Report No. 32510-IN India Report on Observance of Standards and Codes (ROSC) Accounting and Auditing December 20, 2004 Financial Management Unit South Asia Region Document of the World Bank INDIA Reporton Observanceof Standards andCodes (ROSC) . AccountingandAuditing Page ExecutiveSummary ............................................................................................................ iv I IntroductionandBackground . .................................................................................. 1 I1. InstitutionalFramework A. Statutory Framework....................................................................................................... B. ThePro~ession 3 ................................................................................................................. 8 . ............................................................................ D. SettingAccountingandAuditingStandards................................................................. C ProfessionalEducationandTraining 11 13 E EnsuringCompliancewith AccountingandAuditing Standards . .................................. 14 I11 AccountingStandardsas Designedandas Practiced . ............................................ 18 I V AuditingStandardsas Designedandas Practiced . ................................................ 21 V . Perceptionof the Quality of FinancialReporting ................................................. 23 V I PolicyRecommendations . .......................................................................................... 24 Appendices A IndianAccounting Standards:Applicability to Enterprises............................... 30 B IndianAuditing andAssurance Standards......................................................... 32 C. ProposedDefinition of "Control" for Purposesof Consolidation ..................... .. 34 D. InternationalDevelopments inRegulatory Framework of Accounting and Auditing............................................................................... 35 India-Accounting andAuditingROSC - Page ii ACKNOWLEDGMENTS This ROSC Accounting and Auditing review was carried out in active collaboration with the Government o f India" and the various stakeholders, including the Ministry o f Company Affairs, the Reserve Bank o f India, the Institute o f Chartered Accountants of India, the Insurance Regulatory and Development Authority, the Securities and Exchange Board of India, the Bombay Stock Exchange, the National Stock Exchange, the Comptroller and Auditor General o f India, the Central Board of Direct Taxes, the Federation of Indian Chambers of Commerce, the Confederation of Indian Industries, and the Associated Chambers of Commerce. The review was conducted through a participatory process that involved these stakeholders and was led by the country authorities. It included facilitated discussion and roundtable meetings with the representatives o f the profession and other stakeholders. The Ministry o f Company Affairs appointed a Steering Committee consisting of representatives o f the stakeholders to guide and facilitate the study process. The Steering Committee was chaired by Jitesh Khosla, Joint Secretary, Ministry o f Company Affairs, with support from Neerabh Prasad, Director, Ministryo f Company Affairs, as a member (secretary) to the Steering Committee. We gratefully acknowledge the valuable and extensive contributions of eachmember on the Steering Committee. We also thank the officials and the coordinators in the various institutions for their valuable assistancein facilitating this study. World Bank staff, including Ivor Beazley and Vinod Sahgal, provided valuable inputs and suggestions. The report also benefited immensely from comments o f peer reviewers: Naresh Chandra, former Cabinet Secretary, Government of India; Georges Barthes de Ruyter, former Chairman o f the International Accounting Standards Committee; Ian Mackintosh, Chairman of the UKAccounting StandardsBoard; and StephenHowes, LeadEconomist, SouthAsia Region(India), PREM. Thanks are also due to Vinaya V. Vemuri and Girija Sawkar for their efficient administrative support throughout the study. This report was prepared by a task team comprising of M. Zubaidur Rahman, Program Manager, OPCFM (Study Advisor); and Manoj Jain, Senior Financial Management Specialist, South Asia, Financial Management (Task Team Leader). aThis report has been discussed extensively with Government of India; clearance has been obtained for publication, but does not necessarily bear their approval for the entire content including opinions, conclusions, and policy recommendations. India-Accounting andAuditing ROSC Page iii EXECUTIVE SUMMARY This report provides an assessment of accounting and auditing practices in India within the broader context o f institutional capacity available for ensuring high-quality financial reporting. India's accounting profession was among the earliest to develop historically when the Indian Companies Act was enacted in the mid-l800s, 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 standardsand codes. However, thereis roomfor 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 skilledand capable of providing international-standard services. However, inorder to further improve the quality o f corporate financial reporting in India, there is a need to improve the institutional framework and take steps for enhancing compliance with the applicable standards andrules. 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 o f 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 andpromote a gradual process of improvement. India-Accounting andAuditing ROSC Page iv I.INTRODUCTIONANDBACKGROUND 1. This report is basedon a review of the strengths and weaknesses of corporate accounting and auditing practices in India. It forms part of a joint initiative between the World Bank and the International Monetary Fund (IMF) on Reports on the Observance of Standards and Codes (ROSC), which covers a set of twelve intemationally recognized core standards and codes relevant to economic stability and private and financial sector development.' The review involved the assessment of actual practices and an analysis of the effectiveness of monitoring and enforcement mechanisms. International Financial Reporting Standards (IFRS)' and International Standards on Auditing (ISA) served as benchmarks for evaluating comparability of locally applicable accounting and auditing requirements. The review used a diagnostic template developed by the World Bank to facilitate collection of information. This information was complemented by the findings o f a due diligence exercise based on a series of meetings with key stakeholders conducted by World Bank staff. 2. India is the largest democracy and second most populous country in the world with a population of approximately 1.1 billion and a geographical area of about 3.3 million square- kilometers. India has made progress inincreasing incomes and improving living standards over the past decade. After the setback associated with the 1991 balance of payments crisis, economic growth picked up; poverty continued to decline; and many social indicators, particularly inliteracy, continued to impr~ve.~ These developments were supportedby the wide- rangingreforms launchedin 1991to open andderegulatethe economy. 3. India's economic growth during 2003-04 has been reported at over 8 percent. More sectors have been opened to private activity; trade policy and the exchange rate regime have been further liberalized; and capital markets have been reformed, leading to an improved investment climate. Today India has one of the fastest growing economies inthe world with a compounded average growth o f 5.7 percent over the last two decades. The country's total gross domestic product (GDP) at US$3 trillion makes it the fourth largest in the world in purchase price parity terms, yet its per capita income at US$2,880 remains one of the lowest inthe world. A large number of Indians work abroad, sending back to the country about US$18.3 billion a year ininwardremittances, which i s the highest inthe world.4 Within the ROSC initiative, the World Bank andthe IMFassist member countriesin implementinginternationalstandards and codes; the first step inthis regard is to carry out assessmentsand preparereportsina modular form in each of the following areas: accounting and auditing, anti-money laundering and combating the financing of terrorism, banking supervision, corporate governance, data dissemination, fiscal transparency, insolvency and creditor rights, insurance supervision, monetaryandfinancial policy transparency, paymentssystems, and securities regulation. Within this report, IFRS refers to all standards and related interpretationsissued by the InternationalAccounting Standards Board (IASB) and its predecessor, the International Accounting Standards Committee (IASC). IASC-issued standards are knownas InternationalAccounting Standards(IAS). India: Sustaining Reform, ReducingPoverq, PREM, SouthAsia Region, World Bank, July 2003. This reportusesthe rate o fUS$l equals approximatelyRupees(Rs) 46, India-Accounting andAuditing ROSC Page I 4. More recently foreign direct investors and foreign portfolio investors have shown considerable interest due to initiatives, such as economic reforms, further liberalization of the Indian economy, and promise of government disinvestment from several state-owned enterprises. In2003, there were over 9,500 listed companies' and 23 registered stock exchanges inIndia. Since 1999,total marketcapitalization hasrangedbetween 22 and25 percentof GDP. The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the two main competing exchanges.6InMay 2003, there were 5,650 companies listed on the BSE and 1,471 on the NSE;7from these totals, less than 1,000 companies are actively traded. The top 100 BSE companies represent nearly 86 percent of BSE market capitalization. State-owned enterprises account for approximately 32 percent of BSEmarket capitalization. 5. India's economic performance has been aided by the structural reforms introduced over the past decade. However, it also seems clear that higher levels o f private investment and productivity will be neededto raise the growth rate of GDP to more than 8 percent per annum, as targeted in the country's Tenth Five-Year Plan. This would require sustained injection of highlevels of investments in the near future. India's private sector faces a tough challenge in tackling this issue. International comparisons indicate that India has intrinsic advantages that should allow the country to emerge as a major hub for manufacturing and labor-intensive service industries, including accounting-related services, These advantages include relative macroeconomic stability, one o f the world's largest local markets; a large and relatively low- cost labor force; and a large well-educated English-speakingpopulation. It is acceptedthat India would do better by focusing on further strengthening the investment climate in order to capitalize on its intrinsic advantages. This would require buildingon the existing initiatives and further strengthening of the corporate financial reporting regime; and improving comparability, transparency, and accountability. This figure, from the Department of Company Affairs, represents less than 2 percent of the total number of registered companies. Under the Securities ContractsRegulationAct (1956), all Indian stock exchanges have a self-regulatory role, but they may differ inorganizationalform. Inthe BSE, 2,650 out ofthe 5,650 companiesare suspended from trading. Since multiple listings are permitted,there is some overlap betweenthe companies listedontheNSEandthe BSE. India-Accounting andAuditing ROSC Page 2 11. INSTITUTIONAL FRAMEWORK A. StatutoryFramework 6. The Companies Act (1956) provides the basic requirements relating to financial reporting of all companies incorporated in India. The Companies Act requires the preparation, presentation, publication, and disclosure of financial statements; and an audit of all companies by a member-in-practice certified by the Institute of Chartered Accountants o f India (ICAI). Schedule VI to the Act prescribes the form, content, and minimum disclosure requirements o f financial statements. 7. The Central Governmentenforces the CompaniesAct through the Departmentof Company Affairs (DCA),' the Company Law Board: the Regional Directors, and the Registrars of Companies (ROC). Every Regional Director's office has a special unit for inspection of companies' accounts. While in some cases Regional Directors have taken action against erring auditors under the Companies Act, generally they refer such cases to the ICAI." The ROC is expected to scrutinize the records of registered companies for compliance with provisions o f the Act." This function is hamperedby severe lack of capacity interms of trained manpower, thus restricting oversight to listed companies.12 The Company Law Board is an independent quasi-judicial body that receives petitions of complaint from the general public concerning the functioning and management of a company, The Company Law Board also receives applications for waivers from companies with regard to application of some of the provisions o f the Act.13 The powers to implement penalties, notices, and sanctions are delegatedamong DCA, Regional Directors, and ROC. 8. The CompaniesAct (1956) has been amended on numerous occasions. Some major changes have been made through the Companies (Amendment) Acts 1999, 2001, and 2002. The amendment of the Companies Act (I requires all companies to comply with (Indian) 999) Accounting Standards, disclose any deviation, give reasons for such deviation, and state the impact of the deviation on the financial statements. The amendment also requires the auditor to specifically state in the audit report whether the financial statements comply with these a The Department of Company Affairs, which was previouslyunder the Ministry of Finance, became the Ministry of Company Affairs inMay 2004. Within this report, DCA continuesto be usedto refer to the new Ministry of CompanyAffairs. The Companies(Amendment) Act (2001) proposedto dissolve the Company Law Board and form aNational Company Law Tribunal. Within this report, the Company Law Boardis usedto meanthe new National Company Law Tribunal. Io During this inspection, instances of potential professionalauditor misconduct are passed on by DCA to the ICAI for its disciplinary proceedings, which usually take a long time to conclude due to extensive procedures prescribed in the ICAI regulations. '' TheROC I' registry of records is availablefor inspectionby the public for anominal fee. The Mumbai (which is the largest ROC) has over 150,000 registeredcompanies (including 1,800 listedcompanies), out of which approximately 50 percent file their documents. Over 5,000 new companies are incorporatedat the ROC Mumbai eachyear. ROC Mumbai has4 staff who are employedto scrutinizethese filings, noneof whom are charteredaccountantsor companysecretaries. l3 In the fiscal year ending March 31, 2002, the Company Law Board received21,011 petitions and applications(10,080 new and 10,931 pendingfrom the previousyear) anddisposedof 10,397. India-Accounting and Auditing ROSC Page 3 Accounting Standards. Provisions in the Companies Act (1956) with respect to financial reporting are inthe processof being revised. l4 9. Directors and management of a company are required to ensure compliance with provisions of the Companies Act, Also, a company's auditor has an obligation to bringto the attention of the shareholders any noncompliance with provisions of the Act with respect to the financial reporting and associatedlegal aspects. The Act provides guidelinesor limits for related partytransactions involvingdirectors.l5 company must hold an annual general meeting in Every each calendar year within six months of the financial year-end when the company's board of directors i s required to present to its shareholders financial statements for a financial period not exceeding 15 months. Requirements state that financial statements along with the annual return of the company should be filed with the Registrar of Companies within one month of holding the annual general meeting. The directors' report must include several disclosures over and abovethose generally seen internationally. l6Moreover, there is a requirement on inclusionof a "directors' responsibility ~tatement."'