TaxTMI 
TaxTMI 
2023 (7) TMI 1244
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....kground C. Major lapses in the audit: Failure in audit relating to fraudulent diversion of funds and related matters D. Other non-compliances with Laws and Standards E. Articles of Charges of Professional Misconduct by the Statutory Auditor F. Penalty & Sanctions. A. EXECUTIVE SUMMARY 3 Pursuant to Securities and Exchange Board of lndia ('SEBI' hereafter) sharing in April 2022 its investigation regarding diversion of funds worth Rs 3,535 crores from seven subsidiary companies of Coffee Day Enterprises Limited ('CDEL' hereafter), a listed company, to Mysore Amalgamated Coffee Estate Limited ('MACEL' or 'the company' hereafter), an entity owned and controlled by the promoters of CDEL, NFRA initiated investigations under Section 132( 4) of the Act. 4 NFRA's investigations inter alia revealed that the MACEL's Auditor for the FY 2018-19 failed to meet the relevant requirements of the Standards on Auditing ('SA' hereafter) in a number of significant aspects and demonstrated a serious lack of competence. The EP failed to exercise professional judgement & professional skepticism during audit of fra....
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....t 1934 despite the fact that the principal business of MAC EL had changed from coffee grower to Non-Banking Finance Company on account of diversion of funds. Besides these, the EP violated a number of Standards on Auditing and also failed to report violation of Accounting Standards by MACEL. 6 Based on investigation and proceedings under section 132 (4) of the Companies Act and after giving her opportunity to present her case, NFRA has found the EP guilty of professional misconduct and imposes through this Order the following monetary penalties and sanctions with effect from a period of 30 days from issuance of this Order: a) Imposition of a monetary penalty of Rs Five Lakhs only upon CA Lavitha Shetty; b) In addition, CA Lavitha Shetty is debarred for a period of five years from being appointed as an auditor or internal auditor or from undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate; B. INTRODUCTION & BACKGROUND 7 National Financial Reporting Authority is a statutory authority set up u/s 132 of the Companies Act 2013 ('Act' hereafter) to monitor implementa....
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....ffee Day Global Ltd (CDGL) 65 1,112 2 Tanglin Retail Reality Developments Pvt Ltd(TRRDPL) 789 1,050 3 Tanglin Developments Ltd (TDL) (-) 12 620 4 Giri Vidhyuth (India) Ltd. (GVIL) - 370 5 Coffee Day Hotels and Resorts Pvt Ltd(CDH&RPL) - 155 6 Coffee Day Trading Ltd (CDTL) - 125 7 Coffee Day Econ Pvt Ltd (CDEPL) - 103 Total 842 3,535 12 As per the Financial Statements of MACEL, Rs 3,535 crore was further transferred from MACEL to the personal accounts of VGS, his relatives and entities controlled by him and/or his family members, whose outstanding balances receivable were Rs 3,238.95 crores as on 31-03-2019. On examination of the Financial Statements of MACEL, it transpired that MACEL did not have any business transactions with 6 of the 7 subsidiary companies except CDGL. It was also transpired that MACEL was used as a conduit to transfer funds from subsidiaries companies of CDEL to the personal accounts of VGS, his relatives and entities controlled by him and/or his family members, as loans and advances that were never returned to MACEL/CDEL. 13 The modus operandi of the alleged d....
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....o the EP to appear in a financial statement with which the Statutory Auditor are concerned in a professional capacity. c) Failure to exercise due diligence and being grossly negligent in the conduct of professional duties. d) Failure to obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion, and e) Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances. 17 The Auditor sought 30 days extension of time for submitting response to SCN. Extension of time was allowed for 15 days. After availing the extension of time, the Auditor vide letter dated 18.12.2022 submitted a reply to the SCN. 18 M/s Lavitha & Associates is a proprietary firm registered with the ICAI carrying on the profession of chartered accountancy from Chikkamgaluru city in the state of Karnataka. The Audit Firm was the Statutory Auditor of MACEL for FY 2018-19 and CA Lavitha Shetty was the Engagement Partner for this audit engagement. The Firm was also Statutory Auditor of Coffee Day Hotels & Resorts Private Limi....
