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NFRA for changing rules of business

The NFRA will need infrastructure, talent, technology and a high quality membership to keep pace with the times.

In the suite of corporate governance reforms, if there is anything that the Government is not rushing to implement, it is the constitution of National Financial Reporting Authority (NFRA). The new company law makes way for setting up this accounting and auditing regulatory authority which will replace the present advisory body, the National Advisory Committee on Accounting Standards (NACAS) formed under the erstwhile company law. The NFRA is also likely to replace some of the functions of the Institute of Chartered Accountants of India (ICAI) like standard setting and disciplinary functions.

The Companies Act 2013 provides that the NFRA shall make recommendations to the Central Government on the formulation and laying down of accounting and auditing policies and standards; monitor and enforce the compliance with accounting standards and auditing standards; oversee the quality of service of the professions associated with ensuring compliance with such standards. It will also suggest measures required for improvement in service and such other related matters. The NFRA shall consist of a chairperson appointed by the Central Government and up to 15 other part-time and full-time members.

The NFRA in this regime will have vast powers to investigate into the matters of misconduct committed by any member or firm of chartered accountants and will have the same powers as are vested in a civil court. Where misconduct is proved, the NFRA would have the power to impose penalty and even debar the auditor or the entire firm from auditing for up to 10 years.
We believe that the NFRA is going to enhance auditor independence. But to be really effective, it must comprise of people with high integrity and credibility, who are not only independent but are also seen to be independent.

The Companies Act 2013 also provides that the chairperson and members, who are in full-time employment with the NFRA should not be associated with any audit firm (including related consultancy firms) during the course of their appointment and two years thereafter. This does not mean that the NACAS and the ICAI should be seen as ineffective—both have played a crucial role in implementing Ind-AS, and ICAI has upheld the trust and respect for the auditing profession for 66 years now—all of this is more than commendable.

However, the rules of the game are changing. On one hand, businesses and their structures are increasingly sophisticated, and the accounting and financial reporting is becoming more complex than ever before.
On the other hand, auditing too is getting more challenging than ever as businesses try to keep pace with the complexities of the environment and changing landscape of company law. There is every possibility of the audit quality getting compromised, or even simply, things falling through the cracks.

“Globally, a profession that was self-regulated could no longer seen to be independent or having the credibility to set standards and enforce them.”

The profession of auditing around the world was self-regulated for the longest time—by the American Institute of Certified Public Accountants (AICPA) in the US, by the Institute of Chartered Accountants in England and Wales (ICAEW) in the UK and by the ICAI in India. However, those countries moved to an independent regulator of the profession with the establishment of the Public Company Accounting Oversight Board (PCAOB) in the US and the Financial Reporting Council (FRC) in the UK over a decade ago. The issue is not whether self-regulation was working or not but simply that a profession that was self-regulated could no longer be seen to be independent or having the credibility to set standards and enforce them.

Though the budget for the NFRA will come from the Government, the corporate sector too could get involved in its funding. In the United States, listed entities pay a small amount as part of their listing fee to fund the PCAOB. In the US, however, the PCAOB is responsible only for auditing standards and accounting standard setting activity remains the responsibility of the Financial Accounting Standards Board (FASB).

Another debate I often hear is whether the US PCAOB is really effective in sustaining audit quality. There can never be a fool-proof mechanism to detect an orchestrated accounting fraud. And audit is not even designed to detect one. What is at stake is a mechanism to ensure the quality and effectiveness of the auditing standards and procedures.Nevertheless, whoever has dealt with the PCAOB will undeniably agree with the rigour of their work. The NFRA will have to be as rigorous, and maybe even more, given the maturity and discipline of corporate governance in India. But setting up the NFRA alone will not change anything. It will have to be equipped with the best infrastructure in terms of talent and technology to keep it one step ahead of companies and their auditors.

Members of the NFRA will have a great public interest duty, as auditing is about serving a wide public interest—and when auditors get it wrong, it is society at large that suffers through loss of savings, investments and credibility of the system. Investors want the profession to apply the highest standard and without that there is no future for the profession. We encourage the government to take all the steps to make the NFRA operational at the earliest.

(Vishesh C Chandiok is the national managing partner of Grant Thornton India LLP).

The article appeared on CFO-INDIA. The article can be found here.