TaxTMI 
TaxTMI 
2023 (10) TMI 1122
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....ip no: 435804 for the FYs 2017-18 to 2019-20 (both are collectively called as 'Auditors' hereafter). 2. This Order is divided into the following sections: A. Executive Summary B. Introduction & Background C. Lapses in the audit D. Lapses by the Audit Firm E. Articles of Charges of Professional Misconduct by the Auditors F. Additional Articles of Charges of Professional Misconduct specific to the Audit Finn G. Penalty & Sanctions A. EXECUTIVE SUMMARY 3. The National Financial Reporting Authority ('NFRA' hereafter) initiated investigation into the professional conduct of statutory auditors of Lexus Granito India Limited, Morbi, Gujarat, for the FYs 2017-18 to 2019-20 under Section 132(4) of the Companies Act 2013 ('Act' hereafter). This was pursuant to information received from the Securities and Exchange Board of India ('SEBI' hereafter) dated 06.08.2021 about its investigation into the accounting irregularities of the company. Based on further investigation and proceedings under S. 132 (4) of the Act, submissions of the Auditors and preliminary examination of the Financial Statem....
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....for the audit of related party transactions of the company. Approximately 44% of the Initial Public Offer ('IPO' hereafter) proceeds were paid to one of its related parties, however, no sufficient appropriate documentation of audit procedures for verification of utilisation of IPO proceeds was found in the Audit File, except for a list of payments out of IPO proceeds. 10. The Audit Firm, having been appointed as the statutory auditor for the LGIL failed, in addition to being responsible for the lapses of the audit team, in its responsibility to ensure a proper quality environment for the audit and ensure that its personnel complied with professional standards and regulatory and legal requirements, and that the reports issued by the firm or engagement partners were appropriate in the circumstances. 11. Based on investigation and proceedings under section 132(4) of the Companies Act, 2013 and after giving them opportunity to present their case, we found the Audit Firm and its Engagement Partner, guilty of professional misconduct and impose through this order the following monetary penalties and sanctions that will take effect after 30 days from the date of this Order: ....
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....Act after receipt of a letter dated 06.08.2021 from SEBI pointing out discrepancies in the financial statements of LGIL due to improper writing-back of liabilities and reliance of the Auditors on management for valuation of inventory and utilisation of IPO proceeds. 16. Vide NFRA letter dated 04.02.2022, the Audit Files and other Documents were called from the Auditors, who submitted these on 07.03.2022. NFRA also sent a questionnaire dated 01.09.2022, which was responded to by the Auditors on 01.10.2022. 17. On examination of the Audit Files, it was observed that the audit had prima facie been conducted in disregard of most of the SAS and relevant requirements of the Act. Despite this, the EP had issued an unmodified audit opinion in the Independent Auditor's Report on behalf of the Firm stating that "....financial statements... give a true and fair view in conformity with the accounting principles generally accepted in India... ". 18. On being satisfied that a sufficient cause existed to take action under sub-section (4) of section 132 of the Act, an SCN was issued to the Firm and to the EP on 07.12.2022, asking them to show cause why action should not be taken again....
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....ng and ordinary course of business operation etc. c) Liabilities of Rs 1 66 crores under Capital goods were written back on account of defects and poor operational efficiency of the machines etc. d) Liabilities of Rs 1.61 crores under Excess amount/ Advance received were written back on account of non-claiming by the customers / lenders etc. Had these amounts not been written-back to P&L, LGIL would have had significantly lower profits or higher losses, as summarised below: (Amount in Crores) Particular 2017-18 2018-19 2019-20 No. of write-back transactions 60 143 49 Written-back amount (considered as Gain) 2.31 5.89 3.15 Reported Profit before Tax (PBT) 10.91 0.52 -1.11 PBT without considering the written-back amount 8.59 -5.37 -4,26 Overstatement of profit / Understatement of loss (% of reported PBT) 21.16% 1123.89% 283.88% The Auditors were charged with non-application of any audit procedures to test the appropriateness of the accounting for these transactions in conformity with the applicable Financial Reporting Framework ('FRF' hereafter). 22. The Auditors stated....
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....itors carrying any audit test to confirm such assumptions on the basis of which the liabilities were written back. The Auditors did not show any professional skepticism to question the management for such accounting treatment, which was in contravention of the requirement of AS 29 and the Framework 2000, and which led to the FS for the FYs 2017-18 to 2019-20 being materially misstated. Such misstatement^5 had to be identified by the Auditors, who had to ensure^6 that the financials of the company were prepared in accordance with the applicable FRF and if not, the Auditors had to duly consider modifying their audit opinion. 24. The Auditors in their written replies dated 30.01.2023, stated that they were restrained by the management from obtaining third-party confirmation "stating counter party may aware (sic) about the liability or may use auditor confirmation as proof of liability in the books of company" The Auditors stated that they applied alternative audit procedures to assess (he risk implication for determining whether management response was reasonable. This attitude of the Auditors is totally unprofessional. It is expected that the Auditors would show a high level of....
