TaxTMI 
TaxTMI 
2023 (10) TMI 1122
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....19-20 (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 Statements ('FS' hereafter) and the Audit Files, NFRA found the Auditors prima facie guilty ....
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....#39;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: i Imposition of a monetary penalty of Rupees Ten Lakhs upon the Audit Firm M/S Ashok Holani & Co., the appointe....
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....riting-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 against them for Professional Misconduct in the Statutory Audit of LGIL for the FYs 2017-18 to 2019-20. The Auditors were charged with professional ....
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.... 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 that the extinguishment of the liabilities was made by the company commensurate to their trade practices, and the outstanding amounts were written-back after stopping of business dealings with the suppliers or due to trade related matters. The Auditors added that . ..these we....
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.... FS for the FYs 2017-18 to 2019-20 being materially misstated. Such misstatement5 had to be identified by the Auditors, who had to ensure6 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 professional skepticism and be alert to the possibility of mis-statement if restrained by the management from obtaining external confirmations, which is an essential component of independent audit. The Auditors should not only have re-assessed the risks posed by this restraint on their audit and performed alternative audit proced....
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....cies 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 they had applied due audit procedures to verify and evaluate the process of valuation of raw materials, WIP and finished goods and opined that the raw materials and WIP had been valued at lower of cost or NRV. They stated that their team had audited the stock valuation working sheet for the valuation of raw materials and also checked the bills of the l....
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.... 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 23014 states that the objective of the auditor is to prepare documentation that provides sufficient and appropriate record of the basis for the auditor's report; and evidence that the audit was planned and performed in accordance with SAS and applicable legal and regulatory requirements. Further, Para 14 of SA 230 requires the auditors to assemble all the audit documentation in the audit file within 60 days from the date of the auditor's report. The Auditors had averred in their affidavit dated 05.03.202....
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....opriate 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 Recoverability of Indirect tax receivables 36. The Auditors replied that they had discussed their key findings (valuation of finished goods at market price, non-payments to the banking institutions on timely basis, delay in payments of statutory dues and write back of significant payable amounts etc.) with TCWG, had applied additional audit measures to mitigate the risk arising due to these....
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....ccordance 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 liabilities in future, carrying in the books will lead to overstatement of liabilities. 42. Para 6 of SA 705 prescribes the following situations where modification to the Auditor's opinion is required: a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or (Ref: Para. A2-A7) b) The auditor is unable to obtain sufficient appropriate ....
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.... 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 obtaining a certified copy from the management regarding utilisation of the IPO proceeds, does not relieve the Auditors from the responsibility of performing the required audit procedures. There is no evidence in the Audit File that the auditors had performed risk analysis of potential misstatements before the issuance of IPO (over statement of revenue / assets or understatement of expenses / liabilities to present rosy picture to the investors) and after realiz....
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.... 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 55018 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 arising from the entity's related pally relationships and transactions, as fraud may easily be committed through related parties (Para 5). There is emphasis on the susceptibility to fraud risk requiring documentation of discussion among the Engagement Team ('ET' hereafter) addressing such risk (Para 1 2) and requirement of enquiry with the management regarding the identification of related parties, including changes from the prior period; nature of the relationsh....
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.... 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, PCAOB20, 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 Control Measures 53. The Auditors were charged with (i) failure to document the compliance with the independence requirements as per Para Il of SA 22021, which requires an EP to form a conclusion on compliance with the independence requirements and (ii) violating Para 19(a) of SA 220 which requires an EP to determine the appointment of EQCR for the statutory audit of a listed company, and (iii) failure to document his conclusions on compliance with the independence requirements and con....
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.... 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; stating the reasons, if any of the matters required to be included in the audit report under this section is answered in the negative or with a qualification (subsection 4); complying with the auditing standards (subsection 9); and reporting to the Central Government matters which he believes involve the offence of fraud (subsection 12). Para 2 of SA 220 and Para 3 of SQC 1 stipulate that Quality Control Systems, Policies and Procedures are the responsibility of the Audit Finn that has an obligation ....
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....ussed 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, PCAOB23, 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, PCAOB24, in the matter of K G Somani & Co. LLP (the Firm) and Anuj Somani, censured the firm and Anuj Somani, and imposed penalty collectively of $ 175,000 for its failure inter alia to perform all necessary audit procedures, and its violations of PCAOB standards concerning the performance, supervision, documentation of the audit, and quality control standards. E. ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT BY THE AUDITORS 64. As discussed in the foregoing paragraphs, the Auditors have made a series of serious non-compliances of the Standards on Auditing and....
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....ompany, 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 or to understate the losses and failed to obtain SAAE in respect of critical areas such as RPTs, Inventory as required by the SAS and applicable regulations, as explained in the para 21 to 58 above. v. The Auditors committed professional misconduct defined by clause 9 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 invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances". This charge is proved since the Auditors fa....
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....n 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 decisions for material misstatements in the Financial Statements. The Auditors abdicated their specific responsibility provided in the SAS of physical verification of inventory. They failed to perform the required audit procedures with due professional skepticism and report the material misstatement. The Firm, M/S Ashok Holani & Co. has also failed to exercise appropriate control and monitoring of the work of the EP and the ET during the audit engagement and has abdicated its responsibility to ensure audit quality as per professional standards. Under the circumstances, we proceed to impose sanctions, keeping....