRAand the ICAI must work together towards regulating the profession and
establishing high standards in line with global expectations.

A prominent member of ICAI, while speaking on the state of the auditing profession in India,
was quoted as saying, “The institute [ICAI] has to think deeply on the current issues. Where
is the profession headed in India? Has the institute been just a tool at the hands of small
accounting firms? Has it discharged its obligations in taking disciplinary actions? Has it been
forward looking on the global developments? Has it participated adequately on the broader
theme of corporate governance and how it can contribute to the debate?”