~ 10. The Companies (Amendment) Act (2000) accorded mandatory status for the first time to the concept of an audit committee. Every public company that has a paid-up share capital exceeding Rupees (Rs) 50 million is requiredto constitute an audit committee. The audit committee can make recommendations on any matter relating to financial management, includingthe audit report; andthe board o f directors is boundto upholdthese recommendations. 11. The Chartered Accountants Act (1949) governs the accountancy profession in India. A broad revision o f the legislative framework relating to the accountancy profession has been under consideration for a couple of years. The Chartered Accountants (Amendment) Bill 2003 has been prepared to revise the Chartered Accountants Act. This bill proposes to reconfigure the current regulatory regime and the disciplinary arrangements in relation to the accounting profession. The ICAI has indicated to the Government their concerns about several areas where the proposed amendment falls short o f their expectation." The bill has been referred by the Indian parliament to a special committee for discussion and deliberation. Important key amendmentsproposed inthe bill include: e Formation of a Quality Review Board. The Quality Review Board would be an independent body mandatedto fix the standards for audit services, guide membersto improve the quality of services, and review the quality o f services provided by l4For purposes of public debate and consultation, the Government releaseda Companies Act concept paper containinga model codifiedCompany Law that would consolidate existingprovisionsofthe Law, Basedon the feedback, the Governmentwould introducethe Company Bill for parliamentaryapproval. l5Sec. 295, Loans to directors; See. 297, Board/Government approvalfor contracts where directors are interested; Sec. 299, Disclosure of interest by Directors; Sec. 314, Directors not to hold office ofprofit. l6These disclosures include conservationof energy, technology absorption, foreign exchange earnings and outgo. A statement must also show details for each employee who draws an annual remuneration exceeding a prescribedamount (currently Rs.2.4 million). l7This statement representsthat accountingstandards have been complied with; accountingpolicies adopted are consistent and prudent and give a true and fair view; they have taken adequate measures for maintenance of the books of account of the company for safe-guarding the assetsandpreventingand detectingfraud andother irregularities; and, the financial statements are preparedonagoing concernbasis. IsExamples include a fast-track disciplinary mechanism, creation of multi disciplinary partnerships, and encouragement for consolidationof firms. India-Accounting andAuditing ROSC Page 4 auditors. The Board would comprise 11 members, 5 nominated by the Government and 5 by ICAI, and 1 chairperson appointed by the Government, The ICAI would provide funding to the Quality Review Board." Council of the Institute of CharteredAccountants of India. The amendment would increasethe proportion of Government representation on the ICAI Council from the current 20 percent to 25 percent; allow for appointment of a Government nominee on every standing committee of the Council; and give the Government the power to dissolve the Council, Revision of the disciplinary action procedure against ICAI member. A broad revision ofthe current disciplinary procedurehasbeen proposed. 12. The Department of Company Affairs appointed the Naresh Chandra Committee to recommend initiatives to strengthen the institutional framework and legislative environment relating to the accounting and auditing profession. In view of the local circumstances and following a large number of corporate failures in many industrialized countries, the DCA appointed the NareshChandra Committee inAugust 2002 to examine issues such as auditor-company relationship, certification of the financial statements by directors, and setting up an independent regulator along the lines of the Public Company Accounting Oversight Board established under the Sarbanes-Oxley Act of the United States. The Naresh Chandra Committee considered instituting certification of financial statements by chief executive officers and chief financial officers in line with the requirements of the Sarbanes- Oxley Act. However, instead of instituting criminal liability for misstatements as prescribedby Sarbanes-Oxley, the Naresh Chandra Committee favored enhancing penalties to act as effective deterrents. The proposed Chartered Accountant (Amendment) Bill and Companies Act concept paper include some recommendations of the Committee. 13. There are two main pieces of legislation governing the securities market. The Securities Contracts (Regulation) Act of 1956 provides for regulation of transactions in securities and aims to prevent undesirable transactions in securities. And the Securities and Exchange Board of India (SEBI) Act of 1992protects investors and develops and regulates the securities market. Listed companies in India are requiredto comply with SEBI requirements as outlined in the SEBI Act and the Securities Contracts (Regulation) Act. To protect investor interests, SEBI-issued listing requirements specify disclosures applicable to listed companies in addition to other applicable auditing and accounting requirements. SEBI, through Listing Agreement, requires compliance withthe ICAI-issued accounting standards. 14. Under Section 619 of the Companies Act, the auditor of a corporatized state-owned enterprise is appointed and re-appointed by the Comptroller and Auditor General of India. The Comptroller and Auditor General of Indiamaintains and updates annually a panel of private sector firms qualified to undertake audits of state-owned enterprises.20Allocation of audit work among these audit firms is based on a points system that gives credit based on Underthe proposedgovernance and funding arrangements, it is difficult to view the Quality ReviewBoardas an independent *'body. Corporatizedstate-owned enterprises include about 1,400 public commercial and noncommercial enterprises controlled by unionand state governments. India-Accounting andAuditing ROSC Page 5 information self-disclosed by the audit firms:' which includes the number of partners in the firm, number of employees andtrainees, experience of the firm, andterm of association of the partners with the firm.22The board of directors o f the state-owned enterprise determines the professional fee of the auditor on the basis of guidelines issued by the Comptroller and Auditor General of India and subsequently approved by the shareholders of the company. The Comptroller and Auditor General of India conducts a supplementaryhest audit of all such companies on a regular basis. The state-owned enterprises that are incorporated under specific acts have associated rules with respect to accounting and auditing. Depending upon the audit arrangements, as specified by these rules, the audit may be performed either by a private sector auditor or a state-appointed auditor, which may include the Office of the Comptroller and Auditor General of Indiaor its appointee. 15. The Banking Regulation Act (1949) empowers the Reserve Bank of India (RBI) to regulate financial reporting of the financial sector, including banks and financial in~titutions.2~ The Third Scheduleto the BankingRegulation Act prescribes formats for general purpose financial statements (balance sheet, and profit and loss account), including other disclosure requirements. Bankingcompanies are also required to comply with requirements of the Companies Act provided they are consistent with the BankingRegulation Act. The RBIhas issued circulars requiring compliance with the ICAI-issued accounting standards. All banks must publish audited financial statements within three months of the financial ~ear-end.~~ Effective 2002-03, all banks are required to prepare consolidated financial statements; during 2001-02, consolidation was mandatory for listed banks only. The private sector and foreign banks are required to receive prior approval from RBI before appointing their auditors. The public sector banks appoint their statutory auditors (principal auditors and branch auditors)2son the basis of recommendations of RBI (except for State Bank of India where the principal auditors are appointed directly by RBIas per State Bank of India Act); this recommendation is made from the list of RBI-empanelled auditors. A statutory principal auditor relies on branch auditors' reports for issuingaudit opinion on the bank's annual financial statements. The list of RBI-empanelled auditors is compiled from a self-disclosure form completed annually by interested auditors. Bank statutory auditor appointment, re-appointment, or removal requires RBIapproval. All state-owned banks must have a minimum of four (joint) statutory auditors. Bank auditors must be replaced at least once in four years. No audit firm is allowed to audit more than 4 private-sector banksand 1state-ownedbank during any singleyear. 16. The Reserve Bank appointed a working group in 2001 to evaluate and recommend improvements to the auditor appointment process. The working group submitted its "Theauditfirmshavetoprovidetherequiredinformationinstandardquestionnaires,whichisreviewedonalimitedbasisby ''Most the Office ofComptroller andAuditor Generalof India. of these firms are small with about 70% of the firms, empanelled for 2004-05, having2 partners or less and only about 10percenthaving6 partnersor more. 23There are approximately60 Indian banks, including27 state-ownedbanks (19 nationalizedbanks and the State Bank of India andits 7 subsidiaries) and over 30 privatebanks. ''The 24 The ReserveBank canextend the periodnot exceedingthree months(i.e., total of six months). lists include statutoryprincipal and branch auditors. The empanelled list of branch auditors(about 25,000 eligible audit firms) is submittedby ICAIto the ReserveBank.The statutory principal auditor list (482 eligible audit firms with aminimum of seven full-time chartered accountants, of whom five shouldbe full-time partners, effective 2005-06) is obtained from the Comptroller and Audit General of India's empanelment data. In addition, banks also directly appoint concurrent auditors, who conduct internal audit. Statutory principal auditor appointment is based on 5 criteria: number of partners, number of qualified chartered accountants, previous bank experience, previousexperience with state-ownedenterprises, and number of years in practice. Total audit units inthe bankingsector are estimatedat over 40,000. India-Accounting and Auditing ROSC Page 6 recommendations in late 2002 and the RBI has provisionally accepted the recommendations, which are expected to be implemented in 2005. Among the recommendations is that the empanelment exercise will now be conducted bi-annually for the appointment of branch auditors. 17. The RBI formed a committee in 2000 to study observance of international standards and codes in India. Inthis connection, ten advisory groups were formed to study and report on the individual areas of the overall financial system, The Malegam Committee Report, issued in January 2001, compared the Indian accounting and auditing standards and relevant statutes with the international standards and made recommendations for reducing the standards gap. The Institute of Chartered Accountants of India has since issued several new accounting standards, which have substantially reducedthis gap. 18. Urban CooperativeBanksfall under the supervisionof the ReserveBankof India, whereas Rural Cooperative Banks are supervised by the National Bank for Agriculture and Rural Development. Urban Cooperative Banks comprise approximately 7 percent of the total national banking deposits and hence form a small yet significant part of the Indian financial market.26Cooperative banks are incorporated as societies and hence are not requiredto follow the accounting standards mandated for companies; and the auditors of such societies are usually not ICAI members but state auditors. The Registrar of Societies appoints external auditors o f all cooperative banks.27 The Banking Regulation Act has certain sections dedicated to cooperative banks, though these do not extend to appointment and monitoring of auditors. There have been a few cases of big cooperative banks failing inthe recent past, raising issues over the supervision o f such banks. The Reserve Bank of India has requested that the Government transfer regulatory arrangements for the urban cooperative banks to the Reserve Bank, includingpower to appoint auditors. 19. The Insurance Regulatory and Development Authority (IRDA) regulates the financial reporting practices of insurance companies under the IRDA Act. The Indian insurance industry is dominated by state-owned enterprisessince private sector participation has only been recent2' Limits on foreign ownership exist. Insurance companies and their auditors are required to comply with the requirements of the IRDA Regulations (Preparation of Financial Statements and Auditor's Report of the Insurance Companies) in preparing and presentingtheir financial statements and the format and content of the audit report. The IRDA requires compliance with ICAI-issued accounting standards. All insurance companies appoint two firms of auditors for a period of four years. The firms are selectedfrom the list of approved auditors maintained by IRDA.29Appointment of joint auditors and audit firm rotation are mandatory for insurance companies. 26Total Indian bankingdeposits are approximatelyRs 1,100 billion (US$24.45 billion). Of the total 2,104 cooperative banks, 55 are scheduledand2,049 are unscheduled. 27Except in case of cooperative banks, registered under the Multi State CooperativeSocieties Act (2002), where the statutory auditors are appointed by the bankson their own at the annualgeneralmeeting. Basedon its size, the insurancesector does not create a systemic risk for the financial sector, as compared with the banking sector. There are 26 (13 life and 13 general) insurance companies with total earnedpremiums of about US$7 billion. The ratio of premiums to GDP, a measure of the insurance sector penetration rate, was less than 2 percent, well behind the worldwide average of 7.8 percent. 