The Financial Express, Thursday, September 10, 2015
FRC: Accounting profession faces a challenge
The Jatiya Sangsad passed the Financial Reporting Act, 2015 (FRA) on Sunday (September 06, 2015). Among other things, the FRA requires the establishment of a new oversight body, referred to as the 'Financial Reporting Council (FRC)'. The main purpose of the FRC will be to regulate the financial reporting process followed by the companies.
As per the FRA, the FRC will be a 12-member body, comprising of representatives from the government, the Bangladesh Bank, the Bangladesh Securities and Exchange Commission (BSEC), the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), the academia, and the professional accounting bodies. The council will be headed by a full-time chairperson who will be appointed by the government through a panel of experts. In addition, the FRC will have a full-time chief executive. The FRA identifies four major functions of the council, namely, accounting and auditing standard setting, financial reporting monitoring, audit practice review, and enforcement of disciplinary actions.
Judging by the initial reactions as published in the local media, this initiative appears to have a wide support from a number of important stakeholder groups. Especially, the investors seem to be optimistic about the capability of the FRC to bring a degree of discipline in the financial reporting and auditing process, and subsequently, strengthen the capital markets. From that perspective, this is a populist initiative.
To a more inquisitive observer, however, there are reasons to be sceptical about the efficacy of the proposed FRC. The purpose of this article is, therefore, to initiate a debate on these possible shortcomings so that the FRC can actually achieve its objectives.
COMPOSITION OF FRC: To start with, the composition of the FRC is likely to be a potential problem. There is hardly any dispute regarding the competence of the representatives from the ministries of finance and commerce, the Bangladesh Bank, the BSEC, the Comptroller and Auditor General's (CAG) office, and the National Board of Revenue (NBR) in their related fields. However, much of FRC's function would involve overseeing the work of professional accountants, who have years of practical experience in their field. In addition, the FRC would also be responsible for the adoption of International Financial Reporting Standards (IFRS) and the International Standards on Auditing (ISA). Understandably, carrying out these functions will warrant high degree of professional expertise in the area of auditing and financial reporting. Interestingly, out of 12 members of the council, the FRA requires only one member to possess a professional financial reporting and auditing qualification (there will also be one member from the Institute of Cost and Management Accountants of Bangladesh, but membership of ICMAB does not require professional experience and expertise in auditing). It is hard to imagine that the non-accountant members sitting in the FRC would have adequate expertise to make decisions on adoption of international accounting and auditing standards or monitor the activities of professional accountants in public practice. In addition to seriously undermining the role of the professional accountants in Bangladesh, the structure of the FRC, therefore, can significantly affect its capability to carry out its stated functions. To highlight the apparent ridiculousness of the scenario, let us put this in the context of other professions: can the activities and professional judgments of medical doctors be monitored or questioned by non-physicians? Would you allow non-physicians to write prescriptions (synonymous with accounting and auditing standards in this case) for you?
RESOURCE COMMITMENTS: The second function of the FRC will be to monitor if the international accounting and auditing standards, as adopted by the FRC, are being properly implemented by the companies. The implementation of IFRS and ISA is a challenge for many companies. From that perspective, it is a welcome initiative. However, at the same time, this is a mammoth task that will require significant resource commitments. In the context of Bangladesh, the BSEC, even after 25 years of existence, still struggles to monitor the implementation of IFRS in listed public companies due to resource constraints. Is there any reason for us to be optimistic that the FRC, another government-funded body, will receive significantly high resource allocations from the government, so that it can have an impact on the financial reporting scenario?
A pertinent, but usually overlooked point regarding the implementation of IFRS in Bangladeshi companies, is the absence of sufficient number of qualified professional accountants who could facilitate such implementation. For a country with a large population, Bangladesh has a surprisingly small number of professionally qualified accountants in the area of financial reporting and auditing. As of July 01, 2015, the Institute of Chartered Accountants of Bangladesh (ICAB), the only professional accountancy body offering financial reporting and auditing qualifications in Bangladesh, had only 1,536 members, a significant number of which are either deceased, retired or live abroad. This means that a vast majority of the accountants working in the corporate sector (especially in small and medium-sized companies) may not have sufficient skills and expertise to oversee the implementation of IFRS in their respective entities. In such a scenario, what would be the point of the FRC devoting so much resource in monitoring implementation? Rather, wouldn't such resource be better spent in providing training to the accountants, and possibly setting up second-tier accountancy bodies?
