Should Small Companies Be Exempt From Statutory Audit?
India’s tradition of accounting, auditing, and reporting practices can be traced tens of centuries back. Through his studies, this author could find in several scholars’ researched publications Indian practices for reporting, and exacting accountability from people responsible for the exchequer dating as far back as 1500 BC.
According to Kautilya’s Arthshastra, these practices continued over centuries with progressively improved processes for ensuring accountability of rajashyas (kings’ levies) and expenses to run kingdoms. The underlying objective of exacting such accountability used to be mitigation of risks perceived by the kings. Pre-Vedic and Vedic literature, written by Rishi (sage) Veda Vyas, sages of his clan, and subsequent other literature, also contain references about audits. So audit compliance isn’t a new ask in this land.
On Sept. 28, the National Financial Reporting Authority put up a Consultation Paper on Statutory Audit and Auditing Standards for Micro, Small and Medium Companies. The predominant objective behind its proposals is to improve India’s rank for ease of doing business in reports published by the World Bank. It is a perceived reality that such a rank, touted to be a prestige mark for any economy, has prompted many countries to reduce and/or simplify legal and regulatory red tapes. However, it is also a fact that the World Bank has discontinued publishing these reports because of irregularities and data manipulations.
So let’s keep aside the ranking itself, and look at the ten major criteria on which countries were assessed for that index. Those major sub-indices, briefly, are: ease of starting a business measured using certain parameters, obtaining permissions for the construction of facilities, connecting for electricity supply, registration of properties, obtaining credits and loans, protecting investors’ rights, paying taxes and levies, conducting cross-border business, enforcement of contracts, and quick resolution of insolvency.
Keeping these ten parameters in view, the key question that needs to be answered is whether exemption from audit would be of any help for MSMEs to start and run a business at ease. Readers must be aware that two audits under GST Act and tax audits under the Income Tax Act have already been abolished for entities with turnover up to Rs 10 crore. For the latter, the exemption is granted, and rightly so, only if more than 5% of transactions are not conducted in cash. Exemptions have also been granted to many under the Companies Auditor’s Report Order, 2020.
A complete audit holiday, as proposed by NFRA, would mean that there would be no third-party oversight for many companies and the ecosystem would be a kind of free-for-all and hence do as you like.
None can expect to do away with at least one or two window-based approvals, following a simplified procedure, before incorporating an entity and getting all that is needed to run it. Even for granting that and subsequent monitoring, the designated authority would most certainly need to reliably know about the promoters’ identity and source of funds. Again, any investor and lender would also exercise informed judgment based on the financial state of affairs of any entity before staking money on that enterprise. None can deny that reliable financial information is the most critical requirement for such judgment. No regulatory authority would, in the best of their members’ wisdom, agree that reliability is established only by the assertion of executives at the helm of affairs of any entity. At least history does not prove that. Therefore, there is a basic need for attestation by a duly qualified individual performing within the realms of professional ethics.
One of the arguments in the consultation paper is that many of those entities do not have a turnover worth the amount that can warrant a statutory audit. The simple point to rebut this is that many investigations of financial irregularities have conclusively established that paper companies are incorporated for conducting transactions through balance sheet line items. One of the motives for that is the evergreening of money. Even cross-border related party transactions are done for objectives not worth to be written about.
Any argument would defy common sense in believing that promoters run a company without any pecuniarily beneficial motive. For a better score on the sub-index item on dispute resolution, NFRA would do well by encouraging/mandating alternate resolution processes instead of crowding the corridors of courts and tribunals. Again, for these processes, third-party attested financial statements are a must.
The consultation paper also contains examples of developed countries where audits have been exempted for certain categories of companies perhaps with a veiled idea that India should also do that. It is not long before investors from developed countries had shouted for reliable financial information from Indian entities. The International Financial Reporting Standards and internal financial controls for financial reporting inter alia have helped deliver that. Indian Chartered Accountants have served and are continuing to serve meeting expectations. Needless to mention that auditing standards being followed by them are at par with related international standards. The question, therefore, is why India should imitate developed countries?
NFRA must reflect on-ground realities and apply judgment to do what would best befit the country’s needs. India’s ongoing reform measures are for encouraging young entrepreneurs and ‘startupians’ to come forward, serve the nation, and thus the world, for inclusive and shared values.
Indians are generally by nature non-litigating and law-abiding. Then why this move to go back to the dark era of protected confidentiality?
The new generation of Indian entrepreneurs is unlikely to view audit as a compliance burden.
Let us remind ourselves of the rich and respectful tradition of India to consider auditors as guides and conscience keepers. Their service is indispensable to review with risk orientation all that an entity does and is to be reported. The author is of the view that there is no need to influence and change the hitherto well-served entrepreneurial attitude and approach in considering statutory auditors as professionals for establishing the reliability of financial statements, risks management, and thus sustainable prosperity of stakeholders.
Paritosh Basu is Senior Professor and Chairperson of the MBA (Law) Program at NMIMS University School of Business Management.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.