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....negative net worth of Rs 223.65 crores. All the above stated borrowings (except bank borrowings of Rs 272.32 crores) and lending were interest free, repayable on demand and not supported by any Contract/ Agreement. The Financial Statements of MACEL indicated that it had abnormally high transactions in loans & advances and balances with related parties, which were outside the normal course of business of the company, strongly indicating that MACEL was being misused by the promoters for diversion of funds from subsidiary companies of CDEL to promoters, their family members and entities controlled by them. 22 The financial statements indicated that majority of the related party borrowings were from subsidiary companies of CDEL (Table 2) and were further diverted to the personal accounts of promoter, their family members and entities controlled by them (Table 3). Table-2 Rs in crores MACEL's borrowings from subsidiary companies of CDEL (Related Parties) Sr No Name of company from funds whom were borrowed Balance as on 31.03.2019 as per FS MACEL Balance reduced fraudulently by issuing cheques without adequate balance in the account Total outstanding as on 31.....
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....ransactions with group companies and it is evident from Table 2 & 3 above that MACEL was used as a conduit to create an intermediate layer with the ulterior motive to mislead stakeholders and regulators, and fraudulently divert funds to the personal accounts of promoters, their relatives and entities controlled by them. 24 As per para 5 of SA 315, the Auditor was required to perform risk assessment procedures to provide a basis for the identification and assessment of Risks of Material Misstatement (RoMM) at the financial statements and assertion levels. As per para 5 of SA 330^5 , the Auditor was required to respond to the assessed RoMM by performing appropriate audit procedures. In light of the fact that such huge borrowings and lendings involving related parties went unnoticed in audit, as there is no evidence in the Audit File that the Auditor had performed such procedures to identify RoMM due to suspected fraudulent diversion of funds, the SCN charged the Auditor with failure to identify and respond to the RoMM in non-compliance with SA 315 & 330. 25 SA 240 prescribes auditor's responsibilities relating to fraud in audit of financial statements. Para 10 of SA 240 pro....
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....lete absence of internal control and violation of the provisions of the Act. The Auditor knew that funds were being diverted to personal accounts of promoters, their relatives and entities controlled by them and that MACEL was being used only to create an intermediate layer with the ulterior motive to mislead stakeholders and regulators while fraudulently diverting funds to personal accounts of promoters, their relatives and entities controlled by them. 28 MACEL, in its Extra-ordinary General Meeting ('EGM' hereafter) held on 13.02.2019, had passed two special resolutions authorizing the Board of Directors to borrow money up to Rs 6,000 crores under section 180(1 )( c) of the Act and to make investment and grant loans up to Rs 6,000 crores under section 186 of the Act. There was no evidence in the Audit File that in compliance with the above EGM resolution, the Board of Directors had approved any resolution for borrowing and making loans & advances, as required under section 179(3) of the Act. There was also no evidence in the Audit File regarding the approval of Members of the company and 6 Para X of Annexure -A (CARO report) of lndependent Auditor report dated 05-06-20....
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....on of recoverability of loans of Rs 3,235.16 crores. 33 As per para 8 of SA 500^11, the Auditor was required to evaluate the competence, capabilities and objectivity of M/s Sundaresha & Associates (management expert) which issued the net worth certificate dated 09.03.2019, obtain an understanding of the work of expert and evaluate the appropriateness of net worth certificate as audit evidence. However, examination of the Audit File shows that no such audit procedures were performed. Even the net worth certificate does not contain all annexures and hence was incomplete. It appears that the Auditor did not exercise due diligence while evaluating the recoverability of these loans. Thus, the Auditor was charged to have violated SA 500 and section 143(3)(e) of the Act as she had reported that Financial Statements comply with the Accounting Standards. Reply of the Auditor 34 While denying the charge, the Auditor has stated that charge of diversion of funds was a misinterpretation drawn in the backdrop of death of VGS and was an ex post facto analysis. According to her, CDEL is a respected group and the Auditor had no reasons to suspect honesty, integrity and ability of the manag....
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....group at that point of time. The Auditor argued that advances in contention were not diversion of funds but were for furtherance of the interest of the CDEL group for which the company itself funded monies through its subsidiaries. The Auditor admitted that "Based on the information gathered by SEBI and NFRA subsequent to the death of Shri VG Sidhartha, there could be merit in the view of NFRA that advances granted by MACEL were not for business objectives. Certainly, it was not possible for the respondent to form any such conclusion at that point of time when respondent did the audit for 2018-19". 37 While not disputing the facts given in Table 2 & 3 regarding related party borrowings and advances made, the Auditor replied that she would not be able to agree or disagree with the narratives used in SCN that funds were diverted to personal accounts of promoter because such findings can emerge only from an investigation and are not capable of being detected within the scope of a Statutory Auditor. 38 While responding to the charge relating to failure to verify whether borrowings & lendings were approved by the Board of Directors in accordance with section 179(3) of the Act, the....
