(Source: BloombergQuint) 

Redesign ICAI For The Contemporary World

BloombergQuintOpinion

Those who midwifed the Institute of Chartered Accountants of India in 1949 would hardly recognise it in 2018: deficient self-regulation, riddled with conflict of interest, churlish election campaigns... They could not have imagined 2.5 lakh members being ruled by 40 mostly unexceptional people filling as many committees. Unquestionably, the ICAI needs fixing. The recent report of a committee of experts is a reality check on the state of affairs and the future of the audit profession.

Independent Oversight

The formation of the National Financial Reporting Authority superseding the ICAI is the end of self-regulation. The committee has recommended strengthening NFRA including dissemination of its findings on audit deficiencies.

Naming and shaming sloppy and dodgy auditors will help separate the wheat from the chaff.

The appointment of the chairperson and a member of NFRA is proof of the government’s resolve. A separate law will further strengthen its independence.

Also read: NFRA Rules Notified: Audit Super Regulator To Scrutinise Listed And Large Unlisted Companies

Audit Networks

The committee has concluded that the term ‘multinational accounting firm’ is a “misnomer”. Indian chartered accountant firms that are part of the Big Four and other international networks are registered in India and staffed by members of the ICAI. Big firms spend more on technology and training and pay higher salaries. Medium and small firms should merge in order to compete with them. Many CA firms are family outfits, regarded as heirlooms to be inherited. If they want to grow, they should become professional enterprises. Concerns about anti-competitive conduct are best handled by the Competition Commission of India.

That said, there are questions about a Big Four affiliation.

If the Big Four firms are just brand names, are clients and investors justified in assuming that they have identical worldwide standards?

Audit firms, especially the too-big-to-fail ones, should improve their governance by having independent supervisory boards.

Also read: There’s Something Rotten In The State Of Audits In India? Bah, Say Auditors.

Advertising And Promotion

The prohibition on advertising by CAs is a relic of the past when high-minded individuals operated as clubs. Existing members protect their turf and create obstacles for newcomers. Advertising will help new entrants and increase competition. Business promotion happens even now by distributing business cards, maintaining websites, and giving gifts.

The committee’s recommendation to permit CAs to advertise will end this pretense.

Multi-Disciplinary Practices

In a multi-disciplinary practice a lawyer joins with a non-lawyer to provide legal and non-legal services. An MDP is a one-stop shop for legal, accounting and other services. Even now, accounting firms can hire lawyers, and law firms can hire accountants. Efficiency and cost savings are the key arguments for MDPs. PwC and Deloitte are respectively the sixth and seventh largest legal services providers in the world. Accounting firms have an edge in using artificial intelligence and machine learning. The committee’s proposal to allow MDPs will enable audit firms to provide integrated services. Safeguards are necessary to maintain independence.

Non-Audit Services

Non-audit services such as tax advice and consulting are more lucrative than auditing. However, there are concerns about conflict of interest and loss of independence. Currently, auditors are barred from providing accounting, internal audit, and a few other services to their audit clients. While tax advisers strive to minimise their clients’ tax expense, auditors report on the fairness of the financial numbers. The committee has recommended adding taxation, valuation, and restructuring services to the prohibited list.

Tax audit too should be prohibited because of the inherent conflict.

The committee’s recommendations to cap non-audit fees at 50 per cent of audit fees and disclose them to NFRA should improve auditor independence and transparency.

ICAI’s Stranglehold On The Economy

CAs’ legal monopoly in accounting, audit and tax gives them enormous influence over financial markets and institutions and tax administration. The ICAI’s council members are on the boards of RBI, SEBI and IRDAI boards and key government committees.

This is a textbook example of regulatory capture.

The ICAI’s vehement opposition to NFRA shows that it does not care a hoot about accountability. Having got used to decades of capitulation by the authorities, it is unable to stomach the idea of external scrutiny.

ICAI’s challenging the legality of NFRA is outrageous. Probably, it has become too big to regulate. However, it is reassuring that the government has not given in to the pressure.

ICAI’s Flawed Governance

ICAI’s governing council is fraught with conflict. First, CAs elect the council members, who are expected to discipline them.

It must be clumsy to ask for votes after punishing the voters.

Second, council members compete with other CAs for business, but their office and contacts give them an unfair advantage. There is a high risk of self-dealing with no effective safeguards.

Third, council members give opinions on matters that may be later examined by the council. Finally, council members prescribe the CA curriculum and set the examination, and concurrently run coaching shops. Ominously, the number of such ‘edupreneur-CAs’ appears to be increasing over the years.

Also read: At Last, a Small Step to Fix Audit’s Conflict of Interest

The Way Forward

Two radical changes are required.

First, the ICAI should be restructured as a demutualised organisation. An independent board should govern the ICAI. The board may comprise professionals selected by a nomination committee appointed by those who have a stake in financial reporting, including accountants, investors, bankers, lawyers, insurers, government, and regulators.

A team of professionals should manage the organisation and report to the board. Education, training, examination, and research can be managed by autonomous divisions.

CAs will be given a licence to practice but should have no say in running the organisation.

The National Medical Commission which has recently replaced the Medical Council of India can be the model.

Second, the government should introduce competition in the grant of accounting credentials. The monopoly of the ICAI should be ended by setting up a new, demutualised organisation, called The Institute of Certified Public Accountants of India. Many countries, like Australia, Brazil, France, Germany, Indonesia, Iran, Ireland, Malaysia, and the U.K., have more than one recognised accountancy body.

The National Stock Exchange is an example of how demutualisation and competition can transform a disgraced trade. In the 1990s, it was set up as an alternative to the broker-owned, conflict-ridden Bombay Stock Exchange. For much of its existence, the NSE has led in market capitalisation, trading volume, new products, technology, and investor trust.

The ICAI faces the worst crisis of credibility in its history. “You never want a serious crisis go to waste,” said Rahm Emmanuel, who served as Chief of Staff to U.S. President Barack Obama. There can be no better way to benefit from the crisis than making sure the accounting profession is fit for purpose.

R Narayanaswamy is Professor of Finance and Accounting, Indian Institute of Management, Bangalore. Views are personal.

The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.