Lead auditor responsible, accountable 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 on Tuesday for public feedback by the National Financial Reporting Authority (NFRA).

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

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“This would address any concerns about audit concentration (large audit firms cornering a large share of the audit market) as only about 30,000 companies out of the about 1.8 million companies in the country, would get covered by these revised standards,” said a person informed about NFRA’s functioning.

Plugging regulatory loophole

The revised norms for auditing group financial statements—standard of audit (SA) 600—seeks to plug a regulatory leak that had allowed business groups to get away with fund diversions through subsidiaries. The revised norms, for which public feedback has been sought by the end of October, unambiguously states that the group engagement partner, or the lead auditor, remains “ultimately responsible, and therefore accountable, for compliance with the requirements of this standard of audit.”

The existing standard set by the Institute of Chartered Accountants of India (ICAI) allows a parent company’s auditor to rely on the work of a subsidiary’s auditor without being held responsible for it, subject to safeguards. NFRA’s worry is that because of this, any lapses such as diversion of funds from the subsidiary to, say, the group’s promoters could go unnoticed.

Mint reported on 1 September that NFRA was set to issue a draft of revamped rules for the audit of business conglomerates to plug the loophole.

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The revised norms say that the auditor of the subsidiary failing to detect a misstatement in its financial information could lead to a misstatement in the group’s accounts and the lead auditor may not detect this. Therefore, the lead auditor should sufficiently get involved in the work of the subsidiary’s audit and ensure two-way communication. The revised norms offer guidance to the lead auditor for supervision of the subsidiary’s auditor’s work and its review.

A request sent to ICAI seeking comments for the story remained unanswered at the time of publishing.

Public interest entities

Vijay Kapur, a former director at ICAI, welcomed the NFRA move to uphold the best practices in the overall interest of the economy. “But it appears that having regard to the larger goals, the NFRA agreed to exclude state-owned companies, banks, insurers and their branches for the time being. One may hope that such significant public interest entities will be included soon since protection of investors’ interest is the primary objective of NFRA,” said Kapur.

“It is a matter of great delight to all lay investors that today India is watching the issuance of auditing standard by an independent entity, NFRA,” said Kapur.

“The primary reason for proposing adoption of a revised standard for group audits is to help safeguard public interest and investor protection, and the need for a standards framework that is robust enough to meet the challenges posed by complex financial systems today,” 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.

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NFRA said in its explanatory notes that some of the Indian companies have well over 100 subsidiaries, joint ventures and associates, and the highest was 335.

Vishesh C. Chandiok, chief executive officer of consulting firm Grant Thornton Bharat, said it was encouraging to see the regulators presenting their rationale for the proposed changes, including their consideration of apprehensions related to the alignment. “We do believe that this proposal will work towards bringing in global best practices in group audits with clarity in the role of principal auditor, enhanced transparency in component reporting and essentially enhancing trust in financial reporting," he said.