29Incaseofagovemment-ownedinsurancecompany, the ComptrollerandAuditor GeneralofIndiaappointsthe auditors. India-Accounting andAuditing ROSC Page 7 20. The Stock Exchange Listing Agreement requires all listed companies to publish unaudited quarterly financial results. The Stock Exchange Listing Agreement (Clause 41) requires all listed companies to publish unaudited quarterly financial results, according to a prescribed format, in a national English daily and a local regional language daily newspaper within one month from the quarter-end. As of June 30, 2003, the quarterly results have been subject to limited review by the company's statutory auditors (or any chartered accountant in case of state-owned enterprise^),^' The limited review report must be submitted to the Stock Exchange withintwo months of the end of the quarter. Incase of any deviation of more than 20 percent in any line item between the published amount and the limited review amount, a statement approved by the board of directors explaining the reasons for the difference needs to be submitted to the Stock Exchange. However, in practice, not many cases of deviations are reported. As observed inother developed economies, releasing unaudited financial results could lead to potential problems o f influence over subsequent audits, From the quarter ending September 30, 2001, segmental information needs to be published along with the unaudited quarterly results. For the final quarter, publication andlimitedreview of quarterly results are not requiredif annual audited financial statements are made available within three months of the quarter-end. 21. The Income Tax Act empowers Central Government to notify accounting standards for taxation purposes. In this context, the Central Board of Direct Taxes has notifiedtwo IndianAccounting Standards (AS) for taxation purposes without modifying ICAI- issued standards: AS 1 Disclosure of Accounting Policies; and AS 5, Net Profit or Lossfor the Period, Prior Items and Changes in Accounting Policies. The Central Boardof Direct Taxes has established a committee to examine all other accounting standards issued by the ICAI to consider their applicability in the context of tax laws and regulations, This committee is currently examining nine accounting standards for notification purposes. At the present time, accounting standards being used are generally the same for both tax reporting and general purpose financial reporting. However, this may change if the Central Board's accounting standard committee issues accounting standards different from those issued by the ICAI. The Income Tax Act also makes an annual tax audit compulsory for all taxable assesses, including companies with an annual turnover exceeding Rs 4 million (service entities with a turnover exceeding Rs 1 million). For a financial year (which for tax purposes has to necessarily end on March 31), the tax auditor is required to provide information on approximately 100 items relating to various provisions of the Income Tax Act and certify that this information is "true and correct," B. The Profession 22. The Indian accounting profession began its history with the enactment of the IndianCompaniesAct in 1857 that introducedfor the first time the concept of preparing company balancesheet on a voluntary basis. The IndianCompanies Act of 1866 introduced legal requirementsregarding the maintenance of accounts and auditor's qualification. Auditor's certification from the local government started after the enactment o f a new Companies Act in 1913. Following India's independence in 1947, an expert committee was formed to examine the 30Previouslyhalfyearly results(from halfyear endingMarch 31,2000) were subjectto limited review by auditors. India-Accounting and Auditing ROSC Page 8 scheme of an autonomous associationof accountants inIndia, which led to the enactment ofthe Chartered Accountants Act (1949) and establishment of the Institute of Chartered Accountants of India the same year. The ICAI regulatesthe accountancy profession and, inline with India's imperial history, was initially modeledon the Institute of Chartered Accountants inEngland and Wales (ICAEW). The ICAI acts as both an examining body for granting charteredaccountancy qualifications and licensing, and disciplinary authority for its members. ICAI has been a founding member o f the International Federation of Accountants since IFAC's inception in 1977, With a reputation for excellence, ICAI has been the institution of choice for business graduates and aspiring business advisers, and today ICAI has a highly skilled membership of over 110,000, which makes it one ofthe largest professional accountancy bodiesinthe 23. The Chartered Accountants Act (1949) provides for a Council to manage the affairs of the ICAI. The Council's statutory functions include enrolling students, regulating their education and training, conducting examinations, providing professional development, maintaining professional and ethical standards, and taking disciplinary action against erring members, The Council comprises 24 memberselected from across the country and representing 5 regional constituencies, based on the number of members in each region; in addition to 6 personsnominatedby the Central Government,32 24. Other professionalbodies include the Institute of Cost and Works Accountants of India (ICWAI), and the Institute of Company Secretaries of India (ICSI). These professional bodies have governancestructures and powers similar to the ICAI. The ICWAI has approximately 22,000 members and ICs1has approximately 16,000 members as of April 2004. The ICWAI members provide cost audit services to companies falling within certain manufacturing industry sectors as mandatedby Section 233B of the Companies Act. The ICSI members act as company secretaries and provide corporate secretarial services to the companies,33 25. Smaller firms dominate the Indian auditing marketplace, even though the Indian affiliates of large internationalfirm networks audit approximately 47 percent of the top 100 listed companies.34The ICAI reports about 53,245 audit firms operate in India, including memberslaffiliates o f most of the international networks of accounting firms. About 1,000 firms audit at least one economically significant enterprise; and about 15 of the largest firms audit more than 70 percent o f the top 100 listed companies. Government-ownedcompanies, unlisted companies, public sector banks, and insurance companies are generally audited by small- and medium-size firms apparently due to the unremunerative fee scales prescribed for these 3 1Basedon the April 2004 numbers, 65,088 held a full-time ICAI certificateof practice and 12,302 held a part-timecertificate of practice. Many ofthese practicecertificateholdersare not actively involved inpublic practice. 32 Nominationsare made from various government departments and institutions, including the Central Board of Direct Taxes, ComptrollerandAuditor General of India, andDepartmentof CompanyAffairs. 33 Companieswith a paidup capitalexceedingRs 20 million are requiredto employ a full-time company secretary who issues a certificate of compliancewith provisionsof certainsections of the Companies Act. Companies with paid up share capital of more than Rs 1 million but less than Rs 20 million also require a company secretary who may be employed on a part-time basis. 34 Local affiliates of large international networks audit 11 out of the top 50 Indian companies and jointly audit 6 other companiesin the top 50 with another medium-size firm (for 34 percent of the top 50). They also audit 25 out of the top 51- 100companies andjointly audit 5 other companiesinthat bracketwith another medium-sizefirm (for 60 percent). India-Accounting andAuditing ROSC Page 9 engagement^.^^ In most cases, the regulator or the Office of the Comptroller.and Auditor General o f India mandatesjoint auditors for state-owned enterpri~es,~~public sector banks, and insurancecompanies, 26, Membersof the ICAI are requiredto follow a detailedcode of ethics as prescribed under the Chartered Accountants Act. The ICAI Council is entrusted with disciplinary powers that are exercised through its Disciplinary Committee, In matters conceming public interest, the awards of punishment require confirmation by a High Court. Some unique legal restrictions on auditors include these examples: The name of any firm that wants to register for ICAI membership must have a combination o f the names of the partners or a name in being, that is a name in use before this rule was introduced,37 Post-1995 the display of any association with any firm, domestic or intemational, includinglogos, was banned. The number o f partners in an audit firm i s limitedto a maximumof 20. Companies, limitedliability partnerships, and multidisciplinary partnerships are not permittedin the profession. ICAI proposals to permit conduct of nonattest functions through limited liability companies and to increase the limit on the number of partners have not yet been legislated. The Companies Act restricts the number of public limited (not necessarily listed) audit clients to 20 per partner. The Companies Act prohibits indebtednessof audit partner to audit clients inexcess of Rs 1,000, which includes any arms-length transactions (for example, a credit card withabankingclient). Advertising andpublicity is prohibited. 27. India has not yet experienced large-scale litigation against audit practitioners. Audit reports are signed inthe name of a partner, although all partners havejoint, several, and unlimited liability under the Indian Partnership Act, Professional indemnity insurance is not compulsory. ICAI does not specifically require or recommend that auditors take out such insurance. 28. Practicingauditors sit on the boardsof directorsfor some listedcompanies, banks, and insurance companies. Although the audit firms of these respective partners do not perform audit services for these companies, they are not barred from taking up nonaudit service engagements. Even though these directors are required to disclose their interests under the Companies Act, these non-audit service engagementsmay create potential conflicts of interest. 35Recentlyrevisedaudit fee scales for banks prescribea progressive fee arrangement. Basedon total asset size, the maximum fee is set at US$13,000 for banks with assets exceeding US$20 billion, and the minimum fee is set at US$9,500 for banks with total assets less thanUS$2.5 billion. 36The largest state-ownedenterprise, Oil andNatural Gas CorporationLimited, had 5 joint statutory auditors in 2002-03. The largestIndian bank, State Bank of India, had 14joint statutory auditorsin2002-03. 37Because o f this 1988 regulation, 2 Indian afiliates of the Big 4 international network firms operate using their pre-1988 registered brand names. The other 2 did not have any firms registered with the ICAI pre-1988 and hence use completely unconnectedIndian member firm brand names. Also, all 4 firms and some other larger internationalnetworkshave private limited companies registered in India that use the global brand and actively sell all the firms services, other than those restrictedto be provided by ICAI members. These private limited companies are not required to follow the strict code of ethics and are not subject to otherICAIrules and regulations, India-Accounting andAuditing ROSC Page 10 29, In the Companies Amendment Act (2000), individuals who held securities carrying voting rights in a company were barred from auditing that company, effective one year after passageof the amendment.38No regulation currently bars an auditor from having family or other close relationship with the audited company or its key management personnel. Also, there is no cooling-off period prescribed for audit partnerslstaff joining their audit clients in a senior managementpositionor client personneljoining the audit firm, 30. An audit practitioner is allowed to act as a company's statutory auditor, as well as provider of such nonaudit services that might threaten auditor independence. A cap on nonaudit fees was introduced for appointmentsmade after April 2002 inorder that nonaudit fees do not exceed the total audit fees from the same client (restricted to listed companies and other public companies having a turnover exceedingRs 500 million). However, statutory auditors are not specifically prohibited from providing some nonaudit services, including tax restructuring, tax planning, tax advocacy and representationbefore tax authorities, recruitment, due diligence, mergers and acquisitions, and actuarial services. The Naresh Chandra Committee Report has recommendeddisallowing statutory auditors from providingcertain other nonaudit services.39 31. Mandatory audit firm rotation, after serving as auditor for 4 to 5 years, exists for government-owned companies, banks, and insurance companies. Audit partner rotation has never been mandatory and hence is not widely followed across the profession. In considering auditor independence, the Naresh Chandra Committee recommended adoption of audit partner rotation. The ICAI has recently put forward a resolution that will make mandatory audit firm rotations and joint audits for all listed companies. The ICAI has not made a final decision on this issue, which hasbeenreferredto ahigh-levelcommittee for further deliberation. C. ProfessionalEducation and Training 32. The ICAI has been conducting periodic review of its education and training schemes. Effective October 1, 2001, chartered accountancy students follow a new program of study and supervised training. The curriculum for ICAI membership includes Professional Education I(PE-I previously called Fo~ndation),~'Professional Education I1(PE-I1 previously called Intermediate),41a three-month compulsory computer training program prior to practical training, three years o f practical training, general management and communication skills (two- week course after completing practical training), andfinal e~amination.~~bachelor's degree The holders, with a definedminimum score, are exempt from PE-I qualification. The three years of 38Prior to this amendment, disqualification occurredonly when the auditor heldover 5 percent of shares. 39Including financial information systems design and implementation;actuarialservices; broker, dealer, investment advisor or investmentbankingservices; outsourced financial services; managementfunctions; staff recruitment; valuation services; and fairnessopinions. 40PE-I level requires papers in the following subjects: (a) fundamentals of accounting, (b) mathematics and statistics, (c) economics, and(d) businesscommunicationand organizationandmanagement. 41PE-I1level requires papers inthe following subjects: Group I,(a) accounting, (b) fundamentals of financial management and costing, and (c) auditing; and Group 11, (a) business and corporate laws, (b) income tax and central sales tax, and (c) informationtechnology. 42Group I,final professionalexaminationpapers are (a) advancedaccounting(b) advancedfinancial management, (c) advanced auditing, and (d) corporate laws and secretarial practice. Group 11, final professional examination papers are (a) cost management, (b) directtaxes, (c) indirect taxes, and(d) managementinformation and control systems. India-Accounting andAuditing ROSC Page 11 practical training requirements start after passing the PE-I1 and must be under the guidance of an eligible charteredaccountant. Duringthe last year of practical training, a student has the option to undergo ICAI-approved industrial training instead of professional practice training. There is no limit on the number of attemptsto passthe final examination, 33. Many students are attracted to the chartered accountancy program. The number of`candidatestaking professional examinations has steadily increased over the years. About 10 to 12percent o fthe studentspass whenattempting all PE-I1levels and final examination papers. The ICAI claims that in an effort to improve the assessment system it has been increasing emphasis on case studies intheir professional examinations. 34. The range and depth of practical knowledge gained by the trainee accountants significantly vary with the diversity in nature and size of accountancy firms that act as practical training providers in India. The number of training vacancies with audit firms far exceeds the number of studentsseekingtraining contracts. Audit firms have limitsonhow many trainees they can accept basedon the number of partnersandtheir experience. The ICAIhas, in the past, examined the prospectof movingto criteria basedon"quantum of work," inlieuofthe current "efflux of time" to determine the entitlement to train, This matter is still being considered. Moreover, the absence of monitoring the quality and ability of practical training providers seriously impacts practical knowledge of the trainees. An ICAI review committee noted in 1992 that some students who prefer to train with small firms felt the main objective was passing the exams and the quality oftraining was secondary, 35. A Board of Studieswas set up by the ICAIin 1954 to provide theoreticaleducation to accountancy students. The Board of Studies is primarily engaged in imparting distance learning for students taking the professional chartered accountancy course. The Board provides a comprehensive academic package to students including all prescribed study materials. Students in India mostly rely on self-paced study using the material provided by the Board, or they enrol1 for private tutorials. Most students must also bear costs of the exams, the ICAI enrollment fees, and tuition fees,44 In most cases their stipend from practical training i s not sufficient to cover these costs. 