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....ting policies and valuation of inventories as per Para 1 1 (c) of SA 315 ^11 and not performing physical verification of inventory as per SA 501^12. 27. Para 5 of AS 2 'Valuation of Inventories' requires an entity to value its inventories at lower of Cost or Net Realisable Value (NRV). Para 26 requires disclosure of the Accounting Policies and Cost Formulae adopted in the measurement of inventory. However, LGIL disclosed that raw material and Work in Progress (WIP) were valued at Cost for the FYs 2017-18 to 2019-20, whereas finished goods were valued at estimated market price in the FYs 2018-19 and 2019-20, and the cost formula used in the valuation of inventory was not disclosed. 28. Para 4 and 7 of SA 501 require the auditor to obtain sufficient appropriate audit evidence regarding existence and condition of inventory by attending the physical count and performing audit procedure to determine actual inventory count, and if it is not practicable to attend physical count of inventory, then auditor shall modify the opinion in accordance with SA 705. 29. The Auditors stated that Measurement and Disclosures for inventory is the responsibility of management and that th....
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....inventory of finished goods at estimated market price, the accounting policy for valuation of inventory was not in conformity with AS 2. Such accounting treatment led to overvaluation of the inventory and overstatement of profit. LGIL also failed to disclose the accounting formula used in the valuation of inventory. Inventory constituted more than half of the current assets and therefore was a material component. We do not find any audit evidence in support of the claim of the Auditors that they had checked whether valuation of the inventory was lower of the cost or NRV and therefore we hold the Auditors responsible for failure to disclose the misstatement resulting from such accounting treatment. Merely reporting of the improper accounting of finished goods through KAM was not appropriate or adequate, as discussed in Para 42 & 43 of this Order. 31. The contention or the Auditors that mere absence of any documents from the audit file did not indicate that they had violated the provisions of SA 315, is not correct. Para S of SA 230^14 states that the objective of the auditor is to prepare documentation that provides sufficient and appropriate record of the basis for the auditor&#....
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....s has the burden of justifying the opinion expressed. Moreover, in such circumstances, tests of the accounting records alone will not be sufficient for [the auditor] to become satisfied as to quantities; it will always be necessary for the auditor to make, or observe, some physical counts of the inventory and apply appropriate tests of intervening transactions". Inappropriate reporting of matters through KAM 35. The Auditors were charged with reporting of the matters through KAM without obtaining sufficient appropriate audit evidence about the matters mentioned in KAM, and without making prior communication with the TCWG in the FYs 2018-19 and 2019-20. The SCN also alleged that there was difference in reporting of KAM in the Auditor's report (FY 2018-19) as documented in the audit file and as available with NSE, as detailed below: Sr. No. KAMs as per the Report available with NSE KAMs as per the Report documented in the audit file 1 Default in payment to lenders Default in payment to lenders 2 Unilateral extinguishment of trade payables Written-off of Trade payables 3 Evaluation of uncertain tax positions Valuation of inventories 4 ....
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....o the company also shows ignorance of SA 720 and its eventual non-compliance. Forming inappropriate Audit Opinion 40 The Auditors were charged with issuing of unmodified opinion despite the presence of below mentioned material misstatements, in the FS for the FYs 2017-18 to 2019-20. Identified misstatement Reporting requirement Unilateral extinguishment of trade Payables The accounting treatment was not in accordance with AS framework and therefore attracted para 6(a) read with A3 of SA 705 requiring the Auditors to issue modified opinion. Non-compliance with AS 2 for valuation of finished goods Since valuation of the finished goods was not in accordance with AS 2, para 6(a) read with A3 of SA 705 required the Auditors to issue modified opinion. 41. As per their reply dated 30.01.2023, the Auditors stated that "in case of valuation of inventory, we accept that reporting should not 'made in Key Audit Matters but report should he modified." However, in case of writing back of liabilities, the Auditors justified inclusion in the KAM stating that such writing-back was in accordance of regular practice of the LGIL and since LGIL will not be paying these li....
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....lete list of payments, containing names of the parties; purpose of the payments; amounts paid; date of such payments; and verified the same with the bank account to minimize the risk to an acceptable level. Thereafter they had verified the transactions by reviewing the ledgers along with bills and invoices. LGIL had made payments of approx. 9.30 crores (44.29% of the IPO proceeds) to one of its related parties viz, M/S. Kartik Industries for supply of coal, therefore they had applied additional audit procedures to check this transaction viz., approval of Audit Committee minutes, assessment of whether the transaction was at market rates or whether it involved granting of any undue benefits. As they did not find anything contrary after applying all these audit procedures, they did not resort to external confirmation. The Auditors stated that "So mere asking and verifying from the receiver whether you receive the payment or not, we think this does not make any importance as with the detailed checking, we were in opinion that there is no material misstatement". 46. The audit procedures mentioned by the Auditors in their reply to the SCN is not evidenced from the Audit File. Mere obt....
