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MCA report on regulating Audit firms and the Network

Posted on 12 November 2018,    
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Auditors are to resolve agency problems. Moreover, independent audits are fundamental to taking informed and correct investment decisions. Availability of trustworthy nancial information on the performance of companies is important to proper functioning of market economy. Serious concerns arise if auditors' independence is compromised or the trust reposed on them is betrayed.

Determining whether an auditor is independent in fact as well as in appearance is complex. This is especially so because audit rms across jurisdictions often provide services as part of one common `network'. Consequently, separate rms belonging to the same network could provide audit as well as non-audit services to the same audit client or its holding company or subsidiaries across the same or di erent countries. This can give rise to the problem of con ict of interest where independence of the auditor may be compromised. Therefore, measures like sucient disclosure on total fees, imposing cap on non-audit fees from the audit client, revisiting the scope of prohibited non-audit services are needed to address the issue of con ict of interest, especially at the network level.

These networking arrangements also create an impression that the Indian audit rms which are aliated with these international networks constitute Multi-national Accounting Firms (MAFs). However, on closer scrutiny it turns out that these Indian audit rms are set up as partnerships or Limited Liability Partnerships (LLPs) under Indian laws and all their partners are members of the ICAI. Therefore, there is neither any violation of section 29 (reciprocity) nor any violation of section 25 (companies not to engage in accountancy) of the Chartered Accountants Act, 1949. Neither can such Indian audit rms be simply be equated to multi-national corporations. Consequently, the term `MAF' is a misnomer.

However, such Indian audit rms admittedly follow various internal processes, policies and methodology adopted by their respective networks internationally. This is aimed at maintaining consistent standards in audit quality globally within a network. While such networks bring better business opportunities in a global economy, they should be subject to necessary checks and balances. Legal measures need to be supplemented with adequate institutional reforms.

Time and again corporate scandals and accounting frauds have nudged institutional reforms across jurisdictions. One such fundamental reform that has happened globally in the last two decades is a shift away from the Self-Regulatory Organisation (SRO) model towards an independent regulatory structure for the audit profession.

In the aftermath of Enron, the U.S. enacted the Sarbanes Oxley Act, 2002. The Supreme Court in its judgment dated February 23, 2018 has referred to this statute to examine the need of an oversight mechanism for the audit profession. This law inter alia provided for the setting up of the Public Company Accounting Oversight Board (PCAOB) as an independent audit regulator to oversee the audits of public companies. Similarly, U.K., also has a two-tier structure, where the Financial Reporting Council (FRC) is the independent regulator for the audit profession.

In the Indian context, the Satyam incident has been a wake-up call for policy-makers. Pursuant to the global trend of shift from SRO model to an independent regulatory model for audit profession, the Companies Act, 2013 provided for the setting up of the National Financial Reporting Authority (NFRA). However, the continued opposition to the establishment of NFRA has delayed the implementation of this critical reform. Consequently, although Companies Act, 2013 was enacted in August 2013, the section establishing NFRA was noti ed only on March 21, 2018 along with the NFRA Chairperson and Members Appointment Rules, 2018. Once NFRA becomes fully operational, it will be adequately equipped to handle the contemporary challenges in relation to auditors, audit rms and networks operating in India.

Finally, it is important to facilitate a business-friendly environment for corporates as well as professionals in India. It is therefore vital that Indian laws and regulations on professional services keep pace with changing market dynamics.

Opening up professional services to competition is necessary and therefore, audit rms should be allowed to advertise with some restrictions. Further, in a global economy use of international brand names for audit rms must be allowed. Laws must be rationalised to promote Multi Disciplinary Practices (MDPs) to allow rms to o er a bouquet of high quality professional services at par with international standards. The Advocates Act, 1961 needs to be rationalised to facilitate development of Indian law rms as well as Indian audit rms into MDPs. Adopting these three measures i.e., advertising, branding and MDPs will not only enhance the standards of services o ered to corporates, but also facilitate the audit rms to expand in size/operation enabling them to compete

To know more in details, find the attached file

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