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Cos that don’t matter must be out of audit net: Experts

The statutory audit requirement should be eased for small businesses, but only entities that do not matter should go out of the audit net when a threshold for exemption is set, audit experts and industry representatives said in response to a regulatory proposal.

Audit watchdog National Financial Reporting Authority (NFRA) last week published an analysis showing that most of the 600,000 active companies that have filed annual financial statements for FY19 have net worth —the difference between assets and liabilities—below ?250 crore and a large section of them paid paltry sums to auditors for their audits to have any quality.

NFRA sought industry views on whether a relaxation on the statutory audit requirement was needed and what the threshold should be. The regulator also pointed out that audit exemptions given in other markets such as the EU, UK, Singapore, and the US are based on balance sheet total, turnover, and number of employees.

Experts said that in the ideal scenario where businesses use public funds in the right manner, financial statements show a true and fair picture of the affairs of the firm, and 

due taxes are paid, the reliance on statutory audit may be less. However, in a market where the compliance level is not up to scratch and small firms access public funds, there is a need for an independent auditor to vouch for the quality of their financial statements. However, in the case of small firms with no borrowings and where tax implications are insignificant, statutory audit may not be required.

Pradeep Multani, president of PHD Chamber of Commerce and Industry, which has a large membership of micro, small and medium enterprises (MSMEs), said the overall regulatory framework should be proportional to the size of the entities that are subject to the regulations. Multani recommended a different threshold for audit exemption given that businesses, whether big or small, have to establish their credentials before banks, investors, rating agencies, suppliers, and tax authorities. This, he said, can be done only through reliable financial statements that are audited and certified.

?I would suggest that the requirement of statutory audit should be made optional for smaller companies, particularly the micro and small enterprises with (a) turnover (of) up to ?50 crore as per the definition under the MSME Development Act, instead of fixing the exemption threshold limit of net worth of ?250 crore suggested in the NFRA consultation paper. This will help the smaller companies and, at the same time, not dilute the regulatory oversight on large corporates," Multani said.

India is unique among the big economies in mandating compulsory statutory audits for all firms, irrespective of their size, Multani said. This position needs to be reviewed, he said. MSMEs, too, benefit from statutory audits, but a cost-benefit analysis of this regulatory obligation is needed, said Ashok Haldia, an expert in financial reporting and former managing director of PTC India Financial Services Ltd, an infrastructure lender.

MSMEs are also entities in the public interest as they are funded by banks and financial institutions and have a financial interface with external stakeholders such as creditors, investors and government, particularly revenue authorities, he said.

?However, the cost and effort involved in the audit of MSMEs should be commensurate with the benefit from that. This would mean a simpler tool and technique for audit and exemption for those where lax liability or external borrowing is relatively insignificant," Haldia said.