INDIA’S FINANCIAL SECTOR AN ASSESSMENT

Volume V

Contents

Volume V Advisory Panel on Institutions and Market Structure

Committee on Financial Sector Assessment March 2009

© Committee on Financial Sector Assessment, 2009

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Chapter I

Approach to Assessment

The Government of India in consultation with the Reserve Bank constituted the Committee on Financial Sector Assessment (CFSA) in September 2006, with a mandate to undertake a comprehensive assessment of the Indian financial sector focusing upon stability and development. The CFSA was chaired by Dr. Rakesh Mohan, Deputy Governor, Reserve Bank of India. The Co-chairmen were Shri Ashok Jha, Dr. D. Subbarao and Shri Ashok Chawla, Secretary, Department of Economic Affairs, Ministry of Finance, Government of India. The Committee also had officials from the Government of India as its members.

As part of the assessment of standards and codes, the terms of reference of the Advisory Panel on Institutions and Market Structure were to identify and consider the relevant standards and codes as currently prescribed and applicable for accounting, auditing, bankruptcy laws, corporate governance and payment and settlement systems and evaluate their implementation in the Indian context; identify the gaps in adherence to these standards and codes and the reasons therefor; and suggest possible roadmaps addressing inter alia the developmental issues relating to these standards and codes, in a medium-term perspective. The Advisory Panel chaired by Shri C. M. Vasudev, comprised non-official experts as members and officials representing Government and other agencies as special invitees (Annex A).

Technical Group on Institutions and Market Structure

A Technical Group comprising officials drawn from government and other agencies who are directly associated with handling respective areas of work, assisted the Advisory Panel in preparing preliminary assessments and background material, which served as inputs to the Advisory Panel’s work (See Annex B for the composition of the Technical Group and terms of reference). Apart from the officials indicated in Annex B, the Panel also benefited from the inputs of the officials indicated in Annex C.

Approach and Methodology

The Technical Group identified the standards issued by the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standards Board (IAASB) as the relevant standards applicable to the assessment of the accounting and auditing standards, respectively.

The assessment of adherence to bankruptcy laws was based on the revised draft of the ‘Principles and Guidelines for Effective Insolvency and Creditor Rights Systems’ issued by the World Bank.

Likewise, the OECD principles for Corporate Governance were identified as the relevant international standard applicable to assess corporate governance.

The adherence to payment and settlement systems was assessed on the standards developed by the Committee on Payment and Settlement Systems (CPSS) and the International Organisation of Securities Commission (IOSCO).

The preliminary assessments made by the Technical Groups were considered by the Advisory Panel with closer involvement of four sub-panels (Annex D) in the areas of accounting and auditing, bankruptcy laws, corporate governance and payment and settlement systems. The Advisory Panel had a total of five meetings to consider the assessments and recommendations and to finalise its Report.

Peer Review

At the request of the CFSA, seven national and also international experts on areas relating to accounting, auditing, bankruptcy laws, corporate governance and payment and settlement systems peer reviewed the draft Reports on respective assessments and recommendations (Annex E).

The Advisory Panel considered in-depth the comments made by the peer reviewers and appropriately modified the Report after incorporating the comments/suggestions. The Panel had also the option of not concurring with the peer reviewers’ comments, if they were considered not appropriate, particularly in the Indian context. In the interest of transparency, the comments of the peer reviewers and the stance taken by the Panel are provided appropriately in respective parts of this Report.

Scheme of the Report

The Report is divided into seven chapters. After the ‘Approach to Assessment’ in this chapter, chapter II covers assessment of adherence to accounting standards. Chapter III covers assessment of adherence to auditing standards. Chapter IV covers assesment of adherence to corporate governance principles. Chapter V covers the assessment of adherence to standards pertaining to payment and settlement systems. Chapter VI covers the assessment of adherence to principles for effective insolvency and creditor rights systems and chapter VII gives the summary of recommendations of the Panel.

Annex A

RESERVE BANK OF INDIA
CENTRAL OFFICE
SHAHID BHAGAT SINGH ROAD
MUMBAI – 400 001, INDIA

DEPUTY GOVERNOR

MEMORANDUM

  Constitution of Advisory Panel on Institutions and Market Structure

A Committee on Financial Sector Assessment (CFSA) has been constituted by the Government of India in consultation with the Reserve Bank, with the objective of undertaking a self-assessment of financial sector stability and development. One of the analytical components of Financial Sector Assessment would encompass a comprehensive assessment of the status and implementation of various international financial standards and codes.

2. In this connection, the CFSA has decided to constitute an Advisory Panel on Institutions & Market Structure comprising the following:

3. In addition, the Advisory Panel can utilise the expertise of the following ex-officio Special Invitees:

4. The Advisory Panel will have the following terms of reference:

(i)  to identify and consider the relevant standards and codes as currently prescribed and applicable for institutions and market structure in terms of bankruptcy laws, accounting and auditing, payment and settlement systems and corporate governance policies and evaluate their implementation in the Indian context;

(ii)  to identify the gaps in adherence to the respective standards and codes and the reasons therefor; and

(iii)  to suggest possible roadmaps addressing, inter alia, the developmental issues relating to respective standards and codes, in a medium-term perspective.

5. The Advisory Panel would have the option of co-opting as Special Invitees any other experts as they deem fit.

6. The secretarial assistance to the Advisory Panel will be provided by the Reserve Bank of India. The Technical Group on Institutions and Market Structure constituted by the Reserve Bank at the instance of the Committee has already progressed with the technical work with regard to above terms of reference. The technical notes and background material prepared by these groups would inter alia form the basis for discussion by the Panel and in drafting of the Report.

7. The Advisory Panel will prepare a detailed Report covering the above aspects and the Government of India/Reserve Bank of India will have the discretion of making the Report public, after a peer review, as they may deem fit.

8. The Advisory Panel is expected to submit its Report in about three months from the date of its first meeting.

(Rakesh Mohan)

Deputy Governor and Chairman of the
Committee on Financial Sector Assessment

Mumbai
August 10, 2007

Annex B

RESERVE BANK OF INDIA
CENTRAL OFFICE
SHAHID BHAGAT SINGH ROAD
MUMBAI – 400 001, INDIA
DEPUTY GOVERNOR

MEMORANDUM

Constitution of Technical Group on Institutions & Market Structure

The Committee on Financial Sector Assessment (CFSA) will undertake a self-assessment of financial sector stability and development. One of the analytical components of Financial Sector Assessment would encompass a comprehensive assessment of the status and implementation of various international financial standards and codes. CFSA has decided to constitute a Technical Group on Institutions & Market Structure comprising the following:

2. The Group will have the following terms of reference:

(i) to identify the relevant standards and codes as currently prescribed by various standard-setting bodies in relation to bankruptcy laws, accounting, auditing, payment and settlement systems and corporate governance policies;

(ii) to compile relevant data and information on follow-up of earlier assessments and recommendations made by the earlier FSAP and also internally by the Standing Committee on International Financial Standards and Codes on the relevant standards;

(iii) to contribute to technical work in the implementation of the remaining elements of standards and codes pertaining to bankruptcy laws, accounting, auditing,payment and settlement systems and corporate governance;

(iv) to identify the gaps in adherence to the respective standards and codes and the reasons therefor;

(v) to suggest possible roadmaps addressing, inter alia, the developmental issues, in the medium-term perspective; and

(vi) to provide a fair and independent assessment on bankruptcy laws, accounting, auditing, payment and settlement systems and corporate governance in the form required by Advisory Groups constituted by the Reserve Bank and other regulatory agencies.

3. The Group would function under the overall guidance of Shri V.K. Sharma, Executive Director, Reserve Bank of India.

4. The Group will also be directed by decisions taken by the Advisory Panel on Institutions and Market Structure.

5. A list of Special Invitees who could act as resource persons to the Group and whose expertise can be called upon by the Group while preparing inputs for the Advisory Panels is provided in Annex C. The Group may co-opt as special invitees, one or more of the identified officials, or any other officials from the Reserve Bank, Government or other agencies as they deem appropriate.

6. The Group is expected to complete its task in the minimum possible time which, in any case, would not go beyond three months from the date of its constitution.

(Rakesh Mohan)
Chairman
March 1, 2007

Annex D

Annex E

Chapter II

Assessment of Accounting Standards

1. Introduction

1 Accounting Standards provide the basis for accurate financial reporting which is essential in a modern market corporate-driven economy. Robustness, reliability and transparency of financial reports determine the effectiveness of financial decision-making process, resource allocation and functioning of capital markets.

2 Accounting Standards harmonise different accounting policies and practices in use in a country, leading to reduction in accounting alternatives used in the preparation of financial statements, standardisation of presentation and disclosure norms to achieve comparability of financial statements of the different enterprises functioning in a country.

3 This chapter of the Report describes the current status of observance of International Accounting Standards in India and the initiatives taken in this regard by the Institute of Chartered Accountants of India (ICAI), the premier accounting body stablished under an Act of Parliament. ICAI operates in association with and with the support of the Ministry of Corporate Affairs, the Reserve Bank and various other regulatory bodies like Securities and Exchange Board of India (SEBI).

4 This assessment builds on the two immediately preceding assessment reports on the subject:

(i) The Report (January 2001) of the Advisory Group on Accounting and Auditing appointed by the Reserve Bank to evaluate and report on observance of international standards and codes in various areas impacting overall financial system (Advisory Group-2001); and

(ii) The Report on Observance of Standards and Codes (December 2004) (ROSC) issued as a part of joint initiative of the World Bank and the International Monetary Fund (IMF) for reviewing the strengths and weaknesses of corporate accounting and auditing practices in India (ROSC-2004).

5. After listing key findings and recommendations of Advisory Group-2001 and ROSC-2004, this chapter provides a brief description of the international initiatives for harmonisation of accounting practices and policies and the international benchmark used for this assessment. It then proceeds to provide the status of Indian Accounting Standards, the standard-setting process, legal and regulatory framework in this regard and a comparison of Indian Accounting Standards vis-à-vis International Accounting Standards. It then sets out the progress made in relation to the observations/recommendations made in the earlier reports, specifically, ROSC-2004. This is followed by recommendations of the Advisory Panel on the way forward.

1.1 Significant Findings and Recommendations of Advisory Group-2001

6. The Group compared the Indian Accounting and Auditing Standards with international standards, identified gaps and made recommendations to bridge the gaps. Its principal observations relating to Accounting Standards were:

(i) There is a significant gap between Standards issued by International Accounting Standards Committee (IASC) and ICAI, especially in respect of standards relating to financial institutions.

(ii) All standards issued by ICAI do not correspond to the standards issued by IASC.

(i)  ICAI must take steps to reduce the gaps between Indian and International Accounting Standards and take up, on emergency basis, issuance of standards for financial institutions in line with (a) IAS30, Disclosures in Financial Statements of Banks and Similar Financial Institutions; (b) IAS32, Financial Instruments: Disclosure and Presentation; and (c) IAS39, Financial Instruments: Recognition and Measurement.

(ii)  It should be the endeavour of the Accounting Standards Board (ASB) that Indian Accounting Standards correspond, as far as possible with the International Accounting Standards and wherever there is departure, the Standard should identify the same and explain the reasons for departure.

(v) ASB should set up a separate committee to address issues requiring immediate pronouncements.

1.2 Significant Findings and Recommendations of Report on Observance of Standards and Codes-2004

7. ROSC-2004 reported as under:

‘India’s accounting profession was among the earliest to develop historically when the Indian Companies Act was enacted in the mid-1800s, giving the accounting profession its start. Since then, considerable efforts have been made to align India’s accounting and auditing standards and practices with the internationally accepted standards and codes. However, there is room for improvement.

Indian accounting and auditing standards are developed on the basis of international standards; and the country has many accountants and auditors who are highly skilled and capable of providing international- standard services. However, in order to further improve the quality of corporate financial reporting in India, there is a need to improve the institutional framework and take steps for enhancing compliance with the applicable standards and rules.

Enhanced by significant inputs from stakeholders, this Report provides some principles-based policy recommendations aimed at strengthening the corporate financial reporting regime in India. These recommendations specifically focus on strengthening the monitoring and enforcement arrangements. Moreover, suggestions have been made on some important elements of an independent oversight body for the auditing profession, from a public interest perspective. The objectives of the recommendations are to build on the existing system and promote a gradual process of improvement’.

8. The key policy recommendations of ROSC-2004, so far as they relate to accounting and auditing practices, are, accordingly focussed on strengthening of monitoring and enforcement mechanism and the role of each link in the monitoring and enforcement chain:

(i) the top management/preparers and issuers of financial statements;

(ii) the auditors reporting on the extent of compliance with Accounting Standards by the preparers of financial statements while conducting audit in accordance with applicable auditing standards; and

(iii) regulators preventing non-compliance with accounting and auditing standards through monitoring and enforcement of activities of both top management/ preparers of financial statements and auditors auditing and reporting on these financial statements.

The Report made the following key recommendations in relation to Accounting Standards/practices:

(i) Steps be taken to issue national standards for International Financial Reporting Standards (IFRSs) for which national standards are not yet issued.

(ii) Rationalise Companies Act, specifically, Schedule VI and the rates of depreciation, to bring it in line with Accounting Standards.

(iii) ICAI be recognised as single accounting standard-setting body.

(iv) Bring regulations and monitoring of financial reporting practice by all corporate banks under purview of the Reserve Bank.

(v) Scale up structured training programme for ICAI members.

(vi) Improve professional education and training arrangements.

10. The Standards issued by IASC were described as International Accounting Standards (IAS). In April 2001, IASC was reconstituted as the International Accounting Standards Board (IASB) and took over the responsibility of setting Accounting Standards from IASC. The Standards issued by IASB are known as the IFRS. IASC had issued 41 Standards till 2001, when a process of restructuring was undertaken and the role of development of International Accounting Standards was transferred to IASB. Since then, new IFRSs have been issued, many IASs have been revised and certain IASs have been withdrawn. As and when IASs are completely revised, they are issued as the IFRSs. As on date, 29 IASs are in force, the rest having been withdrawn. IASB has issued 8 IFRSs. IASs and IFRSs are collectively referred to as the IFRSs.

11. The interpretations of IASs and IFRSs are developed by the International Financial Reporting Interpretations Committee (IFRIC). IFRIC replaced the former Standing Interpretations Committee (SIC) in March 2002. IFRIC’s mission is ‘to interpret the application of International Accounting Standards (IASs) and International Financial Reporting Standards (IFRSs) and provide timely guidance on financial reporting issues not specifically addressed in IASs and IFRSs, in the context of the IASB framework, and undertake other tasks at the request of the IASB’.