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.... business and on arm's length basis. From the audit files, we note that the Auditors failed to do so and were charged with non-compliance of the provisions of SA 550. 49. The Auditors replied that the resolution of the Audit Committee had been obtained by them and the ET had discussed all audit matters including RPT. They had also obtained list of related parties over mail, kept the ledger accounts of the same in the digital form, and compared the RPT with the previous year, and checked its being on arm's length prices. They stated that the major documents of the audit were kept in the digital form rather than in the audit file for better accessibility, due to which NFRA could not verify the same. 50. SA 550^18 deals with auditor's responsibilities in respect of related parties. There are specific accounting and disclosure requirements for related party relationships, transactions and balances to enable users of the financial statements to understand their nature and actual or potential effects on the FS (Para 3). The auditors have the responsibility to perform audit procedures to understand, identify, assess and respond 10 the risks of material misstatement arisi....
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.... ascertained. Therefore, we are unable to attach any importance to the submissions made by the Auditors as sufficient appropriate audit evidence and conclude that the Auditors failed to perform audit of RPT in accordance with SA 550. 52. Auditor's failure to obtain sufficient appropriate audit evidence in respect of RPTs has been viewed seriously by the International Regulators as well. For example, PCAOB^19, in the matter of Cheryl L. Gore, CPA and Stanley R. Langston, CPA (Respondents), barred the respondents from being associated with a registered public accounting firm and imposed monetary penalty of $30,000 collectively for their failure inter alia to obtain sufficient appropriate audit evidence with respect to related party transactions. In another case, PCAOB^20, in the matter of Yichien Yeh, CPA (Firm) and Yichien Yeh (Respondent), revoked the firm's registration and barred the respondents from being associated with a registered public accounting firm and imposed monetary penalty of $10,000 collectively for their failure inter alia to obtain sufficient appropriate audit evidence with respect to related party transactions. Non-implementation of Quality Contr....
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....stablished. 58. Failure to appoint an EQCR has been viewed seriously by International Regulators as well. For example, PCAOB^22 in the matter of Robert C. Duncan Accountancy Corp. (Firm) and Robert C. Duncan, CPA (Respondent), revoked the firm registration and barred the respondent from being associated with a registered public accounting firm and imposed monetary penalty of $30,000 for their failure to obtain an engagement quality control review and issuance of Audit report without EQCR. D. LAPSES BY THE AUDIT FIRM 59. In addition to the lapses in the audit performed by the Auditors, discussed in the forgoing paragraphs of this Order, the Audit Firm was specifically charged with failure to establish and maintain a system of quality control within the Firm and to fulfil its duties prescribed under section 143 of Companies Act and SQC l. The powers and duties of the statutory auditors have been prescribed u/s 143 of the Act. The duties include making their report to the members of the company after taking into account the provisions of the Act, the accounting and auditing standards (subsection 2); stating in report and expressing opinion on matters listed in subsection 3; s....
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....n grossly negligent in performing the audit of LGIL, by placing blind reliance on the assertions of the management in accounting of unilateral extinguishment of liabilities, valuation of inventory, verification of the utilisation of IPO proceeds and RPTs etc. The contention that they are a small audit firm, cannot be accepted as auditors are duty bound to comply with the requirements of the statutes to safeguard the interest of public. Therefore, in addition to the EP, we hold the Audit Firm also responsible for the lapses discussed in the preceding paragraphs. 63. Failure to establish an effective quality control policy by the audit firm has been viewed seriously by international regulators as well. For example, PCAOB^23, in the matter of Deloitte LLP, censured the firm and imposed penalty of $ 350,000 on the Firm for its failure to establish, implement, and communicate appropriate quality control policies and procedures to provide the Finn with reasonable assurance that the work performed by engagement personnel complied with applicable professional standards, regulatory requirements, and the Firm 's standards of quality. In another case, PCAOB^24, in the matter of K G ....
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....the Company as explained in para 21 to 34 above. iii. The Auditors committed professional misconduct as defined by clause 7 of Part I of the Second Schedule of the CA Act, which states that an auditor is guilty of professional misconduct when they "does nor exercise due diligence or is grossly negligent in the conduct of his professional duties". This charge is proved as the Auditors failed to conduct the audit in accordance with the SAS and applicable regulations in many critical areas of the audit and failed to report non-compliances made by the Company, as explained in para 21 to 58 above. iv. The Auditors committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that an auditor is guilty of professional misconduct when they "fails 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". This charge is proved as the Auditors failed to modify the report in respect of material misstatements in the financial statements arising from unilateral extinguishment of liabilities to overstate the profits o....
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.... fact that a minimum punishment is laid down by the law as below: (A) imposing penalty of- (I) not less than one lakh rupees, but which may extend to five times of the fees received, in case of individuals; and (Il) not less than ten lakh rupees, but which may extend to ten times of the fees received, in case of firms; and (B) debarring the member or the firm being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate; or (Il) performing any valuation as provided under section 247 of the Act, for a minimum period of six months or such higher period not exceeding ten years as may be determined by the National Financial Reporting Authority. 69. The Auditors in the present case placed blind reliance on the assertions of the management relating to accounting of unilateral extinguishment of liabilities, valuation of inventory, verification of the utilisation of IPO proceeds and RPTs, instead of discharging their statutory duty to protect public interest by exercising professional skepticism and questioning the management's decision....