Ideally, the proposed Financial Reporting Council (FRC) should be under the leadership of Ministry of Finance and shall have powers and authority to frame accounting and auditing standards; monitor compliance with established standards; review auditors' practice and enforce sanctions and penalties on violations. As far as its composition is concerned, the global practice may be followed by inducting representatives from the government such as Ministry of Finance, Ministry of Commerce, Auditor General of Pakistan and State Bank of Pakistan and from the professional accounting bodies, ie, ICMA Pakistan, ICAP and PIPFA; representatives from other organisations such as Pakistan Stock Exchange, Federation of Pakistan Chambers of Commerce and Industry (FPCCI) and Pakistan Banks Association. The chairman of the FRC should be nominated by the government and he should not be a member of any of the professional accounting bodies, otherwise the neutrality of FRC would be compromised.
Several advanced and emerging economies such as the US, the UK, Canada, Hong Kong, Australia, Mauritius, Sri Lanka and Japan, etc, have already established such financial reporting authorities that have resulted in strengthening their financial sectors and attracting global investments. The creation of an independent financial watchdog in Pakistan would also stimulate private sector's growth and foreign investments. It would allow investors to evaluate corporate prospects in Pakistan and make informed decisions resulting in lower cost of capital and better allocation of resources. It would also facilitate integration into global financial and capital markets and strengthen country's financial architecture and reduce the risk of financial market crisis and its negative economic impact. Above all, with the opening up of Pakistani market in the backdrop of the China Pakistan Economic Corridor (CPEC), the proposed FRC would definitely help build market confidence in the value and quality of audit and promote sound audit practice and regulations.
Failure of self-regulation model in audit profession Auditing has always been a self-regulated profession; however, emergence of corporate failures and scandals in recent past has raised some profound questions about the validity and suitability of self-regulation in auditing not only in advance economies, but also in emerging economies in South Asia, including Pakistan, where the auditors have to perform their duties in a very complex risk management environment.
The self-regulation model is now being challenged as it has not resulted in any significant improvement in the audit quality due to absence of any penal provisions against non-compliance of financial reporting lapses and submission of incorrect or false audit report to regulators. At the professional bodies' level, there are inherent weaknesses as far as disciplining and enforcement is concerned. It is in this backdrop that to improve overall audit quality and restore public confidence, many countries have either established or intending to create some kind of 'super regulatory or oversight bodies' to frame accounting and auditing standards and regulate the performance of auditors in the larger public interest.
Many examples can be cited around the globe, where outside regulation of auditing profession have been introduced and working effectively, prominent among them are the Financial Reporting Council (FRC) of the UK, Public Company Accounting Oversight Board (PCAOB) of the US, Financial Reporting Council of Nigeria, Financial Reporting Council of Mauritius, Financial Reporting Council of Australia, Financial Services Agency of Japan, Abu Dhabi Accountability Authority (ADAA), Botswana Accounting Oversight Authority and Sri Lanka Accounting and Auditing Standards Monitoring Board (SLAASMB).
In the context of South Asia, we observe that Sri Lanka is pioneer in taking the timely and prudent initiative of establishing an independent financial reporting body way back in 1995. The monitory board is responsible for monitoring compliance of accounting and auditing standards in relation to financial statements as specified in the Act and is also empowered to impose fine. In case of non-compliance, the courts in Sri Lanka may impose penalties extending up to five years' imprisonment. The chairman of the monitoring board is a nominee of the governor, Central Bank of Sri Lanka while board's composition is diversified, ie, ex-officio members, including Registrar General of Companies, Commissioner General, Department of Inland Revenue and DG Securities and Exchange Commission of Sri Lanka; whereas the nominees are from the Institute of Chartered Accountants of Sri Lanka (ICASL); CIMA UK (Sri Lanka Division); Bar Association of Sri Lanka; Ceylon Chamber of Commerce and Sri Lanka Banks Association.
In Bangladesh, Financial Reporting Act, 2015 was passed by the national parliament on 6th September 2016. As per latest information, the finance minister of Bangladesh has already approved the formation of a high-powered financial reporting council which is likely to start functioning soon after vetting by the ministry of law of Bangladesh. The Financial Reporting Council shall act as a sole watchdog to oversee work of auditors and monitor financial matters of various government, autonomous and non-government institutions. The council will consist of 12 members representing ministry of finance; ministry of commerce; Institute of Chartered Accountants; Institute of Cost and Management Accountants; National Board of Revenue; chambers of commerce and Bangladesh Bank.