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....e charge relating to failure to evaluate recoverability of loans given to VGS & Others, the Auditor stated that she did not suspect any possible impairment losses from the advance given to VGS and Others, because as per the management, such advances were given for furtherance of business objectives spread in a large number of coffee plantations managed by the company. According to her, the difference in perception is because of events that happened after the audit of MACEL, which influenced the NFRA. She further stated that as per para 11 of AS 4, the case falls under the category of "remote possibility of loss, as per the judgement of the Auditor during the course of the audit. 43 Regarding the net worth certificate of VGS issued by Mis Sundaresha & Associates, the Auditor claimed that she did not feel the need of hundred percent coverage of advances from the net worth of VGS alone, because the funds were deployed in recoverable business assets, according to management explanations. Regarding competence & capabilities of the expert, the Auditor stated that M/s Sundaresha & Associates, being a respected CA firm with long and credible track record in the state of Karnataka, the A....
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....bvious purpose of making such provision is to ensure that no unauthorized borrowings and lending transactions are entered into by the company management. In this case the EGM authorised the Board to take decisions on borrowings and lendings up to a monetary limit. But the Board made no such authorisation, rendering these huge borrowings and lendings as unauthorised. Further, section 179(3) of the Act is independent of section 134(1) of the Act, which inter alia provides that financial statements shall be approved by the Board of Directors. The reply of the Auditor that the approval of financial statements by the Board of Directors of the company is evidence that all the transactions in it have the stamp of approval of the Board of Directors is astonishing and reflects a total lack of understanding of what an 'authorisation of transaction' by the Board means. Such a flawed understanding by the Auditor who is entrusted to check adherence to Standards and the Laws, is alarming and disconcerting. It appears that the Auditor has furnished this absurd reply to cover up her deficiency during performance of this Audit. 46 It is an undisputed fact that all borrowings and lendings....
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.... from the audit procedures performed in previous audits, the auditor shall determine whether changes have occurred since the previous audit that may affect its relevance to the current audit. There is no record of such determination in the Audit File. Further, the Auditor was required to perform risk assessment procedure at the beginning of audit for FY 2018-19 to understand MACEL and to identify possible RoMM in the Financial Statements of FY 2018-19 as required under SA 315, which she failed to do. 49 The Auditor had admitted that she could not identify any Ro MM during the course of the audit and did not assess and respond to any RoMM. This is an admission that she relied on management explanation only. She failed in her duty as she did not perform sufficient and appropriate audit procedure to identify, assess and respond to Ro MM due to fraud. This is tantamount to turning a blind eye to the ruse that lay before her. With reference to the reply that diversion of funds can emerge only from an investigation and is not capable of being detected by a Statutory Auditor, it is relevant to mention that diversion of funds was evident from the Financial Statements and other informati....
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.... non-recoverable portion of these loan/advance. This was essential to ensure that the Financial Statements of MACEL give a true and fair view of its financial position and financial performance. 53 The Auditor obtained a net worth certificate of VGS showing his net worth as Rs 2,485.40 crore issued by M/s Sundaresha & Associates. This net worth certificate has five chapters i.e., Background, Scope of Information, Methodology of Valuation of Assets (Coffee Plantations), Methodology of Valuation of Shares in Companies and Computation of Net Worth. Valuation of coffee plantations was done at fair market value, based on Agriculture and Valuation reports of Mr. P. K. Ramesh, registered valuer in respect of some plantations. Valuation of shares of listed companies i.e., CDEL, Mindtree Limited and SICAL Logistics Limited, was done on market price prevalent on 31.03.2018, valuation of shares of CDGL was done based on valuation report, valuation of shares of M/s Shankar Resources Private Limited was based on market price of its investment and valuation of shares of M/s Devadarshini Info Technologies Private Limited was done according to fair valuation model adopted by this company. 54....
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....f performing audit, which was not done. 59 Furthermore, 'Management expert' is defined in para 5(d) of SA 500 and 6(c) of SA 620 as "An individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements". The Auditor's reply regarding definition of management expert is out of context as providing net worth certificate is neither accounting nor auditing service. It is a kind of valuation service. M/s Sundaresha & Associates, though a CA Firm, issued the net worth certificate as a valuation expert. Valuation certificates were also the basis of the net worth certificates. In the net worth certificate, many of the assets of VGS were valued at fair value, which is specialized area of valuation and not accounting & auditing job. Therefore, the Auditor was duty bound to evaluate competence and capability of M/s Sundaresha & Associates, besides the methodology and assumptions used in calculation of fair value of assets, which she failed to do. 60 From the above analysis, it is clear that the Auditor has not given any importance to this impor....
