NFRA’s suggestion to exempt MSMEs from statutory audit may prove a hurdle in insolvency resolution
The National Financial Reporting Authority (NFRA)’s consultation paper — Statutory Audit and Auditing Standards for Micro, Small and Medium Companies (MSMCs) — suggested relaxing the statutory audit obligation of small companies.
The Institute of Chartered Accountants in India (ICAI) has already rejected the NFRA’s recommendations terming it as views of a small section of stakeholders and not based on research-based evidence.
Industry experts feel that the move could create serious hurdles for investors, insolvency professionals, banks, minority shareholders, venture capital funds, angel investors and also create scope for fraud. Bank finance will dry up for small units as banks usually lend to SMEs on the strength of audited reports.
The consulting paper proposes to fix a threshold for MSMCs with net worth below Rs. 250 crore that are subjected to get a relief from the annual statutory audit mandated by the Companies Act, 2013. The paper also suggests setting up a separate set of auditing standards for the MSMCs.
NFRA in its paper argues that as most MSMCs are family-owned enterprises, there is no public interest in foisting external audits on them.
Though the intention behind the paper is to assist MSMCs and enable ease of doing business, industry representatives observe a lack of popular demand and sound rationale behind the proposed recommendations.
- CA Vivek Davanam
“There has been no discussion whatsoever on the outcome the regulator seeks to achieve by removing audits other than for cost savings. Have any industry bodies sought for a change in the present system? No analysis has been done showing the benefits and drawbacks of the current system of audits.
The paper states that there is a mismatch between current payments being made to auditors as reported by the companies. It argues 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 that the audits are not up to mark. 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 alternate mechanism that it would introduce after removal of audits.
Auditing standards have been useful in ensuring the uniformity of the audit reporting and standardization of the audit practice.
We need no separate set of standards as Auditing Standards are the yardsticks against the quality of audit. Auditing Standards provide minimum guidance to the auditors to fulfill the objective of the audit and ensure the quality of audit and thereby keeps the profession relevant.
Audits conducted in line with the standards set by the ICAI will rescue the auditors in the event of fraud, defend them in case of questioning by the statutory authorities and define their role and responsibilities against the shareholders.
Any dilution to the Auditing Standards will reduce the scope of the auditor and result in a poor-quality audit, which poses a great threat to the reliability of the audit report and the immunity of the auditor against the inverse situations.”
- CA Guruprasad Makam
“According to the NFRA, exempting small companies from mandatory audit would result in furthering ease of doing business. Removal of statutory audits will not help in improving India’s rank in any way but result in a poor score. India has relatively performed better in financial parameters such as ‘Protecting Minority Interests’ and ‘Getting Credit’. The existing statutory audit has ensured India in getting a good rank in financial parameters considered by the World Bank.
Similarly in cross-border transactions, without the audit under Section 92 of the income tax Act, and without adequate processes, it does become difficult to achieve governance and transparency.
The financial risk of suppliers, customers and employees does not depend on any financial threshold, and they currently draw succor from company form of organisation and its implied authenticity of financial information.
Auditors verify and report on compliance, valuation / estimates in the financial statements of basic items such as receivables, cash and inventory. Removal of this requirement does not obviate other, more expensive options for potential borrowers, seekers of investments or other tenders and RFIs that companies routinely answer.
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
“With the focus of avoiding undue burden for MSMCs, NFRA has done a preliminary analysis of key financial parameters of companies with net worth below Rs. 250 crore. The proposed threshold creates a new set of challenges for insolvency resolution professionals.
As per the Insolvency and Bankruptcy Board of India (IBBI) data, of the 234 cases resolved under the Insolvency and Bankruptcy Code (IBC) till May 31, 2020, in 144 cases the financial creditors had an admitted claim of less than Rs 250 crore and in 176 cases, they recovered amounts less than INR Rs 250 crore. None of these cases have net worth in excess of 250 crore as prescribed by NFRA. The insolvency period is just 180 days. 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.
Using international benchmarks is misleading. Systems are different, voluntary compliances are different, development indices are different. Around 50% of the population of countries (US, UK, Singapore, Australia), which have abolished statutory audit, have a bachelor’s degree or an equivalent qualification. In the Indian context, only 8% of the population has got a bachelor’s degree or an equivalent of that. In the digital era, it will not be possible for SMEs to be vigilant on ‘Evolving Frauds’ without the auditor.”
- B.S. Shashi Kumar, VP Finance, Autotec Defense and Aerospace Solutions
“Absence of an audit 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 audit, scope for such frauds is less and in case of a fraud, the auditor is also held responsible.”
Also See: Highlights of pre-pack scheme for MSMEs
