Responsible Principal Auditor, Responsible for Consolidated Financial Statements: NFRA Proposal

New Delhi: Lead auditors of business groups will be “ultimately responsible and accountable” for their consolidated financial statements even if subsidiaries or branches are audited by other auditors, according to a proposal released for public feedback by the National Financial Reporting Authority (NFRA) on Tuesday.

However, to prevent large audit firms from monopolising the audit market by taking over auditing of subsidiaries of smaller audit firms, the new requirement will only apply to public interest entities that fall under the purview of the NFRA, such as listed entities and large unlisted companies that meet certain thresholds, excluding select entities such as state-owned enterprises, state-owned banks and state-owned insurers. These entities have additional oversight from institutions such as the Reserve Bank of India (RBI) and the Comptroller and Auditor General (CAG).

“This would address any concerns about audit concentration (large audit firms cornering a large share of the audit market) as only about 30,000 firms out of the country’s estimated 1.8 million firms would be covered by these revised rules,” said one person briefed on how the NFRA works.

Closing regulatory loopholes

The revised standards for auditing group financial statements (Auditing Standard 600) seek to plug a regulatory loophole that had allowed corporate groups to get away with diverting funds through their subsidiaries. The revised standards, on which public feedback has been sought before the end of October, state unequivocally that the group partner, or lead auditor, remains “ultimately responsible for, and therefore accountable for, compliance with the requirements of this auditing standard.”

The current standard laid down by the Institute of Chartered Accountants of India (ICAI) allows the auditor of a parent company to rely on the work of the auditor of a subsidiary without being held liable for it, provided certain safeguards are met. NFRA’s concern is that because of this, any oversights, such as the diversion of funds from the subsidiary to, say, the group’s promoters, could go unnoticed.

Mint On September 1, it was reported that the NFRA was preparing to issue a draft of revised standards for auditing corporate conglomerates to address this gap.

The revised standards state that if the auditor of a subsidiary fails to detect an inaccuracy in the subsidiary’s financial information, an inaccuracy may occur in the group accounts, which the principal auditor may fail to detect. Therefore, the principal auditor must be sufficiently involved in the audit work of the subsidiary and ensure two-way communication. The revised standards provide guidance to the principal auditor in supervising and reviewing the work of the subsidiary auditor.

A request to ICAI seeking comment on the article remained unanswered at the time of publication.

Public interest entities

Vijay Kapur, former director of ICAI, welcomed the NFRA’s initiative to champion best practices for the benefit of the economy at large. “But it seems that keeping in mind the broader objectives, the NFRA has agreed to exclude state-owned enterprises, banks, insurance companies and their branches for the time being. It is to be hoped that these important public interest entities will be included soon as protection of investors’ interests is the primary objective of the NFRA,” Kapur said.

“It is a matter of great satisfaction for all retail investors that India is now witnessing the issuance of an auditing standard by an independent body, the NFRA,” Kapur said.

“The primary reason for proposing the adoption of a revised standard for group audits is to help safeguard the public interest and investor protection, and the need for a framework of standards that is sufficiently robust to meet the challenges posed by today’s complex financial systems,” the NFRA said in a note explaining its proposal.

The inherent complexity of group structures cannot be handled by the current version of SA 600 issued in 2002, the audit regulator said.

The NFRA noted in its explanatory notes that some of the Indian companies have more than 100 subsidiaries, joint ventures and associates, with the highest number being 335.

Vishesh C. Chandiok, chief executive of consultancy Grant Thornton Bharat, said it was encouraging to see regulators laying out their reasons for the proposed changes, including consideration of apprehensions around alignment. “We believe this proposal will help bring global best practices into group audits with clarity on the role of the lead auditor, greater transparency in component reporting and, essentially, improve confidence in financial reporting,” he said.