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....ared on 31.03.2019 and shown in Bank Reconciliation Statements (' BRS' hereafter) as cheques issued but not cleared. Similarly, in March 2019, MACEL received cheques of Rs 324.80 crores from related parties. These cheques were not realised on 31.03.2019 and were shown in BRS as cheques received but not realised. Analysis of cheques issued and received by MACEL in FY 2018-19 but debited and credited in FY 2019-20 indicates structured circular transactions with fraudulent intention of suppressing true balances of borrowings from related parties and presenting a sound financial position. This accounting fraud resulted in understatement of the Related Party Borrowings by Rs. 1,713.74 crores (Rs 2,038.54 crores of cheques issued - Rs 324.80 crores of receipts) and overstatement of Bank Borrowings by Rs 1,713.74 crores in the Balance Sheet. 64 It can be observed from Table 4 that MACEL had a nominal bank balance but issued cheques of Rs 2,038.54 crores. Similarly, cheques for Rs 324.80 crores were received in 2018-19 but were not credited in the Corporation Bank account in the same year. These cheques were used to effect a series of circular transactions in 2019-20 aimed at ev....
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....estion to Those Charged With Governance ('TCWG' hereafter) and Management about these unusual transactions. The Auditor was charged with non performing the audit with required level of professional judgement and professional skepticism. 69 As per section 143(1) of the Act, the Auditor is also required to inquire whether transactions are represented merely by book entries and are prejudicial to the interest of the company. As explained above, accounting entries for Rs 2,038.54 crores were mere book entries without adequate bank balance and/or bank credit limit. The Auditor did not perform any audit procedure and did not report these apparently fictitious accounting entries and thus violated section 143(1) of the Act. 70 Accordingly, the Auditor was charged with non-compliance with SA 200, SA 240, SA 315, section 143(1), 143(12) of the Act and the CARO. Reply of Auditor 71 While denying the charge, the Auditor did not dispute the facts. She replied that uncleared/unrealised cheques on 31-03-2019 were pipeline bank entries and she could not see any wrong intent of the management. Credit balance in bank accounts were properly shown and disclosed in the Financial Sta....
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.... cheques. The Auditor stated that she did not examine the source of funds used for clearing those cheques and for the audit of 2018-19, it was not necessary for her to conduct a detailed examination of cash/fund flow recorded in the books of accounts of 2019-20. 75 While drawing attention to para 13 of SA 240 relating to professional skepticism, the Auditor submitted that she had no reason to believe any wrongful intentions of management (evergreening of loans and circular transactions) while undertaking the audit of2018-19. 76 The Auditor replied that disclosure of Related Party Transactions ('RPT' hereafter) was in compliance with AS 18. She argued that 'credit balance in bank accounts' represented by uncleared cheques, is not the same as bank borrowing. It is just a book balance. According to her, allegation of conversion of related party liabilities into bank liabilities has no merit and there is no material misstatement in the Financial Statements. She argued that she had not found any fraud from these transactions therefore there was no case for reporting u/s 143(12) of the Act. 77 With reference to use of traditional method of cheques payment at year....
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.... party borrowings without having sufficient bank balance and without having any approved credit limits in bank accounts. It is also a fact that MACEL received cheques worth Rs 324.80 crore from related parties and that these cheques were cleared in the next financial year i.e., FY 2019-20 by circulating funds among related parties. MACEL had outstanding loan of Rs 2893.25 crores on 31.03.2019 payable to seven largest related parties, out of which six parties were subsidiary companies of CDEL. On 30/31.03.2019, it had issued cheques of Rs 1,879.17 crores in favour of these companies and brought down the outstanding loan from Rs 2,893.25 crores to Rs 1,014.08 crores. This is depicted in Table-5 hereunder: Note-* Gross amount of cheques issued in FY 2018-19 to TRRDPL was Rs 826 crores, which was cleared in FY 2019-20. MACEL had also received cheques of Rs 140.99 crores from TRRDPL in FY 2018-19, which were realised in FY 2019-20. Therefore, net amount has been shown. 82 These cheques were cleared/realised in FY 2019-20 by evergreening of loans through structured circulation of funds. One example of such circulation of funds for clearance of cheques of Rs 1,175 crores (relating t....
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....019-20. * Bank ale no xxxxxxxxx with Induslnd Bank had a balance of Rs 13,13,699.00 on 31.03.2019. There was no sanctioned bank credit limit for this account. MACEL had issued five cheques of total amount of Rs 25.00 crores on 30.03.2019 to CDGL. On 02.04.2019, it received Rs 32 crores from CDGL through six RTGS transactions, which were then used to clear on the same day, one by one in circular manner, the five cheques issued on 30.03.2019. * Bank ale no xxxxxxxxx with Yes Bank had nil balance on 31.03.2019. There was no sanctioned bank credit limit for this account. On 04.04.2019, MACEL received credit of Rs 30 crores (from related parties including CDGL), thereafter, this fund was used on the same day for clearance of three cheques valuing Rs 65.50 crores issued to CDGL on 30.03.2019. These bank transactions were done one by one in a circular manner by circulating funds between MACEL and CDGL in smaller amounts on the same day. 84 It can be observed from the bank statements, that all the cheques of Rs 2,363.34 crores were cleared in the same fraudulent manner by circulating smaller amount to create transactions of larger amount. There is no doubt that promote....