12. Besides the IFRSs, which are currently adopted or adapted by large number of countries, the Accounting Standards developed by United States of America (commonly referred to as US GAAPs – Generally Accepted Accounting Practices) have also assumed significance in the world of global financial reporting because of the increased number of global enterprises seeking listing in US capital markets. This has resulted in two widely recognised and used financial reporting standards; IFRSs and US GAAPs.

17. The Report of Advisory Group-2001 and ROSC-2004 used IFRSs as the benchmark for their assessment. Accordingly, IFRSs have been used as the benchmark for this Report.

3. Accounting Standards in India

3.1 Composition of the Accounting Standards Board

20. ICAI has established the ASB as a committee of the Council of ICAI. The composition of the ASB is broad-based with a view to ensuring the participation of all interest groups in the standard-setting process. These interest groups include industry, various departments of government and regulatory authorities, financial institutions, academic and professional bodies. Industry is represented on the ASB by their apex level associations, viz., Associated Chambers of Commerce and Industry of India (ASSOCHAM), Federation of Indian Chambers of Commerce and Industry (FICCI) and Confederation of Indian Industries (CII). As regards government departments and regulatory authorities, the Reserve Bank, Insurance Regulatory Development Authority, Ministry of Corporate Affairs, Central Board of Direct Taxes, Comptroller & Auditor General of India, Controller General of Accounts, Securities and Exchange Board of India and Central Board of Excise and Customs are represented on the ASB. Besides these, representatives of academic and professional institutions such as universities, Indian Institutes of Management, Institute of Cost and Works Accountants of India and Institute of Company Secretaries of India are also represented on the ASB. Apart from these interest groups, members of the Central Council of ICAI are also nominated on the ASB.

3.2 The Accounting Standard-setting Process

21. Accounting standard-setting, by its very nature, involves an optimal balance of requirements of financial information for various interest groups having a stake in financial reporting. With a view to reaching consensus, to the extent possible, as to the requirements of the relevant interest groups and thereby bringing about general acceptance of Accounting Standards among such groups, considerable research, consultations and discussions with the representatives of the relevant interest groups at different stages of standard formulation becomes necessary.

The standard-setting procedure of the ASB, as briefly outlined below, is designed to ensure such consultation and discussions:

(i) Identification of the broad areas by ASB for formulating Accounting Standards.

(ii) Constitution of the study groups by ASB for preparing preliminary drafts of the proposed Accounting Standards.

(v) Meeting with the representatives of specified outside bodies to ascertain their views on the draft of the proposed Accounting Standard.

(vi) Finalisation of the Exposure Draft of the proposed Accounting Standard on the basis of comments received.

(vii) Issuance of the Exposure Draft inviting public comments.

(viii) Consideration of the comments received on the Exposure Draft and finalisation of the draft Accounting Standard by ASB for submission to the Council of the ICAI for its consideration and approval for issuance.

(ix) Consideration of the draft Accounting Standard by the Council of ICAI, and if found necessary, modification of the draft in consultation with ASB.

(x) Issuance of the Accounting Standard, so finalised, under the authority of the Council of ICAI.

3.3 Recognition of Accounting Standards

22. Accounting Standards issued by ICAI received legal recognition in 1998 with the insertion of Sections 211(3A), (3B) and (3C) in the Companies Act, 1956. These sections require all companies (private or public) to prepare their financial statements in accordance with the Accounting Standards recommended by ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards (NACAS), which was constituted by the Central Government on 29 August 2001 under authority of Section 210 A of the Companies Act, 1956 with its secretariat at the ICAI. Its constitution is given in Appendix A.

4. Present Status of Accounting Standards

4.1 Accounting Standards for Enterprises Engaged in Commercial, Industrial or Business Activities

AS 1 Disclosure of Accounting Policies

AS 2 Valuation of Inventories

AS 3 Cash Flow Statements

AS 4 Contingencies and Events Occurring after the Balance Sheet Date

AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

AS 6 Depreciation Accounting

AS 7 Construction Contracts (revised 2002)

AS 8 Accounting for Research and Development (withdrawn pursuant to the issuance of AS 26)

AS 9 Revenue Recognition

AS 10 Accounting for Fixed Assets

AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003)

AS 12 Accounting for Government Grants

AS 13 Accounting for Investments

AS 14 Accounting for Amalgamations

AS 15 Employee Benefits (Revised 2005)

AS 16 Borrowing Costs

AS 17 Segment Reporting

AS 18 Related Party Disclosures

AS 19 Leases

AS 20 Earnings Per Share

AS 21 Consolidated Financial Statements

AS 22 Accounting for Taxes on Income

AS 23 Accounting for Investments in Associates in Consolidated Financial Statements

AS 24 Discontinuing Operations

AS 25 Interim Financial Reporting

AS 26 Intangible Assets

AS 27 Financial Reporting of Interests in Joint Ventures

AS 28 Impairment of Assets

AS 29 Provisions, Contingent Liabilities and Contingent Assets

AS 30 Financial Instruments: Recognition and Measurement (Recommendatory from April 1, 2009 and mandatory from April 1, 2011) AS 31 Financial Instruments: Presentation (Recommendatory from April 1, 2009 and mandatory from April 1, 2011)

AS 32 Financial Instruments: Disclosures

4.2 Accounting Standards for Small and Medium-sized Enterprises

• The criteria for being categorised as a Level I company of ICAI and those of companies other than SMCs under the Rules are now identical. Similarly, the criteria for being categorised as a Level II company under ICAI’s classification and those of SMCs under the Rules are the same.

•  Entities that are bodies corporate but not companies (e.g. a corporation set up under a Central or State Act) would be classified under the revised scheme of classification of ICAI under Levels I and II only.

•  Certain exemptions/relaxations have been given to enterprises falling in Levels II and III (i.e., small and medium-sized enterprises). The exemptions/relaxations are primarily in respect of disclosure requirements. In general, the recognition and measurement principles to be applied by SMCs are the same as those to be applied by Level I enterprises. The exemptions/relaxations available to Level II non-company entities as per ICAI’s classification would be the same as those available to SMCs under the Rules except that the aforesaid Level II entities that employ less than 50 employees during the accounting year will continue to enjoy certain exemptions/relaxations from AS 15, Employee Benefits, which are not available to SMCs under the Rules.

•  AS18 (Related Party Disclosures) and AS24 (Discontinuing Operations) apply to Level II non-company entities also. The Rules too do not give any exemption to SMCs from AS18 or AS 24.

4.3 Accounting Standards for Not-for- Profit Organisations (NPOs)/Non- governmental Organisations (NGOs)

32. Accounting Standards issued by ICAI do not apply to only those NPOs/NGOs who carry on activities that are not commercial, industrial or business in nature. The Research Committee of ICAI has issued a Technical Guide on Accounting and Auditing in NPOs/NGOs which recommends that the Standards issued by ICAI should be applied by even NPOs/NGOs engaged in purely non-commercial, non-business or non- industrial activities. The Technical Guide explains the manner in which the Accounting Standards should be applied by NPOs/NGOs to their activities.

4.4 Accounting Standards for Local Bodies

33. ICAI has been deeply involved in accounting reforms in government accounting, particularly, accounts of urban local bodies. It initially constituted a Sub-Committee of ASB for issuing Accounting Standards, for governments including urban local bodies in 1999. As a first step, it issued a Technical Guide on Accounting and Financial Reporting by urban local bodies, which contains recommendations relating to application of Accounting Standards, issued by ICAI, to urban local bodies. The purpose of this Technical Guide is to provide a broad framework for and directions to state governments and urban local bodies, ICAI members and others as they work to improve urban bodies’ accounting and financial reporting systems. The recommendations contained in the Technical Guide have received a positive response from many urban local bodies that have shifted or are in the process of shifting from cash basis accounting to accrual basis accounting. The process has gained momentum as these bodies are increasingly going to the capital markets for raising funds. However, these bodies are still following diverse accounting policies and practices in the preparation of their financial statements. Therefore, a need was felt for formulating a single set of high quality financial reporting standards for local bodies setting out recognition, measurement, presentation and disclosure requirements dealing with transactions and events in general purpose financial statements of local bodies.

4.5 Accounting Standards for Governments

37.The Office of the Comptroller and Auditor General of India constituted the Government Accounting Standards Advisory Board (GASAB) in August 2002 in order to establish and improve standards of governmental accounting and financial reporting and enhance accountability mechanisms for Union and the State Government accounts. The recommendations made by GASAB will be considered by the Central Government for notification of the Standards to be adopted by governments. Amongst others, ICAI and the Reserve Bank are members of GASAB.

4.6 Accounting Standards for Business Enterprises Governed by Specific Acts of Parliament

38. Enterprises engaged in specified activities like banking, insurance or rate-regulated entities like electricity companies are governed by their specific statutes or regulations. These statutes or regulations, in general, set out the presentation and disclosure norms and, in specific cases, recognition and measurement principles. These norms and principles have an overriding effect over the norms and principles set out in the Indian Accounting Standards. These enterprises adopt Indian Accounting Standards in the absence of specific requirements or prescriptions under the statute or regulations governing an enterprise. Prescriptions under the statute or regulations are aimed at making more meaningful presentation of the financial information in the context of the activities of the concerned enterprise.

5. Divergences between Basel Committee Norms and IFRS and the Indian Position

loan-loss provisioning. Attempts are being made to achieve convergence between IASB and BCBS on various contentious issues. However, AS30 corresponding to IAS39 has not yet been implemented in India. A Group has been formed by the Reserve Bank comprising members from the Reserve Bank, ICAI and bankers under the umbrella of Indian Banks’ Association to iron out the differences and integrate the two approaches for smooth implementation by Indian banking system.

The insurance companies are required to adopt specific norms on income recognition, asset classification and provisioning as laid down by IRDA guidelines on the issue. Stipulations on insurance contracts as per the laws applicable to insurance companies in India and the one stipulated under IFRS4 on Insurance Contracts also have divergences from each other. Efforts have been initiated at ICAI and IRDA to integrate the two approaches and have a uniform standard. The ICAI has initiated steps to lay down the Accounting Standards with regard to insurance contracts.

6. Enforcing Compliance

6.1 The Companies Act

41. Companies governed by the Indian Companies Act, 1956 are required, by Section 211, to comply with Accounting Standards while preparing and presenting profit and loss account and balance sheet. The Section further requires that, in case of non-compliance, the company concerned shall disclose, in its profit and loss account and balance sheet, the deviation from the accounting standard, the reasons for such deviation, and the financial effect, if any, arising due to such deviation. Failure to comply with these requirements attracts fine upto Rs. 10,000 or imprisonment for a period up to six months or both.

43.Auditors of companies are required to state whether, in their opinion, the profit and loss account and balance sheet comply with the accounting standards. This has been laid down in Section 227(3) of the Companies Act. Default by an auditor to report non-compliance invites disciplinary action. ICAI has a very robust system of dealing with complaints against members and it also takes suo motu action based on information relating to negligence or non- compliance of the provisions of the Companies Act and various other matters.

6.4 Financial Reporting Review Board

6.5 Peer Review Board

6.6 Quality Review Board

46.Although not directly concerned with the enforcement of Accounting Standards, the Quality Review Board, newly constituted in June 2007, will also have a persuasive influence and will encourage reporting of non-compliance with Accounting Standards. The Board will perform the following functions:

(i) make recommendations to the Council with regard to the quality of services provided by the members of the Institute;

(ii) review the quality of services provided by the members of the Institute including audit services; and

(iii) guide the members of the Institute to improve the quality of services and adherence to various statutory and regulatory requirements.

47. The Board has ten members, excluding the Chairman. Five are nominated by the Central Government and five by the Council of ICAI. The Chairman to the Board is nominated by the Central Government.

7. Status of Progress on Recommendations of Reports of 2001 and 2004

7.2 Reducing Areas of Departures from IAS/ IFRS

7.2.1 Reasons for Departures

54. IFRSs are adopted as a basis for formulation of Indian standards and due consideration is given to local customs, usage, practices, legal and regulatory environment. Departures have arisen:

• On account of local legal and regulatory requirements – e.g. AS21 and IAS27, Consolidated Financial Statements due to definition of ‘control’ in terms of Indian Companies Act, 1956; AS25 and IAS34, Interim Financial Reporting as regards requirement of disclosure and presentation of interim statements.

• On account of local economic environment – adoption of fair value – various IFRSs are based on fair value approach whereas markets in India were not considered to have necessary depth and breadth to provide reliable fair values for measurement purpose of accounting.

• On account of conceptual differences – There are few areas of conceptual differences, e.g., recognition of provision on the basis of constructive obligation in IAS37, Provisions, Contingent Liabilities and Contingent Assets. As per this IAS, in case of restructuring, constructive obligation arises when an enterprise has detailed formal plan and the enterprise has raised valid expectation to those affected that it will carry out restructuring. ICAI feels that on aforesaid considerations, a liability does not crystallise and if a provision is required to be made on the aforesaid basis, it will be recognised at an early stage. In view of this aspect, AS29 does not specifically deal with constructive obligation. However, AS29 requires a provision to be created in respect of obligations arising from normal business practice, custom and a desire to maintain good business relation or act in an equitable manner. Hence, in such cases, general criteria for recognition of provision are required to be applied.

• On account of level of preparedness – Accounting Standards in India, in general, apply to non-corporate entities as also to small and medium-sized enterprises. Further, Indian economy is in the developmental stage and, therefore, it was felt that the economy was not at a level that could have directly adopted International Standards; implementation of these Standards would have caused serious challenges.

55. A statement containing major departures in Indian Accounting Standards from the corresponding IFRSs is given in Appendix E.

7.2.2 Steps taken to Reduce Departures

Differences on account of local, legal and regulatory environment

56. India has gained experience in applying Accounting Standards and as businesses are globalising, the ASB has taken a decision to include accounting treatments in accordance with IFRSs in the corresponding Indian Standards even though they may be inconsistent with legal or regulatory requirements on the basis that until the law is amended, the relevant legal requirement would prevail. For example, as per IAS32, redeemable preference shares, based on their substance, may be considered as a debt instrument instead of equity instrument. In the Indian legal framework, the settled position is to consider these as part of equity. ICAI has decided to retain the IAS32 position in AS31, Financial Instruments: Presentation, corresponding to IAS32. However, it is recognised in the standard itself that until the law is amended, legal position will prevail over the position set out in the AS.

Differences on account of local economic environment

57. In the context of changing economic environment, the ASB has now decided to adopt fair value basis for valuation adopted in IAS39 in AS30, Financial Instruments: Recognition and Measurement, corresponding to IAS39.