36. The stipend for trainee accountantsis not commensuratewith the current cost of living. The stipend is calculated on a minimum scale prescribed by the ICAI, based on the population of the city where the trainee is employed. Minimummonthly stipends prescribedby ICAI are Rs 450 (US$lO), Rs 600 (US$13), and Rs 800 (US$15),4s respectively, in the first, second, and third years o f training.46 In comparison, a newly qualified chartered accountant's salary ranges from US$200 to US$700 per month across the country, 37. University courses in accountancy focus on the Indian Standards and do not cover International Financial Reporting Standards and International Standards on Auditing. 43The minimum training for each year requires 1,250 hours. Trainee students are required to sign agreements with training providersand submittheir training recordsfor ICAIreview. 44The cost curriculum of the Chartered Accountancy course is Rs.10,500 (US$210) for a periodof more than 4.5 years, which is fairly low in comparisonto other professionalcourses in the country. 45Larger firms sometimespay monthly stipend inexcessof the minimum prescribed, inorder to attract talented students. 46A revisedscheduleofstipend, recommendedby the ICAI, is currently under considerationofDCA. India-Accounting andAuditing ROSC Page 12 These courses also do not enable the students to gain exposure to the intemational dimensions o f accounting and auditing practices. The curricula are restricted to teaching only Indian standards. In addition, accounting course books, as well as examinations, lack adequate focus on the practical application of standards. 38. The Chartered Accountancy curriculumincludesprofessionalethics as a topic ina subject, and not as a separate subject.. The IFAC Education Committee recommends that professional ethics be taught separately in the prequalifying education of professional accountant^.^^ Professional and ethical issues have been incorporated into one topic to comprise 20 percent of advanced auditing subject inthe final examination curriculum. 39. ICAI introduced a mandatory requirement for continuing professional education (CPE), effectiveJanuary 1,2003, Monitoringand enforcementofthis requirement is yet to be put inplace. Many qualified professional accountants require updating on recent developments infinancial reporting, auditing, andother related subjects. Minimumrequirementsfor members inprofessional practice are 15 CPE hours in2004 and20 CPE hours in2005. For the members who are in industry or engaged outside professional practice, the ICAI has recommended(not mademandatory) 15 CPE hours in2004, andmandated10 CPE hoursin2005, D. SettingAccountingandAuditing Standards 40. The Accounting Standards Board (ASB) and the Auditing and Assurance Standards Board (AASB), are responsiblefor assisting the ICAI in setting standards. Due process is followed to promulgate Accounting Standards, and Auditing and Assurance Standards (AAS). Based on the draft regulations preparedby the ASB and the AASB, the ICAI Council approves and issues new standards under its authority and prescribes a deadline for adoption. 41. ICAI uses IFRS and ISA extensively in developing the national standards. The ICAIduly considers the IFRS andISA inthe standardsettingprocess and may depart from these standards ifjustified, keeping inmindthe local environment andpractices. 42. The Central Government makes official notification of accounting standards applicable to companies. Exercising powers conferred by subsection(1) of section 21OA ofthe Companies Act (1956, amendment o f 1999), the Department of Company Affairs constituted in August 2001 the National Advisory Committee on Accounting Standards (NACAS) to advise the Central Government on the prescription of accounting standards for observance by companies registered under that Companies Act. However, the Chartered Accountants Act (1949) regulates the accounting profession in India and accordingly mandates the ICAI to issue Accounting Standards and Auditing and Assurance Standards. The NACAS reviews the applicability of the ICAI-issued Accounting Standards to companies and, if necessary, may recommendmodification of the ICAI-issuedstandards. 47IFAC Educational Guideline No. 10, Professional Ethics for Accountants: The Educational Challenge and Practical Application. India-Accounting andAuditing ROSC Page 13 43. The standards prepared by the Auditing and Assurance Standards Board lay down the principles governing an independent audit. It is mandatory for ICAI members to ensure that Auditing and Assurance Standards are followed inthe audit of financial information coveredbytheir audit reports,48 44. Guidance notes on accounting and auditing practices are issued by ICAI, particularly in areas where standards do not exist. Certain guidance notes are replaced by the issuance of standards. Certain guidance notes deal`with implementation of some existing accounting and auditing standards. The guidance notes are primarily designed to provide assistance to members on matters that may arise in the course of their professional work, includingassurance-relatedengagements. E. EnsuringCompliancewith AccountingandAuditing Standards 45. Regulatorsprimarily focus on compliance with requirements on "special purpose" regulatory reporting. The governmental regulatory agenciesinclude the DCA, SEBI, RBI, and IRDA. These regulators enforce regulatory norms and act decisively against any noncompliance. The DCA has the mandate to monitor general purpose financial reporting, which is exercised primarilythrough the statutory audit. The DCA may further examine cases, when it is felt that the regular mechanism has not worked effectively, under section 233A (special audit) and Section 209A (inspection of books of accounts) of the Companies Act. Enforcement by the DCA is largely restricted to the levy of fines, which are usually not a credible deterrent.49 46. The SEBI does not proactively monitor compliance with financial reporting requirements,which is unlike many other international securities market regulators.The SEBI only looks at financial statements contained in the prospectus at the time of a public offering or in the case of a complaint against a listed company. The SEBI refers cases of noncompliance that come to its attention to the Stock Exchange, ICAI, and DCA, as applicable." 47. The Bombay and National Stock Exchanges rely on external auditors to monitor compliance with the accounting and disclosure requirements. Listed companies are required to submit their financial statements to the Stock Exchange. The Stock Exchanges closely monitor compliance with requirementsof their Listing Agreement and promptly act on publishing of any information that could mislead investors. The Stock Exchanges in India are generally satisfied if a publicly traded company issues audited financial statements on a timely basis, and such statements are accompanied by an unqualified audit opinion. The Corporate Relations Department of the Stock Exchange pursues any qualification by the auditors with the 48Part Iof the Second Schedule to the Chartered Accountants Act specifies that an ICAI member's failure to bring attentionto any materialdeparture from A A S shallbe groundsfor professionalmisconduct. 49Prescribed fine can be compounded for all noncompliance, including repeat offenses, within provisions of the Companies Act. The sanctions for noncompliancewith financial disclosures range from a maximum fine of Rs 10,000 up to six-months imprisonment.In practice, there have beenno instances of imprisonment,Moreover, judicial delays diminish the deterrence factor of such penalties. 50InJuly 2004, SEBIusedthe provision under the 1995 SEBIRegulations (Prohibition offiaudulent and unfair tradepractices relating to securities market) to investigateinappropriateaccountingpracticeof a listedcompany. India-Accounting andAuditing ROSC Page 14 company and requires corrections by the following year-end. The Stock Exchanges lack sufficient number o f qualified professionals and financial resources to systematically carry out monitoringo f compliance with accounting andfinancial reporting requirements. 48. The RBI relies on banks' statutory auditors to ensure compliancewith the general purpose financial reporting requirements. The RBIofficials conduct both offsite and onsite supervision o f banks to ensure compliance with prescribed RBInorms and guidelines. Incases when differences arise between the findings of a bank's statutory auditor and RBI's onsite supervision team, RBI appoints an independent auditor for resolution. A bank's statutory auditor must report to RBIany violations of established standards, rules, regulations, and laws and submit a long-form audit report inaddition to the prescribed audit opinion. Inthe course of monitoring compliance with prudential regulations, RBI officials identify and require corrections o f departures from established accounting requirements and also pursue auditor's qualified opinions with the bank and the auditor. RBI's role with respect to the general purpose financial reporting by banks includes reviewing financial statements, approving appointments o f statutory auditors, reviewing long-form audit reportslmanagement letters directly from the statutory auditors, holding meetings with banking supervision staff and a bank's statutory auditors, and reviewing feedback from bank management on the performance o f statutory auditors. The RBIrefers to the ICAI any apparent issues regarding professional misconduct of bank auditors. The RBI supervision staff comprises experienced bankers who have generally passedthe examination of the Institute of Bankers, which includes accountancy as a subject. In recent years, there have been some cases of bank failures allegedly associated with misleading financial reporting5' indicating a need to take steps for further strengthening RBI's capacity withregardto monitoringandenforcement offinancial reporting requirement^.^^ 49. The public sector insurance companies have been facing problems in meeting the requirements under the new regulatory regime. The power to regulate the financial reporting of insurance companies was given to IRDA in the financial year 2000-01 when new private insurers entered the Indianinsurance market. While the private insurance companieshave set up systems to meet the various requirements under the IRDA Act and the related rules, the public sector insurance companies have been facing practical problems in meeting the requirements under the new regulatory regime. The IRDA has the authority to impose sanctions for noncompliance. However, inpractice, this power has rarely been exercised. 50. The Electricity Act influences financial reporting by power sector companies. Electricity companies in India are required to follow the Electricity Act (2003) that has an overriding effect in cases of any inconsistency with the Companies Act. The Electricity Act does not provide guidance on computation o f depreciation taking into account economic life of assets; this has created significant confusion inpower sector accounting andreporting. Different Inone case, a privatebank that failed in July 2004 was accused by RBIof misreportingits net worth and assets in 200112 and 200213. The RBI accused the auditor of providing an inappropriate auditor's report and referred the case to the ICAI disciplinarycommittee. 52An RBI working group, chaired by a former ICAI president, identified banks' compliance gaps with Indian Accounting Standards and recommended steps to eliminate or reduce them. Four standards were identified where noncompliancewas found: Prior period items, Revenue recognition, Effects of changes inforeign exchange rates, andRetirement benefits. Banks also had difficulty in applying 4 recently issued accounting standards: Segment reporting, Related party disclosures, Consolidated financial statements, and Deferred tuxation. An RBI-issued circular has provided further guidance on applicationof 7 ofthese standards. India-Accounting andAuditing ROSC Page 15 power sector companies (primarily state owned) engagedinthe same business andusing similar types of assets apply different rates of depreciation resulting invariations inprofit statement^.^^ The office of Comptroller and Auditor General of India took note of this issue and asked the Ministry of Power to provide necessary clarification to ensure consistency in the financial statements of the power sector companies. 51. The ICAI requires its members to ensure compliance with all applicable accounting and auditing standards in the performance of assurance engagements. The ICAI membersmust also report any departure from the applicable standards. There i s no robust arrangement for monitoringand enforcing compliance with these requirements. The ICAI relies on its disciplinary mechanism for ensuring that its members comply with the applicable accounting and auditing standards, including code of professional ethics. This disciplinary mechanism is widely regardedas being very slow and requiring im~rovement.~~ The Chartered Accountants (Amendment) Bill, which proposes revisions inthe disciplinary mechanism of the ICAI, is currentlyunder consideration of the Parliament. 52. The ICAI has made a modest beginning as a self-regulator by introducing peer review of audit firms. There is a need for strengthening and implementing an effective mechanism for an independent review of the quality assurance arrangements of audit firms dealing with economically significant enterprises. The ICAI still lacks an adequate proactive arrangement for monitoring and ensuring compliance with auditing standards and code of ethics for professional accountants. Incompliance with IFAC requirements, a country should develop and enforce quality control arrangements, which require audit firms to put in place the necessary policies that conform to professional performance standards. An independentreview mechanism can ensure that audit firms have effective quality control arrangements. The ICAI established an 11-member Peer Review Board in March 2002.55 The Peer Review Board provides guidance to enhance the quality of services provided by ICAI members. In the first phase, peer review focuses on the review of firms that audit major enterprises at least once in a three-year block. The peer review does not lead to any disciplinary or regulatory mechanism. Peer review certification is either given or not given based on the findings o f the review. Peer reviewers are members currently inpractice with at least 15 years o f audit experience. 53. The FinancialReportingReview Board (FRRB), constituted by ICAI inJuly 2002, has a mandate to review the financial statements of certain major enterprises. The objective of the FRRB review i s to determine apparent noncompliance with standards and regulations.'6 Unlike the Peer Review Board process that helps build capacity, FRRB findings have disciplinary implications for ICAI members if they fail to discharge their attest functions s3Inone case, inits accounts for 2004 a state-ownedcentralpublic sector company appliedthe rates of depreciationfor tariff purposes as pronounced by the electricity regulator. In another case, a central public sector company applied the rates of depreciationas prescribed under the CompaniesAct, Schedule XIV, which are substantiallyhigher than the first case. Inthe former case, the profit impact (overstatement) was over US$lOO millionfor FY2004. 54The NareshChandraCommittee reportedthat "procedures framed under the Chartered AccountantsAct have not been able to cope with the changed scenario" and "ICAI, despite best intentions, seems to have been unableto adjudicatedisciplinary cases within reasonabletime." 