TaxTMI 
TaxTMI 
2023 (8) TMI 260
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....apses and Violations D. Articles of Charges of Professional Misconduct E. Penalty and Sanctions A. EXECUTIVE SUMMARY 1. This Order is being passed as a result of investigation by the National Financial Reporting Authority (NFRA) into the professional conduct of CA Harish Kumar T K for his role as the Engagement Partner (EP) in the audit of three branches of Dewan Housing Finance Corporation Limited (DHFL). DHFL, a housing finance company listed on both NSE and BSE and operating through a network of branches, was reportedly involved in financial fraud. NFRA took suo motu notice of the matter and carried out an Audit Quality Review (AQR) of the statutory audit of DHFL for FY 2017-18, conducted by Chaturvedi & Shah (CAS), a Mumbai-based Chartered Accountant Firm. During the review, NFRA noticed that 33 Engagement Partners (EP) or branch auditors had signed the "Independent Branch Auditors' Report" for nearly 250 branches. NFRA investigated these EPs under section 132 (4) of the Companies Act, 2013 (the Act), including K. Varghese & Co. (the Audit Firm), which was the "Statutory Branch Auditor" of 17 branches of DHFL for FY 2017-18, and CA Harish Kumar T K, ....
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....including the Engagement Partners and the Engagement Team that conduct the audit, are bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA), including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed under Section 132 (4) (c) of the Act. 7. Fallowing media reports regarding the alleged siphoning of public money of around t31000 crore and the Enforcement Directorate's reported action in April 2020 on an alleged banking fraud of about Rs.3700 crore by the promoter/ directors of DHFL, NFRA suo-motu initiated an AQR to probe into the role of the Statutory Auditors of DHFL for the FY 2017-18, the year in which the alleged fraud was primarily stated to have occurred. While examining the Audit Files^1 of the statutory audit carried out by CAS, a Mumbai-based CA firm, certain prima facie violations were observed relating to the appointment of Branch Auditors and the conduct of branch audits of DHFL which were relied upon by CAS. Accordingly, NFRA suo motu called for the audit files from EPs who had signed th....
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....023 but was granted an extension of time following a request vide e-mail dated 04.01.2023. The EP submitted the reply on 04.02.2023. A "Supplementary Audit File" was also submitted by EP along with the reply to the SCN wherein some additional documents (including the Previous Year's Trial Balance for FY 2016- 17 for branches at Kottayam, Thrissur and Coimbatore; Audit Scope and Plan 2013-14; Cash Verification; and Loan Verification Sheets, etc.) were submitted. The EP did not avail of the offer of a personal hearing. The various charges levied in the SCN and the response of the EP to the charges are discussed in Part C of this Order. C. MAJOR LAPSES AND VIOLATIONS BY THE EP 12. The major lapses for which the EP was issued the SCN primarily relate to (i) accepting the audit engagement issued without a valid authority and thus violating the provisions of the Act and (ii) violations of the Standard of Auditing in conducting the audit. I. Acceptance of audit engagement without valid authorization and without complying with ethical requirements; and issuing an audit report in violation of the Act 13. The EP was charged with acceptance of an audit engagement with....
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....altogether. The words "appointed as such" only meant "appointable". b. "If the intent of the law was to ensure appointment of branch auditor as per the provisions of Section 139, then there would have been no exemption for auditors for foreign branches either . ... The Form ADT 1 prescribed under Rule 4(2) of Company (Audit and Auditors) Rules 2014, to be filed by a company on appointment of auditors, does not envisage appointment of branch auditors. If the intent of the law was to appoint branch auditors under Section 139, then there would have been provisions in ADT 1 for reporting to the government on appointment of auditors". c. " ... appointment of a branch auditor would depend on the decision of the company auditor. For this reason the tenure of appointment would depend on the inability of the company auditor to do audits of branches on his own......... In view of the above stated multiple reasons embedded in the legal provisions, appointment of branch auditors can only be an administrative matter between the company's auditor and the Board of Directors." d. "A branch auditor is not a company's auditor. Appointment of auditor dealt within Se....