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....o evaluate this evident evergreening of loans while verifying clearance of cheques issued in 2018-19. It is clear that the Auditor has failed to exercise professional skepticism while verifying bank statements. Therefore, we are of the view that the Auditor's inert passivity in the face of known and visible evergreening of loans & understatement of related party borrowings does not insulate her from her gross failure in the performance of Audit. 88 Para 10 to 15 of SA 700- 'Forming an Opinion and Reporting on Financial Statements', provides that in order to form an audit opinion, the Auditor is required to conclude whether she has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatements whether due to fraud or error. Evergreening of loans through circulation of funds was visible from bank statements, which are claimed to have been verified by the Auditor. However, she failed to consider the same while forming the audit opinion. Accordingly, we find that the Auditor was grossly negligent in making conclusions and forming an audit opm10n. 89 The Auditor's plea that the use of traditional method of issua....
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....ware of this modus of understatement of loans at year end and evergreening of loans in subsequent year but did not consider it a misstatement in the Financial Statements of MACEL. Despite being privy to this accounting fraud, she did not report this to the Central Government and has tried to justify its motive. Such a view of the Auditor implies her acquittal of a ruse and a colourable devise used by the company for fraud. We find that the Auditor failed in discharge of her statutory duty in performance of the statutory audit of MACEL for FY 2018-19. 93 In respect of contention of the Auditor that SAs are not reference material for deciding misconduct of an auditor, we notice that auditor is duty bound to comply with SAs in terms of section 143(9) &143(10) of the Act^14. Further, ICAI in its Implementation Guide on Reporting Standards issued in Nov 2010, had opined in response to question no-12 relating to the Auditor's responsibility paragraph that "A key assertion that is made in this paragraph is that the audit was conducted in accordance with the SAs. SA 200^15 , which in a way is the ''parent standard" on auditing, prohibits the auditor from representing complia....
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....pect of these circular transactions. In view of the above analysis, we find that this charge is proved that the Auditor had violated section 143(1)(b) & 143(12) of the Act, CARO, SA 200, SA 240 and SA 315. C.3 Lapses in audit of inappropriate recognition of finance cost of Rs 55.38 crores 97 The Auditor was charged with failure to perform risk assessment procedure & analytical procedure and failure to exercise professional skepticism in respect of inappropriate recognition of finance cost of Rs 55.38 crores as corresponding borrowings were not used for business activity of MACEL. The Auditor was also charged with violation of section 143(2) & 143(3)(e) of the Act, as finance cost was an extraordinary expense but was shown as ordinary finance cost resulting in violation of Division I of Schedule III of the Act and Accounting Standards 5^16. 98 MACEL has recognized finance cost of Rs 55.38 crores in FY 2018-19, which constituted 90.89% of total expenses of Rs 60.93 crores. Total bank borrowing of the company was Rs 405.64 crores on 01-04-2018 and Rs 272.32 crores on 31.03.2019. Borrowed money was not used for the business activity of the company but diverted to related parties.....
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....d Loss Statement in the manner described above. Examination of the Financial Statements shows that MACEL did not disclose finance cost as extraordinary expense but disclosed it as ordinary finance cost, thus violating Division I of Schedule III of the Act and AS 5. Section 143(3)(e) of the Act requires an auditor to state in the auditor's report whether the Financial Statements comply with the Accounting Standards. It was reported in the Audit report that the Financial Statements comply with the Accounting Standards specified under section 133 of the Act, read with Rule 7 of the Companies (Accounts) Rules, 2014. The Auditor was therefore charged to have violated section 143(2) & 143(3)(e) of the Act. Reply of Auditor 101 While denying the charge, the Auditor has stated that she had no role to play in deciding whether advances granted by the company would earn interest or not. MACEL was required to pay interest on money borrowed whereas in respect of advances made by MACEL, there was no contractual obligation on the borrowing entities to pay interest. Therefore, interest expenses accounted for was not in violation of any law nor was it inconsistent with accounting principl....