58. The development and growth of the economy has led to more maturity and stability in the Indian businesses, leading to an enhancement of the ability of businesses to absorb structural changes, e.g., accounting for employee benefits, AS15, Employee Benefits, (Revised 2005) is now generally in consonance with the corresponding IAS19, despite complexities in the recognition and measurement requirements in relation to employee benefits.

7.3 Mention of Deviation from IFRS and Reason Therefor in AS

7.4 Convergence with IFRSs

63. ASB has constituted a Group on Implementation of Convergence with IFRSs, broadly with the following objectives:

•  To approach various ministries and agencies such as NACAS and regulators for seeking their co-operation for this purpose, particularly, in changing various laws and regulations, where appropriate, with a view to achieve convergence.

• To liaise with the industry associations, such as, ASSOCHAM, FICCI, CII, IBA, etc., for getting the industry ready for convergence with the IFRSs.

•  To prepare the work plan for the ASB regarding fixing the priority for revising certain existing Standards and issuing new Standards corresponding to IFRSs prior to 2011.

• To look into the requirements of training the preparers and auditors and to formulate ways to meet the requirements.

•  To consider any other aspect, such as, liaising with IASB, where required, to settle conceptual issues.

7.5 Single Standard-setting Authority

65. There are several regulators for different sectors in India, e.g., the Reserve Bank for banking sector, SEBI for listed companies, IRDA for insurance companies, with each one having authority for setting Accounting Standards for the entities regulated by them. However, in practice, all these regulators have accepted the standards formulated by ICAI and do not issue separate standards. The income tax department issued two standards based on AS1, Disclosure of Accounting Policies and AS5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies for Taxation Purposes but discontinued it. Thus, ICAI is now the single standard-setting body for establishing standards for all entities other than Central and State Governments.

66.So far as Accounting Standards for preparation of financial statements of Central and State Governments are concerned, as stated earlier, the Standards are being developed by the Comptroller and Auditor General of India in terms of Article 150 of the Constitution. The Standards so developed are recommended for implementation of the Government. The process is in a nascent stage.

7.6 Emerging Issues Task Force

67. The Research Committee of the ICAI considers on a regular basis emerging issues and makes pronouncements on these issues on a timely basis. It is generally assisted by specifically constituted Task Forces comprising members having experience and expertise in relevant areas.

7.7. Monitoring Compliance with Accounting Standards

68. ICAI has established the Financial Reporting Review Board which reviews financial statements from compliance perspective and recommends appropriate action to Ministry of Corporate Affairs, SEBI and other regulators. The Ministry, too, has started the process of considering recommendations and initiating inquiry.

7.8 Rationalisation of Provisions of Companies Act with Accounting Standards

8. The Way Forward

8.1 Convergence with IFRSs

8.2 Greater Participation in the International Standard-setting Process

71. If, as proposed by the Council of the ICAI, there is to be total convergence with IFRSs in India by April 1, 2011 it is essential that India should have a more significant influence, both in the agenda-setting of the IASB as also in its technical output. ICAI, therefore, needs to identify individuals within the country who can play a more active role in various organisations of IASB. ICAI also needs to constitute a group of academicians and professionals which would be more pro-active in suggesting items for the agenda of IASB and IFRIC as also for consideration of exposure drafts issued by these bodies.

8.3 Development of Accounting Standards

72. Currently, the Standards issued by ICAI are anchored in the standards issued by IASB. Its work programme, therefore, follows the work programme of IASB. But situations may arise when India finds that there is no international standard on a subject of importance for the country and there is imminent need to have one, e.g., on emission rights. ASB ought to consider the development of a standard on such subjects if the work programme of IASB does not permit taking up development of standard on that subject. If and when ICAI commences work of development of a new standard, it ought to keep IASB informed and seek their comments on the basic principles being enunciated in the standard. Such standard(s) ought to be replaced by the standard on the subject, as and when issued by IASB.

8.4 Sector-specific Application Guidance

73. Accounting Standards issued by ICAI and IASB are general purpose Accounting Standards and the principles enunciated in the standards apply across the board to all industries alike. Typical issues, specific to an industry, do arise in application of these standards, e.g., the insurance sector or the banking sector. ICAI needs to consider providing sector-specific guidance in application of these standards. Such guidance, in a sense, is rule-based guidance in the application of principle-based standard(s). Such an approach will lead to uniformity in application of standards in specific, complex and typical issues relating to a sector/industry segment. Care and caution must, however, be excercised in issuing such a guidance to ensure that the guidance does not travel beyond the principles set out in standards. It should not lead to establishment of new principles.

74. Current Indian Standards are based on international standards and, therefore, in an ideal scenario, all issues relating to interpretations ought to be referred to IFRIC. This is necessary since, if each country which has adopted or adapted international standards starts issuing interpretations, it could frustrate the very objective of convergence and global adoption of a common set of Accounting Standards. Having said that, one should also bear in mind that IFRIC may not be able to provide a timely response to each of the issues referred to it for interpretation.

75. ICAI will need, therefore, as an interim measure, an institution for providing interpretations/address issues relating to interpretations, on need basis. The issues requiring interpretation, ought to be brought to the notice of IFRIC and the interpretations that are issued also ought to be brought to the attention of IFRIC. The interpretations issued by India may need to be modified if interpretations, as and when issued by IFRIC, are different from the ones issued by the ICAI. It is, therefore, necessary that an independent ‘Interpretation Committee’ be constituted by ICAI and that the same ‘due process’ be followed before an ‘interpretation’ is issued. Interpretations issued by IFRIC or its predecessor, Standing Interpretations Committee (SIC), may be adopted by the ‘Interpretations Committee’ of the ICAI where the issue relates to a matter on which Indian Accounting Standard is identical or substantively similar to corresponding IFRS.

8.6 Authority for Issuance of Standards

76. The ASB is a committee of ICAI and the standards are issued by the Council of ICAI and not by the ASB. Though it has representation from outside, it is not truly autonomous. It is true that insofar as companies are concerned, the Standards issued by the Council of ICAI are only recommendatory and have to be prescribed by the Central Government in consultation with NACAS. This lends some degree of outside review. Nonetheless, the autonomy of the ASB would be greatly enhanced if it is given the authority to issue the standards and if the Council of ICAI confines itself to administrative, but not the functional, control of ASB. Also, codifying the constitution of ASB, total number of members, number of members to be nominated by ICAI, representatives of regulators, trade, industry, academics as also independent professionals will add to the transparency of the process adopted by ICAI.

8.7 Accounting Standards for Government

77. The Government Accounting Standards Advisory Board (GASAB), set up by the C&AG, should accelerate its activities and have a time- bound program to:

(a) have research conducted to identify and articulate reforms in government accounting in countries like the US, the UK, Canada, New Zealand, Australia, etc.,

(b) lay down a time-bound program for reforms in the existing system, such as:

• Sharper distinction between revenue and capital receipts and disbursements in the existing cash-based accounting system.

•  Accounting for indirect subsidies.

• Transition towards modified accrual-based or full accrual-based accounting system. Depending upon the experience of other countries, the extent and the manner in which elements of accrual-based system can be introduced in India should be determined and introduced.

• Issue standards that improve the usefulness of financial reports based on the needs of financial report users. The attempt should be to enhance the primary characteristics of understandability, relevance and reliability and the qualities of comparability and consistency.

• Keep standards current to reflect changes in Governmental environment.

• Provide guidance on implementation of standards.

• Consider significant areas of accounting and financial reporting that can be improved through the standard-setting process.

• Improve the common understanding of the nature and the purpose of information contained in government financial reports.

8.8 Co-operative Banks

78. There is need for scheduled co-operative banks to adopt the same principles as applicable to commercial banks. Similarly, even large non-scheduled co-operative banks need to adopt the same accounting principles as applicable to commercial banks.

79. Smaller co-operative banks may, however, be given some concessions in the application of accounting principles just as concessions are given to medium and small-sized enterprises. The government, in consultation with the Reserve Bank, should consider taking steps that require scheduled co-operative banks to immediately adopt the accounting principles being adopted by commercial banks.

8.9 Harmonisation of Legal and Regulatory Positions with Accounting Standards

81. The ICAI should also continuously hold dialogues with regulatory bodies and take early action for formulation or implementation of standards in developing areas and work with such agencies to bring about change in policy or legal provisions leading to robust accounting, presentation and disclosure norms and to remove disparities, if any, between legal provisions, policies and recommended accounting treatment. These agencies should also provide early responses and facilitation in this direction.

8.10 Compliance Monitoring Programme

82. The Financial Reporting Review Board established by ICAI has commenced the process of monitoring compliance by reporting entities. It has recommended action to the authorities who need to initiate action where gross non- compliances are brought to their notice by the FRRB.

8.11 Compliance Guidance/Training Programme

84. ICAI has been conducting training programmes for its members and also for accountants in the industry. It should continue to do so and take steps to enhance and broaden the scope, possibly together with regulators, to impart more formalised training to preparers of financial statements.

85. As the standards become more complex, the need will arise for guidance, both for the preparers of financial statements as also for those who audit them, on the application of the standards. It is, therefore, necessary that ICAI increases the scope and frequency of its training programmes on the implementation of Accounting Standards.

Appendix A

Composition of NACAS

Section 210A of the Companies Act, provides for composition of the NACAS as under:

(i) a chairperson who shall be a person of eminence and well-versed in accountancy, finance, business, administration, business law, economics or similar discipline;

(ii) one member each nominated by the ICAI constituted under the Chartered Accountants Act, 1949 (38 of 1949), the Institute of Cost and Works Accountants of India constituted under the Cost and Works Accountants Act, 1959 (23 of 1959) and the Institute of Company Secretaries of India constituted under the Company Secretaries Act, 1980 (56 of 1980);

(iii) one representative of the Central Government to be nominated by it;

(iv) one representative of the Reserve Bank to be nominated by it;

(v) one representative of the Comptroller and Auditor General of India to be nominated by him;

(vi) a person who holds or has held the office of professor in accountancy, finance or business management in any university or deemed university;

(vii) the Chairman of the Central Board of Direct Taxes constituted under the Central Boards of Revenue Act, 1963 (54 of 1963) or his nominee;

(viii) two members to represent the chambers of commerce and industry to be nominated by the Central Government; and

(ix) one representative of SEBI to be nominated by it.

Appendix B

Comparative Statement of International Accounting Standards/International

Financial Reporting Standards and Indian Accounting Standards

(As on October 31, 2008)

Reconciliation of the International Accounting Standards/International Financial
Reporting Standards with the Indian Accounting Standards
(As on October 31, 2008)

Appendix C

Definition of Small and Medium-sized Company as per Clause 2(f) of the Companies (Accounting Standards) Rules, 2006

‘Small and Medium Sized Company’ (SMC) means, a company –

(i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India;

(ii) which is not a bank, financial institution or an insurance company;

(iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding accounting year;

(iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year; and

(v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company.

Appendix D

Harmonised Criteria for Classification of Non-corporate Entities as

Decided by the Institute of Chartered Accountants of India

Level I Entities

Non-corporate entities which fall in any one or more of the following categories, at the end of the relevant accounting period, are classified as Level I entities:

(i) Entities whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India.

(ii) Banks (including co-operative banks), financial institutions or entities carrying on insurance business.

(iii) All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds rupees fifty crore in the immediately preceding accounting year.

(iv) All commercial, industrial and business reporting entities having borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year.

(v) Holding and subsidiary entities of any one of the above.

Level II Entities (SMEs)

Non-corporate entities which are not Level I entities but fall in any one or more of the following categories are classified as Level II entities:

(i) All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds rupees forty lakh but does not exceed rupees fifty crore in the immediately preceding accounting year.

(ii) All commercial, industrial and business reporting entities having borrowings (including public deposits) in excess of rupees one crore but not in excess of rupees ten crore at any time during the immediately preceding accounting year.

(iii) Holding and subsidiary entities of any one of the above.

Level III Entities (SMEs)

Non-corporate entities which are not covered under Level I and Level II are considered as Level III entities.

Appendix E

Major Departures in Indian Accounting Standards from the Corresponding IFRSs

The present position of Indian Accounting Standards has been depicted in the following comparative statements of International Financial Reporting Standards and Indian Accounting Standards.

⁶ It may be noted that International Accounting Standards nos. 3, 4, 5, 6, 9, 13, 15, 22, 25, 30 and 35 have already been withdrawn by the International Accounting Standards Board (IASB).
⁷ It may be noted that the existing ASs are in the process of revision to converge with IFRSs, where they are not presently converged with IFRSs.

Appendix F

Composition of the Task Force

Appendix G

Para 30 in the Report

Para 31 in the Report

The following is a suggestive redraft of para 31:

For the purpose of the application of Accounting Standards, ICAI has categorised the enterprises into three levels, i.e., Level I, Level II and Level III enterprises. Level II and Level III are considered to be SMEs. However, as per the notification of the Accounting Standards under the Companies Act, companies have been classified into two categories only, i.e., Small and Medium Companies (SMCs) (Refer Appendix C for meaning of SMC) and other than SMCs. The ICAI has recently harmonised its classification criteria with those under the Companies Act. Consequently, from accounting periods commencing on or after 1 April 2008, the position would be as follows:

– The criteria of Level I of the ICAI and those of companies other than SMCs under the Rules are now identical. Similarly the criteria of Level II under ICAI’s classification and those of SMCs under the Rules are the same.

– Entities that are bodies corporate but not companies (e.g., a corporation set up under a Central or State Act) would be classified under the revised scheme of classification of ICAI under Levels I and II only.

– Certain exemptions/relaxations have been given to enterprises falling in Levels II and III (i.e., small and medium-sized enterprises). The exemptions/relaxations are primarily in respect of disclosure requirements. In general, the recognition and measurement principles to be applied by SMCs are the same as those to be applied by Level I enterprises. The exemptions/relaxations available to Level II non-company entities as per ICAI’s

⁸The response of the Advisory Panel vis-à-vis the observations made by the Peer Reviewer are indicated in bold and italics.

The harmonised criteria applicable to non-companies have been provided in
Appendix D.

Stance of the Panel: Accepted. The suggestions have been incorporated in the Report.

Para 38 in the Report

A slight modification of this para may be necessary to bring out the position that recognition and measurement principles laid down in the statute or regulations governing an entity override those prescribed in an accounting standard. This is clearly recognised in the Preface to the Statements of Accounting Standards, according to which ‘the Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country.’

Stance of the Panel: Accepted. The suggestions have been incorporated in the Report.

