The National Financial Reporting Authority (NFRA)

The National Financial Reporting Authority (NFRA) is a body constituted under the provisions of Section 132 of the Companies Act, 2013. The constitution of this authority is effective from 1st October 2018.
The Union Cabinet approved the proposal to set-up the National Financial Reporting Authority (NFRA), intended to serve as an Independent Regulator for auditing profession. After various recent scams like PNB scam and other financial scams and frauds in the country, NFRA is a very welcoming move by the present government.

The aim of the Central Government in this regard appears to be:

Setting up of a separate and independent regulatory body to assist in the framing and enforcement of legislation relating to accounting & auditing and
Improving investor and public confidence in the financial reporting of an entity.

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.

Scope of the NFRA

NFRA has the power to investigate and also conduct quality reviews for a certain prescribed class of companies. While the draft NFRA Rules have not been prescribed yet, they would include the following class of companies if implemented as it is:
Companies listed in India
Unlisted Companies whose:
Net worth - Rs. 500 crore; or
Paid up Capital - Rs. 500 crore; or
Annual turnover - Rs. 1000 crore(As on 31stMarch of the preceding financial year); OR
Companies whose securities are listed outside India

The NFRA also holds the power of investigation of a certain class of bodies corporate or persons (auditors) in relation to matters of professional or other misconduct by a member or firm of Chartered Accountants or auditors. In this regard, as per the draft NFRA rules, the auditors or audit firms which conduct the audit of the following category of companies or their branches (including through the network/brand to which it belongs) whether directly or indirectly, are covered:
Audit of - 200 companies in a year;
Audit of - 20 listed companies;

Company or companies (whether listed or not), having:
Net Worth - Rs. 500 crores; or
Paid up Capital - Rs. 500 crores; or
Annual turnover - Rs. 1000 crores;(As on 31stMarch of the immediately preceding financial year); OR
Company or Companies listed outside India

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 suomotuor 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.

Composition of the NFRA

The Companies Act requires the NFRA to have a chairperson who will be appointed by the Central Government and a maximum of 15 members. The appointment of such chairperson and members are subject to the following qualifications:

They should be having an expertise in accountancy, auditing, finance or law.

They are required to make a declaration to the Central Government that there is no conflict of interest or lack of independence in their appointment.

All the members including the chairperson who are in full-time employment should not be associated with any audit firm (including related consultancy firms) during their term of office and 2 years after their term.

The terms and conditions relating to the appointment of the chairperson and members have not yet been prescribed. However, the draft NFRA rules outline the following composition of the authority:
1. Chairperson is a Chartered Accountant and a person of eminence having expertise in accountancy, auditing, finance or law;
2. Member – Accounting;
3. Member – Auditing;
4. Member – Enforcement;
5. One representative of the MCA not below the rank of Joint Secretary or equivalent (ex-officio)
6. One representative of RBI, being a member of the RBI Board is to be nominated by the RBI;
7. One representative of SEBI, being the Chairman of SEBI or whole-time member of SEBI is to be nominated by SEBI;
8. A retired chief justice of high court or a person who has been the judge of a high court for more than 5 years is to be nominated by the Central Government,
9. President of the Institute of Chartered Accountants of India (ex-officio)
The Chairman may also invite any other person to the meeting to give their expert opinion.

Role of the NFRA

The NFRA has the following responsibilities:
Make recommendations on the foundation and laying down of accounting and auditing policies and standards;
Monitor and enforce the compliance of the accounting standards and auditing standards:
Oversee the quality of service of the professionals (such as auditors, CFOs, etc) and suggest measures required for improvement in the quality of service;
Perform such other functions related to the above.

Prior to the constitution of this authority, the Central Government would prescribe accounting standards on the recommendation of ICAI. The ICAI would prescribe the same only after consulting with the National Advisory Committee on Accounting Standards who will provide their recommendations. The ICAI will now have to consult with the NFRA and examine its recommendations in this regard. Thus the National Advisory Committee on Accounting Standards is effectively replaced by the NFRA.

Jurisdiction of NFRA

The jurisdiction of NFRA for investigation of Chartered Accountants and their firms under section 132 of the Act would extend to listed companies and large unlisted public companies, the thresholds for which shall be prescribed in the Rules. The Central Government can also refer such other entities for investigation where public interest would be involved.
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The inherent regulatory role of ICAI as provided for in the Chartered Accountants Act, 1949 shall 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.

The Quality Review Board (QRB) will also continue quality audit in respect of private limited companies, public unlisted companies below prescribed threshold and also with respect to audit of those companies that may be delegated to QRB by NFRA. Further, ICAI shall continue to play its advisory role with respect to accounting and auditing standards and policies by making its recommendations to NFRA.

Powers of the NFRA

The NFRA shall have the following powers:
To investigate the matters of professional or other misconduct committed by a prescribed class of CA firms or CAs. No other authority can initiate or continue proceedings where the NFRA has initiated an investigation. Such an investigation can be initiated either suo moto (by itself) or on a reference made by the Central Government.
The same powers as a Civil Court under the Code of Criminal Procedure, 1908, in respect of a suit involving the following matters.
Discovery and production of books of account and other documents, at such place and time as may be specified by the NFRA
Summoning and enforcing the attendance of persons and examining them under oath
Inspection of any books, registers, and other documents of any person at any place
Issuing commissions for the examination of witnesses or documents

Where professional or other misconduct is proved, it shall have the power to impose the following punishment:
Penalty:
For individuals a fine between Rs. 1,00,000 to 5 times the fees received;
For firms a fine Between Rs. 5,00,000 to 10 times the fees received;
Debarring the member/firm from practice as a member of ICAI between 6 months to 10 years as may be decided
Any person who is not satisfied with the order of the NFRA can then make an appeal to the Appellate Authority.

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?

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.