55Peer ReviewBoardcomprises6 ICAI members and 5 membersfrom industry and several other governmentbodies andusers offinancial statements, like the office of Comptroller andAuditor Generalof India, DCA, and IRDA. 56FRRB's mandate includesreviewof publishedfinancial statementsofenterprises that canmake the public interest susceptible due to bad financial reporting. Initially, it proposes to restrict its review to the top 500 listed companies in the country by turnover and any companyreferredto ICAI. India-Accounting andAuditing ROSC Page 16 in accordance with the standards. While a positive step inthe monitoring process, the FRRB does not have sufficient resources and required coverage to achieve its objectives. FRRB has, duringthe first year of its operation, reviewedonly 20 public interest entity financial statements, which represents a small fiaction of the total "public interest" entities in India where there are over 5,500 listed companies. India-Accounting andAuditingROSC Page 17 111. ACCOUNTINGSTANDARDSAS DESIGNED AND AS PFUCTICED 54. The ICAI has issued and revisedseveral accountingstandardsover the last couple of years, significantly reducing the gap between the Indian Accounting Standards and IASB-issuedinternationalstandards. Appendix A summarizes IndianAccounting Standards, their equivalent intemational standard, and their applicability to large and small enterprise^.^^ Since April 1,2001,large companies, including listed companies, need to disclose relatedparty transactions, disclose segmental information, and account for deferred tax assets and liabilities5*Since April 1, 2003, large companies need to apply a new accounting standardwith respect to intangible assets. Since April 1, 2004, large companies are also required to disclose information related to discontinuing operations andaccount for impairment of assets. 55, Financial reporting requirementsfor small- and medium-size enterprises (SMEs) have been simplified. A recent revisioninICAI-issuedaccounting standardswith regardto the applicability framework of these standards has seen several exemptions being grantedto small- and medium-size enterprisesconceming disclosure requirements of certain standards.59 56. It is mandatory only for listed companies and banks to prepare consolidated financial statements. The requirementswith respect to presentation of consolidated financial statements are prescribed under the Stock Exchange Listing Agreement and RBI regulations. This requirement is not mandatedeither by the Companies Act or IndianAccounting Standards, Even after SEBI introduced the requirement to present consolidated financial statements for a listedcompany inthe Listing Agreement, the current Companies Act still requires annexing the single company audited financial statements o f all subsidiary undertakings (including overseas subsidiaries) prepared under Indian laws and regulations. The companies, which prepare consolidated financial statements, usually seek an exemption inthis respect. 57, Although Indian Accounting Standards are largely aligned with IFRS, differences do exist. Differences exist becausecertain IFRS and IFRS-concepts are yet to be adopted, less detailed disclosures are required in some Indian Accounting Standards, and certain Indian Accounting Standards are narrower inscope than equivalent IFRS. The following intemational standards do not have equivalent Indian Accounting Standards: IAS 1, Presentation of Financial ~tatements;IAS 26, Accounting and Reporting by Retirement BeneJit Plans; IAS 29 Financial Reporting in ~yperin~ationaryEconomies; IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions; IAS 32, Financial Instruments: Disclosure and Presentation; IAS 39, Financial Instruments: Recognition and ~easurement; IAS 40, InvestmentProperty;60andIAS 41, Agriculture. The bankingregulator (RBI) currently prescribesrules andnormsrelating to topics covered by IAS 30, 32, and 39, which are generally narrower inconcept. And the Companies Act prescribes the presentation o f financial statements 57New Indian standards correspond to the following international standards: IAS 12, Income Taxes; IAS 14, Segment Reporting; IAS 24, Related Party Disclosures; IAS 17, Leases; IAS 28, Investments in Associates; IAS 3 1, Interests in Joint Yentures; IAS 34,Interim Financial Reporting; IAS 38, Intangible Assets; IAS 35, Discontinuing Operations; IAS 36, Impairment of Assets and IAS 37; Provisions, Contingent Liabilities and Contingent Assets. Recently revised standards '*Large include localequivalents of IAS 11, Construction Contracts; andIAS 21, TheEffects of Changes in Foreign Exchange Rates. companies includethose with aturnover exceedingRs 500millionandlor borrowingsexceedingRs 100 million. 59SMEs includecompanieswith aturnoverof less than Rs500 million andborrowingsof less than Rs 100million, 6oThe IndianAccountingStandard, AS 13,Accountingfor Investments,covers parts of IAS 39 and IAS40. India-Accounting andAuditing ROSC Page 18 ina way that is not fully consistent with the requirements of IAS 1.61Further, an Accounting Standard exists that covers the Disclosure of Accounting Policy requirement of IAS 1. Disclosure requirements are not as detailed in some standards as IFRS and more detailed than IFRS in other cases. The ICAI is currently reviewing all these international standards for adoption, except IAS29, which they consider not applicable inIndiancircumstances.With their adoption, the standards gap will be further reduced. 58. And more differences betweenIndian AS and IFRS. The degree of application of fair value varies across national standards as compared to IFRS requirements. The dividend proposed after balance sheet date i s provided for as an "adjusting event" because of Companies Act requirement,which i s contrary to the requirements of IAS 10. Indian AS defines "control" narrowly by restricting it to more than 50 percent of the voting power or control of the composition of the board, because of Companies Act requirement (See Appendix C for definition of control). A period of non-coterminous year-end of subsidiaries permittedunder Indian Accounting Standards is six months, whereas IAS 27 allows a period of three months. The rebuttable presumption under IFRS for the useful life of intangible assets is twenty years, whereas under IndianAccounting Standards this presumption is ten years. 59. Evidence of compliance gaps exists despite substantial overall improvement in the corporate financial reporting practices in India over the past decade. A ROSC-led review was conducted of 50 sets o f published financial statements of selected major enterprises, including 4 banking companies, 1 financial institution, 2 nonbanking finance companies, 2 power companies, and 1 insurance company.62 In addition to the sample reviews, interviews conducted with experienced senior corporate accountants, financial analysts, practicing auditors, academics, and regulators revealed several instances of compliance gaps.63Issues noted during the review indicated noncompliance with certain accounting standards and applicable statutes. Inseveralcompanies, application or disclosure ofthe standardwithrespectto segment reporting was inadequate. Similarly, in many companies, earnings per share disclosure was not appropriately calculated or not appropriately disclosed. In many companies, problems were noted with respect to profit calculation for the purposes of directorslmanagement remuneration or nonprovision of management commentary on significant cash balances that is not available for use by the entity as required under the Companies Act. Some companies failed to provide for other than temporary diminution inthe value of investments, apply the standard on foreign exchange appropriately, make the disclosures necessary with respect to investments, properly classify items within their cash flow statements, and provide for certain retirement benefits on the basis of an actuarial valuation. 60, A significant proportion of sampled banks and financial institutions failed to fully apply the requirements of the Indian Accounting Standard on "related party transactions" and on "segment reporting." Further, disclosure with respect to "credit exposure for borrowings" was found to be inadequate in many reviewed banks' financial statements. In 2001, -1 formed a working group to study the reported noncompliances with `* " ScheduleVI ofthe CompaniesAct lays down the format for presentationofthe financial statements. For the sample, 23 companies were selected from the top 50 listedcompanies by market capitalization, and the balance were selected from other larger listed companies, giving a representative cross-section of audit firms. State-owned enterprises auditedby privatesector auditorsrepresented 16 percent of the sample. Compliance gap refers to the deviationo factualpracticefrom the applicableaccountingstandards. India-Accounting andAuditing ROSC Page 19 recently issued Accounting Standardsby banks.64This working group identifiednoncompliance with respect to certain disclosure requirements of some Accounting Standards for banks, includingthose on related partytransactions andsegment reporting. 61. Vague statements were noticed in some reviewed financial statements that raise a question on the validity of the auditor's opinion on "true and fair view." There was a nonstandard disclosure in one company's notes to accounts that "the debtors, advances and creditors were subject to reconciliationlconfirmation." Another set of financial statements said that the information provided by the company as required under Indian Accounting Standards on segment reporting was unaudited. The auditor remarked that the present accounting system of corporations does not give the requisite informationfor preparation of segment accounts. 64See footnote52 for details India-Accounting and Auditing ROSC Page 20 Iv. AUDITING STANDARDSAS DESIGNED AS PRACTICED AND 62. Indian Auditing and Assurance Standards are broadly in linewith ISA. The text of AAS generally replicates the text of the equivalent ISA with modifications that adapt to local circumstances when considered necessary. India has not issued equivalent AAS for ISA 100, Assurance Engagements;ISA 501, Audit Evidence-Additional Considerationfor Specific Items; ISA 720, Other Information in Documents Containing Audited Financial Statements; and ISA 910, Engagements to Review Financial Statements, although a guidance note currently covers the subject matter of ISA 501 and ISA 910. The IndianAAS, Responsjbjljties of Joint Auditors, does not have an equivalent ISA mainly due to the prevalence o f the concept ofjoint audits in state-owned enterprises, banks, and insurance companies. Appendix B shows Indian Auditing and Assurance Standards, includingequivalent international standards. 63. The gap between AAS and ISA is significant in its material affect on assurance engagements, except in a few areas. Inthese exceptions, the modifications made to ISA when adapting to Indian A A S appear to allow a less flexible audit approach, perhaps in order to reduce the extent of auditor judgment required to properly apply sophisticated auditing standards and procedures. Several IndianAAS have modified ISA requirements when the ISA prescribes a review o f another auditor's work or ajudgment of their professional ~ompetence.~' Inreality, a new (incoming) auditor's inability to access former (outgoing) auditor's working papers may affect the quality of audit, departing from international best practice. The standard on "audit sampling and other selective testing procedures," both as written and as practiced in the country, significantly differs from ISA. Few auditors use sampling techniques prescribed by ISA.Moreover, the requirementsof IndianAAS on "management representations," "planning," "quality control for audit work," and "using the work of another auditor" have gaps that need to be aligned with corresponding ISAs. 64. Auditors often issue "subject tolexcept for" audit opinions with a list of observationsinapparent violation of national standards. Some audit reports often contain a "subject tolexcept for'' audit opinion with a long list of audit observations, which may either appear inthe audit report or innotes to accounts or in an annex, the cumulative effect of which may be material enough to warrant issuance of "an adverse or disclaimer" opinion. The auditors o f such enterprises often give an appearance of tryingto convey a messageto the reader without necessarily appropriately qualifying their audit opinion. The AASB Statement on Qualifications inAuditor's Report requiresthe auditor to consider the collective effect of all the qualifications taken together inpreparing an audit opinion on "true and fair view," such as a case that might substantially affect profit or loss o f the company. However, adverse or disclaimer opinions are rare in India, in both private and public sector enterprises. Rather than apparently positive opinions, subject to the various material observations, disclaimers or adverse opinions would helpthe readersto get a clearer understanding of financial statements of the enterprises (mostly inthe public sector) inappropriate circumstancesthat call for so severe anindictment. 65. The quality of audit practice differs significantlyamong audit firms, This is mainly due because of inadequacy o f quality control arrangements inmost o f the smaller audit firms. 65For example, AAS 24, Audit ConsiderationsRelating to Entities UsingService Organizations; A A S 22, Initial Engagements- -OpeningBalances; and AAS 10, Using the Work ofAnother Auditor. India-Accounting and AuditingROSC Page 21 To assess actual auditing practices, the ROSC team interviewedsenior practicing auditors and experienced corporate accountants. Facilitated discussions were conducted with professionals representinga cross section of audit firms. Most of these specialists were of the opinion that a majority o f auditors use a traditional vouching-based audit approach focusing on transactions, as opposed to the modern risk-based approach focusing on critical assertions. Inaddition, most auditors focus their audit effort on financial reporting and compliance with provisions of statutes. 66. Improvements in audit quality can be achieved by the development and disseminationof practicalguidelineson the implementationof auditingstandards. A small proportion o f audit firms use high-quality audit practice manuals. In the absence of proper guidance, auditors generally find it difficult to address important concepts, such as audit risk, audit planning, internal control, materiality, documentation, and quality control. Many stakeholders expressedtheir concern about close relationships betweensome auditors andtheir clients, In cases when auditors are defending the majority owners' interests as opposed to protecting the minority shareholder, this may cause undue influence on auditors, resulting in noncompliance with applicable auditing requirements, India-Accounting andAuditingROSC Page 22 v. PERCEPTION OFTHE QUALITY OFFINANCIAL REPORTING 67. A general perception is that financial reporting practices have improved over the past 5 years; however, significantly strengthened enforcement mechanisms are needed to further improve the quality of corporate financial reporting. Interviews and discussions with stakeholders-foreign and local investors, investment bankers, financial analysts, and regulators-reveal that financial reporting practices in India have experienced a substantial improvement with enhancement ingood corporate governance practices and the introduction of several new accounting standards that aim to harmonize Indian Accounting Standards with International Financial Reporting Standards. Despite these improvements, many stakeholders also expressedconcern about the independenceof many practicing auditors,66The peculiar form and layout o f Indian financial statements and lack of comfort with the quality of audits sometimes discourage foreign investors from relying on published financial statements. Most interviewees agreed that a majority of the qualified accountants in India are capable of providing internationally comparable professional services, and improvement of the quality of financial reporting requires an effective monitoring and enforcement mechanism for ensuring compliance with accounting and auditing standards, auditors' independence, and adherence to the professional code of ethics. 