Para 54 in the Report

ICAI’s official paper on convergence with IFRSs also cites ‘level of preparedness’ as another reason for departures from IFRSs in the past. Its inclusion may be considered, specially in view of the fact that in Appendix E, this has been cited as a reason in respect of some of the standards.

Stance of the Panel: Accepted. The suggestions have been incorporated in the Report.

Section 18 – The Way Forward (Section 8 in the Report)

• This section may start with convergence with IFRSs as the first point, since this arguably is the single most important step towards improved financial reporting.

• Another point that may be made is that while striving to achieve the goal of convergence, the ICAI should continue with its process of issuing new standards and revising the existing ones in line with IFRSs. This process will create a greater awareness and understanding about the requirements under IFRSs among preparers, auditors, etc., in the intervening period. Also, it would ensure that even if wholesale adoption of IFRSs is delayed (say, due to the number of regulatory changes which are required in this regard), the process of convergence still goes on.

• As far as issuance of interpretations is concerned, it may be added that in respect of issues where the Indian Accounting Standards are similar to corresponding IFRSs, the interpretations issued by IFRIC/Standing Interpretation Committee (SIC) may be adopted.

The following suggestive draft may be considered.

‘8.1 Convergence with IFRSs

ICAI should make its best efforts to achieve convergence with IFRSs by 1.4.2011 as far as listed entities and other public interest entities are concerned. Apart from seeking the co-operation of regulatory and other authorities, ICAI should create awareness about the requirements of IFRSs amongst preparers, auditors, etc., particularly to ensure that entities get sufficient time to put in place the systems and procedures to be able to comply with IFRSs. At the same time, ICAI should continue with its efforts to issue new as well as revised standards to bridge the existing gap between the two sets of standards. This will smoothen the process of transition to IFRSs and also ensure that Indian standards are largely IFRS-compliant even if full convergence with IFRSs cannot be achieved due to any reason by 1.4.2011.’

The following may be added towards the end of existing para 75.

‘—————’ interpretation’ is issued. Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) or its predecessor, the Standing Interpretations Committee (SIC) may be adopted by the ‘Interpretation Committee’ of the ICAI where the issue relates to a matter on which Indian Accounting Standard is identical or substantively similar to the corresponding IFRS.’

Stance of the Panel: Accepted. The suggestions have been incorporated in the Report.

Appendix H

Accounting Standards⁹ A Peer Review of the Advisory Panel Report

By Mr. Ian Mackintosh,

I have reviewed both documents¹⁰. In both cases I cannot comment on the accuracy of the reporting of the history and the present situation. I have no personal knowledge of these matters. My comments are therefore contained to the situation going forward.

I would firstly say that I agree with the actions for convergence in paragraphs 60 to 64 in the Report. I think this plan, if implemented, will be a major step forward for financial reporting in India.

Also, the items mentioned in paragraphs 65 to 69 in the Report.

I would call for caution in the development of country-specific Accounting Standards, sector-specific guidance and interpretations. Taking them one at a time,

•  One should be very certain that standards labelled as country-specific are indeed country-specific. The example given of accounting for emission rights is not a country-specific issue and guidance on this matter is needed all over the world. In such a case, it is not for a national standard-setter to pre-empt the international standard-setter. The preferred solution is to get the IASB to act on the matter and to provide an international solution for national application. I would see country-specific matters as being very rare.

•  I would also advise that care should be taken with sector-specific guidance, so that you are not seen as setting standards in conflict with international standards. It is not something to be precluded entirely, but to be handled with great care.

•  Interpretations should generally be referred to IFRIC and only in the very rare circumstances of a purely Indian issue should the standard-setter be involved.

Stance of the Panel: As regards the country and sector-specific standards, the Panel observed that there may be areas where IASB may not come out with a standard but it could be an area of importance for India. Accordingly, ICAI could come out with sector or country-specific guidance in respect of these areas. However, as and when the IASB comes out with IFRSs in these areas, the standards issued by ICAI would be replaced by the IFRSs.

⁹ The response of the Advisory Panel vis-à-vis the observations made by the peer reviewer are indicated in bold and italics.
¹⁰ Mr. Mackintosh had reviewed both accounting and auditing documents. His comments relating to auditing are in the
separate Chapter on auditing standards.

I agree that, as recommended in paragraph 76, the standard-setter should have sole authority over technical matters.

In relation to paragraphs 78 to 80, I agree that banks across sectors should use the same accounting principles.

I also agree with the sentiments in paragraph 81.

I agree in general with the paragraphs on monitoring and training, but care will need to be taken that the ICAI is not seen as interpreting the standards. While advice can be given on general principles, the accounting treatment will depend on the nature of the transaction involved and professional judgement will be required.

Stance of the Panel: Accepted. This has been incorporated in the report

The way forward section might also give some consideration as to how the standard-setter might be organised and operate to influence the IASB both as to its agenda and as to the technical output it produces. How is the voice of India to be heard in the global situation going forward? I see this as a very major role for the board.

Contents

1. Introduction

2. Auditing – the International Benchmark

2.1 The International Federation of Accountants

2. Sixty-three professional accountancy bodies from 51 nations came together in 1977 to form the International Federation of Accountants (IFAC). The ICAI was one of the founding members. IFAC has four-fold objectives; developing high quality international standards and supporting their adoption and use; facilitating collaboration and co-operation among its member bodies; collaborating and co­operating with other international organisations; and serving as the international spokesperson for the accountancy profession. The Federation is headed by a Council with a term of three years. The ICAI, too, had its representatives on the Board of the IFAC Council since its inception in 1977 through 1995, from 1997 to 1998 and then from 2001 to 2008.

2.2 The International Auditing Practices Committee

3. To achieve its objectives, IFAC, over a period of time, constituted several boards/ committees to work in several areas of professional interest. The International Auditing Practices Committee (IAPC) was constituted in October 1977 with the prime objective of enhancing the quality and uniformity in practice throughout the world and strengthening public confidence in the global auditing and assurance profession. Towards this end, the IAPC, which was renamed as the International Auditing and Assurance Standards Board (IAASB) in 2002, is entrusted with the task of developing standards on auditing and review of historical financial information, as also standards on other types of assurance engagement carried out in the context of information other than historical financial information. The IAASB also develops related practice statements. English is the official language of the IAASB.

4. The Standards and Practice Statements issued by the IAASB are the benchmarks for high quality auditing and assurance practices. They are designed to help professional accountants meet the changing expectations of users. In addition, IAASB also develops the quintessential quality control standards for the auditors. From the first International Auditing Guideline¹, Objective and Scope of the Audit of Financial Statements, issued by the IAPC in 1979, to the first International Standard on Auditing (ISA) issued in 1991, as on date, the tally of IAASB Standards has risen to 39², covering an array of important aspects of auditing and other assurance services. Based on the functional classification, the International Standards on Auditing have been classified in seven categories, viz., introductory matters, general principles and responsibilities, risk assessment and response to assessed risks, audit evidence, using the work of others, audit conclusions and reporting, and specialised areas.

2.3 International Auditing Standards and the Indian Contribution

5. ICAI represented India on the IAPC (later known as IAASB) during the latter’s early years, spanning the period 1980 to 1986.

6. In addition to helping draft the international standards, the ICAI’s representation on the IAPC helped in rooting the international standards as the anchor in the formulation of the auditing standards in India.

7. Since 2002, the Chairman and Secretary of the Auditing and Assurance Standards Board (AASB) also participate as representatives of the Institute in the meetings of the National Auditing Standard-Setters³ [comprising ten countries including India], organised by the IAASB annually. The purpose of these meetings is to share knowledge on matters affecting international convergence and on international and national developments affecting the priority of topics on future standard-setting agendas, to optimise the process of bringing the strengths of IAASB and the national standard-setter (NSS) to bear on reaching consensus and convergence in standards at an early stage, to achieve closer co-operation and strengthened communication for identifying opportunities for closer collaboration on projects, leveraging of resources, further development of staff skills, minimisation of duplication, and to achieve wider involvement of NSS in IAASB task forces. For the purpose of these annual NSS meetings, only those standard-setters are invited by IAASB that:

• are significantly active in the development of national auditing standards, or by way of contributing to the development of International Standards on Auditing (ISAs);

¹ The nomenclature was changed to International Standard on Auditing (ISA) in 1991.
² The number of Standards issued by IAASB is 39 (excluding those which are the revised versions of the earlier Standards
issued under the Clarity Project) as on January 1, 2008.
³IAASB constituted a National Standard-setters (NSS) Group comprising of eight countries in 2001. India was invited
to become its member in 2002.

• have adopted or plan to adopt ISAs, or are demonstrably committed to the achievement of convergence of international and national standards;

• are sufficiently strong in terms of resources to participate actively in collaborative efforts identified through the activities of the liaison group; or

• represent the world’s largest economies.

2.4 International Auditing and Assurance Board – The Clarity Project

8. The IAASB embarked upon its Clarity Project in 2004 with the twin objectives of greater use of its International Standards and ease of their translation. Until then, the Standards issued by the IAASB were written in a format wherein the principles or the fundamental requirements of the Standards were given in the bold text, the mandate being indicated by the use of the word ‘should’, followed by its explanation in the normal type face, as a running text. Besides, the ISAs were quite concise and the explanation to the principles also did not contain any guidance aimed specifically at application of these Standards to audit of small entities. The Clarity Project, as the name suggests, was aimed at improving the clarity of the IAASB’s pronouncements, making the ISAs easy to understand and implement. The IAASB is, therefore, also in the process of revising and/or redrafting its entire suite of Standards and hopes to complete the project by the end of 2009.

9. Till December 2003, all the Standards issued by the IAASB were known as the International Standards on Auditing. However, pursuant to its Clarity Project, the IAASB, with effect from January 2008, has categorised its International Standards as under, on the basis of type of assurance provided by different types of engagements:

• International Standards on Auditing (ISAs) – to be applied in the audit of historical financial information (100 – 999).

• International Standards on Review Engagements (ISREs) – to be applied in the review of historical financial information (2000 – 2699).

• International Standards on Assurance Engagements (ISAEs) – to be applied in assurance engagements dealing with subject matters other than historical financial information (3000 – 3699).

• International Standards on Related Services (ISRSs) – to be applied to compilation engagements, engagements to apply agreed upon procedures to information and other related services engagements as specified by the IAASB (4000 – 4699).

The above four categories of International Standards are collectively known as the Engagement Standards.

10. The Standards written under the Clarity Project have the following distinct features:

(i) The principles and the relevant application guidance in the Standard do not appear as running text. Instead, a Standard is now divided into two distinct sections. The first section contains the Requirements (i.e., the principles) apart from the Introduction, Scope and Objectives, whereas the second section contains the Application and Explanatory Material (i.e., the application guidance) in respect of the principles enunciated in the Requirements section. A Standard, therefore, now does not make a distinction between the principles and application guidance in the format of a bold type vis-à-vis normal text, rather the mandate is reflected in the Requirements paragraphs through the use of the word ‘shall’.

(ii) Recognising the fact of existence of large number of small and medium enterprises across the world, the Standards provide appropriate guidance to the auditors in respect of application of these Standards to such entities without diluting the principal requirements of the Standard. The Application and Explanatory Material Section of the Standard issued under the Clarity format, accordingly, contains separate guidance on application of the principles enunciated in the requirements section to the audit of small entities.

(iii) Prior to the Clarity Project, the IAASB had a separate Standard on audit in a computerised information systems environment. But now the different aspects of information technology environment have also been embedded in all the relevant Standards written under the Clarity Project. The said erstwhile Standard has been withdrawn pursuant to the issuance of its two Standards, ISA 315, Understanding the Entity and Its Environment and Assessing the Risk of Material Misstatements, and ISA 330, Auditor’s Procedures in Response to Assessed Risks, focusing on risk-based auditing.

(v) The Application and Explanatory Material section, at relevant places, also contains guidance on application of the principles laid down in the Standard to the audit of public sector entities. It is pertinent to note that the IAASB defines ‘public sector’ as ‘national governments, regional (for example, state, provincial, territorial) governments, local (for example, city, town) governments and related governmental entities (for example, agencies, boards, commissions and enterprises)’.

11. In July 2006, IAASB issued a policy paper for national standard-setters (NSS) outlining the extent and manner of modification that a NSS could make to the corresponding International Standard (IS). A gist of these criteria is as follows:

(i) National Standard (NS) cannot be in conformity with the corresponding International Standard (IS) unless the standard-setter has in place a Standard conforming to the IAASB’s International Standards on Quality Control.

(ii) NS cannot be in conformity with the corresponding International Standard unless the NS includes all the requirements and guidance contained in the corresponding ISA, except as provided in (iii) and (iv) below.

(iii) Limited additions permitted to an IS:
(a) National legal/regulatory requirements.
(b) Other requirements/guidance that are not inconsistent with the current requirements/guidance in IS.

(iv) Limited deletions from the ISs are:
(a) Elimination of options.
(b) Requirement/guidance which the law/regulation does not permit.
(c) Requirement/guidance where the IS recognises different practices may exist in different jurisdictions.

(v) All the ISs of a particular category have been included.

3. International Acceptance of International Standards on Auditing

12. ISAs are widely accepted now. The global acceptance of ISAs is confirmed by the 2006 survey by the IFAC Compliance Advisory Panel which indicates that more than 100 countries are using ISAs, either adopted as written or locally adapted, or as a basis for preparing their national standards. The 2006 Survey also revealed that 40 per cent of the countries adopt ISAs without any amendment; 35 per cent of the countries adopt ISAs and amend as necessary; and, 25 per cent of the countries compare National Standards with ISAs to eliminate differences. India falls in the category of those countries which adopt ISAs and make amendments subject to local laws, customs and usages. ISAs are also accepted as the basis for the audit of the financial statements of foreign listed entities by many of the world’s major capital markets for the public sector, the International Organisation of Supreme Audit Institutions (INTOSAI)⁴ uses ISAs as a basis for its Financial Audit Guidelines.

⁴ INTOSAI is the representative organisation of supreme it institutions, which are central government auditors.
⁵In Kautilyas Arthashastra.
⁶Source: The History of Accountancy Profession in India, Vol.I, The Institute of Chartered Accountants of India.

