'Networking' Chartered Accountants
Published: Jan 21, 2019
TRADITIONALLY, professions like auditing was self-regulated, where its members established and monitored professional standards and conducted disciplinary actions. However, the global trend indicates decline in self-regulatory model and shift towards independent regulatory oversight model for the auditing profession. In India, keeping in view the recommendations of various government committees and the global developments, the Companies Act 2013 brought in National Financial Reporting Authority (NFRA), an independent regulatory body to regulate the profession of auditors.
Network means the existence of a group of firms which have common ownership, control of management, use common brand-name and/or professional resources. CA firms belonging to one network are found providing audit as well as non-audit services to the same client or its holding or subsidiaries in India or even outside India.
Legal framework
Under section 141(1) of the Companies Act, 2013, a statutory auditor can be a CA or an audit firm, with majority of partners who are CAs, set up as a partnership firm under the Indian Partnership Act, 1932 or under the Limited Liability Partnership Act, 2008.
The Institute of Chartered Accountants of India (ICAI) permits networking through the revised guidelines of network issued in 2011. As per ICAI the term 'network' means a larger structure clearly aimed at common quality control, policies, procedures, common business strategy etc. Therefore, supervision and control of internal processes of an Indian chartered accountant firm by the network is obvious under the Revised Guidelines of 2011.
Types of Networks
The networks operating in India can be broadly divided in to three categories.
Category 1 - This is a domestic network formed by CA firms set up by CAs registered with ICAI. The name of such a network must be approved by ICAI.
Category 2 - This is an international network, where Indian/domestic CA firms network with entities outside India using the membership route. In this case, a foreign entity (the international network) enters into a membership arrangement/contractual agreements with the domestic CA firm which operates under its local trade name. Ironically, there is no registration requirement for Category 2 networks in India. Merely, a duly authorised representative of the Indian member firm is required to file a declaration with ICAI, within 30 days of entering into the network arrangement.
Category 3 - This is also an international network, where Indian/domestic CA firms, network with entities outside India using the sub-licensing route. Under this type of networking, there is no direct membership arrangement with the international entity. Instead, there is execution of sub-licensing agreement between an Indian entity/firm with international network. This sub-licensing agreement allows the domestic firm to use the brand name(s) of the international network without entering into any direct contractual relationship with the international entity itself. Domestic firm follows the same global procedures and methodologies prescribed by that international network by virtue of the sub-licensing agreement and other contractual arrangements.
If we look at the structural pattern of U.K. based companies - Price water house Coopers International Limited, Ernst & Young Global Limited, Deloitte Touche Tohmatsu Limited and KPMG International Cooperative, which is a cooperative under Swiss law then it is interesting to know that these are all umbrella entities. They do not provide any client services, themselves. Rather they act as coordinating entities for a network of independent firms, each of which provides services in a particular jurisdiction, subject to the respective local laws. In India, audit firms with international brands such as Price Water house, Love lock and Lewess, A.F. Ferguson and Co., Fraser & Ross came into existence in the pre-independence era and were already part of the respective international networks.
Degree of control of Indian network firms from outside India
Ministry of Corporate Affairs (MCA)'s Expert Group report on "Issues Related to Audit Firms" suggests that merely being part of a network and sharing of global costs do not make these Indian network firms owned and controlled by the global parent.
But still the fact is that these international network entities bring better business opportunities in the days of global economy and have ability to invest hugely in technology to improve processes & standards and they directly and indirectly have influence on the Indian audit firms which are part of the network.
Importance of Level play field
Part I of the First Schedule to the Chartered Accountants Act, 1949 mentions about professional misconduct in relation to chartered accountants in practice with relation to advertising. The problem is that network members which are Indian entities but are not practicing as CAs are not bound by these prohibitions.
This loophole creates an opportunity for networks to engage in a regulatory arbitrage. As per MCA's Expert Group report these networks take advantage of these differential regulatory standards by making surrogate advertisements by virtue of their consultancy services, circumventing the prohibitions on advertisements by ICAI.
Even the Committee of Experts in their report on "regulating audit firms and the networks" has mentioned that to create a level playing field between network firms and non-network firms as well as individual CAs, it is essential that advertisements by all CAs are allowed subject to reasonable restrictions.
Restrictions on Networks for providing non-audit services to auditee companies
Section 144 of the Companies Act, 2013 provides an exhaustive list of prohibited non-audit services and also allow the government to add any other kind of services in this list. There is always a self-review risk if certain services are allowed to be provided by the auditor. The international practices adopted in EU, Australia, U.K. showed prohibition on non-audit services like taxation, restructuring and valuation as they are likely to influence the objectivity and independence of auditors. In India presently, these services are permitted. Therefore, there is a need to revisit the list keeping in view the various kinds of services rendered by auditors which can possibly result in conflict of interest.
In India, there is a cap which requires that non-audit services fee earned by statutory auditor along with its associate concern or corporate bodies must not exceed the aggregate statutory audit fee. However, this cap was set in 2002 by ICAI and since then the market of non-audit services has evolved. Therefore, this cap on non-audit services also needs to be reviewed.
Companies Act, 2013 does not have any provision which mandates disclosure of non-audit fee earned by the auditor in the financial statements of the auditee company. Securities and Exchange Board of India (SEBI) has regulations that requires a listed company to disclose total fees for all services paid by the listed entity and its subsidiaries, on a consolidated basis, to the statutory auditor and all entities in the network of which the statutory auditor is a part. But, this disclosure obligation is only applicable to the listed entity. Non listed companies are still not bound to disclose.
It is, therefore, recommended that a statutory auditor must separately disclose to NFRA the audit as well as non-audit fees earned from each of its auditee company or its holding or subsidiary companies.
Conclusion
An audit failure or fraud can happen because of two reasons. Firstly, it can be due to lapses on the part of the auditor or audit firm. In India there are various provisions in the law to hold the auditor or audit firm liable for such a lapse. Secondly, an audit failure or fraud can also happen because the audit method followed by auditor or audit firm as part of a network is itself flawed. Since this is a fault of the method being followed by the network, it is important that regulators in India have power to extend the liability on the network. It could be civil liability in the form of monetary penalties on the international network.
To conclude, it is time that the law relating to networks is adapted to the present day requirements.
(The views expressed are strictly personal.)