68, Most stakeholders praised ICAI's efforts in the last 5 years for issuing new accounting and auditing standards, introducing CPE requirements, initiating a process of peer review, and constituting the Financial Reporting Review Board. However, most stakeholders were also absolute in recognizing the need for an effective monitoring and regulatory regime/ There was a widely held view among accountants, both in the audit profession and inthe corporate sector, that the government should not interfere inthe regulation of the profession. Most regulators and some professionals agreed to the need for creating an independent oversight arrangement for the auditing profession inline with recent developments inmany developed and emerging market economies. Many professionals and business leaders share the view that full adoption of IFRSand ISA-with respectto financial reporting by banks and other financial institutions, listed companies, and other large-size business enterprises- would provide an incentive to the profession for keepingpace with international best practices and the latest worldwide developments in accounting and auditing. Among views of the participating stakeholder^,^^ some regulators and corporate accountants and analysts expected improvement in the monitoring of the integrity, objectivity, independence, and standards compliance by auditors. A minority o f auditors and corporate accountants felt that Indian membersof the profession were fiercely independent and completely compliant with standards. During ROSC-facilitated discussion with a sample of audit firms, there was a consensus that adherenceto audit standards and code o f ethics varied across the levels o f profession. 66Inthis regard, some stakeholders pointedto issues of conflict of interest; in one instance, involving a large audit firm in the country, one of the senior members of the external audit team resignedfrom the audit firm andjoined as a senor financial managementpositionof the client, which is apublic interest entity. 67Stakeholdersincluderepresentativesand senior partnersof professionalaccountingfirms; chief financialofficerso flistedand large Indian companies; university accountancy professors; credit analysts; financial analysts; investment bankers; and regulators (from Registrarof Companies, Regional Directors in the office of Departmentof Company Affairs, ICAI, SEBI, ICWAI, governingcouncil members and standardsetters, and RBI's Departmentof Banking Supervisionand Department of BankingOperationsandDevelopment). India--Accounting and Auditing ROSC Page 23 VI. POLICY RECOMMENDATIONS 69. Duringthe course of carrying out the ROSC accounting and auditing review in India, representatives of stakeholder groups suggested that it would be useful to prepare "principles- based" policy recommendations based on findings from the ROSC exercise. It was further suggested that a high-level working group use these policy recommendations as inputs for preparing a comprehensive action plan aimed at strengthening the institutional framework of accounting, auditing, and corporate financial reporting. From this perspective, the following policy recommendations have been prepared with significant inputs from leaders of the accounting profession, experienced practitioners, regulators, academics, investment analysts, top management personnel of major corporations and financial institutions, local and foreign investors, and various other stakeholders. The objectives o fthese recommendations are twofold: Build on the existing system Recommendations should not jeopardize the achievementsofthe current framework and systems inplace. Promote a gradual process of improvement. Listed companies and other public interest entities should lead the reformprocess.68 70. Strengtheningthe monitoring and enforcement mechanism. High-quality financial reporting depends not only on havingappropriate accounting and auditing standards, but also on a proper monitoring and enforcement mechanism. There are three links in the enforcement chain: (a) Top management needs to make necessary arrangements for ensuringthat corporate financial statements are prepared in compliance with the applicable accounting and financial reporting requirements. (b) Auditors need to be independent and competent for ensuring that auditing is conducted incompliance with the applicable auditing standards, and to determinethe extent to which the preparers of financial statements have complied with the applicable accounting andreporting standards. (c) Regulators need to protect public interest through monitoring and enforcement activities aimed at preventing noncompliance with accounting and auditing requirements. To be effective, a regulatory body must have sufficient capacity, authority, and independence. Regulatory oversight covers a range o f very sophisticated and complicated activities, requiring adequate human and financial resources. It should have staff with the same skill and competence as the industry it i s meant to regulate. For the economy as a whole, and financial sector in particular, it can tum out to be a very costly exercise if auditing activities and regulatory oversight o f auditors are not carried out properly. The regulatory authority should also have adequate power, granted by law, to carry out its functions, which would include its ability to conduct on-site examinations; impose effective sanctions; revoke audit practice InIndia, public interest entities could include all listed companies (equityldebt), banks, financial institutions, mutual funds, insuranceenterprises, companies with turnover in excess of Rs500 million per year, companies with borrowingsinexcess of RslOO million and all holdingl subsidiarycompanies of the above. The ICAI Council has enunciated a similar definition for Level-I enterprises in connectionwith prescribingsimplified accountingand reportingrequirements for small- and medium- size enterprises. India-Accounting andAuditing ROSC Page 24 license; and, when needed, start criminal proceedings. Regulatory actions are often politically unpopular with the professional accounting bodies, and therefore the regulator must be independent and have the right to act against a practicing accountant and auditor without seeking approval from the professional accounting body or any other interest groups. 71, Strengthening the regulatory arrangements for monitoring and enforcing accounting and auditing requirements in regard to public interest entities. The composition, functions, and powers of the body responsible for monitoring and enforcing these requirements need to be configured in line with the emerging international trends to ensure independence and effectiveness in regulating general purpose financial rep~rting.~'This body should be empowered with oversight to assess whether the auditing profession is appropriately serving the interests of users of audited financial statements and o f the wider public. It should adjust the scope of its work in coordination with the monitoring and enforcement activities of other regulators, including professional self-regulatory organizations. Other regulators (RBI, SEBI, andIRDA)could strengthentheir capacitiesto complement the role ofthis body. The top management of this body should comprise eminent persons from various fields, with sufficient exposure to financial reporting and the auditing profession, Above all, it should be independent andtherefore should be fundedinthe same way as inthe case of other regulatory agencies(e.g., SEBI, IRDA, and Telecom Regulatory Authority of India). Practicing accountants and auditors (including those associated with entities affiliated to auditors or audit firms) would not be normally eligible for inclusion on the governing board of the oversight body, This oversight body should maintain a list o f authorized audit firms that are eligible to be appointed statutory auditors of public interest entities. The oversight body should also have power to disqualify an audit firm from carrying out audits o f public interest entities. And, it should have powers to prescribe penalties, restrictions, and ethical standards. In order to execute the above mandate, the oversight body could set up subsidiary units with fulltime staff. While the main board will act as the overall policymaker, these subsidiary units will monitor general purpose financial reporting by the public interest entities and their auditors: Practice Review Unit. With responsibility for conducting practice reviews of the auditors of public interest entities and ensuringeach firm i s reviewedat a reasonably regular interval, this unit should decide and impose effective sanctions on audit firms for preventing noncompliance with auditing requirements. ~in~nciaZReporting Review Unit. With responsibility for reviewing published financial statements for compliance with standards o f the public interest entities on a proactive basis, this unit should decide and impose effective sanctions on corporate management for preventing noncompliance with accounting and financial reporting requirements. The individual regulators could continue to monitor for compliance with their regulatory pronouncements (for example, RBI will monitor prudential norms and the Stock Exchanges will continue to monitor compliance with the ListingAgreement). The external auditors might also be mandated to report directly 69This could either be done through separate legislationor by revisingthe proposedCharteredAccountantsAmendmentAct by enhancing the role of the proposed Quality Review Board. The composition, functions, and powers of the proposed arrangement needto focus on protectingpublic interest.Indevelopingsuch an arrangement, lessonslprinciplesmay be drawn from similar arrangements in other countries-some examples of the evolving regulatory structures are: United Kingdom's Financial ReportingCouncil, Australia's Financial ReportingCouncil, and the United States' Public Company Accounting Oversight Board. India-Accounting andAuditing ROSC Page 25 to this unit any material unresolved noncompliances observed when auditing financial statementsoftheir clients. 72. Rationalizingthe CompaniesAct. Simplify ScheduleVI to the CompaniesAct with an arrangement in line with IAS 1, Presentation of Financial Statements. Legislated disclosure requirements have not kept pace with changes in standards, disclosures, and relevant international practices becauseamendmentsto the Companies Act are cumbersome and difficult to implement on a timely bask7' Regulatory information can still continue to be submitted under the current requirements (RBI guidelines, IRDA guidelines, BankingRegulationAct) and the general purpose financial statement should follow the national equivalent of IAS 1. In addition, there i s a need to amend the Companies Act to delete the requirement to annex subsidiary company financial statements with parent company's financial statements. The Schedule o f the Companies Act that prescribes minimum rates of depreciation for financial reporting purposes needs to be discontinued infavor of the accounting standard recommending computation on the basis of estimated useful life of each asset; depreciation rates for tax purposes can continue to be prescribed by tax legislation. 73. Bridgingthe gap betweenIFRS and IndianAccountingStandards.Immediate steps should be taken to issue IFRS-equivalent national. standards that are not yet adopteda7' Disclosure-related requirements should be reinstated through adoption of IAS 1. Requirements for preparing consolidated financial statements should be made mandatory for all public interest entities. Certain existing differences need to be re-examined to bringthem inline with IFRS. As a fiture step, the Indianauthorities could also explore possibility o f full compliance with IFRS for the public interest entities. 74. Bridgingthe gap betweenISA and the equivalent Indian AAS. India should prepare and issue the national equivalent of ISA 100, Assurance ~ngage~ents; ISA 501, Audit Evidence-Additional Consideration for Specijk Items; ISA 720, Other ~nformation in Documents Containing Audited Financial Statements; and I SA 910, Engagements to Review ~inancialStatements. Any differences still existingbetween ISA andany comparableAAS that have already been adopted need to be corrected. Certain narrowly conceived concepts in local AAS need to be re-examined in the light of international experience. The following specific actions cbuldalso be considered: a ICAI could reference the example of quality control for audit work as provided by the equivalent ISA in order to guide firms on how to implement the requirementso f this standard. 0 ICAI could consider permitting the review of audit working papers on a "hold- harmless" basis and hence suitably modify A A S 24, Audit con~iderationsrelating to entities using service organizations; A A S 22, Initial engagements--Opening balances; and AAS 10, Using the work of another auditor. 70The presentation and layout of financial statements is defined in Schedule VI of the Companies Act, Schedule I11of the BankingRegulationAct and RBIguidelines(for banks), andIRDAregulations(for insurancecompanies). 71Internationalstandardswithout an equivalentAS are IAS 26,Accountingand Reporting by Retirement Benefit Plans; IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions; IAS 32, Financial Instruments: Disclosure and Presentation; IAS 39, Financial Instruments: Recognition and Measurement; and IAS 41, Agriculture. India-Accounting and AuditingROSC Page 26 e ICAI could consider defining a minimum proportion of major financial statement captions that must be audited by the primary auditor, while leaving up to the auditor to determine whether that proportion is sufficient or not inorder to issue the overall opinion. e The AAS on Audit sampling and other selective testing procedures needs to be brought inline with the latest ISA. 75, Facilitating coordination among multiple accounting standard committees set up by regulators. The function of preparingand recommendingaccounting standards needs to be primarily vested with the Accounting Standards Board of ICAI. The Accounting Standards Board should be fully supported by the other accounting standards committees of SEBI, RBI, and the Central Board of Direct Taxes. The Central Government through NACAS could continue to notify the accounting standards for companies as required under the prevalent law. The other standards committees should pool resources with ICAI and provide inputs at the standardsetting stage for due consideration. 76. Recognizing affiliates of audit firms as part of one economic entity for purposes of regulatory restrictions and independence considerations. This recommendation would assist in addressing issues related to independencelconflict of interest as described in paragraph 26 and footnote 37, At present, separate legal entities belonging to the same network of firms provide various professional services. One or more of such a network members are licensed by ICAI to provide auditing services, The other members of the same network provide various professional services other than audits; they are not requiredto follow the ICAI's code of ethics, andthey are not treated as a part of one economic entity. Although these firms are separate legal entities, in reality they share the same resources, infrastructure, and methodologies, and are rarely independento f each other in true spirit. Applicable laws do not currently recognize an audit firm's affiliated entities as part o f an economic entity, which leads to legal requirements beingfollowed inappearance rather thaninsubstance.72 Recognizing affiliates of an audit firm as part o f an economic entity would help inbetter addressingconflict of interest issues andother related regulatory requirements. 77. Revisiting the policy on publishing unaudited quarterly results by the listed companies. As described in paragraph 20, in cases ,of listed companies, publishing unaudited quarterly results in the press before a limited audit review needs to be re-examined. Furthermore, the deadline for submission of audited annual financial statements could be shortenedto a maximumo f 90 days from the balance sheet date for the listedcompanies. 