TaxTMI 
TaxTMI 
2024 (3) TMI 27
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....16-17. 2. This Order is divided into the following sections: A. Executive Summary B. Introduction & Background C. Lapses in the conduct ofaudit D. Article of Charges of Professional Misconduct by the EP E. Penalty & Sanctions A. EXECUTIVE SUMMARY 3. The National Financial Reporting Authority ('NFRA' hereafter) initiated action under section 132 (4) of Companies Act 2013 ('Act' hereafter) against CA Ratan Laxminarayan Rathi, the Engagement Partner, for professional or other misconduct in the statutory audit of Bilcare Limited for the FYs 2014-15, 2015-16 and 2016-17. This was following to the information received from Securities Exchange Board of India ('SEBI' hereafter), that the Financial Statements ('FS' hereafter) of Bilcare for the FYs 2014-15, 2015-16 and 2016-17, did not present a true and fair view as the company did not recognise the full interest cost on its Borrowings from banks, which were classified as Non-Performing Assets ('NPA' hereafter) by those banks. As Bilcare was listed on Bombay Stock Exchange ('BSE' hereafter) and therefore falls under NFRA domain[Vide Rul....
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....GROUND 9. The NFRA is a statutory authority set up u/s 132 of the Companies Act 2013 to monitor and enforce compliance of the auditing and accounting standards and to oversee the quality of service of the professions associated with ensuring compliance with such standards. NFRA is empowered u/s 132 (4) of the Act to investigate prescribed classes of companies and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 10. The statutory auditors, both individuals and firms of Chartered Accountants, are appointed by the members of company u/s 139 of the Act. The statutory auditors, 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, including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed u/s 132 (4) (c) of the Act. 11. NFRA took up investigation under section 132(4) of the Act after receipt of a letter dated 16.06.2022 from SEBI about understatement of losses....
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....ce, 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 any material departure from the generally accepted procedures of audit applicable to the circumstances. 14. The reply to the SCN was submitted by the EP on 04.08.2023. The EP also availed the opportunity of a personal hearing on 08.12.2023. During the personal hearing, the EP stated that he had submitted the complete replies and nothing had to be added. However, he requested to take a lenient view considering his age, illness and retirement from the profession. He further requested to compound the offence, if proven. 15. We have perused all the material on record including the written responses of the EP in response to the charges levelled against him. Our findings are discussed in the following paragraphs. C. LAPSES IN THE CONDUCT OF AUDIT Non-recognition of interest cost on Bank Borrowings classified as NPAs 16. The EP was charged with failure to evaluate the appropr....
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....rest cost on the borrowings classified as NPA. 17. The EP replied that the banks had stopped charging interest on NPA accounts due to RBI norms and discussions for restructuring of NPA accounts were positive and there were indications that part of the interest component could be waived. Accordingly, the management decided to consider average rate of 10% (then Banking Lending Rate) for recognising interest cost to reflect true & fair view. Therefore, this accounting policy was sufficient compliance of AS 1 read with AS 29. The EP quoted various clauses of AS 1, 4, 5, 29 and Framework 2000, to establish that the management can deviate from the Fundamental Accounting Policies and can make its own accounting policies, provisions and estimates of the liabilities by disclosing it in the FS to reflect true and fair view. The EP added that, in the extant case, there was no present obligation on the company, as the company was under discussions with the banks regarding waiver of liability and decided to recognise the interest cost@ 10% against the legally agreed interest rates of 10.75% to 18% with the Banks, while the balance interest cost was disclosed as contingent liability. The EP a....
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....ipulates that liability is a present obligation arising from past events, and the settlement of which results in outflow of resources (Para 10.2). Further, as per Para 61 of Framework for the preparation and presentation of Financial Statements, 2000 (Framework, 2000), present obligation may be settled in a number of ways, for example, by: a) payment of cash; b) transfer of other assets; c) provision of services; d) replacement of that obligation with another obligation; or e) conversion of the obligation to equity. An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights." c) As per Para 10.4 (b) of AS 29, A contingent liability is a present obligation that arises from past events but is not recognised because: i. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or ii. A reliable estimate of the amount of the obligation cannot be made. In the Ind AS framework, interest cost is to be dealt with the following provisions - Ind AS 109 'Financial Instruments', which in....