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....ny. Further, this has resulted in recognition of loss of Rs 56.89 crores in the Profit & Loss Statement for FY 2018-19. Had the interest been recovered from the related parties, which used these funds, loss of MACEL would have been of a minuscule amount. Similar trend is visible in FY 2017-18. This practice has eroded the entire net worth of the company, bringing it down to a negative Rs 223.65 crores in the Balance Sheet on 31.03.2019. 107 The Auditor has replied that interest expense was incurred and duly accounted for. She could not give any reply as to why such interest expense should be ultimately borne by MACEL, when the borrowed money was not used by MACEL, but lent out to related parties mostly at zero interest. In fact, interest expenses should have been at least recovered from those entities which had ultimately used the funds borrowed by MACEL, which was not done. In that context, we find that interest expense of Rs 55.38 crores has resulted in misstatement in the Profit and Loss Statement of MACEL. 108 Diversion of interest-bearing loan proceeds to promoters/their entity without any interest was a proof of fraudulent intention of promoters to recognize loss in the....
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....ng Activities and understatement of Cash Flow from Financing Activities by Rs 850.90 crores. Further, as per AS 3, Loans and advances made to third parties are to be disclosed as Cash Flow from Investing activity (other than advances and loans made by financial enterprise). MACEL did not consider itself a financial enterprise. However, MACEL has disclosed increase in short term loans & advances made (assets) of Rs 59 .09 crores as Cash Flow from Operating Activity (as negative figure) resulting in understatement of Cash Flow from Operating Activity and overstatement of Cash Flow from Investing activity by Rs 59.09 crores. Reply of Auditor 112 The Auditor has partially admitted the charge relating to wrong presentation of cash flow from short-term borrowing in Cash Flow from Operating Activities. According to her, out of Rs 850.90 crores, Rs 68 crores represented borrowings and deserved to be included under 'Cash Flow from Financing Activities' and remaining amount represented changes to operating assets/liabilities like advances received and advances given, and therefore correctly classified under 'Cash Flow from Operating Activities'. The Auditor further stat....
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....nvesting and financing activities, which are defined as under: a) Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. b) Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. c) Financing activities are activities that result in changes in the size and composition of the owners' capital (including preference share capital in the case of a company) and borrowings of the enterprise. 116 Therefore, the importance of Cash Flow information and its classification are clearly prescribed in AS 3, which were to be complied by MACEL. In her reply, the Auditor has admitted wrong presentation of cash flow from short-term borrowing of Rs 68 crores in 'Cash Flow from Operating Activities' in place of 'Cash Flow from Financing Activities'. Accounting and analysis of Cash Flow is an important aspect of Auditing. The reply of the Auditor asking it to be treated as an inadvertent error in presentation, smacks of her casual approach. 117 For the remaining borrowings of Rs ....
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....r Form and Materiality. There is nothing in AS 1 which allows an entity to treat borrowing/investing transactions as operating transactions. Further, para 17 of AS 1 state, 'The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form'. In this case money given by MACEL to related entities was not for supply of any goods or services to MACEL, therefore keeping in view the substance of transactions in accordance with para 17 of AS 1, such transactions were to be classified as 'Cash Flow from Investing Activities', as defined in AS 3. 121 It is clear the MACEL did not comply with AS 3. Section 129(5) of the Act provides that "Without prejudice to sub-section(1), where the financial statements of a company do not comply with the accounting standards referred to in sub-section (]), the company shall disclose in its financial statements, the deviation from the accounting standards, the reasons for such deviation and the financial effects, if any, arising out of such deviation". MACEL did not disclose noncompliance with AS 3 in its Financial Statements, and thus viola....
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....k. The Auditor did not evaluate whether these were not prejudicial to the interest of the company and she has now contended that there was no such obligation on her to evaluate whether issuance of corporate guarantee and creation of charge was not prejudicial to the interest of MACEL. 127 Section 143(2) of the Act casts reporting obligation on the statutory auditor, which includes, inter alia, to "make a report to the members of the company on the accounts examined by him and on every financial statements which are required by or under this Act to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder or under any order made under sub-section (11) and to the best of his information and knowledge, the said accounts, financial statements give a true and fair view of the state of the company's affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed." 128 We observe that ....
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....aled that she did not determine materiality. She did not perform this basic audit procedure for forming the audit opinion. 133 Misstatements in Financial Statements not only represented substantial proportion of the Financial Statements but also affected all components of the financial statements, and accordingly had a pervasive effect on the Financial Statements in terms of para 5(a) of SA 705, Modifications to the Opinion in the Independent Auditor's Report. These misstatements and the evergreening of loans prove that Financial Statements did not give true and fair view of the state of affairs of MACEL. Further, reporting of fraudulent diversion of funds was fundamental to the understanding of users of the Financial Statements. The Auditor had given unmodified audit opinion and did not consider the misstatements of Rs 11,393.69 crores and evergreening of loans while making audit conclusion and forming the Audit Opinion. Accordingly, the SCN charged the Auditor with violation of SA 320 & SA 700. Reply of Auditor 134 The Auditor has denied the charge and stated that the amounts shown as misstatement in SCN do not meet the criterion of misstatements as defined in para 4....