78. Bringing the regulation and monitoring of financial reporting practices by all cooperative banks under purview of the Reserve Bank of India. As described inparagraph 18, the regulation, auditor appointment, and monitoring of cooperative banks (both urban and rural) should be brought under the purview of the Reserve Bank o f India. Cooperative banks should be subject to the same accountinglauditing standards and regulatory monitoring as the rest of the bankingsector, '' For example, recently some private banks changed their auditor to meet the RBI guideline on mandatory auditor rotation every 4 years, where the incoming audit firm was a close affiliate (part of the same internationalnetwork of firms) of the incumbentauditfirm. India-Accounting andAuditing ROSC Page 27 79, Introducing practices to ensure compliance with code of ethics by the auditors of public interest entities. For example, ICAI-member auditors could provide a standard annual letter o frepresentation that would be an annualcertificate of compliance with the code of ethics, including disclosure o f any infractions. Incase any representation is found to be incorrect, the membercouldbe suitably dealt with, includingpermanentlossofICAImembership. 80. Scaling up structured training programs for ICAI members. ICAI should make arrangements for scaling up the delivery of training programs to provide guidance on (a) implementation of new accounting and auditing standards; (b) new concepts like fair value, true and fair override, materiality, and divisionof work; (c) best practice audit report disclosures and report writing and evolving risk-based audit methodologies; and (d) implementation of quality control procedures and code o f ethics insmall andmediumaudit firms. 81. Revising the ICAI Code of Ethics and Chartered Accountants Regulations to bring in line with the IFAC Code of ProfessionalEthics. Some restrictions prescribed under the current ICAI Code of Ethicsneed immediate revisioninorder to increasethe competitivenessof Indian audit firms, Other restrictions need to be introduced through the Code in order to enhance auditor independence.The Naresh ChandraCommittee has made several commendable recommendations in this regard that should be legislated. The ICAI Code of Ethics defines several rules; these rules may appear to be stricter than those definedby the IFAC Code, which can be complied with to the letter but circumvented in substance. Therefore it is recommended that a broad revision o f the ICAI Code and the Chartered Accountants Regulations be undertakento insert a principle-based conceptual framework while retaining some of the rules.73 The ROSC team advocates a framework approach that (a) sets out fundamental ethical principles, (b) provides a reasoned analysis of the possible threats to these principles, and (c) gives guidance on the safeguards that may be necessary to mitigate these threats. The following issues could be considered: e Remove restriction on number of partners permitted in an auditfirm; permit audit firms to be limited liability partnerships while prescribing a minimum professional liability insurance cover basedon the quantum of revenues of an audit firm. Address undue dependence on an audit client. Maximum fee from one client compared to total firm fee needs to be brought down from the currently permissible 40 percent o f total fees to a level that would not compromise audit firms' independence. e Prohibit persona~usinessrelationsh~swith audit clients for audit firms, its partners, and their relatives, as opposed to current regulations that only require disclosure o f such relationship inthe audit report. e Prescribe a 44cooling-of~period. Situations where audit partners join clients or vice-versa are not uncommon, It is recommended that a three-year "cooling- off" "TheIFACCodeofEthicsforProfessionalAccountantsstates,"Aconceptualframeworkthatrequiresfirmsandmembersof assurance teams to identify, evaluate, and address threats to independence, rather than merely comply with a set of specific rules which may be arbitrary, is, therefore, in the public interest. Independence is potentially affected by self-interest, self- review, advocacy, familiarity, and intimidation threats." ICAEW states, "The most effective way to ensure the reality of independence is to provide guidance centeredaround a framework of principlesrather than a detailedset of rules that can be compliedwith to the letter but circumventedin substance." India-Accounting andAuditing ROSC Page 28 period be prescribed. This requirement should extend to the audit firm partners, managers, and any management-gradeemployee ofthe client. 82, Taking steps for improving professional education and training arrangements. Continuing professional education requirements prescribed by ICAI need to be brought in line withthose prescribed by the IFAC-issued pronouncementonContinuing Professional Education and Development. Although India has a highly reputededucation system, the following steps should be taken with regardto professional education andtraining inaccountancy: e Introduce an elective course on inter~ationalstandards, including topics on practical application of IFRS and ISA, and detailed discussions on the differences between these international standards and Indian standards, as part of the undergraduate businesslaccountingprograms. e Teach business ethics as a separate subject in undergraduate businesslaccounting programs, and test candidates' knowledge about the practical aspects of professional ethics inthe professional qualification examinations. . e Further improve theprofessional examinations of ICAI by undertaking a detailed andindependentreview ofthe current assessment methodology. ICAIcould consider including objective-type questions, introducing case studies that test the students' practical training and application of standards as opposed to theoretical questions, and examining students on the differences between Indian and international standards a 0 Put in place an arrangementfor licensing authorized training providers. The ICAI should screenaudit firms before allowing them to accept any trainees. Inorder to be an authorized trainingprovider, a firm should be involvedinproviding auditing services to at least one major business enterprise in the region,74and it should have sufficient capacity to enable the trainee-auditors to gain exposure to the practical aspects of all the applicable standardsand codes. The ICAI should maintain a list of authorized practical training providers. The list should be updated on the basis of periodic assessment o f the capabilities of the existing and potential training providers. 74ICAI's regional body will be responsible for determiningwhether a particularclient of an authorizedtraining provider meets the previouslyestablishedthresholdofamajor businessenterprise, India-Accounting andAuditing ROSC Page 29 APPENDIX A. INDIANACCOUNTINGSTANDARDSAND THEIRAPPLICABILITY TO ENTERPRISES I MandatorvI Indian Accounting Standards (AS) AS 1 Disclosureof Accounting Policies (Underpreparation- RevisedAS 1- Presentationof Financial Statements) I AS 2 (Revised)Valuation of inventories IAS7 AS 3 (Revised)Cash Flow Statements 11412001 1 . 1 1 No Date AS 4 (Revised)Contingenciesand Events Occurringafter the BalanceSheet Date IAS 10 (Underpreparation-RevisedAS 4- Events after Balance Sheet Date) AS 5 (Revised) Net Profitor Lossfor the Period, Prior Period Items and Changes in Accounting Policies (Underpreparation- RevisedAS 5- same title) AS 6 (Revised) DepreciationAccounting ** AS 7 (Revised) ConstructionContracts AS 8 Accountingfor Research and Development (AS-8 was withdrawnfrom the date AS-26 became mandatory) AS 9 Revenue Recognition IAS 18 (Underpreparation- RevisedAS 9- same title) ~ AS 10Accountingfor FixedAssets IAS 16 (Underpreparation- Revised AS IO- TangibleFixed Assets) AS 11(Revised)The effects of Changes in Foreign IAS 21 ExchangeRates AS 12 Accountingfor GovernmentGrants - IAS 20 (Underpreparation- RevisedAS 12- same title) IAS 39; 40 AS 13 Accountingfor Investments AS 14Accountingfor Amalgamations IAS 22 (Underpreparation- RevisedAS 14-same title) AS 15 Accountingfor Retirement Benefits in the FinancialStatementsof Employers IAS 19 (Underpreparation- RevisedAS 15- Employee Benefits) AS 16 Borrowing Costs 1 IAS 23 IAS 14 AS 17 Segment Reporting 11412001 1 . 1 1 No Date I Mandatory I /AS Mandatory only for equivalent IndianAccounting Standards (AS) date LevelI *** Mandatoryfor all other enterprises enterprises from IAS 24 AS 18 RelatedParty Disclosures 11412001 4 No Date IAS 33 AS 20 EarningsPer Share 11412001 Mandatory for all companies and other enterprises that presentsEPS m AS 22 Accountingfor Taxes on Income AS 24 DiscontinuingOperations AS 25 InterimFinancialReporting Recognitionand measurement requirementsare applicableto listedenterprisesand other IAS 34 11412002 enterprisesthat present interimfinancial results; fully applicable if an enterprise is required or elects to prepare and presentan interim IAS 38 AS 26 IntangibleAssets AS 27 FinancialReportingof Interestsin Joint IAS 31 Ventures A Level II**** enterprises AS 28 Impairmentof Assets from - 01.04.2006 00 Certain disclosure requirements of these standardsare exempted for Level IIand Level 111 enterprises (collectivelyreferredto as SMEs). A ** Requirements relating to separatefinancial statementsare mandatory, for consolidated financial statements, mandatory only if presented *** From date AS 26 is mandatory (1/4103), the provisionsrelatingto the amortization of intangibleassets containedin AS 6 stand withdrawn. Large & Listed Enterprises or "Level I" Enterprises- I) Listed enterprises/ enterprises in the processof being listed(equity or debt) ii) Banks (including Cooperative Banks), FinancialInstitutionsand Insurance Companies iii) Enterpriseswhose turnover (excludingOther Income)exceeds Rs 500 million in the previous year iv) Entities with Borrowings including Public Depositsexceeding Rs 100millionat any time during period ****v) Holdingand Subsidiary Companiesof the above entity anytime during the period Level II Enterprises- i) Enterpriseswhose turnover (excluding Other Income)exceeds Rs 4 million in the previousyear but does not exceed Rs 500 million. ii) Entities with Borrowings including Public Depositsexceeding Rs 10 million at any time during periodbut not exceeding Rs 100million. *****iii)Level 111 Enterprises- Holdingand Subsidiary Companiesof the above entity anytime duringthe period All entities that do not qualify as Level I or Level II India-Accounting and AuditingROSC Page 31 APPENDIXB. INDIANAUDITING ANDASSURANCE STANDARDS ( u s ) . . . . . . . Indian Auditing Title of the lndian AAS Effective date" /SA equivalent and Assurance (d"m/yy) Standards (AAS) 200 1 Basic Principles Governingan Audit 11411985 - - - __I I I 200 2 Objective and Scopeof an Audit of FinancialStatements I1411985 230 3 Documentation - - - _ _ _ _ _ ._ _.. _ _ 1171985 - - I The Auditor's Responsibilityto Consider Fraudand Error in an Audit of FinancialStatements 240 4 (Revised) 11412003 RevisedAAS issued in January 2003. OriginalAAS issued in June 1987 - - ... -. . . . . . - .-_.. I 500 5 Audit Evidence 1I1I1989 -. . . . . . . - - - RiskAssessments and InternalControl 400 6 (Revised) RevisedAAS issued in June 2002. OriginalAAS issued in , 11412002 May 1988 - _Relying_ Uponthe _ Work- of an InternalAuditor 11411989 - _.- ._ Audit Planning I 11411989 ___ __ - .._ - - - I -_ _- - - __I____ I Usingthe Work of an Expert 11411991 - - - _ _ Usingthe Work of Another Auditor 600 10 (Revised) RevisedAAS issued in September2002. OriginalAAS 11412002 I _ _ __ issued in Apri/ 1995 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . ...I- 580 11 Representationsby Management 1I411995 - 1 Nocoms- 1 l - ponding /SA 12 Responsibilityof Joint Auditors 11411996 I - _ _ i- _ I 320 13 Audit Materiality 11411996 - .- . _ _ - 1 520 14 Analytical Procedures 11411997 - - - - - - _ _ _i _I_ I 530 15- Audit Sampling I 1141199% . - _ _ -_ I I- I 570 16 Going Concern 1I411999 .. ! - - .. - I 4 220 i 17 Quality Controlfor-Audit Work. 11411999 - _.. - - - ___ _ - - - - I - - - -- -- I 540 18 Audit of Accounting Estimates 11412000p , I __ 1 __- - - - . . . I - - . ." . .,_~ . ~ Effective date" IndianAuditing Title of the IndianAAS /SA equivalent andAssurance (d~"/yy) Standards (AA9 - _ _ _ - 560 19 Subsequent Events 114120009 - __. - _ _ - 310 20 Knowledgeof the Business 11412000p . . - ___ - __ - - - _ 250 21 Considerationof Laws and Regulationsin an Audit of FinancialStatements 11412001 _..-- - -._ . - _ _ - .- 510 22 Initial Engagements-Opening Balances In12001 _ _ _ _ - 550 23 Related Parties I1412001 - - 402 24 Audit Considerationsrelatingto EntitiesUsing Service Organisations 11412003 , - 710 25 Comparatives 11412003 ~ - 210- 26 Terms of Audit Engagement I1412003 _ - . . _ _ - . - _ _ _ _ - ._- 260 27 Communicationsof Audit Matterswith Those Chargedwith Governance 11412003 - __- - _ _ -. _ _ - _ _ _ _ I . -- 700 The Auditor's Reporton FinancialStatements I1412003 _ _ _ _ _ _ __I I 401 Auditing in a Computer InformationSystems Environment I1412003 - 505 External Confirmations 11412003 _ _ _ 930 Engagementsto Compile FinancialInformation 11412004= _ _ - _ _ _- - I _ 920 32 Engagementsto PerformAgreed upon Procedures regarding Financial Information 11412004 - . -. - - - - - _ _ ' --'The Auditing and Assurance Standards are effective for all audits commencing on or after the dates specified in the respective cells in column 4. 'Applicableto Applicable to all compilation engagements beginningon or afterthe date specified in the respectivecell in column 4. all agreed upon procedures engagements beginningon or after the date specified in the respectivecell in column 4, India-Accounting andAuditingROSC Page 33 APPENDIXC. PROPOSEDDEFINITION OF "CONTROL" FORPURPOSESOF CONSOLIDATING The definition of "control" in the Indian Accounting Standards-more than 50 percent of the voting power either directly or indirectly or control of the composition of board-is narrower than that prescribed in IAS 27-a more principles-based definition, "the power to govern the financial and operating policies of anenterprise so as to obtain benefits from its activities." Inrare situations, Indiangroups couldtake advantage ofthe "rule-based" nature ofthe definition of control under Indian Accounting Standards (as opposed to the "principle-based'' nature of the IAS) whereby they can reduce the voting power tojust under 50 percent and ensure that they do not control the board on paper to get out of consolidating a subsidiary they do not want to consolidate. Therefore the definition o f "control" should be amended in line with the I A S 27 definition (see below) to also include control over the financial and operating decisions of the entity as part o f a 3-way test: e 51percent ownership o r voting, o r Control over governing board, or e Control over financial and/ o r operating decisions. As per IAS 27, control is presumedto exist when the parent owns, directly or indirectly through subsidiaries, more than 50 percent of the voting power of an enterprise unless, in exceptional circumstances, it can be clearly demonstratedthat such ownership does not constitute control. Control also exists even when the parent owns 50 percent o r less o f the voting power o f an enterprise when there is: power over more thanone halfofthe voting rights byvirtue o f an agreement with other investors, power to govern the financial andoperating policies of the enterprise under a statute or an agreement, power to appoint or remove the majority ofthe members ofthe boardof directors or equivalent governing body, or power to cast the majority of votes at meetings of the board of directors or equivalent governing body. India-Accounting andAuditingROSC Page 34 APPENDIXD. INTERNATIONALDEVELOPMENTS INREGULATORY FRAMEWORK OFACCOUNTINGANDAUDITING This note describes salient features of regulatory structures in three countries, for example. For more details, refer to (a) www,frc,orrr.uk for the United Kingdom's Financial Reporting Council, (b) www.frc.9-ov.au for Australia's Financial Reporting Council, and (c) www.Dcaobus.org for the United States' Public Company Accounting Oversight Board. 