Background

In November, 2018 the Ministry of Corporate Affairs (MCA) notified the National Financial Reporting Authority (NFRA) Rules, 2018. This has brought to reality the 5 year proposal of the government to create and establish an independent one stop regulatory authority to monitor the quality of services rendered by chartered accountants / statutory auditors of certain types of large entities. The Authority has been proposed in order to protect and safeguard interests of various parties such as creditors, investors and others associated with companies / bodies corporates by ensuring there is effective accounting and auditing standards in place.

Vide the notification dated 13th November, 2018 the MCA has clearly laid down the scope, jurisdiction, applicability, functions, duties and responsibilities of the NFRA.

A detailed look at the same:

1. Scope of the NFRA

The NFRA has been proposed to be established to monitor the professional services of auditors, enforcement and monitoring of accounting and auditing standards and initiate investigation of work of the auditors of notified entities.

2. Applicability

The Rules shall be applicable to auditors of the following entities:

1. All Listed entities / Listed body corporates
2. Unlisted entities with paid up capital of not less that Rs. 500 crores or annual turnover of Rs. 1,000 crores or having loans, debentures or deposits of not less than Rs. 500 crores as of 31st March of the preceding financial year
3. All Banks
4. All Insurance companies
5. All Electricity / Power companies
6. All Foreign subsidiary / Associate company of an Indian company mentioned in any of the above points if the income / Net worth of such foreign subsidiary /Associate company exceeds 2% of the consolidate income / net worth of the above mentioned Indian companies
7. Bodies corporate referred to it by the Central government

Once the NFRA rules become applicable to a company, then the applicability will continue for 3 more years even during such period the limits are reduced or the status of the entity changes.

3. Functions & Duties of the NFRA

1. Collect and maintain details of auditors appointed by companies to which the NFRA rules are applicable
2. Receive recommendations on amendments to existing accounting /auditing standards as well as new accounting / auditing standards from the Institute of Chartered Accountants of India (ICAI)
3. Basis on the above, recommend accounting and auditing standards for approval by the central government
4. Monitor and enforce compliance with accounting standards and auditing standards by way of review of financials as well as working papers of such bodies corporate, calling for additional information on internal control procedures, quality control and other procedures, seeking explanation from  concerned officials, personnel including the auditors
5. Oversee the quality of service of compliance professions by suggesting recommendations on modifying the audit procedures and processes to such bodies corporate
6. Ensure compliance with such standards and suggest measures for improvement in quality of service
7. Liaison with national and international organisations of independent audit regulators in establishing and overseeing adherence to accounting standards and auditing standards
8. Promote awareness in amidst bodies corporate in relation to compliance of accounting / auditing standards
9. Investigate, either suo motu or on receipt from central government, any information of fraud and or professional misconduct by the body corporate and or auditor.
10. Basis the investigation, issue show cause notice and initiate legal / disciplinary proceedings including but not limited to fines. This will include penalties and or debarring from professional practice

4. Complaint

1. Every existing Body corporate other than companies governed by these Rules has to inform to the NFRA in the prescribed Form and prescribed timeline, details of the auditor appointed
2. Every Auditor who comes under the ambit of these rules is required to submit a return in prescribed form or on before 30th April of every year

NFRA Vs ICAI?

The enactment of the NFRA and rules actually sent mixed signals. Speculation was rife that the enactment of the authority will render the professional body of Chartered Accountants – the Institute of Chartered Accountants of India (ICAI) toothless tiger. Amidst uncertainty that the disciplinary powers of the ICAI will be clipped, the Ministry of Corporate Affairs clarified that the ICAI will still be the sole regulatory authority for sole proprietorships, Partnership Firms, LLP’s, Trusts, societies and private companies and unlisted public companies that do not fall under the threshold / limits prescribed in the NFRA Rules, 2018.  The Rules only divests ICAI’s disciplinary and monitory powers over auditors of companies that come under the ambit of the NFRA Rules.

Besides the Quality review Board (QRB), constituted under Section 28A of the Chartered Accountants Act, 1949 since 2007 will very much make its presence felt by functioning in accordance with objects for which it was established – monitoring, quality analysis and audit, review, making recommendations and suggestions to the auditors in improving services.

Effective governance mechanism - need of the hour

There are many questions on whether there is need for another regulatory body in addition to the host of regulatory bodies already in place – the ICAI, SFO, RBI, CBI and even the Courts. But a look at the alarming increase in Non-performing assets (NPO) (across large companies, banks, insurance companies) large scale frauds, scams and tax evasion, sudden exit of auditors from such companies seem to have left the government with no other option except to establish another independent regulatory authority.

In doing so, India is only adopting accounting healthy practices followed by large economies the world over – be it the financial reporting council (FRC) in U.K or the The Public Company Accounting Oversight Board (PCAOB) in the U.S.A.

By bringing in the NFRA, the government has clearly demarcated companies and auditors that will be governed by it. The remaining will be under the scrutiny of authorities such as ICAI, SFO etc. However, ensuring proper systems, mechanism and credible people to run these bodies only can ensure their effective functioning. Given the unwanted excess baggage that the economy is carrying, establishing an independent public regulatory body is a welcome move. Time to pull up socks!