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....r the borrowers, these amounts are liabilities. The applicable accounting provisions are meant to ensure that the assets are not overstated and liabilities are not understated. Using such arguments not only shows the ignorance of the EP but also a wishful thinking which is un-becoming of a professional. 21. The contention of the EP regarding availability of room for deviation for the management in adoption of accounting policies is not acceptable, as such deviation can only be done within the provisions of the Framework. The contention of the EP that as per the management representation, it was in negotiation with the lending banks for restructuring of the loans, and therefore could not measure the liability, is not acceptable, as the company was required to measure the full liability until new terms of loans had been formally agreed with. We do not find any working of the EP regarding accounting of new liabilities in replacement of the restructured borrowings, in accordance with para 3.3.2 of Ind AS 109 in the financial year 2016-17 and as of Ind AS Transition Date of 1st April 2015. We note that the EP was aware of the material amount of Rs 114.32 crores of unrecognised financ....
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....315, and stated that the auditor cannot be expected to disregard past experience of honesty and integrity of the management. Considering the smallness of the entity and being the auditor for the past 29 years, he argued that para 11, 12 & 25 of SA 315; and para 25 & 26 of SA 240 were not applicable. He also took the support of paras Al44 to Al46 of SA 315, as below: "A144. For entities that have uncomplicated businesses and processes relevant to financial reporting, the documentation may be simple in form and relatively brief(It is not necessary to document the entirety of the auditor's understanding of the entity and matters related to it. A145. The extent of documentation may also reflect the experience and capabilities of the members of the audit engagement team. A146. For recurring audits, certain documentation may be called forward, updated as necessary to reflect changes in the entity's business or processes." The EP also submitted that in addition to the statutory audit, other audits were also conducted by the different auditors viz. Internal Audit, Cost Audit, Secretarial Audit and periodical audits by the department of Sales tax, Excis....
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....ist in Yes / No format, which does not establish obtaining of sufficient appropriate audit evidence by the EP. The contention of the EP that Bilcare was a small entity and he was its statutory auditor for the past 29 years, and his argument for the need to document the understanding of the entity in relatively brief and simple form in case of Bilcare is not acceptable, as we do not find any audit documentation in this regard. We also note that para A144 of SA 315 referred to by the EP, also requires that the documentation should include the key elements of the understanding obtained by the auditor, including those on which the auditor based the assessment of risk of material misstatement. Such documentation was not done by the EP. The EP's long association with the company and his experience of honesty and integrity of the management cannot relieve him of the duty of exercising professional skepticism, as Para A22 of SA 200 states that nevertheless, a belief that management and those charged with governance are honest and have integrity does not relieve the auditor of the need to maintain professional skepticism or allow the auditor to be satisfied with less-than persuasive aud....
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....tions. As part of the audit procedures, the EP was required to confirm whether the approval for related party transactions had been accorded by the Audit Committee/ Board of directors/ Shareholders as per sections 177, 185, 186 and 188 of the Act and whether these transactions were in the ordinary course of business and on arm's length basis, which the EP failed to do. 30. The EP, in his reply, has referred to the net (and not the gross) amount of transactions with the related parties and stated that being approx. 7% of revenue, it was not material. The EP further added that since the Approvals and Resolutions of the audit committee were not shared with the EP, but it was duly verified; that there was also no adverse remark in the Secretarial Audit Report and the board of the directors had given a declaration in the annual report that RPTs were in the ordinary course of business and at arm's length basis, therefore not against the interest of the company. 31. SA 550 deals with auditor's responsibilities in respect of related parties. There are specific accounting and disclosure requirements for related party relationships, transaction....
