Auditors in India are up in arms against a proposal by the National Financial Reporting Authority (NFRA) to do away with the statutory audit of small and medium companies.
The regulator of auditors of listed and large companies in India has issued a consultation paper, the “Statutory Audit and Auditing Standards for Micro, Small and Medium Companies (MSMCs)”, which proposes to fix a threshold for MSMCs.
Companies below the INR 2.5bn (£24.85m; $32.88m; €29.15m) mark are proposed to be exempted from mandatory annual statutory audit currently stipulated under the Companies Act 2013.
The NFRA also proposed a separate set of auditing standards for MSMCs.
Though the intention behind the paper is of assisting MSMCs and ease of doing business, stakeholders say the proposals, if implemented, will lead to drying up of bank finance for small and medium companies, frauds and deter venture funds and angel investors from potentially profitable small ventures.
The white paper
A group of chartered accountants and consultants issued a white paper as a comprehensive study of the pros and cons of the suggestions made by the regulator and the impact they will have on various stakeholders.
The white paper said the recommendations are not based on research-based evidence and therefore reject them as they will have serious impact on all stakeholders and the economy in general.
“Doing away with the established practice can remove the basic gatekeeping function and put all the stakeholders’ interests such as public exchequer, government, lenders, investors, suppliers, customers and employees at risk,” they said in the document.
Prompted by a set of incentives offered to entrepreneurs by the Indian government, many NRIs started small businesses in India and they welcome the audit exemption proposal which will save them the audit fee.
At the same time, lured by the statutory audit fees from thousands of small units, many qualified NRIs started consulting and auditing services firms in India. If implemented, the proposals will deprive them of a major revenue stream.
The Institute of Chartered Accountants in India (ICAI) has already rejected NFRA’s recommendations deeming them as views of a small section of stakeholders and not based on research-based evidence.
Serious hurdles for investors
Industry experts feel that the move could create serious barriers for investors, insolvency professionals, lenders, minority shareholders, venture capital funds, angel investors and will also create scope for fraud.
Bank finance will dry up for small units as banks usually lend to SMEs on the strength of audit reports.
“The consultation paper states that there is a mismatch between current payments being made to auditors as reported by the companies,” said Vivek Davanam, a chartered accountant and co-author of the White Paper.
“NFRA says that as the audit fee being charged in many companies is less than the estimated cost, there is a likely assumption that audits performed are not up to the mark. This is just an assumption and not supported by any evidence.
“There is no actual finding whether there are deficiencies in the audit performed in cases where low fee is charged. NFRA has not even made an attempt to suggest an alternative mechanism that it would introduce after removal of audits,” he added.
Status quo demanded
The white paper, which called for maintaining status quo as far as statutory audit of small units is concerned, argued that the NFRA’s proposals are an attempt to address a non-existent problem.
Chartered accountant Guruprasad Makam, another co-author of the white paper, added: “This is an attempt to create an issue rather than resolving one. NFRA’s proposed reforms are neither warranted nor their need is felt. A hypothetical issue shouldn’t be a matter of concern for NFRA.
“Audit by chartered accountants acts as a safety net. A right audit showcases to the business promoters the health of their business. If you remove audit for aspiring SMEs, there is no independent financial health checkup and it may put the business itself in danger if corrective actions are not taken based on the financial health checkup report, which is the audit report and the audited financial statements.”
Jayesh Sanghrajka, insolvency and bankruptcy expert, said: “The proposed threshold creates a new set of challenges for insolvency resolution professionals. Without audited financial statements, an insolvency resolution professional is at risk and has no data to function and resolve the insolvency. The unaudited financial statements will have no common process or policy and it will be chaotic to read them.”
For BS Shashi Kumar, vice president of finance at Autotec Defense and Aerospace Solutions, it’s a worrisome factor that the absence of statutory audits will open up opportunities for fraud and misstatement of financial statements.
“If statutory audit is not insisted, it will give more room to commit fraud. In the existing structure, there is little or no room for stakeholders to verify the intended use of assets. A fraud can masquerade as ‘ignorance’ in the absence of a statutory audit in SMEs. With statutory audits, scope for such fraud is less, and in case of a fraud, the auditor is also held responsible.”