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....uired/or the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud. When the auditor expresses an opinion on whether the financial statements give a true and fair view or are presented fairly, in all material respects, misstatements also include those adjustments of amounts, classifications, presentation, or disclosures that, in the auditor's judgment, are necessary for the financial statements to give a true and fair view or present fairly, in all material respects". (Emphasis supplied). The term 'Fraud" is defined in SA 240 as "An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage". It has already been proved that entire borrowings & lending transactions were fraudulent with ulterior motive to divert funds to promoters. Misstatements relating to Finance Cost & Cash Flow Statement have also been proved (It is also partially admitted by the Auditor) and misstatement in issuance of corporate guarantee has also been admitted by the Auditor. These misstatements were clearl....
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.... f) Failure to comply with SA 505, External Confirmations g) Failure to comply with Standard on Quality Control and SA 230, Audit Documentation h) Failure to comply with SA 580, Written Representations Reply of Auditor 139 The Auditor has denied her wrongdoings and professional misconduct m all the charges mentioned in the previous paragraph. 140 In respect of auditor's failure to understand the control environment, identify and report absence of adequate effective internal controls and identify potential RoMM due to misuse of bank cheques by a person functioning as de facto management of MACEL, the Auditor has refuted the charges saying NFRA has viewed the principles of SA 315 without considering the limitations associated in assessing efficacy of internal controls and that she had ensured proper authorization of transactions. The issue of cheques by the de facto management was not a matter of absence of internal control but the desire of the majority shareholders. Further, she has asserted that the company did not suffer any losses because of internal financial control issues. 141 In relation to violation of RBI requirements on registration ....
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....by failing to appreciate the criticality and significance of the need for robust internal financial controls in MACEL, an unlisted closely company held by promoters of the listed entity. Further, it is alarming to note that the Auditor turned a blind eye to the accounting jugglery in a company by an individual who was neither a shareholder nor a director nor an employee. The accounting jugglery was to misrepresent financial affairs of the company and involved massive amounts. The Auditor's work relating to testing of controls was very casual, and in fact a charade. 149 The Auditor's judgment regarding the true nature of' Advances' given by MACEL is flawed and lacks maturity. The Advances given by MACEL to entities purported to be suppliers of goods/services were in substance 'loans' or 'financial assets' but camouflaged as non-financial assets to avoid the regulatory requirements of financial services sector regulator viz. RBI. The Auditor's much needed professional skepticism was starkly absent here also, as is the case in many other areas discussed in this Order. 150 Presentation and disclosures in financial statements are as important as....
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....e auditor 'shall' request from appropriate management written representations. Further, the work papers referred to by the Auditor in her reply relate only to the outdated audit work papers on going concern assessment and a letter from an unnamed director clarifying certain queries raised by the Auditor. 156 In view of this analysis, the above charges are proved that the Auditor has violated section 143(2) & 143(3)(i) of the Act, CARO, SQC 1, SA 230, SA 505, SA 570, SA 580 and failed to ensure whether MACEL had complied with section 134(1) of the Act. The charge regarding the auditor's failure to report non-constitution of Audit Committee is dropped in view of the satisfactory reply given by the Auditor. E. Omissions and commissions by the Audit Firm 157 The Audit Firm was charged with various omissions and commissions observed in the audit, as discussed in the preceding paragraphs, for its role as the statutory auditor appointed under section 139 of the Act. 158 The Audit Firm was also charged with failure to comply with para 2 of SA 220 and para 3 of SQC 1, which stipulate that Quality Control Systems, Policies and Procedures are the responsibility of the ....
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....nal capacity". This charge is proved as the Auditor failed to disclose in the Audit Report the material non-compliances the Company made as explained in Section C, and Section D (a, b, c and d) above. ii. The Auditor committed professional misconduct as defined in clause 6 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when she "fails to report a material misstatement known to her to appear in a financial statement with which she is concerned in a professional capacity". This charge is proved as the Auditor failed to disclose in the Audit Report the material misstatements made by the Company as explained in Section C, and Section D (a, b, c and d) above. iii. The Auditor committed professional misconduct as defined in clause 7 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when she "does not exercise due diligence or is grossly negligent in the conduct of her professional duties". This charge is proved as the EP failed to conduct the audit in accordance with the SAs and applicable regulations, failed to report the material misstatements in th....
