Are Small Company Audits vanishing?

Recently, the news of abolition of Statutory Audit for small companies spread like a wildfire and social media have emerged as a comforting shoulder for the Chartered accountants, who are mostly dependent on the small company audits. There was no official version of the said story but it was not an unexpected one as across the world, the audit requirements for the small companies have been dispensed in the last ten years. However, the fraternity has received it as a severe blow to the CA profession due to continuing vanishing of audit work. In the recent past, the increase in Turnover limit of Tax Audit under Income Tax Act, 1961 to 10 Crore under specified conditions and thereafter the GST Audit was abolished from FY 2020-21 onward. So, a proposal to do away with Statutory Audit for certain classes of companies viz small companies was like a nightmare for the majority of the practicing members of the small firms spread over to small cities.

How did the news spread?

A news channel “CNBC-Awaaz” broadcasted a news that the MCA, is contemplating to do away with the requirement of statutory audit of “Small Companies”. A snippet of the relevant News is being reproduced hereunder:

As per news coming from reliable sources, the Ministry of Corporate Affairs (MCA) might do away with Statutory Audit as per the Companies Act 2013 for small companies. This decision to do away with statutory audit for small companies is proposed considering the ease of doing business for the taxpayers.

It is pertinent to mention here that in order to promote ease of doing business the Turnover limit of Tax Audit under Income Tax Act, 1961 was increased, thereafter the GST Audit was abolished from FY 2020-21 onward. In continuation of above steps, it is now being proposed to do away with Statutory Audit for certain classes of companies viz small companies.

As per reliable sources, Companies with paid-up capital of up to Rs. 2 crore and Turnover of up to Rs. 20 crores are small companies and benefit of audit abolition may be provided to them from next financial year.

Relaxation/Exemption to Small Companies

Earlier, MCA has constituted an expert committee to look after the various issues prevailing in the matter of compliance by the company. The Committee was of the view that Small Companies need not be subject to the costs of a regime suited to large companies with a wide stakeholder base. Relaxations to small companies with regard to the format of accounts to be prescribed in the Act/Rules may also be considered. If necessary, a separate format for small companies may be devised. Exemptions from certain disclosures may also be considered and relaxations, if any required, in respect of compliance with Accounting Standards may be provided for while notifying the Accounting Standards. If necessary, a separate Accounting Standard may be framed for small companies.

Expanded definition of Small Company

A reference has been made to the expression “Small Companies”. In this regard, the definition of “Small Companies” as contained under Section 2(85) of the Companies Act, 2013, which prescribed –

“Section 2(85) “small company” means a company, other than a public company-

(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than ten crore rupees; and

(ii) turnover of which as per profit and loss account for the immediately preceding financial year does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than one hundred crore rupees.

Provided that nothing in this clause shall apply to—

(A) a holding company or a subsidiary company;

(B) a company registered under section 8; or

(C) a company or body corporate governed by any special Act;”

However, the definition of “Small Companies” was expanded in the Budget 2021 speech which expressed the resolve of the Government to expand the and accordingly vide Notification GSR 92(E) dated 01.02.2021 the Companies (Specification of Definitions Details) Rules, 2014 were amended which amended Rule have come into force from 01.04.2021. As per these Rules, the definition of “Small Companies” has been amended by enhancing the paid-up capital base from the limit of Rs 50 lakh to Rs. 2 crores. Similarly, post amendment, the turnover threshold of “Small Companies” has also been enhanced from Rs 2 crores to Rs 20 crores. Thus, it can be summarised that presently so in-order to be qualified as a “Small Companies”, a Private limited company must have paid-up share capital up to/not exceeding Rs. 2 crores &its turnovers as per its profit and loss account for the immediately preceding financial year must not exceed Rs.20 crores. However, the small companies are already having few privileges as far as audits are concerned. Such as, the exemption is there for small companies to follow the condition laid in Section 139(2) of the Company Act 2013, which mandates the rotation of auditors every five years (individual auditors) and every 10 years (firm of auditors) and Auditor’s reports do not have to report about the adequacy of internal controls and their operational effectiveness in their reports.

President ICAI Address covered up in a hurry

A national reputed channel broke the news about the MCA. There were two related parties. One the regulator MCA and the other national channel. Both of them have neither denied the news as merely rumour nor regretted the wrong news. There cannot be a fire without a spark. The flames move and change. They go up and down. They blow in the wind. The same thing is happening here for such news. When both the parties have kept mum, certainly there was some spark and the fire is on.