QUALITY CONTROL: The third stated function of the FRC is to perform a quality control review of the practising auditors. According to the FRA, each practising audit firm will be inspected by the FRC one in every three years. Presumably, such inspection would involve looking at the performance of the auditors as well as questioning their judgements in individual audit assignments through detailed inspection of working papers. Again, this would require substantial resource commitment as FRC would need to hire professional accountants for such review. Already, the existing salary offered in competing regulatory bodies (such as the BSEC) is not sufficient for attracting high quality professional accountants. Also, similar quality control reviews are currently undertaken by the ICAB, and it is difficult to see how the FRC would be more competent compared to a professional accounting body, such as the ICAB, in inspecting the work of professional accountants. Based on such quality review, the FRC can recommend actions against auditors. Alarmingly, this includes a maximum punishment of five years' imprisonment for the auditors.
DISCIPLINARY ACTION: FRC's power to take disciplinary actions against auditors can be viewed from two perspectives. Firstly, this takes away the self-regulatory aspects of the profession. Since its inception, the ICAB has been in charge of monitoring the activities of its members. Arguably, the professional body has not been very proactive in taking actions against its members. Also, a few actions have been affected by the lengthy judicial process. However, before taking such actions, the professional judgements of the auditors would need to be evaluated, and due process would need to be followed in order to establish, without any doubt, that the auditors, despite possessing the skills and the expertise, intentionally issued a wrong audit report. The investigators would thus require high degree of experience and expertise in the area of auditing and corporate affairs. This will require significant resource commitments by the FRC. Secondly, given the socio-economic environment of the country, we cannot rule out the risk of potential abuse of such disciplinary powers for undue economic benefits. In such a case, the establishment of the FRC may end up as counterproductive for the corporate sector.
There are reasons for the policy makers and other interested parties to be concerned about the state of financial reporting and auditing practices in Bangladesh. The ICAB, despite its recent efforts, has not been able to create sufficient confidence regarding its capability to monitor its own members. Consequently, perceptions regarding the quality of audit have remained poor, perhaps compelling the policy makers to offer the FRC as a regulatory alternative.
POOR LEVEL OF FEES: However, a close look at the state of audit profession would identify the single most important factor that affects quality of audit in Bangladesh: the appallingly poor level of fees offered to the auditors. The fees paid to the auditors in Bangladesh are significantly low even compared to neighbouring India and Pakistan. This is mainly due to the corporate culture in Bangladesh where the value of audit is not appreciated, as opposed to more 'tangible' services, such as legal and tax services. The fees are so low that many audit assignments result in losses for the audit firms, forcing the firms to look for other sources of revenue, including the provision of various non-audit services (many of which have now been prohibited by the BSEC order on corporate governance, 2006, squeezing the revenue stream further). Consequently, many audit firms have to be economically dependent on their clients for their own survival, compromising audit independence, and eventually, audit quality.
The appallingly low levels of audit fees have failed to attract the internationally reputed Big 4 audit firms to consider Bangladesh as a potential market. At present, only one Big 4 firm operates in Bangladesh, whereas in neighbouring India, Pakistan and Sri Lanka, these firms have a more prominent presence. Arguably, the training offered in Big 4 firms could have raised the overall quality of audit in Bangladesh.
Thus, the main problem with auditing in Bangladesh lies with poor audit fees rather than the adoption of international financial reporting and auditing standards. Unfortunately, the FRA does not address the issue of audit fees. Rather, it requires auditors to register with the FRC in order to be able to continue public practice, hence, potentially increasing the cost of audit further. Given the reluctance of the Bangladeshi corporate sector to pay higher audit fees, it is likely that such increase in the cost of audit would not be matched by a corresponding increase in fees, eventually lowering the quality of audit.
WITH EVERY ADVERSITY COMES AN OPPORTUNITY: With the passing of the FRA in parliament, the FRC has now become a reality that the audit profession will have to deal with. For the time being, the FRC appears to be a threat to the profession, as the council will take away most of the powers exercised by the ICAB. However, with every adversity comes an opportunity. The ICAB, therefore, needs to ensure that the FRC acts in a manner so that the profession is benefited. To start with, this will require devoting substantial efforts to convince the government to appoint professionally qualified persons in the positions of chair and chief executive of the FRC. Also, as a first step, the FRC can start reviewing the levels of audit fees offered to auditors in Bangladesh, and perhaps engage in discussions with practising auditors to determine a mandatory minimum level of audit fees, at least for publicly listed companies. Once this is ensured, the FRC can then devote its time and resources in taking actions against auditors for professional malpractice. After all, the finance minister has justified the recent pay-hike of the public servants by stating that such increase is likely to be followed by subsequent decrease in corrupt public practices. The same logic should work for the auditors as well!
Dr Javed Siddiqui is an Associate Professor of Accounting at the Manchester Business School, University of Manchester, UK.