4.2 The Emergence of the Institute of Chartered Accountants of India

15. The passing of the Chartered Accountants Act, 1949 led to the creation of the ICAI. It has been entrusted with the task of regulation of the accountancy profession in India. For this purpose, the Council of the Institute has established a number of Committees and Boards, each to address an aspect critical to such regulation, for example, students’ registration, education and training, auditing standards, accounting standards, ethical issues, continuing professional education, disciplinary aspects, etc. Some of these Committees and Boards are as follows:

⁷ Earlier known as the Coaching Board.
⁸Earlier known as the Post Graduate Courses Committee
⁹Prior to September 1982, Auditing and Assurance Standards Board was a part of the Research Committee.
10 Source: History of Accountancy Profession in India, Volume I, pp 361, The Institute of Chartered Accountants of India.

line with the IAASB’s revised Preface under the Clarity Project. This aspect has been discussed in subsequent paragraphs. A table showing the new categorisation and re-numbering of the auditing standards and reconciliation are given in Appendix B.

5.1 Composition of Auditing Practices Committee

18. Till 2002, the membership of APC comprised members of the Council of the Institute as well as co-opted members. As per the provisions of the Chartered Accountants Act, 1949 only chartered accountants, either from industry or practice can be co-opted on the Board. In July 2002, to bring in greater transparency and efficiency in the working of the APC, the Council of the Institute opened up the meetings of the APC to regulators, industry representatives as well as academicians as special invitees. Such representatives need not be chartered accountants. The regulators invited were the Reserve Bank and the SEBI. One special invitee was sought from the apex industry associations, viz., Federation of Indian Chambers of Commerce and Industry, Confederation of Indian Industry and the Associated Chambers of Commerce, on an annual rotation basis. Similarly, a representative was requested from leading management institutes of India, e.g., the Indian Institute(s) of Management – Ahmedabad, Lucknow, Indore, Kolkata, Kozikode, Bangalore, on an annual rotation basis.

5.2 Auditing Standard-setting – Considerations and Process

19.India is one of the founder members of the IFAC. Its responsibility in respect of the International Standards, therefore, emerges from one of the IFAC membership obligations whereby the Institute is required to promote the Standards promulgated by the IFAC. Accordingly, while formulating these Standards, the APC was also required to give due consideration to the corresponding standard(s) issued by the International Federation of Accountants as well as applicable laws, customs, usages and business environment in India. Though, periodically, IFAC undertakes assessment of the membership obligations by the member bodies, there is more to convergence with the international best practices than a mere need for compliance with a membership obligation, namely, conviction and commitment.

20. Auditing standards in India are formulated following a due process approved by the Council of the ICAI. This due process¹¹ is set out in the Preface to the Statements on Standard Auditing Practices issued in June 1983. In terms of the 1983 Preface, a Standard passes through the following stages:

Stage I: At the first stage, the AASB determines the broad areas in which Standards need to be formulated and the priority in regard to the selection thereof.

Stage II: AASB constitutes study groups to write the Standards.

Stage III: The draft of the Standard prepared by the study group is discussed by the AASB and subject to necessary changes, if any, is issued as an Exposure Draft of the Standard for public comments.

Stage IV: AASB considers the comments received on the Exposure Draft on the basis of which the draft of the proposed Standard is finalised and submitted for the consideration of the Council of the Institute.

Stage V: The Council considers the draft of the proposed Standard and, if necessary, modifies it in

¹¹The due process has been revised in 2007 and made more rigorous. The revised due process is discussed elsewhere in the Report.

consultation with the AASB. The final Standard is then issued under the authority of the Council.

21. As a matter of policy, as laid down in the Preface to Statements on Standards on Auditing Practices issued in 1980, the Standards issued by the AASB are anchored on the corresponding standards issued by the IAASB. Changes to the latter are made only as warranted by the local conditions.

5.3. Standards, Statements and Guidance Notes

22.The Auditing Practices Committee, in addition to the Standards, has also brought out Statements on a number of auditing issues. The Statements, normally, provided guidance to the members on issues of contemporary relevance and were issued primarily when auditing standards were either not yet in place or were in evolutionary stages. For example, the Statement on Auditing Practices, issued in 1964, a period when the concept of Standards had yet to take a concrete form, provided extensive guidance to the members on issues such as true and fair, materiality, comparative study, accounting policies, internal controls, auditor’s approach, etc. The Statement on Manufacturing and Other Companies (Auditor’s Report) Order, 1975 provided detailed guidance to the members for effective discharge of their reporting requirements under the said Order. The Statement on Qualifications in Auditor’s Reports was published as far back as in 1970 to provide guidance to members regarding the form, purpose and manner of qualifications and thereby improving the overall standards of reporting on the financial statements by chartered accountants.

23.Both the Standards as well as the Statements on auditing codify the best practices in the area of auditing and are regarded by the Council as being critical and are, therefore, mandatory in nature. If, for any reason, a member has not been able to perform an audit in accordance with the applicable Standard or Statement, he is required to draw attention to the material departures there from. It is, however, important to note that there can be situations in which certain matters are covered both by a ‘Statement’ and by a ‘Standard’. In such a situation, the ‘Statement’ prevails till the time the relevant ‘Standard’ becomes mandatory. Once a ‘Standard’ becomes mandatory, the concerned ‘Statement’ or the relevant part thereof automatically stands withdrawn.

24. The APC was also entrusted with bringing out Guidance Notes on auditing. Guidance Notes are designed primarily to provide guidance to members on matters which may arise in the course of their professional work and on which they may desire assistance in resolving issues which may pose difficulty. Guidance Notes are recommendatory in nature. A member is required to ordinarily follow recommendations in a Guidance Note relating to an auditing matter except where he is satisfied that in the circumstances of the case, it may not be necessary to do so. Till date, the AASB has issued a number of Guidance Notes on auditing, including four industry-specific Guidance Notes. A list of Statements and Guidance Notes is given in Appendix C.

5.4 Developments at the Auditing and Assurance Standards Board Pursuant to the International Auditing and Assurance Board’s Clarity Project

25. In May 2007, the Council of the Institute, as a part of its strategy to fall in line with the best practices followed at the AASB, approved a revised due process for the issuance of auditing standards. The revised due process is a necessary companion to the revised Preface and the new/revised Standards to be issued by the AASB is in line with the corresponding International Standards issued by the IAASB pursuant to its Clarity Project. The Revised Preface issued pursuant to the Clarity Project also paved the way for a new format of writing the Standards, i.e., dividing the Standards in two parts, viz., Requirement Section and Application and Explanatory Section. (The new Standards issued by the AASB corresponding to the ISs issued under the Clarity project have been discussed subsequently in this Report.) Though the principles of transparency and fairness lie at the heart of the revised due process, some critical modifications have been introduced to further strengthen the working of the AASB, especially, its standard-setting process. A brief summary of the significant changes made is given below:

5.4.1 Composition of Auditing and Assurance Standards Board

26. In respect of the composition of the AASB, the Revised Preface and the Due Process has introduced the following changes:

(i) IRDA (apart from the existing Reserve Bank and SEBI) has been added as another regulator from which a special invitee to AASB would be requested.

(ii) The academicians would now, in addition to the Indian Institute(s) of Management, be represented by any other prominent academic and/or research organisation.

(iii) Public interest would be represented on the AASB, for example, by a representative of a not-for-profit organisation.

(iv) Term of the Chairman of the AASB would be at least three years to ensure continuity and consistency in policy decisions and approach.

5.4.2 Standard-setting Process

27. The standard-setting process has been modified for the following requirements by the Revised Preface and Due Process:

(i) The AASB meeting where a Standard/ Statement is to be considered, requires the presence – in person or through telecommunication link – of at least two-thirds of the membership of AASB.

(ii) Absence of a member for a consecutive period of three AASB meetings needs to be brought to the notice of the Council of the Institute.

(iii) The AASB has been authorised to undertake joint projects with regulators and others.

(iv) The draft of the Standard/Statement to be considered by the AASB is to be hosted on the website of the Institute at least twenty one days before the said AASB meeting.

(v) The period of exposure has been increased from 45 days to at least 60 days.

(vi) Comments of the respondents are to be hosted on the website of the AASB.

(vii) The manner of disposal of these comments by AASB is also required to be hosted on the website of the AASB .

(viii) Members of the public can attend the AASB meetings where a particular Standard is to be considered, subject to the specified conditions.

(ix) The final Standard for submission to the Council would be cleared by the AASB after a voting process.

28. Some of the other significant changes brought in by the revised Preface and the Due Process are:

(i) Guidance Notes, clarifications on Standards, technical guides, practice manuals, studies and other papers have been formally listed as documents that can be issued by the AASB.

(ii) The AASB has been given a formal authority to issue technical guides, practice manuals, studies and other papers, etc., under its own authority.

(iii) Procedure for issuance of the documents mentioned in (i) above has also been formalised.

6. Encouraging Implementation and Enforcing Compliance of Standards

¹² Source: The History of Accountancy Profession in India,Vol. II, The Institute of Chartered Accountants of India,

than 5000 CPE hours in total. In the year 2008-09, the CPE Committee has till October 31, 2008 held many learning programmes in the area of audit, generating more than 3,500 CPE hours. The Committee also brings out non-authoritative publications on various subjects. As on date, CPE is mandatory for the practicing members. However, from 2008, the CPE has become mandatory for the members in industry as well.

6.1.2 Peer Review Board

32. The Institute also has in place a system of peer review of audit firms (i.e., practice units), done under the aegis of the Peer Review Board of the ICAI, established in April 2002. The Board consists of ten members appointed by the Council of the ICAI of whom at least six are from amongst the members of the Council. The Board also has representatives from the Ministry of Corporate Affairs, the CAG, SEBI and the industry (as represented by FICCI/CII).

33. The review process involves an evaluation of the process followed by the Practice Units (PUs) in performing attestation engagements. Under a peer review, the reviewer examines the adequacy of the founding pillars of quality control system in an audit firm, viz., compliance with technical standards, audit procedures and documentation, quality of reporting, office systems and procedures and training of the staff and makes a report thereon. The report, rather than being a fault-finding weapon, is aimed at helping the reviewee to improve its performance. Importantly, the PUs found wanting/deficient by the peer reviewer are again subjected to a peer review process after a period of about six to twelve months to assess the improvements made by them.

34. Peer review was introduced in three stages to cover all types of PUs – sole proprietors, partnerships, etc. Stage I of the peer review process covered all such PUs which carry out audits of enterprises involving large amounts of funds – Government/public (paid-up capital above Rs. 5 crore and annual turnover of more than Rs. 50 crore), central statutory auditors of banks, insurance companies, central co­operative societies, asset management companies, mutual funds, etc. Stage II covered firms carrying out audits of branches of public sector banks/private sector and foreign branches, regional rural banks, co-operative banks, NBFCs listed on stock exchanges and not covered in Stage I. Stage III covered all the rest of the firms. As per the statistics available, 1,188 PUs fall under Stage I while Stage II covers 16,478 PUs and Stage III covers all residuary 38,356 firms including members that practice in individual name. The process of review is also cyclical since PUs covered under Stage I are reviewed mandatorily after every three years while in respect of Stage II and Stage III PUs, a four-year and a five-year cycle, respectively, has been decided by the Board. So far more than 11,000 PUs have been selected for review under different stages. As on date, 1,479 certificates have been issued to different PUs while follow-up reviews have been ordered in respect of about 248 PUs.

35. Peer review being an instrument of encouraging compliance with standards and improving the overall quality of work by audit firms, it is essential that the peer reviewers are themselves strong technically and are experienced enough to understand the intricacies of practice. The Institute has, therefore, till date empanelled more than 3,900 peer reviewers and has provided extensive training to 3,100 reviewers at 79 programmes organised so far throughout the country. The training, incidentally, also ensures consistency and uniformity in the peer review process. The Institute has also developed a strong trainer base for the training of the peer reviewers.

36. A move that can be seen as supporting the peer review process is the recommendation of the SEBI’s Committee on Disclosures and Accounting Standards (SCODA) that, in view of the public funds involved, audit of listed companies should be carried out by only those auditors who have themselves been subject to the peer review. The said recommendation of SCODA has, in principle, been accepted by the Council of the Institute.


6.1.3 Quality Review Board

37. Section 28A of the Chartered Accountants Act, 1949 as amended by the Chartered Accountants (Amendment) Act, 2006 envisages establishment of a Quality Review Board (QRB) by the Central Government to perform the following functions:

(i) to make recommendations to the Council with regard to the quality of services provided by the members of the Institute;

(ii) to review the quality of services provided by the members of the Institute including audit services; and

(iii) to guide the members of the Institute to improve the quality of services and adherence to various statutory and regulatory requirements.

38. The Central Government, through its notification issued in June 2007, has constituted the QRB. The Board has a total of ten members, excluding the Chairman, whereof five members are nominated by the Central Government and five by the Council of the Institute. The Chairman to the Board is also nominated by the Central Government.

6.2 Enforcing Compliance – Disciplinary Mechanism

39. A member of ICAI is subject to its disciplinary jurisdiction. The Chartered Accountants Act, 1949 (hereinafter the Act unless specified otherwise) gives authority to the Central Council of ICAI to enquire into cases of professional or other misconduct on the part of members of ICAI and to take disciplinary action.

40. The Act, as amended by the Amendment Act of 2006, provides for the constitution of the Board of Discipline consisting of a presiding officer who has knowledge of disciplinary matters and of the profession and of two members, one of whom shall be a member of the Central Council and the other a person to be nominated by the Central Government out of persons of experience having eminence in the field of law, economics, business, finance or accountancy. The Board looks into complaints which fall under the First Schedule to the Act.

41.  There is also a Disciplinary Committee which consists of the President or Vice-President of ICAI as the presiding officer and of two members who are members of the Central Council of ICAI and two members to be nominated by the Central Government from amongst persons of eminence having experience in the field of law, economics, business, finance or accounting. The Disciplinary Committee looks into complaints against members falling under both the First Schedule as well as the Second Schedule to the Chartered Accountants Act, 1949.

42. To a large extent, the First Schedule covers professional and other misconduct related to non-observance of the internal regulations of the Institute. It has four parts, namely:

• Part I – applicable to professional misconduct by members in practice;

• Part II – applicable to professional misconduct by members in service;

• Part III – applicable to professional misconduct by members generally (whether in practice or not); and

• Part IV – applicable to other misconduct by members generally.

43. The Second Schedule generally covers professional misconduct in areas where public interest is involved. It has three parts, namely:

Part I – applicable to professional misconduct by members in practice. This includes inter alia disclosure of confidential information, failure to disclose material facts or misstatements in financial statements, failure to exercise due diligence or grossly negligent conduct, failure to obtain sufficient information to warrant the expression of an opinion and failure to invite attention to material departures from generally accepted audit procedures;

Part II – applies to professional misconduct by members generally (whether in practice or not); and

Part III – applies to other misconduct by members generally.

