It is ironical that whenever frauds are detected, many are of the opinion that, on hindsight and as a post-mortem, that they could have detected the fraud had they been a bit more alert and paid a little more attention to detail. Amongst those who could be having this opinion are some auditors.

Though it is by now well established that the key responsibility of an auditor is to express his opinion on the financial statements and not detect fraud on a routine basis, auditors are mandated to report frauds if they have reasons to believe that there could be a hint of fraud in an entity.

The line between detecting a fraud and having reasons to believe that no fraud has been committed is a very thin one. Over the last few years, the National Financial Reporting Authority (NFRA) has taken disciplinary action against audit firms that appear to have been remiss in this regard.

In a Circular dated June 26, 2023, the NFRA has clarified the auditors duty with regard to the occurrence of a fraud in a company.

Auditors’ obligations

Statutory auditors are under a mandatory obligation to report fraud or suspected fraud if they observe suspicious activities, transactions or operating circumstances in a company that indicate reasons to believe that fraud is being or has been committed against the company by its officers or employees.

In such an event, the Statutory Auditor shall initiate the steps prescribed under Rule 13 of Companies (Audit and Auditors) Rules 2014 which begins with reporting the matter to the Board/Audit Committee within two days of his/her knowledge of the fraud.

In the case of reporting of a fraud involving or expected to involve individually an amount of ₹1 crore or above, if the Statutory Auditor fails to get any reply/observations from the Board/Audit Committee within 45 days, the auditor shall forward a report in Form ADT-4 to the Secretary, Ministry of Corporate Affairs.

The Circular clarifies that the report to the Centre needs to be sent even if the auditor is not the first person to detect the fraud.

The Circular ends with a couple of advisories to auditors — resignation from the audit cannot be used as a cover to brush off one’s responsibility and they need not be influenced by a legal opinion provided by the company.

In a recent public interaction, the Chairman of NFRA re-emphasised the above points. It is now a known fact that the only saviour for auditors would be their audit documentation.

NFRA’s objective

The NFRA Chairman stated that NFRA should not be looked at as a villain — the sole objective of the NFRA is to improve financial reporting across the board. The only manner to do this would be by censuring some auditors who have crossed the line and ensuring that the rest do not do the same by adhering to the diktats of NFRA.

It is possible that the audit firms who have been censured by the NFRA did not expect them to take up past cases. Some firms have filed petitions in courts questioning whether the NFRA can pick up cases that existed before it was established. It has now been established beyond doubt that if the auditor has a reason to believe that a fraud has occurred or he can smell a fraud, he needs to report it to the management and the Central Government.

But an auditor need not go hunting for frauds in the course of his audit. An auditor can have a reason to believe or not only by relying on the work of others who are a part of the entity’s environment — these could be internal auditors, concurrent auditors, independent directors, whistleblowers, etc.

There have been instances wherein whistleblowers have been silenced by the management before they blew the whistle. The Companies Act should encourage whistleblowers to report directly to the Centre on possible fraud just as they have asked of the auditors. India has a Whistle Blowers Protection Act that was passed in 2014.

However, this Act has a limited scope since it is invariably thought to be applicable only to PSUs and public servants. This Act needs to be strengthened by giving more power to whistleblowers to say things as they are and give them protection from retaliation.

Even if the whistleblower’s complaints turn out to be a shot in the dark, auditors have some material to work upon during their audits.

What does the future look like for NFRA and the auditing fraternity? Auditors will be more careful since they now know that the devil is in the documentation.

History informs us that frauds will keep occurring every once in a while which will keep auditors busy. NFRA would focus on giving advisories on accounting and auditing standards.

The writer is a chartered accountant