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....at the branch auditor must meet the requirements of the qualification for an auditor under the Act and must be appointed to the role of auditor under Section 139 of the Act. The use of "as such" clarifies that the auditor must be appointed specifically as an auditor of the company and that their qualifications for appointment must meet the requirements set out in the Act. There is no room for any other interpretation or to examine the intention of the law when the plain meaning of the law is sufficiently clear and not contradicting any other parts of the Act. It is also pertinent to refer to A Ramaiya's Guide to The Companies Act, 19th Edition, wherein it is explained that "considering under the Act, the auditor of a company is appointed by shareholders, it follows that the above mentioned^2 position would continue and thus the decision whether a branch should be audited by the company's auditor or by any other auditor has to be taken by the shareholders in a general meeting". b. The EP's contention that Form ADT 1, to be filed by the Company on the appointment of statutory auditors, does not cover the appointment of branch auditor and hence the law "does not e....
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....rd Annual General Meeting of DHFL - held on 21-07-2017 read with the declaration of Voting Results of the resolution to ratify such appointment only refers to the appointment of CAS (Firm Registration No: 101720W) as the Statutory Auditors of the Company to audit the accounts of all the Company's offices including those of its zonal/ regional and branch offices for the financial year 2017-18. No other branch Statutory Auditors were appointed or ratified by the Company in the said meeting. Only CAS was appointed as the Statutory Auditor for the company as well as all its branches. Thus, the shareholders of the company approved only one Statutory Auditor (viz. Chaturvedi & Sah) for the Company and its branches. Therefore, in absence of any valid appointment, EP' s acceptance of the appointment as Statutory Auditor of the branches shows the absence of due diligence. f. Despite the invalid appointment letter issued by DHFL addressing the Audit Firm, the acceptance letter dated 12.09.2017 issued by the Audit Firm and the "Independent Branch Auditor's Report" issued by the EP for the three branches of DHFL, including the report required under CARO 2006 described the ....
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....in the branch audit as well, being an audit of historical financial information. Accordingly, the various violations of the SAs with which the EP was charged in the SCN are discussed in the following paragraphs. Non-Compliance with SA 210 "Agreeing the Terms of Audit Engagements" 19. The EP was charged with non-compliance with SA 210^4 and displaying an absence of professional scepticism and professional judgment in documenting the objective and scope of the audit, thereby violating SA 200^5 as well. SA 210^6 stipulates that the auditor shall agree to the terms of the audit engagement with management or Those Charged With Governance (TCWG) and that subject to paragraph 11 of the SA, the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable forms of a written agreement and shall include (a) the objective and scope of the audit of the financial statements; (b) the responsibilities of the auditor; ( c) the responsibilities of management; ( d) identification of the applicable financial reporting framework for the preparation of the financial statements; and ( e) reference to the expected form and content of any reports to be issued....
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.... i.e., Section 143(8) of the Act, which is not the case. The EP cannot take shelter behind SA 600^8 , the purpose of which is to establish standards to be applied when a 'principal auditor' uses the work of another auditor. SA 600 is not a law or regulation that prescribes in sufficient detail the terms of the branch audit engagement. Hence, the contention that the details mentioned in para 10 of SA 210 are not required to be included in the engagement letter is baseless and not acceptable. 23. The EP accepted the appointment letter issued by DHFL and issued the audit report without complying with the requirements of SA 210. Between 2015-16 and 2016-17, there was a significant change in the circumstances relating to the branch audit. In 2015-16 the AGM decided to have a separate branch auditor and company's auditor, while in subsequent years there was only one auditor (CAS) to audit the Company and all its branches. This calls for the application of para 13 of SA 210 as well. EP's negligence of the provisions of SA 210 resulted not only in accepting an illegal appointment and non-compliance with SA 210 but also in the absence of professional skepticism and profes....