44. The First and Second Schedules to the Chartered Accountants Act, 1949 are reproduced in Appendix D.

45. The Chartered Accountants Act, 1949 provides for the appointment by the Central Government of an Appellate Authority consisting of a person who is or has been a judge of a High Court as the Chairperson and two past members of the Central Council and two persons to be nominated by the Central Government from amongst persons having knowledge and practical experience in the field of law, economics, business, finance or accountancy.

46. Appeals to the Appellate Authority against an order of the Board of Discipline or the Disciplinary Committee can be made by an aggrieved member and/or the Director (Discipline).

6.3  Enforcing Compliance – Supervisory Mechanism

6.3.1 Financial Reporting Review Board

47. The Financial Reporting Review Board (FRRB) was constituted by the Council of the ICAI in July 2002, comprising of the members of the Council of the Institute (including a nominee of the Central Government on the Council) as well as representatives of IRDA and the CAG as special invitees. The primary function of the FRRB is to review the compliance inter alia with the reporting requirements of various applicable statutes, Accounting Standards and Auditing and Assurance Standards issued by the ICAI.

48. The Board reviews general purpose financial statements and the auditors’ reports thereon of certain randomly selected enterprises with a view to determine, to the extent possible:

• Compliance with the generally acceptedaccounting principles in the preparationand presentation of financial statements;

• Compliance with the disclosure requirements prescribed by regulatory bodies, statutes and rules and regulations relevant to the enterprise; and

• Compliance with the reporting obligations of the auditor.

49. The FRRB can review the general purpose financial statements of the enterprise and the auditor’s report thereon either suo motu or on a reference made to it by any regulatory body like, the Reserve Bank, SEBI, IRDA, Ministry of Corporate Affairs, etc. The FRRB may also review general purpose financial statements of the enterprises and the auditor’s report thereon relating to which serious accounting irregularities in the general purpose financial statements have been highlighted by the media reports.

50. The enterprises within the purview of the FRRB include:

• enterprises whose debt or equity securities are listed on a recognised stock exchange in India;

• public financial institutions and banks;

• non-listed and other commercial enterprises having a turnover of Rs. 50 crore or more; and

• such other category of enterprises which in the opinion of the Board make the public interest vulnerable due to susceptibility to non-compliance of generally accepted accounting principles in the preparation and presentation of financial statements, non-compliance of the disclosure requirements prescribed by regulatory bodies, statutes and rules and regulations relevant to the enterprise and non-compliance of the reporting obligations of the enterprise and the auditor.

51. For suo motu reviews, the FRRB decides every year, the number of companies to be reviewed in each Council year. The companies are short-listed on the basis of the criteria decided by the Board, using the company database available from a nationally renowned source. After short-listing, the companies are sorted in the ascending order of turnover. From this list, the required number of companies are selected using scientific methods such as random sampling. In its reviews, the FRRB is assisted by its various Financial Reporting Review Groups (FRRGs). The members of the FRRGs are adequately trained by the FRRB and work under strict confidentiality requirements.

52. In case the FRRB finds any non-compliance with the factors stated above, it refers the case to the Secretary to the Council of the Institute of Chartered Accountants of India¹³ for initiating action against the auditor under the Chartered Accountants Act, 1949. Insofar as the management of the enterprise is concerned, pending the grant of relevant powers to the FRRB by the Central Government, the FRRB informs irregularity to the regulatory body relevant to the enterprise.

53. In cases where no material non-compliance and/or non-compliance affecting the true and fair view of financial statements are observed by the FRRB, and only immaterial non-compliance and/or non-compliance, which do not affect the true and fair view of financial statements are observed, the FRRB may not refer the case to the Secretary¹⁴ to the Council of the ICAI for initiating action against the auditor under the Chartered Accountants Act, 1949. In such cases, the FRRB would appropriately bring the non-compliance to the attention of the auditor and/or the enterprise concerned. Till 2007, the FRRB has taken up the review of 245 companies, out of which 74 cases have been referred to the Secretary to the Council of the Institute and 76 cases have been referred to the relevant regulators.¹⁵

¹³ Pursuant to the amendments introduced by the Chartered Accountants (Amendment) Act 2006, the cases now need
to be referred to the Director (Board of Discipline).
¹⁴ See footnote 4.
¹⁵ The Institute has its own disciplinary mechanism, as prescribed under the Chartered Accountants Act, 1949 (amended
by the 2006 Amendment Act), to deal with the complaint cases filed against the members of the Institute. This disciplinary
mechanism has been discussed in this Report subsequently.

54. With a view to apprising the members of the Institute and others concerned about the major non-compliance observed during the review, the FRRB compiles information on instances of such non-compliance from time to time and publishes the same in the Journal of the Institute and also hosts them on the website of the Institute, without mentioning the names of the enterprises concerned and/or their auditors. The FRRB does not have any power to impose any kind of penalty on the concerned enterprise/auditor.

7. India and the World – Report on the Observance of Standards and Codes-2004

7.1 Report on the Observance of Standards and Codes’ Evaluation Process

55. The Financial Stability Forum (FSF) of the World Bank, established following the East Asian crisis,1997 enunciated twelve core principles of financial stability, with accounting and auditing being one of them. The Report on Standards and Codes (ROSC), a joint initiative of the World Bank and the IMF is aimed at assessing the level of compliance in the member countries of the twelve core principles enunciated by FSF, comprising assessment of actual practices as well as the effectiveness of the monitoring and enforcement mechanisms. For the purpose of collecting relevant information, diagnostic templates have been developed by the World Bank.

56. Insofar as auditing is concerned, the International Standards on Auditing (ISAs) issued by the IAASB of IFAC were taken as the benchmarks for the assessment and comparison. The diagnostic tool for the purpose evaluated the audit standard-setting framework as well as the position of each Auditing and Assurance Standard¹⁶ vis-a-is the corresponding International Standard on Auditing. The aspects evaluated include:

• Existence of auditing standards;

• Legal backing for these standards;

• Existence of a national standard-setter;

• Legal authority of the national standard-setter;

• Composition of the standard-setting body;

• Accountability of the standard-setting body;

• Due process of standard-setting; and

• Issuance of practical implementation guidance on auditing standards.

57. In respect of the individual standards, the following specific aspects were evaluated:

• Standards gap and compliance assessment;

• Whether standard has been adopted;

• Whether the national standard-setters address certain specific aspects of each of the ISAs;

• Standards as practiced;

• the extent to which the practice differs from the written requirements of the national standards; and

• difficulties faced by the professional accountants in public practice to fully comply with the standard.

7.2 Significant Findings of the Report on the Observance of Standards and Codes-2004

58. The ROSC-2004 was finalised by the representatives of the World Bank through a participatory process involving various
stakeholders such as the Ministry of Corporate Affairs, the Reserve Bank, the ICAI, IRDA, SEBI, the Bombay Stock Exchange, the National Stock Exchange, the CAG, the Central Board of Direct Taxes, the Federation of Indian Chambers of

¹⁶Now known as the Engagement Standards.

Commerce, the Confederation of Indian Industries, and the Associated Chambers of Commerce. Some of the significant findings of the ROSC-2004 are as follows:

• ICAI follows a due process in formulating and issuing standards.

• AASs generally replicate the ISAs, modifications being made to adapt to the local circumstances

• Lesser audit alternatives as compared to ISAs.

59. The ROSC-2004 identified the following differences in the AASs issued by the ICAI vis-a -vis the ISAs.

I. No AAS corresponding to the following ISAs:

(i) ISA 100, Assurance Engagements

(ii) ISA 501, Audit Evidence – Additional Consideration for Specific Items

(iii) ISA 720, Other Information in Documents Containing Audited Financial Statements

(iv) ISA 910, Engagements to Review Financial Statements

II. Significant differences in Standards related to audit planning, management representations, audit sampling and quality control.

III. Inability of the incoming auditor to access the working papers of the outgoing auditor.

IV. No requirement for assessment of the professional competence of another auditor.

V. Quality of audit practices differs significantly among audit firms.

VI. Improper use of the expression ‘subject to/except for’ audit opinions in audit reports.

7.3 Institute of Chartered Accountants of India’s Response to Report on the Observance of Standards and Codes’ Findings

60. Pursuant to observations made by the ROSC, ICAI took several steps including expediting the issuance of updated Standards. Such response, along with the Panel’s response, are discussed below:

7.3.1 Auditing Standards Corresponding to ISAs

61. Subsequent to the issuance of the ROSC-2004, the ISA 100 was withdrawn by the IAASB and in its place a document titled Framework for Assurance Engagements was issued. In 2007, the ICAI issued a document titled Framework for Assurance Engagements corresponding to the IAASB document.

62. Though the ICAI did not have an auditing standard corresponding to ISA 501, it did have Guidance Notes on some of the topics covered in ISA 501 namely, guidance notes on ‘Audit of Inventories’ and on ‘Audit of Liabilities’. A full-fledged Standard on ‘Audit Evidence – Additional Consideration for Specific Items’ (AAS 34¹⁷) was issued in March 2005.

¹⁷Now known as the Standard on Auditing (SA) 501.

63. The AASB has already issued the Exposure Draft of the SA 720 corresponding to ISA 720.

64. Insofar as ISA 910 is concerned, ICAI had issued a Guidance Note on ‘Engagements to Review Financial Statements’ which was substantially on the lines of ISA 910. In March 2005, it has issued a standard (AAS 33¹⁸) on the subject.

8. On the Road to Convergence – Ironing Out the Standard-specific Differences

65. Subsequent to ROSC-2004, the IAASB, pursuant to its Clarity Project, has till date issued twenty Revised/Redrafted International Standards on Auditing and thirteen exposure drafts of revised/redrafted ISAs which are yet to be finally issued by IAASB. In addition, IAASB had also issued a ‘mother standard’ on quality control by the nomenclature of ISQC 1, Quality Control for Audit Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements. One of the major implications of ISQC for the IFAC member bodies is that having a Standard corresponding to ISQC 1 is an essential pre-requisite for the national standard- setters to claim compliance with the International Standards. The Institute has already issued a Standard (SQC 1) corresponding to ISQC 1. The IAASB has recently issued an Exposure Draft of the Redrafted ISQC 1 under the Clarity Project.

8.1 Access to Working Papers

66. The inability of the auditors to share working papers among themselves in the Indian context has given rise to differences vis-à-vis a number of ISAs, for example, in the Standard dealing with audit of group financial statements. This inability seems to have stemmed from the requirements of clause (1) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 which states that, ‘a chartered accountant in practice will be guilty of professional misconduct if he discloses information acquired in the course of his professional engagement to any person other than his client so engaging him, without the consent of his client or otherwise than as required by any law for the time being in force’. Even in the case of an audit of a branch of a company, though section 228 of the Companies Act, 1956 empowers the principal auditor to visit the branch and inspect the documents maintained thereat but does not empower him to seek the working papers of the branch auditor. It shall, however, be well within the ambit of the legal provisions that an outgoing auditor may share his working papers subject to the permission of the client. Therefore, the principal auditor, both in the case of a branch or a subsidiary of the client company, may have access to the working papers of the latter if the parent company (client) so permits the branch/subsidiary auditor. The auditor may, however, at his discretion make copies of his working papers available to the client.

67. The Panel, however, reaffirms the recommendation of the SEBI Committee on Disclosures and Accounting Standards (SCODA) that, where a company has a material subsidiary whose audit has not been done by the principal auditor, the principal auditor should have the obligation to review the working papers of the other auditors who have audited the financial statements of such subsidiaries. To give effect to the ability of the principal auditor to fulfil this obligation, specific authority should be given to the auditor of the subsidiary in the engagement letter to allow such access.

8.2 Assessment of Professional Competence

68. The International Standards on Auditing, envisaging situation where an auditor uses the work of another auditor, requires the former,

¹⁸Now known as the Standard on Review Engagements (SRE)2400.

in all cases, to assess the professional competence of the other auditor whose work he intends to use/rely upon. Such a requirement in ISAs, perhaps, has been incorporated to cover twin situations, viz., a multinational corporation may have several branches or subsidiaries operating in different parts of the world or probably on account of the fact that in some countries, for example, the United Kingdom, there may be more than one professional accounting body recognised under the law whose members can carry out the audit of the financial statements. In such jurisdictions, where there is only one professional accounting body recognised by law whose members can carry out the audits of financial statements, (for example, in India, this would comprise the members of ICAI), the need to assess the professional competence of the other chartered accountant on whose work the main auditor wishes to rely/relies, may still be necessary. The need arises on account of the fact that in today’s complex economic environment involving the highly specialised nature of industry and financial services sector, professional accountants are required to deal with several intricate issues pertaining to a particular industry. Therefore, one may come across a situation wherein an auditor having adequate experience and standing in the profession may not have relevant experience of the particular industry. Thus, it may be imperative for an auditor assuming the ultimate responsibility for the audit opinion to assess the professional competence of the other auditor in the context of the particular assignment before relying upon the latter’s work.

8.3 Quality of Audit Practices

69. A large number of audit firms in India – more than 80 per cent according to the statistics maintained by ICAI – are sole
proprietors, most of them having limited resources and small entities as their clients for audit and taxation work. This, however, cannot be a reason to compromise on the audit quality. The Institute has, therefore, undertaken rigorous steps such as the mandatory Continuing Professional Education for one and all practicing chartered accountants, peer reviews as well as training programmes throughout the nook and corner of the country. It is hoped that these initiatives of the ICAI, some of which have been elaborated in earlier paragraphs, coupled with the recent issuance of a comprehensive standard on quality control, corresponding to the ISQC 1 of the IAASB, would go a long way in ensuring a uniformly high quality among audit firms.

8.4 Manner of Making Qualified Reports

70. ICAI has always been conscious of the fact that quality of reporting is the ultimate test of true professional and, thus, has taken several steps from time to time to bring in better practices in reporting by the auditors. As a measure to bring in uniformity in the reporting practices among the statutory auditors of companies under the Companies Act, 1956 the Institute, issued the Statement on Section 227(1A) of the Companies Act, 1956 in 1965. This Statement was subsequently merged with the Statement on Qualifications in Auditor’s Report, issued by the ICAI in 1970-71. This publication of the ICAI was a benchmark of sorts in the sense that it contained fundamental principles on when and how to qualify the audit reports. To provide a greater and clearer understanding to the readers as to how the auditor’s qualifications have affected the financial statements of the entity, the Statement was revised in 2000 to incorporate a significant provision to the effect that the auditor must give the aggregate impact of his quantifiable qualifications on the net profit/loss of the auditee. In 2002, the ICAI also issued a prescribed format of an audit report. Thereafter, in 2003, ICAI issued the AAS 28, The Auditor’s Report on Financial Statement, corresponding to the then existing ISA 700. Through this AAS, for the first time, the ICAI laid down the basic elements of the auditor’s report. The Standard also introduced the concept of an ‘emphasis of matter paragraph’ and also laid down guiding principles as to situations warranting a qualified/adverse or a disclaimer of opinion.