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....s length basis, are tantamount to his acceptance of this charge. Considering the above, the charge regarding failure of the EP in performance of the required audit procedures for verification of RPTs is established. 33. Non-evaluation of related party transactions has been viewed seriously by International Regulators as well. For example, the PCAOB, the US Regulator[PCAOB Release No. 105-2017-038], censured and imposed monetary penalty of$ 30,000 collectively on the firm and respondents in the Matter of Seale and Beers CPAs, LLC, and Charlie B. Roy, CPA, for their failure inter alia to obtain, or ensure that the engagement team obtained, sufficient appropriate audit evidence for significant items reported in the financial statements, including related party transactions and expenses. Inappropriate Opinion on the Financial Statement for the FYs 2014-15 to 2016-17 34. The EP was charged for not obtaining sufficient appropriate audit evidence, as per Para 11 of SA 700, to form an opinion that the Financial Statements as a whole were free from material misstatements and reflect a true & fair view. The EP was charged with issuing unmodified opinion on the FS for the FYs 2014....
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....dering qualitative aspects such as entity's accounting practices and indicators of possible bias in the management's judgements in accounting practices (Para 11 and 12). Para 16 specifically states that the auditor shall express unmodified opinion only when the auditor concludes that financial statements are prepared in accordance with the applicable FRF. As the FS were not in conformity with the requirements of applicable financial reporting framework viz. AS / Ind AS framework due to partial recognition/ non-recognition of interest cost on borrowings classified as NPA and there was failure on the part of the EP in obtaining sufficient appropriate audit evidence for the verification of revenue and RPTs, the EP could not issue unmodified opinion. The understanding of the EP is also misplaced in respect of Para 18 of SA 700 referred to by him in his reply. This para states that "if the financial statements prepared in accordance with the requirements of a fair presentation framework do not achieve fair presentation, the auditor shall discuss... ". Since the FS were not prepared in accordance with the AS/ Ind AS framework, therefore, para 18 is not relevant to the EP's....
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....d AS framework for the company, which should be considered as appointment of EQCR because independent expert work was done by them. 42. The replies of the EP show lack of his understanding about the provisions of SAs and SQC 1, as the appointment of EQCR is a mandatory requirement for the audit of listed entities and every audit firm is required to ensure the compliance of the same. For smaller firms, para 72 of SQC states that "Suitably qualified external persons may be contracted where sole practitioners or small firms identify engagements requiring engagement quality control reviews. Alternatively, some sole practitioners or small firms may wish to use other firms to facilitate engagement quality control reviews... This provision is made to provide an alternative to the smaller firms to comply with the mandatory requirements of SQC 1 and SA 220, and not to provide any exemption. Accordingly, the contention of the EP that provisions of EQCR is discretionary, cannot be accepted. Further, the contention of the EP to consider the appointment of KPMG as EQCR is also misplaced, as KPMG was engaged in the FY 2016-17 for the transition work of AS framework to Ind AS framework and not....
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....sted out in the SCN, are stated below: (a) The EP committed professional misconduct as defined by clause 5 of Part I of the Second Schedule of the CA Act, which states that a CA is guilty of professional misconduct when he "fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where he is concerned with that financial statement in a professional capacity". This charge is proved as the EP failed to disclose in his report the material non-compliances by the company as explained in Para 16-22 above. (b) The EP committed professional misconduct as defined by clause 6 of Part I of the Second Schedule of the CA Act, which states that a CA is guilty of professional misconduct when he "fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity". This charge is proved as the EP failed to disclose in his report the material non-compliances by the company as explained in Para 16-22 above. (c) The EP committed professional misconduct as defined by clause 7....
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....roved. The seriousness with which proven cases of professional misconduct are to be viewed, is evident from the fact that a minimum punishment is laid down by the Jaw. 51. The EP in the present case was required to ensure compliance with SAs to achieve the necessary audit quality and lend credibility to Financial Statements. As we have explained in this Order, deficiency in the conduct of Audit, abdication of responsibility and inappropriate conclusions on the part of CA Ratan Laxminarayan Rathi establish his professional misconduct. 52. Section 132(4)(c) of the Companies Act 2013 provides that National Financial Reporting Authority shall, where professional or other misconduct is proved, have the power to make order for- (A) imposing penalty of-(]) not less than one lakh rupees, but which may extend to five times of the fees received, in case of individuals; and (II) not less than five lakh rupees, but which may extend to ten times of the fees received, in case of firms. (B) debarring the member or the firm from-{!) being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the function....