To diffuse the fire, in an unprecedented manner, The President of ICAI decided to address the members. It was like an address of the President of India, briefing about the National policies on the eve of republic day and Independence Day. Few term it as Man ki baat of the President ICAI on the line of PM” s talk to the Nation. In his address, at the last moment a line appeared that MCA doesn’t have any plans to relax the audit norms for small firms. The vital questions arose from the President’s address. One such is about verbal communication only. ICAI has failed to issue any written clarification on the issue. In his address, he failed to mention the source of the information. Till today, no one related to regulators have come up with the clear verdict on the issue. The doubts have been raised about the address as accommodating in nature due to forthcoming council elections. The sitting council members were facing a hardship on the questions raised by common members, specifically the small firms. Moreover, a CCM from big 4 has broadcasted lacs of messages with a note to hear the President’s message till the end. The ICAI or its corporate affairs committee should come out clearly about their stand on the mindset for vanishing the audit of small companies.

Is Voluntary auditing a future for Small Companies?

Voluntary auditing has received increased attention from researchers in recent decades. Empirical studies that have examined demand for voluntary audits have suggested that regulatory intervention may not always be necessary, though some argue that regulators protect society from market failure by demanding statutory audits. To date, there has been no review of the literature on determinants of voluntary audits. A thorough research framework is required to move for the voluntary audits and identify areas that need further examination. Otherwise, this will not only be disastrous for the profession but at large for the businesses. There may be two major reasons for going ahead with the proposal to drop the audit requirements for small companies. One is that the Schedule-III amendments that are being rolled out from next year must have arisen out of feedback from bankers, ROC technical scrutiny, forensic audits, etc. There is a paramount importance of audited financial statements for lenders. Further the intention to deregulate audits for smaller companies is to relieve cost burdens. In case of voluntary auditing, such companies will no longer require to conduct statutory audit of their financial statements from a Chartered Accountant. Rather the CMD / Director(s) of the company will be able to self-certify the financials and upload the same on MCA / ROC portal.

European countries & Ease of doing business

Many European Union countries are having exemptions for small companies from audits. They have abolished mandatory audits for small firms to reduce the regulatory and administrative burden for these firms. However, we still lack knowledge on whether such legislative changes affect those firms that become free to choose to have external audits. There is also no study about the impact of such legislation on the professional firm. As per the reform’s activities, the mandatory audits act as a growth barrier for small firms. However, before switching over to voluntary auditing a thorough homework is required to implement. In India, we have a different environment for working. Here the compliance is tough and voluminous. There cannot be any efficiency in day to day working of the business unless backed by the support from the experts. In India, the Chartered accountants are providing that support through numerous ways. Their role cannot be ignored. It is indeed a challenging time. If such a mindset continues with this type of so-called “Ease of Doing Business” initiatives, then in the next 4-5 years the scope of practice especially for small professional firms will definitely vanished.

Auditing is not a mere formality

The role of the auditor is not merely limited to signing the financial statements but is also extended to express an opinion on the financial health of the company. Further, the auditor is required to express an opinion on the truthfulness and fairness of the Balance Sheet, year after year. In-case of any inconsistencies or where the financial statements are not in parametria to the extant rules and regulations, the auditor expresses his opinion accordingly. This is to be understood in probity that the purpose of auditing is to satisfy the users of financial statements that the accounts presented to them are drawn up on correct accounting principles and that they represent a true and fair view of the state of affairs of the organisation. In the absence of audit of financial statements of annual accounts by independent auditors, the financial statements would be merely an insider document having no sanctity or relevance. A number of authorities and organizations including Banks, Financial Institutions, other Lenders, Provident Fund authorities, ESIC authorities, rating agencies, investment agencies, etc look for the audited figures from the Auditors to arrive at the conclusion of their opinion about the financial health of the entity. It is submitted that in the absence of audited annual accounts, there is a high likelihood that the financial accounts of the companies may get dressed up/ cooked up. Thus, absence of audited annual accounts is likely to result in substantial loss of revenue/funds to various users of statement of accounts.

As per the Companies Auditors Report Orders, an auditor is required to ascertain and comment as to whether the public money borrowed from bank and other lenders have met the requisite / ultimate use or not. In the absence of statutory audit, there would be no checks on usage of such public money which would not only jeopardise the banks and other lenders but would also lead to stress on the Government to infuse more equity in the Public Sector Banks. Moreover, people will stick to restricting their expansions to avail such types of benefits of no audit. Further, that will be an hilarious job for the Statutory Auditors, when such un-audited companies cross their limits and to be taken up for the auditing.