1. UNITED KINGDOM: FINANCIAL THE REPORTING COUNCIL (FRC) The Financial Reporting Council (FRC) o f the UK is a unified, independent regulator which (a) sets, monitors and enforces accounting and auditing standards, (b) oversees the regulatory activities of the professional accountancy bodies, (c) regulates audit; and (d) promotes high standards o f corporate governance. It was initially established in 1990 and the mandate was expanded in 2003. It has five subsidiary boards with a Management Board that co-ordinates the key policy and resource issues of the organization. The FRC i s the parent o f all the subsidiary boards, all o fwhich are established as companies limitedby guarantees. 0rganization chart The Council is headed by a chief executive and comprises of a chairman, a deputy chairman (both of whom are directors o f FRC limited) and three additional directors (each representing a community o f stakeholders, namely Confederationo f BritishIndustry(CBI), consultative committee of the Accountancy Bodies (CCAB) and, a representative o f the investor community). The Council determine the strategic direction of the organization, oversee the delivery by each subsidiary Board of its functions, reviews and amendsthe combined code as necessaryto secure and maintain observance o f highstandards o f corporate governance; and manage the broad strategic relationship with key players domestically and India-Accounting andAuditingROSC Page 35 internationally. The FRC and its subsidiaries are currently supported and funded jointly' by the accountancy profession (through the Consultative Committee of the Accountancy Bodies [CCAB]), business(through a levy collected by the FSA) and the Government. The AccountingStandardsBoard(ASB) The role of the Accounting Standards Board (ASB) is to issue accounting standards under the Companies Act 1985, which took over the task o f setting accounting standards from the Accounting Standards Committee (ASC) in 1990. The ASB has up to ten Board members, o f whom two (the Chairman and the Technical Director) are full-time, and the remainder, 'who represent a variety o f interests, are part-time. Under the ASB's constitution, votes.of seven Board members (six when there are fewer than ten members) are required for any decision to adopt, revise or withdraw an accounting standard. Board members are appointed by a Nominations Committee comprisingthe chairman and fellow directors of the FinancialReportingCouncil (FRC). The AuditingPracticesBoard(APB) The new Auditing Practices Board (APB) was established inApril 2002 which a APB which had been in place since 1991. The APB establishes standards o f auditing, meets the developing needs of users of financial information; and ensureepublic confidence inthe auditing process. The PublicOversightBoardfor Accountancy(The POBA) The POBA provides (a) independent oversight of the regulation o f the auditing profession by the recognized supervisory and qualifying bodies; (b) monitoring o f the quality of the auditing function in relation to economically significant entities; and (c) independent oversight o f the regulation of the accountancy profession by the professional accountancy bodies. Audit Inspection Unit. The POBA includes an Audit Inspection Unit (AIU), which in the initial year (2004-05) is focusing on the audits o f the FTSE 350 companies and the Big 4 firms of auditors, which audit 97% of those companies. Coverage will be extended over the following two years to other public interest entities, including listed companies with a minimummarket capitalization o f 2100 million, major charities, major pension funds, mutual organizations and other public interest entities over the following two years. A sample o f audits will be subject to review inany one year, the selection of audits will, inpart be on a risk basis, and to provide coverage across the audit firms.The Professional Bodies own monitoring units will continue to be responsible for monitoring audits not falling within the scope of the AIU. The AIU will be supported by a Panel of very senior individuals with experience o f audit who will be available to provide advice on inspections, and particularly on issues involving professional judgment. The ATU will present their reports with recommendations for actionto the Audit RegistrationCommittees (ARCS) o f the accountancy bodies, who will then exercise their existing functions: taking appropriate regulatory action andor referring the matter to the bodies' disciplinary procedures for action. The POBA will monitor the response o f the Audit Registration Committees to ATU reports to ensure itself that appropriate action is being taken. In addition, the AW can inform the AIDB if it identifies concerns, which might lead to disciplinary action. The AIU can also inform the FRRP o f concerns it has with the audits of individual companies, so that the FRRP may take appropriate action in relation to the company accounts. The FinancialReportingReview Panel(FRRP) The FRRP (commonly referred to as "the Panel") considers whether the annual accounts of public companies and large private companies comply with the requirements o f the Companies Act 1985 ' The FRC has one-thirdgovernment funding, one-third funding from the CCAB and the balance from listing companies and the banking and investment sector. Previously, the Accountancy Foundationhad been funded solely by the CCAB, which was consideredto riskthe independenceof the organization. India-Accounting andAuditing ROSC Page 36 including applicable accounting standards. The Panel can ask directors to explain apparent departures from the accounting requirements. If the Panel is not satisfied by the directors' explanations it aims to persuade them to adopt a more appropriate accounting treatment. The directors may then voluntarily withdraw their accounts and replace them with revised accounts that correct the matters in error. Depending on the circumstances, the Panel may accept another form of remedial action-for example, correction o f the comparative figures in the next set of annual financial statements. Failing voluntary correction, the Panel can exercise its powers to secure the necessary revision o f the original accounts through a court order. The AccountancyInvestigationandDisciplineBoard(AIDB) The ATDB is the independent investigative and disciplinary body for accountants inthe UK. It has upto eight members and is responsible for operating and administering an independent disciplinary scheme (`the scheme') covering members of professional accountancy bodies under its purview. The AIDB deals with cases which raise or appear to raise important issues affecting the public interest in the UK and which need to be investigated to determine whether or not there has been any misconduct by an accountant or accountancy firm. The Scheme and Regulations contain the detailed rules setting out how cases are dealt with by the AIDB. Inthe first instance, complaints about accountants or accountancy firms would be made to the accountancy body of which the accountant or the firm is a member. Matters which raise serious issues affecting the public interest will be referred to the AIDB by the accountants' professional bodies. The AIDB will then decide whether to investigate the matter, inwhich case it will be referred to an Executive Counsel. The AIDB may also decide of its own accord to investigate a matter without it having been referred to it by one of the accountants' professional bodies. The Executive Counsel will conduct the investigation and decide whether or not any accountant or accountancy firm should be subject to disciplinary proceedings. If disciplinary proceedings are to be commenced, the Executive Counsel will file a complaint with the AIDB and the AIDB will appoint a Disciplinary Tribunal to hearthe case. 2. AUSTRALIA:THEFINANCIALREPORTING COUNCIL The Financial Reporting Council (FRC) is a statutory body under the Australiun Securities and vestments Commission Act 2001 (ASIC Act), as amended by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004. The FRC is responsible for providing broad oversight of the process for setting accounting and auditing standards as well as monitoring the effectiveness o f auditor independence requirements in Australia and giving the Minister reports and advice on these matters. Specific accounting and auditing standard setting functions for which the FRC i s responsible include (a) appointing the members o f the Australian Accounting Standards Board (AASB) and Australian Auditing Standards Board (AuASB), (b) determining, approving and monitoring the AASB's and AUASB's priorities & business plans, (c) giving the AASB and AUASB directions, advice or feedback on matters o f general policy and on the AASB's and AUASB's procedures, (d) monitoring the development of international accounting and auditing standards and the accounting and auditing standards that apply in major international financial centers, (e) promoting the continued adoption of international best practice accounting and auditing standards inthe Australian accounting and auditing standard settingprocesses, (0 monitoring - (i)the operation o f accounting and auditing standards to assess their continued relevance and their effectiveness in achieving their objectives inrespect o f both the private and public sectors of the Australian economy; (ii)the effectiveness o f the consultative arrangements used by the AASB and AUASB; and (iii)seeking contributions towards the costs o f the Australian accounting and auditing standard settingprocesses; India-Accounting andAuditingROSC Page 37 Specific auditor independence functions for which the FRC is responsible include (a) monitoring and assessingthe nature and overall adequacy of (i) the systems and processes used by Australian auditors to ensure compliance with auditor independence requirements; (ii)the systems and processes used by professional accounting bodies for planning and performing quality assurance reviews o f audit work undertaken by Australian auditors to the extent to which those reviews relate to auditor independence requirements; (iii)the action that Australian auditors who have been subject to such quality assurance reviews have taken in response to the reports prepared as a result o f those reviews; (iv) the action taken by professional accounting bodies to ensure that Australian auditors who have been subject to such quality assurance reviews respond appropriately to the reports prepared as a result o f those reviews; and (v) the investigation and disciplinary procedures of professional accounting bodies as those procedures apply to Australian auditors, (b) monitoring the overall compliance by companies, registered schemes and disclosing entities with the audit-related disclosure requirements of the Corporations Act and the accounting and auditing standards, (c) giving the Minister and the professional accounting bodies reports and advice on the above matters, (d) monitoring international developments in auditor independence, assessing the adequacy o f the Australian auditor independence requirements in the light o f those developments and giving the Minister, and professional accounting bodies, reports and advice on any additional measures needed to enhance the independence o f Australian auditors; and (e) promoting, and monitoring the adequacy of, the teaching of professional and business ethics by, or on behalf of, professional accounting bodies to the extent to which the teaching of those subjects relates to auditor independence. The members o f the FRC are appointed by the Treasurer and hold office on terms and conditions determined by the Treasurer. The FRC includes members appointed from nominations put forward by key stakeholder groups, as well as members appointed independently o f stakeholder interests. 3. UNITED STATES: PUBLIC COMPANYACCOUNTINGOVERSIGHTBOARD(USPCAOB) Followingare the most important accounting and auditing related requirements of the Sarbanes-OxleyAct of2002. The Act includes provisions concerning various other matters affecting investorprotection. Oversight of Public CompanyAudit. The Act establishesthe Public Company Accounting Oversight Board (PCAOB), to be organized as a non-profit corporation, with SEC administration and oversight. The PCAOB's mission is to overseethe audits o f public companies and relatedmatters. Organ~~ation PCAOB. The Securities and Exchange Commission appoints the chairman and of members o f the Public Company Accounting Oversight Board. The Board comprises five members- two can be professionallyqualified accountants. Auditor registration.All auditors of public companies must register with the PCAOB, identify public audit clients, identify all accountants associated with those clients, list fees earned for audit and nonaudit services, explain their audit quality control procedures, and identify all criminal, civil, administrative, and disciplinary proceedings against the firm or any o f its associated persons in connection with an audit. Inspection of CPAflrm. The PCAOB must inspect all CPA firms that audit public companies to assess compliance with the law, SEC regulations, rules established by the PCAOB, and professional standards. Firms that audit more than 100 public companies will be inspected annually. Firms that audit 100 or fewer public companies must be inspected at least once every three years. Ifviolations are found, the PCAOB must take disciplinary action. India-Accounting andAuditingROSC Page 38 Audit committees. All audit committee members must be independent (non-executive) directors. Audit firms will be appointed by, and will report directly to, the audit committee. Audit committees mustestablish proceduresto deal with complaints about accounting, auditing, and internalcontrols. Audit, quality control, ethics, and independence standards. The PCAOB must adopt audit, quality control, ethics, and independence standards. In doing so, the PCAOB may look to standards established by recognized professional organizations such as the AICPA. Quality control. The PCAOB's quality control standards must require that registered firms properly supervise all work, monitor compliance with ethics and independence rules, and establish internal systems for consultation, professional development, and client acceptance and retention. Restrictions on services to audit clients. The Act restricts consulting work auditors can do for their audit clients. Restricted services include (with certain exceptions) bookkeeping, financial systems design, appraisal and valuation, actuarial, internal audit, management functions, human resources, broker-dealer, investment banking, and legal. PCAOB may enumerate additional prohibited services. The registrant's audit committee must pre-approve engaging the auditor for other nonaudit services, including tax work. Partner rotation. The Act requires 5-year rotationofthe audit partner and second reviewing partner. Accounting standards. The law permits the SEC to recognize standards established by a private- sector accounting standard-setter provided that the standard-setter is deemed acceptable by the SEC and considers internationalconvergence indeveloping standards. Disclosures. The Act requires certain disclosures in financial reports, including information about off-balance sheet transactions, and orders the SECto develop rules regardingpro forma disclosures. Princbles-based standardk The SEC is required to study the "adoption by the United States financial reporting system o f a principles-based accounting system" and, within one year, submit a report to specified committees o f the U S Senate and House of Representatives. e Corporate and criminal fraud The Act provides for criminal penalties for corporate fraud and document shredding. e Restatements. The Act specifically prohibits improper influence on audits and requires forfeiture of executive bonuses and equity gains iffinancial statements must be restated. Compliancewith SOX Section 404. Section 404 o fthe SarbanesOxley Act requires the management of a company registered with the SEC to assess and report on the effectiveness o f the company's internal control over financial reporting, and requires auditors to attest to and report on management's assessment. India-Accounting andAuditingROSC Page 39