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....SQC I; and enabling the conduct of external inspections in accordance with applicable* legal, regulatory or other requirements" among the additional purposes that are served by the audit documentation. Para 7 of SA 230 emphasises the "Timely Preparation of Audit Documentation" i.e. in a manner contemporaneous with the events that are being sought to be documented. b. Apart from SA 230, there are other SAs also that require the documentation of events, data, evidence, opinions and conclusions. SA 230 makes it very clear that reliance can be placed only on the audit file as evidence of what was done. Para AS of SA 230 is explicit: "Oral explanations by the auditor, on their own, do not represent adequate support for the work auditor performed or conclusions the auditor reached, but may be used to explain or clarify information contained in the audit documentation". Para 14 mandates that the auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor's report. c. SA 230 requires that the auditor shall prepare audit documentation that is s....
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....in an audit needs to be completed before signing the audit report. Any changes permitted thereafter are either administrative or exceptional. The EP has not followed these mandatory requirements in maintaining the audit documentation. Any evidence added to the audit file in violation of the standards and after the prescribed archival period is not acceptable. The inevitable conclusion, in this case, is that the EP did not maintain the audit documentation in accordance with the SAs and SQC 1. 9 Standard on Quality Control (SQC) 1, Quality Control for Finns that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements. 27. The EP also contended that since it "was not required to audit the financial statements of the branch office of DHFL, there was no straight jacket application of the provisions of SA 230 ", which permitted the EP to adapt the standard as necessary in the circumstances when applied to audits of other historical financial information rather than financial statements. We find that while adaptations of SAs are permitted in certain cases, they should not be taken as a reason for deviating from the fundamenta....
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....gnorance of the EP. b. Summary of the accounting policies, observations from previous audits, inspection reports, and internal audit reports (refer to SA 315); c. Proof of verification of trial balance items, including assets (substantive audit procedures); d. Procedures adopted to verify the loans sanctioned during the year and classification of loans as per regulatory norms (substantive audit procedures); and e. KYC verification, anti-money laundering verification, and security verification (substantive audit procedures). 30. The lack of sufficient documentation in an audit is not a mere technical and procedural fom1ality but is a serious issue which strikes at the very root of the audit and may defeat the very purpose of the audit itself. Lack of sufficient documentation has been viewed seriously by national and international regulators as well. For example, in the matter of Bharat Parikh & Associates Chartered Accountants, dated 19-03-2019, the US audit regulator PCAOB took a serious view on the lack of sufficient documentation and imposed penalties and sanctions for violations including insufficient documentation. The PCAOB Order states "....
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....charges and stated that "According to Rule 12 (1) of Company (Audit and Auditors) Rules 2014 .... for the audit of the branches of a company, the responsibility of auditor as provided in Section 143(1)- 143(4) are on the company's auditor and not on the branch auditor .... It was an not an audit report of the company, nor was an audit report on the financial statements, and therefore was not falling within the scope of SA 700 ". 34. The contentions of the EP, we find, are a flawed interpretation of the law. Para 2 of SA 200^12 makes it clear that the SAs are written in the context of an audit of financial statements by an auditor. They are to be adapted as necessary in the circumstances when applied to audits of other historical financial information. Branch auditors appointed under section 143(8) read with Section 139 of the Act are statutorily required to comply with the SAs since section 143(9) requires "every auditor" to comply with the SAs. The interpretation of Rule 12 (1) of Company (Audit and Auditors) Rules 2014 by the EP that ''for the audit of the branches of a company, the responsibility of auditor as provided in Section 143(1)-143(4) are on the company&#....
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....edgers) of such nonaccounting of entry would be Rs.1.15 crores. Other such observations were also noted by the EP in the same document. The same working paper goes on to say that "The unadjusted misstatements, including disclosure misstatements, are immaterial, based on the materiality level". However, we note that without a determination of materiality thresholds in the audit file, there is no basis for ruling out the identified misstatements as immaterial. The above instances also indicate control deficiency which EP did not evaluate. In his reply to the SCN, the EP stated that " ... Since the loan was not appearing in the Trial Balance of the Branch, non accounting of the closure of loan would not have resulted in any misstatement of the Branch Trial Balance ... the accounting effect if any for the loan account transaction of Rs 1.15 crores would only have a misstatement effect in the Trial balance of the HO alone because the loan accounts and bank account were in the Trial Balance of the HO. Test of materiality was to be applied at the HO Level ... in the Trial Balance attested by the Respondent it was not a case of unadjusted misstatement ... to give correct treatment in the F....