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....ppropriate audit evidence to support Marcum 's opinion on the Issuer's financial statements". For this misconduct, PCAOB censured Marcum LLP ("Marcum"); imposed a civil money penalty of $250,000 on Marcum; prohibiting Marcum, for a period of three years from the date of this Order, from issuing an audit report for an issuer client with substantially all of its operations in the People's Republic of China; and requiring Marcum to undertake a review of its quality control policies and procedures regarding initial acceptance of, and audits performed for, certain issuer clients. Further, PCAOB censured John E. Klenner, CPA ("Klenner"); barred Klenner from being an associated person of a registered public accounting firm, but allowed Klenner, after two years, to petition the Board for consent to associate with a registered firm; in the event Klenner seeks and the Board grants consent for him to associate with a registered firm, prohibited him from serving as an engagement partner or engagement quality reviewer on issuer audits for a one year period after the Board grants consent for him to associate with a registered firm; imposed a civil money penalty of $25,000; and requir....
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....his one, PCAOB censured Grant Thornton LLP ("Grant Thornton"), imposed on Grant Thornton a civil money penalty in the amount of $1,500,000; and required Grant Thornton to undertake certain remedial actions. 165 In the Matter of Richard H. Huff, Jr., CPA, (partner of Grant Thornton LLP) PCAOB^22 has observed that "Huff also failed to obtain sufficient appropriate evidence in connection with certain specific loan reviews because he (a) repeatedly ignored red flags or contradictory evidence indicating that loans may have been improperly risk rated, impaired, and/or require reserves; (b) repeatedly relied on management representations without obtaining relevant and reliable evidence to corroborate those representations; and (c) failed to identify and evaluate potential control deficiencies". For this violation, PCAOB censured and suspended Engagement Partner from being an associated person of a registered public accounting firm. G. PENALTY & SANCTIONS 166 Section 132( 4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed, is evident from the fact that....
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....t of financial statements or internal audit of the functions and activities of any company or body corporate". 171 This order will become effective after 30 days from the date of issue of this order. Foot Notes ^1 Rule 3 of The NFRA Rules 2018. ^2 See para 11 (b) of SA 315, Identifying and assessing the risk of material misstatement through understanding the entity and its environment. ^3 Para 16 of SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, provides that 'The auditor shall exercise professional judgment in planning and performing an audit of Financial Statements. Para 13 (k) of SA 200 defines Professional Judgement as 'The application of relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement'. Professional skepticism is defined at para 13 (I) of SA 200 as - 'An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due t....
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.... 2002, 'Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering'. 'Proceeds of Crime', as defined at section 2 (u) of PMLA Act, means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence. List of schedule offences in Part A of the schedule under PMLA Act 2002, covers section 420 of Indian Penal Code i.e., 'Cheating and dishonestly inducing delivery of property'. ^9 SA 250, Consideration of Laws and Regulations in an Audit of Financial Statements. ^10 As per footnote 1 to AS 4, "the impairment of financial assets such as impairment of receivables (commonly known as provision for bad and doubtful debts) is governed by this Standard". Loans being financial assets are covered in this standard. Para 5 .1 of AS 4 provides "The accounting treatment of a contingent loss is determined by the expec....
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....cument 2 Table-5 Loans from seven largest Related Parties taken by MACEL Sr Name of company from whom Balance as on Balance funds were borrowed. No 31.03.2019 as reduced Rs in crores Total outstanding as per FS Fraudulently* on 31.03.2019 (1) (2) (3) (4) (5=3+4) 1 Tanglin Retail Realty Development 789.35 685.01* 1,474.36 Pvt Ltd 2 Coffee Day Global Ltd 64.82 222.50 287.32 3 Tanglin Development Ltd -11.68 474.00 462.32 4 Coffee Day Trading Ltd 0 125.00 125.00 5 Coffee Day Hotels & Resorts Pvt Ltd 0 150.00 150.00 6 Giri Vidhyut (India) Ltd 0 50.00 50.00 7 Gonibedu Coffee Estate Pvt Ltd 171.59 172.66 344.25 Total 1,014.08 1,879.17 2,893.25 Document 3 Table-6 (Rs in crores) Transaction Instrument Transaction Date Number particulars Withdrawals Deposits Balance 10-04-2019 CDGL 85.00 85.02 10-04-2019 CDGL 5.00 90.02 10-04-2019 467643 TDL 90.00 0.02 10-04-2019 GVIL 90.00 90.02 10-04-2019 467653 GVIL 50.00 40.02 10-04-201....