71. The ICAI, through its CPE and other training programmes on auditing as well as the peer review process, has provided guidance to members on the appropriate use of the expression ‘subject to/except for’ in audit reports. In fact, the quality of reporting is one of the main focus areas in the process of peer review. In addition, the ICAI’s seriousness on the quality of audit reports is also reflected by the fact that the FRRB has referred to the Secretary, ICAI, more than 74 cases against auditors due to shortcomings in their audit reports on the financial statements of the companies reviewed by the FRRB.

9. 2008 – Four Years After Report on the Observance of Standards and Codes-2004

72. The ICAI being a founder member of the IFAC, has followed a conscious policy of harmonisation with the international Standards, which, accordingly, form the basis for the national auditing standards (i.e, AASs) subject to any modifications arising out of the requirements of laws and regulations or customs and usage of trade. Since 2004, the AASB has also started the practice of giving a separate section on material departures from the corresponding ISA at the end of the Standard for better understanding of the users of financial statements. Beginning with the new/revised Standards, being issued corresponding to the ISAs issued under the Clarity Project, there is a conscious move on the part of the Institute to keep the departures from the ISAs at the bare minimum, having regard to the IAASB’s policy paper on compliance with the International Standards by the National Standard-Setters. Moreover, the information on the material departures from the corresponding ISAs is also being presented in a format which is more informative. The additions/deletions are now being given separately.

73. Another important difference between the IAASB Standards and the auditing Standards issued by the ICAI is that whereas the international standards contain separate guidance on application of the principles laid down in the Standard to public sector entities, the auditing standards issued by the ICAI do not contain any such separate guidance. The reason for this approach is the difference in the definition of ‘public sector entities’ as adopted by the IAASB and that adopted by the AASB of the ICAI. In India, public sector generally refers to public sector enterprises which are now working on commercial principles like any other business enterprise. The AASB, therefore, does not make any distinction in application of the auditing standards to public vis-à-vis non-public sector entities. Moreover, to the extent practicable, the guidance relating to public sector in ISAs has been retained in generic manner. Further, in India, government companies are subject to a supplementary audit by the C&AG in addition to the normal statutory audit conducted by a chartered accountant. In its Report of May 2005, the Expert Committee on Company Law noted that ‘since statutory audit is conducted by the statutory auditor appointed by the C&AG in the manner directed by him, the test/supplementary audit is superfluous since it would duplicate the work already done by statutory auditor.’

74. Significant changes have taken place the world over in the environment in which the audit is carried out today, the technology used by the clients for their business operations and, most importantly, the changing expectations of the various stakeholders, especially the regulators. Appropriate refinements in the auditing methodologies and technology were, therefore, imperative to match these changes and to help the profession maintain continued relevance in the society. The following paragraphs give a snapshot of the initiatives of the ICAI to match the pace of the economic developments taking India by storm.

9.1 Towards Risk-based Auditing

75. In order to make the audit more efficient and effective as also a value-adding proposition for the client, there was a conscious move globally towards developing a risk-based approach in auditing. Though the IAASB began its Clarity Project in 2004, a major boost to the auditing process came in 2003 when the IAASB issued two new standards, ISA 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, and ISA 330, The Auditor’s Procedures in Response to Assessed Risks, and revised two of its existing Standards, viz., ISA 200, Objective and General Principles Governing an Audit of Financial Statements, and ISA 500, Audit Evidence. These four Standards were collectively known as the Audit Risk Standards. These Standards were effective in respect of audits of financial statements for periods beginning on or after December 15, 2004. Issuance of these four standards gave rise to conforming amendments/revision to almost the entire suite of the International Standards on Auditing. The accordingly revised International Standards on Auditing were issued by the IAASB during the period 2004 and were effective for all audits of financial statements for the periods beginning on or after December 15, 2004.

9.2 On the Road to Convergence with International Standards on Auditing – the Strategy

76. The Institute has again reiterated its commitment to bring out internationally benchmarked auditing standards. For this purpose, ICAI’s Auditing and Assurance Standards Board has not only initiated an ambitious project of revising all its existing Auditing and Assurance Standards in the light of the various ISAs being issued by IAASB under its Clarity Project to achieve total convergence with the same but is also looking forward to meeting the dateline set by IAASB for winding up the Clarity Project. AASB has also charted out a strategy for successfully finishing this project. According to this strategy, the standard-setting process would be accelerated without compromising on the consultations with the various stakeholders and deliberations required in formulation of a standard. For this, the AASB issues exposure drafts of the revised Standards on Auditing co-terminus with the exposure drafts of the revised/new ISAs issued under the Clarity Project. The AAS are being given shape only after the final ISA has been issued by the IAASB. The Board, in association with the Continuing Professional Education Committee of the Institute, is also holding a number of training programmes and workshops, etc. on auditing standards for members.

9.3 On the Road to Convergence with the International Standards on Auditing – the Progress

77. As the first and the most fundamental step towards convergence, AASB in 2007 issued the Revised Preface in line with the Preface issued by the IAASB. The Revised Preface paves way for the introduction of Standards written in a format which is in harmony with that adopted by the IAASB for its ISA under the Clarity Project. The Preface, which is effective April 1, 2008 categories auditing standards into the following five categories, based on the types and levels of assurance that an engagement aims to provide:

(i) Standards on Auditing (SAs) – to be applied in the audit of historical financial information.

(ii) Standards on Review Engagements (SREs) – to be applied in the review of historical financial information.

(iii) Standards on Assurance Engagements (SAEs) – to be applied in assurance engagements, engagements dealing with subject matters other than historical financial information.

(iv) Standards on Related Services (SRSs) – to be applied to engagements to apply on agreed-upon procedures to information and other related services engagements such as compilation engagements.

78. Pursuant to the Revised Preface, therefore, the AASs, have been re-named as above and also re-numbered and re-categorised on the pattern followed by the IAASB for its Standards. The Revised Preface also provides for an SA to have two sections – the requirements section containing the basic principles and the application guidance section containing the implementation guidance.

79. In terms of a recent policy of IAASB, no National Standard-Setter (NSS), like the ICAI, can claim to have achieved convergence with the International Standards unless, among other things, it has a Standard equivalent to the International Standard on Quality Control (ISQC). The ISQC issued by the IAASB ranks highest in the hierarchy of the structure of IAASB pronouncements, preceding all the Standards issued by the IAASB. Therefore, as mentioned in earlier paragraphs, it is a mother Standard laying down extensive guidelines in respect of the quality control practices to be established and maintained by the accounting firms for the audits, reviews and other assurance engagements undertaken by them. The ICAI has also issued a mother standard on quality control corresponding to the ISQC.

80. In addition, the ICAI has also issued the revised Framework for Assurance Engagements corresponding to that issued by the IAASB. The Framework is a basic document, explaining the concept of assurance and the elements involved therein in the details.

81. A list of the final SAs issued by the ICAI under the Clarity Project is as follows:

240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements – Effective for audits of financial statements for periods beginning on or after April 1, 2009.

250 Consideration of Laws and Regulations in an Audit of Financial Statements – effective for audits of financial statements for periods beginning on or after April 1, 2009.

260 Communications of Audit Matters with Those Charged with Governance – effective for audits of financial statements for periods beginning on or after April 1, 2009.

300 Planning and Audit of Financial Statements – Effective for audits of financial statements for periods beginning on or after April 1, 2008.

315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment – effective for audits of financial statements for periods beginning on or after April 1, 2008.

330 The Auditor’s Responses to Assessed Risks – Effective for audits of financial statements for periods beginning on or after April 1, 2008.

570 Going Concern – Effective for audits of financial statements for periods beginning on or after April 1, 2009.

580 Written Representations – Effective for audits of financial statements for periods beginning on or after April 1, 2009.

A gist of the major differences between the AASB’s Standards and ISAs is given in Appendix E.

10. The Way Forward

82. From the above, it is clear that the strength and future of auditing in India hinges delicately, among other things, on the
commitment of the various players in the auditing environment, essentially the government and the ICAI, to certain fundamental aspects. It is hoped that the following recommendations of the Advisory Panel would act as a catalyst in taking the auditing profession in the India to the next level of change.

10.1 Convergence with International Standards on Auditings

83. Notwithstanding the efforts being made by AASB to achieve full convergence with the international standards at the earliest, the road to convergence is difficult. Whereas the extensive requirements of the new Standards could have implications in terms of escalation in the costs of audit, some firms might find it difficult to persuade their clients for increasing the audit fees. Further, a big effort would also be required both at the level of the Institute as well at the level of these individual firms to not only equip the latter with the requirements of the new Standards but also give up their old methodologies and fall in line with the new audit techniques. This is also aggravated by the fact that at the international level also, the auditing standards are undergoing changes very frequently. The difficulties notwithstanding, convergence with the international standards has to be pushed forward and in future, EDs must be issued co-terminus with the EDs issued by IAASB.

84. The omission of a specific reference to ‘Public Sector’ in Standards on Auditing issued by AASB under the Clarity format needs reconsideration, particularly in view of the significant development that the INTOSAI is using ISAs as a basis for its Financial Audit Guidelines. Though generic guidance regarding specific aspects of public sector has been incorporated in the standard itself, but explicit reference to public sector would go a long way because ultimately these standards would also form the basis for auditing public sector by C&AG of India in the larger context.

10.2 Implementation of Auditing Standards

85.As discussed earlier, the Indian auditing scene is marked by the presence of a large number of small and medium practitioners. Given their limited resources and need to provide service in multiple aspects of the practice, these practitioners are bound to face difficulties in keeping pace with the fast-changing auditing literature and the resultant changes to the audit methodology. A seamless integration of these small and medium practitioners in the Institute’s efforts to make the auditing profession in India truly benchmarked with international practices is, therefore, quintessential for success of these efforts. For this purpose, the Institute needs to adopt a three-pronged strategy. The first part of the strategy being bringing out more technical guidance and other literature to help the practitioners not only understand the new auditing standards and aspects relating to their practical implementation but also appropriately appreciate the need for these changes. AASB has already initiated projects on bringing out implementation guides for its proposed Standards on risk-based audits and quality control in audit firms. The second part would be organising training programmes, conferences and such other programmes on the new auditing literature and methodology, which would help practitioners not only unlearn the old concepts and learn new ones, but also provide a platform for the Institute and the members to interact and understand the problems, apprehensions and expectations from each other and possible solutions thereto. However, with the Institute being the second largest accountancy body in the world with a membership of nearly 1,50,000 spread out over an extensive geographical area, reaching out to them and overcoming their professional, social, cultural and age prejudices and pre-conceptions, would require concerted, well-planned and, above all, patient efforts on the part of the Institute. The third and the final part would be to send a strong message among the practitioners that there is no option but to comply with the new requirements if they really want to contribute to as also share the fruits of the economic growth of the country. It should be clearly demonstrated that the delinquents and the errant would not be let off lightly. This can be ensured by strengthening the quality review and the disciplinary process.

10.3 Strengthening Peer Review

86. As mentioned in the preceding paragraphs, the peer review process is aimed at encouraging compliance with the auditing standards. A closer look at the data available with the Institute makes it clear that even for a significant proportion of Stage I and Stage II Practice Units, the actual peer review remains to be completed. ICAI needs to examine the causes of these delays to ensure the continuous efficacy of the process.

87.The Institute should also not lose sight of the Stage III Practice Units, which comprise auditors of small and medium enterprises. The importance of the Stage III auditors and their clientele in economic development of the country should not be underrated. The small and medium enterprises can also be said to involve public interest given the fact that they also use public funds and other resources in the form of loans from banks, etc., Further, gaps in their accounting concepts and systems, existence of a large number of related parties in the form of individuals, weaker internal control systems, and above all, a fairly free operating environment, without much legal and regulatory oversight, etc., make it all the more important that their audits are done carefully. Another reason for keeping a close watch on the quality of audits of small and medium enterprises is the fact that their audits are done mainly by small and medium audit firms (SMPs), a segment of auditors which is typically plagued by issues such as inability to keep up with the technical pronouncements of the Institute on a regular basis, inadequate staff and failure to provide them proper training and mentor them, over-familiarity with/financial over-dependence on a few clients leading to potential independence threats, etc. Moreover, attestation services performed by a chartered accountant holding certificate of practice ought to be a subject matter of review in the larger public interest. While these are valid considerations, until the resources of the ICAI are significantly enhanced, it may be desirable to give priority to Stage I and Stage II Practice Units where large public interest is involved.

88. There is a feeling that in some cases because of restrictions on cost, the time devoted to the peer review is inadequate. Some alternative method of financing the cost has to be examined so that the adequacy of the peer review is not compromised.

10.4 An Independent Oversight Mechanism

89. As stated earlier in the Report, the Chartered Accountants Act, 1949 has recently been amended to set up the QRB with the Central Government having a majority (six out of eleven members including the Chairman to the Board) representation thereon and the representation of the Council of the ICAI being lesser than that. Such a constitution of the QRB has definitely sent positive signals all across as to the Board’s commitment to a fair and transparent quality review process of audit firms. It is, therefore, essential that the government and the Institute ensure that the Board starts functioning at the earliest.

90. The main issue in the above context is clarifying the exact role of the QRB, whether it would be advisory or regulatory in nature. It is felt that to be really effective, it would be essential for the QRB to play a more proactive role as an independent oversight body for the auditing profession in India, as has become the norm in most of the developed countries. Such an independent oversight body would increase the credibility of the work done by the Indian audit firms, at the global level.

10.5 The Board of Discipline and the Disciplinary Committee

91. With a two-layer disciplinary process, and with the Disciplinary Committee, (having Government nominees on board in terms of the provisions of the Chartered Accountants Act, 1949) being bestowed with more powers than the Board of Discipline, it is believed that the process of reining in errant members would be more rigorous and strict and would also cut down on the time factor. Since the nominations to the Board of Discipline and the Disciplinary Committee have already been made by the Institute and the Government, they should now accelerate the process of making the Board and the Committee functional. It is also suggested that until the current backlog of disciplinary cases is eliminated, complaints received from regulatory authorities and government entities like banks, where greater public interest is involved, be dealt with on a fast-track basis.

