All about NFRA in 5 minutes

The Union Cabinet last week approved the proposal to set-up the National Financial Reporting Authority (NFRA), intended to serve as an Independent Regulator for auditing profession.

After recent PNB scam and other financial scams and frauds in the country, NFRA is a very welcoming move by the present government.

What does section 132 say about NFRA?

The Companies Act 2013, through section 132, gives the Centre the power to set up such an authority to regulate the auditors of the companies. A Parliamentary committee also recommended constitution of one such committee.

Section 132 of the Act provides for the creation of NFRA for matters relating to accounting and auditing standards under the Act.

What are the key functions of NFRA?

• Recommendations to the CG on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or their auditors.
• Monitor and enforce the compliance with accounting standards and auditing standards in such manner as may be prescribed.
• Oversee the quality of service of the professions associated with ensuring compliance with such standards, and suggest measures required for improvement in the quality of service and such other related matters as may be prescribed.
• Have the power to investigate, either suomotu or on a reference made to it, for specified class of bodies corporate or persons, into the matters of professional or other misconduct committed by any member or firm of Chartered Accountants.

Who will be on the bench of NFRA?

NFRA will comprise a chairperson, three full-time members, and a secretary.

Why is NFRA needed?

• Auditing Requires Complete Independence: Auditor has been entrusted with the responsibility to ensure the truthfulness and correctness of financial statements before these are presented to its various stakeholders. However, there is an inherent conflict of interest in the auditing process as the auditee company also pays the auditor. In order, therefore, to ensure that the auditor performs his responsibility to the desired levels, they are regulated and subject to auditing standards and potential liability.
• Independent Regulator is needed: In the wake of the accounting scams worldwide, Independent Regulators like PCAOB (US) and FRC(UK) have been established and other major countries have also followed the same trend. Therefore, being worlds one of the largest economies, India is expected to do the same.
• Deficiencies of Self-Regulation Model: The present electoral process of appointing regulators is inherently saddled with compromises and attracts professionals who may not be best suited for the task at hand. Members or their elected representatives should not be expected to take action against themselves. It is a bit like asking students to grade their own homework.
• Request by other regulators: SEBI had engaged an International Consultant to revisit their structural and organizational issues. The Consultant in their report has clearly stated that 'Currently the ICAI is responsible for maintenance of accounting, auditing, and ethical standards.
  However, the ICAI's oversight is passive in nature and with limited focus on active investigations. In addition, oversight is rendered challenging given a large number of auditors in India (around 15000 vs around 3000 in the USA). In the long term, we recommend that SEBI drive the case for establishing a separate regulator (NFRA) which is independent of the audit profession.

What are ICAI's reservations against NFRA?

• Multiple Regulatory Bodies: Creating NFRA would result in two regulatory bodies (ICAI and NFRA) governing the same audit profession. This would result in duplication of efforts, added huge costs with no significant incremental benefits.
• The relevance of NFRA in the context of the Companies Act 2013: The objective of NFRA is to regulate audit quality and protect the public interest. These, in any case, are also the main objectives of ICAI which strives to be a world-class regulator.
• Competent Disciplinary Mechanism: The existing Disciplinary Committee of ICAI normally completes the process in a reasonable period of about three to four years.
• Auditing Standards: ICAI as a world-class regulator would be more aligned to market needs, international practices and risks to be able to define and improve Auditing standards rather than NFRA.
• Uniform administration: Scale based differentiation of regulating authority may results in conflicting judgments on the same issue. Seamless coordination may always not be possible between NFRA and ICAI due to the multiplicity of disciplinary issues that may be handled by both agencies.

What is ICAIs role now after NFRA?

ICAI's role will continue in respect of its members, in general, and, specifically, with respect to audits pertaining to private limited companies and public unlisted companies below the threshold limit to be notified in the rules.

ICAI will continue with its advisory role on accounting and auditing standards and policies by making its recommendations to NFRA.

How does the community view NFRA?

For some, it is a welcoming move towards more transparent auditing, quality improvement and strict disciplinary actions against wrongdoers. For others, it is a warning signal to not to go astray.

What do you think about the latest establishment of NFRA as a regulator of Chartered Accountants? Do let me know in the comments below.