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.... as per SA 230". The replies are not acceptable since SA 300 requires the auditor to include in the audit plan the timing^14 of the audit and to update and change the overall audit strategy and the audit plan as necessary during the course of the audit^15 The audit plan made in 2013-14 has not been updated to meet the requirements of the audit in 17-18. The EP's contentions that since the audit fee is low, the "Audit plan and strategy in such cases are not required to be complex that necessitate detailed documentation" and the audit plan is not required since the scope of work is "well defined" have no basis in the SAs and show the EP's absolute disregard to the quality of audit. Moreover, the audit plan now submitted by the EP was not forming part of the Audit File for 2017-18. Such contentions of the EP are against the fundamentals of SA 230 that require the maintenance of an Audit File that can enable an experienced auditor having no connection with the audit to understand the nature, timing and extent of the audit procedures performed to comply with the SAs. To evidence compliance with the requirements of the SAs, it is the fundamental stipulation of SA 23 0 that the au....
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....amounts as the audit progress. The audit documentation in the present case did not contain any of these details and hence the replies of the EP are not acceptable. d. Non-compliance with para 5, 6, 8, 14 & 15 of SA 450^19 in the absence of the evaluation of identified misstatements and uncorrected misstatements. The EP submits that there were no instances of identified misstatements and material misstatements and hence SA 450 is not applicable. The reply of the EP is not acceptable in the absence of any documentation or conclusions in the audit file in this regard. e. Non-compliance with para 6 & 9 of SA 500^20 in not designing and performing audit procedures to obtain sufficient appropriate audit evidence and not evaluating the reliability of information produced by the company. The EP replied that "it is a matter of judgment for the auditor to design the audit procedure to obtain audit evidences" and stated that SA 500 has complied. The replies are not accepted since there is no evidence in the Audit File of designing and performing audit procedures, such as an audit plan, the substantive procedures performed and the conclusions drawn. f. Non-compliance....
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....e following failures on the part of EP CA Harish Kumar TK, as contained under the Articles of Charges in the SCN, are established: a) Failure to ascertain from the audited Company whether the requirements of Sections 139 of the Act in respect of such appointment had been duly complied with, as explained and proved in part Cl above (As per Section 22 and Clause 9 of Part I of the First Schedule to the CAs Act): b) Failure to exercise due diligence and being grossly negligent in the conduct of professional duties, because of the lapses and omissions as explained and proved in parts Cl and C2 above (As per Section 22 and Clause 7 of part I of the Second Schedule to the CAs Act); c) Failure to obtain sufficient information which is necessary for the expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion, because of the lapses and omissions as explained and proved in part C2 above, (As per Section 22 and Clause 8 of part I of the Second Schedule to the CAs Act); and d) Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances of....
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....the deterrence, proportionality, and signalling value of these sanctions. 45. As demonstrated by the discussions above, there are gaps in EP' s understanding of SAs that need to be addressed. To enhance CA Harish Kumar T K's skills as an auditor capable of carrying out the audit of public interest entities, CA Harish Kumar T K would benefit from further training in the area of SAs, Therefore, we recommend that CA Harish Kumar T K to undertake relevant training on SAs to improve proficiency in this area. By doing so, CA Harish Kumar T K will be better equipped to provide high-quality audit services. 46. Considering the fact that professional misconducts have been proved and considering the nature of violations and principles of proportionality and keeping in mind the deterrence, proportionality, signalling value of the sanctions and time required for improvement in knowledge gaps we, in the exercise of powers under Section 132(4)(c) of the Companies Act, 2013, proceed to order the following sanctions: i. Imposition of a monetary penalty of Rs.100,000 (One Lakh) upon CA Harish Kumar T K; ii. CA Harish Kumar T K is debarred for one year from being appoi....