10.6 Enforcing Stricter Reporting Requirements for Listed Companies

92.The Listing Agreement of the SEBI, has been instrumental in improving and strengthening the reporting and disclosure practices among the listed entities. It requires the companies to furnish details regarding audit qualifications, viz., the reason for the audit qualification in their accounts, the reason for the company failing to publish accounts without audit qualifications, and the time within which the company will remove the qualification and publish accounts without qualification. Further,SEBI’s Committee on Disclosures and Accounting Standards (SCODA) in August 2002 also recommended three things. First, that the stock exchanges should be required to inform SEBI in cases where companies fail to remove audit qualifications; second, that SEBI may constitute an Advisory Committee to examine the cases reported by the stock exchanges where the companies have failed to remove audit qualifications, and, third, that SEBI may refer the matter to the Department of Company Affairs (now the Ministry of Corporate Affairs) to initiate necessary action under the Companies Act, 1956 and also to the ICAI in cases where actions are required against the auditors of the company. With this kind of a requirement in the Listing Agreement, SEBI has tried to build in a regulatory framework akin to the SEC in the US, wherein the SEC does not accept qualified audit reports of companies.

93. The path of ‘no qualified audit reports’ approach is, however, like a double-edged sword and, therefore, needs to be tread cautiously. Whereas, on the one hand, it would act as a strong deterrent to the companies indulging in what is called ‘earnings management’ and ‘creative accounting’, on the other hand, the inability of the auditor to issue qualified audit reports can lead to deadlocks with managements in case of genuine differences of opinion, which normally results in resignation of the auditors without the issuance of the audit report. In the extreme cases, such inability may also lead to impairment of auditor’s independence. It may also be noted despite SEC’s refusal to accept qualified reports, there has been a slew of re­statements in the last five years or so by the listed companies in the USA, indicating need for some checks and balances in the SEC’s policy.

94. Incidentally, SCODA, at its December 2006 meeting, recommended that the auditors of the listed companies may be required to submit to SEBI financial statements containing audit qualifications and that, to this effect, SEBI may write to the ICAI requesting them to advise its members suitably. This recommendation needs to be implemented in the right earnest.

95. Further, SCODA’s suggestion made at its meeting held in January 2007 ‘to amend Clause 41 of the listing agreement to make it mandatory for listed companies to ensure that their auditors submit the Annual Financial Statements to SEBI, along with the Auditor’s Report wherever the same are qualified by the auditors’ needs closer examination as to the actual follow-up of such a requirement. Guidelines may be prepared for determination of materiality of audit qualification having regard to following major areas:

(i) Where financial statements do not give a true and fair picture of the financial position of the company;

(ii) Non-observance of statutory provisions which may lead to imposition of penalties; and

(iii) Absence of information due to which auditors were unable to express an opinion or instances where auditors have been misled.

10.7 Access to Working Papers

96. Keeping in view the global environment and emergence of large corporate entities in India, the Panel endorses the recommendation of SEBI that, where a company has a material subsidiary whose audit has not been done by the principal auditor, the principal auditor should have the obligation to review the working papers of the other auditors who have audited the financial statements of such subsidiaries.

10.8 Functional Independence to the Auditing and Assurance Standards Board

97. To maintain the credibility and continuing relevance of the profession to the society, it is essential that a message is sent to the stakeholders that the Institute exists to serve the public interest. It is also, similarly, important to demonstrate that the auditing standards that are used by the auditors in carrying out audits of financial statements are to protect and serve the public interest and not to protect the auditors or help them shirk their responsibilities. As of date, though the Standards, are formulated by the AASB, the same are finally subject to the approval of the Council of the ICAI, which is the supreme body in the Institute, with a majority representation from practicing chartered accountants. It is, therefore, essential that, as is the world-wide phenomenon today, that functional independence is given to the Auditing and Assurance Standards Board vis-à-vis the Council of the Institute by making it the final authority for drafting and issuance of the Standards and the Council confining itself to the administrative, but not functional, control of the AASB.

10.9 Rationalising and Strengthening Auditor Independence

98. As mentioned earlier, the Companies Act, 1956 contains stringent provisions to protect the financial/personal independence of the auditors. In addition to the fundamental requirements in a number of clauses in the two Schedules to the Chartered Accountants Act, 1949 which again are explicitly or implicitly aimed at protecting the independence of the auditors, the Institute, too, has issued a number of self-regulatory measures for its members. One such measure is restricting the fees from one client to 40 per cent of the total revenues of the firm. Having regard to the growth of the auditing profession and changes in the economics of audit firms and operating environment of the clients, it is felt that the limit of 40 per cent is too large. The independence of the auditor may actually, or apparently, be jeopardised by the time the limit of 40 per cent is reached. It is, therefore, suggested that the limit be reduced to 25 per cent.

10.10 Free Flow of Information Among Different Players in the Regulatory Framework

99. Business enterprises today are functioning in an expanded regulatory regime, especially, those functioning in the corporate form and/or those which involve large public interest, for example, banking companies, insurance companies, or per se companies listed on stock exchanges. The Ministry of Corporate Affairs, through its Registrar of Companies, calls for a number of documents to be submitted by the companies, including their financial statements and the related audit report. Similarly, the Reserve Bank as well as the IRDA also require a number of returns, containing vast amount of information, to be filed by the entities falling under their regulatory regime. In the same way, SEBI, through means of the various requirements in the Listing Agreement, requires all listed companies, to submit financial and other information periodically.

100. In addition to the filing requirements, certain regulators, for example, the Reserve Bank undertakes inspections of banks. It would be beneficial if there is a free exchange of information between the different players in the legal and regulatory framework, especially, in relation to financial irregularities found by them.

References

1. The International Federation of Accountants’ website www.ifac.org (history of IFAC).

2. The International Auditing and Assurance Standards Board’s website www.ifac.org/IAASB.

3. The Institute of Chartered Accountants of India, (2000); History of the Accountancy Profession in India, Vol. I.

4. The Institute of Chartered Accountants of India, (2000); History of the Accountancy Profession in India, Vol. II.

5. The Companies Act, 1956.

6. The Institute of Chartered Accountants of India, (2007); Preface to the Statements on Standard Auditing Practices, Handbook of Auditing Practices (Vol. I).

7. The Institute of Chartered Accountants of India, (2007); Announcements of the Council regarding Status of Various Documents Issued by the Institute of Chartered Accountants of India, Handbook of Auditing Practices (Vol. I).

8. The Institute of Chartered Accountants of India, (2007); Preface to Standards on Quality Control, Auditing, Review, Other Assurance and Related Services, Handbook of Auditing Practices.

9 The World Bank, (2004); Report on Observance of Standards and Codes (ROSC) – Accounting and Auditing, December.

10. The Chartered Accountants Act, 1949.

11. The UK Companies Act, 2006.

12. The International Federation of Accountants,(2007); Handbook of International Auditing, Assurance and Ethics Pronouncements.

13. The Institute of Chartered Accountants of India (2007); Handbook of Auditing Pronouncements.

1952. Non-partner Chartered Accountant not to Sign Report on Behalf of the Firm

1955 Audit of Accounts of General Insurers

1957 Answers to Queries Regarding the Companies Act, 1956

1958 Council’s View on the Form of Certificate

1959 Disclosure in the Final Accounts of the Company

1961 Profit & Loss Account and Profit & Loss Appropriation Account

1962 Auditing of Accounts of Liquidators Mode of Valuation of Fixed Assets

1963 Recommendations regarding Non-Provision of Taxation Form of Balance Sheet Recommended by the Council Accounting & Auditing: Statement Issued by the Research Committee

1964 Maintenance of Unduly Heavy Cash Balances by Companies Treatment in Accounts of Taxation & Proposed Dividend Statement on Auditing Practices

1965 Statement on Section 227(1A) of the Companies Act, 1956

1966 Obligations under Certain Provisions of the Companies Act, 1956

1967 Guarantees and Counter-Guarantees given by Companies

1968 Independence of Auditors

1970-71 Statement on Qualifications in Auditor’s Report A Guide to Company Audit
Audit of Banking Companies

1975 Statement on Manufacturing and Other Companies (Auditor’s Report) Order, 1975

Statement on Payment to Auditors for Other Services

¹⁹ Publications brought out by the ICAI prior to formation of the Auditing Practices Committee in 1982.

New Categorisation and Re-numbering of Auditing Standards

Reconciliation of the International Standards on Quality Control, Auditing, Review, Other Assurance and Related Services, issued by the International Federation of Accountants with the Standards issued by ICAI (as on April 1, 2008)

Appendix C

Statements on Auditing

1. Statement on Auditing Practices (1964)

2. Statement on Qualification in Auditor’s Report (1970)

3. Statement on Section 227 (1A) of the Companies Act, 1956 (1975)²⁰

4. Statement on the Companies (Auditor’s Report) Order, 2003 [Issued under Section 227 (4A) of the Companies Act, 1956] (Replaced the Statement issued in 1975)²⁰

5. Statement on Payments to Auditors for Other Services (1975)

List of Guidance Notes

1. Provision for Proposed Dividend

2. Auditing of Accounts of Liquidators

3. Guidance Note on Independence of Auditors (Revised)

4. Preparation of Financial Statements on Letter-heads and Stationery of Auditors

5 Guidance Note on Auditor’s Report on Revised Accounts of Companies Before Circulation to Shareholders

6. Guidance Note on Certificate to be Issued by the Auditor of a Company Pursuant to Companies (Acceptance of Deposits) Rules, 1975

7. Guidance Note on the Duty Cast on the Auditors under Section 45-MA of the RBI Act, 1934

8. Guidance Note on Audit Reports and Certificates for Special Purposes

9. Guidance Note on Accountants’ Report on Profit Forecasts and/or Financial Forecasts

10. Guidance Note on Section 293 A of the Companies Act and the auditor

11. Guidance Note on Audit of Fixed Assets

12. Revision/Rectification of Financial Statements

13. Guidance Note on Audit of Accounts of Non-corporate Entities (Bank Borrowers)

14. Guidance Note on Reports in Company Prospectuses (Revised)

15. Guidance Note on Audit of Abridged Financial Statements

16. Guidance Note on Certification of Documents for Registration of Charges

17. Guidance Note on Audit of Inventories

18. Guidance Note on Audit of Investments

19. Guidance Note on Audit of Debtors, Loans and Advances

20. Guidance Note on Audit of Cash and Bank Balances

21. Guidance Note on Audit of Liabilities

22. Guidance Note on Audit of Revenue

23. Guidance Note on Certificate on Corporate Governance (Revised)

24. Guidance Note on Section 227(3)(e) and (f) of the Companies Act, 1956 (Revised)

25. Guidance Note on Audit of Expenses

26. Guidance Note on Revision of the Audit Report

27. Guidance Note on Special Consideration in the Audit of Small Entities

28. Guidance Note on Audit of Miscellaneous Expenditure [Revised]

29. Guidance Note on Audit of Consolidated Financial Statements

30.Guidance Note on Computer-assisted Audit Techniques (CAATs)

31. Guidance Note on Audit of Payment of Dividend

32. Guidance Note on Audit of Capital and Reserves

Industry-specific Guidance Notes

1. Guidance Note on Audit of Banks

2. Guidance Note on Audit of Companies Carrying on Life Insurance Business

3. Guidance Note on Audit of Companies Carrying on General Insurance Business

4. Guidance Note on Audit of Accounts of Members of Stock Exchanges

²⁰ Currently in force

Appendix D

Extracts from the Chartered Accountants Act, 1949
The First Schedule

[See sections 21(3), 21A(3) and 22]

PART I

Professional misconduct in relation to chartered accountants in practice

A chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he

(1) allows any person to practice in his name as a chartered accountant unless such person is also a chartered accountant in practice and is in partnership with or employed by him;

(2) pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his professional business, to any person other than a member of the Institute or a partner or a retired partner or the legal representative of a deceased partner, or a member of any other professional body or with such other persons having such qualifications as may be prescribed, for the purpose of rendering such professional services from time to time in or outside India.

Explanation :- In this item, ‘partner’ includes a person residing outside India with whom a chartered accountant in practice has entered into partnership which is not in contravention of item (4) of this Part;

(3) accepts or agrees to accept any part of the profits of the professional work of a person who is not a member of the Institute:

Provided that nothing herein contained shall be construed as prohibiting a member from entering into profit sharing or other similar arrangements, including receiving any share, commission or brokerage in the fees, with a member of such professional body or other person having qualifications, as is referred to in item (2) of this Part;

(4) enters into partnership, in or outside India, with any person other than a chartered accountant in practice or such other person who is a member of any other professional body having such qualifications as may be prescribed, including a resident who but for his residence abroad would be entitled to be registered as a member under clause (v) of sub-section (1) of section 4 or whose qualifications are recognised by the Central Government or the Council for the purpose of permitting such partnerships;

(5) secures, either through the services of a person who is not an employee of such chartered accountant or who is not his partner or by means which are not open to a chartered accountant, any professional business:

Provided that nothing herein contained shall be construed as prohibiting any arrangement permitted in terms of items (2), (3) and (4) of this Part;

(6) solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means:

Provided that nothing herein contained shall be construed as preventing or prohibiting

(i) any chartered accountant from applying or requesting for or inviting or securing professional work from another chartered accountant in practice; or

(ii) a member from responding to tenders or enquiries issued by various users of professional services or organisations from time to time and securing professional work as a consequence;

(7) advertises his professional attainments or services, or uses any designation or expression’s other than chartered accountant on professional documents, visiting cards, letter-heads or sign boards, unless it be a degree of a University established by law in India or recognised by the Central Government or a title indicating membership of the Institute of Chartered Accountants of India or of any other institution that has been recognised by the Central Government or may be recognised by the Council:

Provided that a member in practice may advertise through a write-up setting out the services provided by him or his firm and particulars of his firm subject to such guidelines as may be issued by the Council;

(8) accepts a position as auditor previously held by another chartered accountant or a certified auditor who has been issued certificate under the Restricted Certificate Rules, 1932 without first communicating with him in writing;

(9) accepts an appointment as auditor of a company without first ascertaining from it whether the requirements of section 225 of the Companies Act, 1956²¹ in respect of such appointment have been duly complied with;

(10) charges or offers to charge, accepts or offers to accept in respect of any professional employment, fees which are based on a percentage of profits or which are contingent upon the findings, or results of such employment, except as permitted under any regulation made under this Act;

(11) engages in any business or occupation other than the profession of chartered accountant unless permitted by the Council so to engage:

Provided that nothing contained herein shall disentitle a chartered accountant from being a director of a company (not being a managing director or a whole-time director) unless he or any of his partners is interested in such company as an auditor;

(12) allows a person not being a member of the Institute in practice, or a member not being his partner to sign on his behalf or on behalf of his firm, any balance-sheet, profit and loss account, report or financial statements.