In India, the government is all set to establish a new regulatory body by the name and title of 'National Financial Regulatory Authority (NFRA)' which would oversee the quality of service of professionals and monitoring and enforcing compliance with accounting standards. The proposed NFRA would have same powers as vested with a civil court under the Code of Civil Procedure. It shall have power to investigate matters of professional misconduct by CAs or firms and such investigation could not be challenged. The formation of an independent Financial Reporting Council was realized in 2012 when the Standing Committee on Finance of Parliament proposed the need for a quasi-regulatory body for supervising the quality of audit in India. Accordingly, the Indian Companies Act, 2013 incorporated this proposal under Section 132 to form a new regulatory authority with wide powers to recommend, enforce and monitor compliance of accounting standards. The Ministry of Corporate Affairs of India has also issued rules that will give NFRA an overarching role to regulate chartered accountants and set standards.
This new provision in the Indian Corporate Act was strongly opposed by the concerned professional body which is presently charged with developing of accounting and auditing standards but the Indian government is quite adamant on its stance of forming this independent regulatory body in the larger public interest. Evidently, this move was also supported by the members of the chartered accountants community such as Yogesh Sharma, Partner, Grant Thornton India LLP (one of big four firms) who is of the view that introduction of NFRA is in line with the international practice of having an independent regulator, which monitors the auditors.
In one of his presentations made on 20th September 2013, after the promulgation of Indian Companies Act, 2013, he said that "the constitution of the NFRA and powers being conferred to NFRA will bring in a significant change to the current structure of standard setting regulations". There is, however, some final negotiations going on between the government and ICAI with regard to jurisdiction of NFRA and its representation. With the formation of NFRA, significant regulatory powers of ICAI will be shifted to new super regulator and ICAI's role would be limited to holding exams for CAs and recommending accounting standards to the new authority.
Abysmal quality of audit practice in Pakistan The abysmal quality of audit practice and weak oversight by the financial regulator merit immediate action by the government to bring radical changes in the existing legal financial audit and reporting framework of the country. The pathetic performance of both the auditors and regulator has put the interests of all the stakeholders at stake. The existing monitoring system lacks stringent mechanism to check malpractice by audit firms to compromise on audit quality. Due to a lack of transparency and compromising attitude of regulators, the investors, audit firms and accounting bodies are being denied a level playing field. Recently, the default by statutory auditors of brokerage houses is an ample proof of deteriorating quality of audit. It has been observed that few auditing firms were acting as statutory auditors for large number of stockbrokers. This necessitates critical assessment of role of auditors and stringent legal action by the regulator against such auditing firms.
Another glaring example of pathetic audit practice in Pakistan is that many statutory auditors or auditing firms, in order to avoiding comprehensive audit, normally adopt the option of 'test checking' in which only few transactions are selected at random from a large number of transactions, for doing audit. In the auditing profession, this test checking is considered a substitute for detailed checking of company records and if these are found to be correct, the auditor 'presumes' that all other transactions would also be correct. This sort of assumption is altogether contrary to norms of justice and transparency as the choice for adoption of testing methods is fully dependent at the discretion of the auditor. This creates complacency on the part of auditor and provides avenue or excuse for them to ignore investigation aspect in those transactions, which seem to be required attention for a detailed checking.
Accordingly, the audit judgement and report given by the auditor is based on an overall opinion acquired and in many cases, it is qualified. In the absence of any internal check and control mechanism, the lapses or negligence on the part of statutory auditors could result in serious consequences for corporate sector. In this backdrop, it is absolutely important that the regulator should scrutinise 'test checks' in audit programmes to improve the quality of statutory audit in Pakistan.
There is a need for promoting the audit quality to enhance public confidence in audit process and financial reporting. Quite unfortunately, the audit of financial statements by statutory auditors has become an annual ritual and over the years, the term 'audit report' has lost its credibility as it merely represents an 'Accounting Compliance Report'. The auditors focus mostly on compliance of international standards on accounting, reporting and audit, which has limited application in Pakistan. There is no reporting by auditors on the mismanagement, frauds or leakages of funds.
While the proposed Financial Reporting Council comes into legal effect and starts functioning in Pakistan, the existing financial regulator must take the initiative to make reporting on fraud and mismanagement an integral part of audit report by making necessary amendments in the Companies' Law. The auditors should have powers and mechanism to report significant matters, including fraud and mismanagement to the SECP directly. The mechanism for appointment of statutory auditors should also be made transparent and more independent of the majority shareholders.
Further, in order to safeguard the interests of all investors and stakeholders, the regulator must also make it legal binding on companies to have credible cost-based and operational audits for better performance. It is to be realized that financial audit alone would not suffice as it just reports compliance with the so-called regulatory requirements. By credible audit, it means that financial audit should be reliable and credible and may lead to good governance; better performance and improved service delivery of public and private sector entities to general public and the national economy.
(The writer is President, ICMA Pakistan)
Copyright Business Recorder, 2017