TaxTMI 
TaxTMI 
2024 (12) TMI 166
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....ections: A. Executive Summary B. Introduction & Background C. Lapses in the Audit D. Articles of Charges of Professional Misconduct by the EP E. Penalty & Sanctions A. Executive Summary 3. National Financial Reporting Authority (NFRA) is India's independent regulator, in respect of matters relating to accounting and auditing, of prescribed classes Rule 3 of NFRA Rules, 2018 of entities broadly described as 'Public Interest Entities' (PIEs). 4. NFRA initiated action under section 132 (4) of Companies Act 2013 ('CA-2013' or 'Act' hereafter) against the Auditor of Sanwaria Consumer Limited for professional or other misconduct in relation to statutory audit for FY 2017-18, pursuant to information received from Securities and Exchange Board of India (SEBI) pertaining to the financial irregularities in the company and the failure of the auditor to qualify or emphasize in his independent audit report, any matter related to misstatement/ irregularities in the transactions. 5. M/s Khandelwal Kakani & Co. was the statutory auditor of SCL and CA Santosh Deshmukh was the Engagement Partner (EP) for this statut....
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....sessment procedures in order to obtain sufficient audit evidence so as to minimise the risk of material misstatement due to fraud or otherwise in the revenue recognition (C.4). f. The EP was grossly negligent in preparing sufficient audit documentation in accordance with the requirements of SA 230(C.7). g. The EP failed to communicate deficiencies in internal control to Those Charged with Governance (TCWG) (C.8). 9. Based on the proceedings under Section 132 (4) of the Companies Act and after giving the EP opportunities to present his case, we find the EP guilty of professional misconduct. Accordingly, this Order imposes upon CA Santosh Deshmukh a monetary penalty of 5,00,000/- (Rupees Five Lakhs) and also debars CA Santosh Deshmukh for 1 (One) year 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 10. The National Financial Reporting Authority is a statutory authority set up under section 132 of the Companies Act 2013 to monitor implementation and enforce compliance of the a....
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....ancial statement in a professional capacity. b. Failure to report a material misstatement known to him to appear in a financial statement with which a CA is 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. e. Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances. 15. Vide his reply dated 23.05.2024 to the SCN, the EP requested for being heard in person. Vide NFRA email dated 04.06.2024, the EP was granted an opportunity of being heard on 13.06.2024. As no confirmation was received from the EP with respect to attending the personal hearing, vide email dated 11.06.2024, the EP was granted another opportunity of being heard on 25.06.2024. The EP vide email dated 21.06.2024 requested for a further extension of 15 days stating that he found the emails from NFRA in the junk folder of his email and therefore co....
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....ted Items and SA 705 SA 705: Modifications to the Opinion in the Independent. Auditor's Report. 18. As on 31.03.2018, the total inventories of the SCL amounted to 524.90 crores. The breakup of these inventories is as follows: TABLE 1 S. No Item Rs. in crore 1 Raw Material 328.03 2 Work in Progress 2.73 3 Finished Goods 151.46 4 Stores and Spares 3.87 5 Packing Materials 3.09 6 Stock in Trade 35.70 19. Of the total inventories as on 31.03.2018, raw material (62.49%) and finished goods (28.85%) formed the largest part of the total inventories. The raw material mainly consists of Soya Seed (Rs.191.06 crores) and Paddy (133.97 crores) and the finished goods mainly consist of Soya DOC (Rs.38.22 crores) and Basmati Rice (Rs.117.21 crores). The details are as follows: TABLE 2 S. No Item Quantity in MT Rate per MT in Rs. Rs. in crore 1 Soya Seed 44956 42500 191.06 2 Paddy 33494 40000 133.97 3 Soya DOC 10921 35000 38.22 4 Basmati Rice 14652 80000 117.21 20. On examination of the Financial Statements of SCL and the Audit File for the FY ....
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.... keeping raw material available for processing throughout the year... In case of paddy, paddy qualifies that substantial period of time definition based on the fact that according to the Company, the paddy is seasoned for a year by the company to acquire the required aroma after procurement. The SCL generally sales basmati rice only after seasoning of one year thus making it certain to be qualifying assets as it is ready to be used only after one year of procurement...... SCL was following this practice consistently since last many years, the net impact on current year (2017-18) financial after removing impact of overvaluation of opening inventory on account of interest works out to be Rs. 4.21 crore. This amount is below the materiality level. Therefore, applying our professional judgement we had not qualified the same. Further, in the personal hearing held on 05.07.2024, the EP while reiterating the above statement, also quoted and submitted the accounting policy of another such company to justify the inclusion of borrowing cost in the valuation of rice. 23. In reference to obtaining sufficient appropriate audit evidence regarding the existence and c....
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....ualifying asset, an asset should "necessarily" take "sub- stantial period of time" to get ready for its intended use or sale. This is not stated or clarified in the SCL's accounting policy. The inventory policy of SCL states that "Raw material, stores and spares are valued at lower of cost (on FIFO basis) or net realisable value, whichever is lower". There is no mention about the inclusion of borrowing cost for valuation of inventories in the said policy. There is no evidence in the Audit File to show if the EP had verified/concluded that the Paddy and Soya seeds are qualifying assets based on established criteria. There is nothing in the Audit File to support the claim made by the EP about his understanding of the client business, its production process and ageing of its inventory, the process of procurement of raw materials etc. or any efforts on the part of EP to obtain any report of technical expert that substantiates the claim of the EP. In fact, the MRL given by management of SCL states that "Rice" (not the paddy) is time aged to get better price in the market and therefore, the conten- tion of the EP that paddy is seasoned by SCL is not acceptable. iii. The subm....
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.... ii. The contention of the EP that the ET had witnessed the physical verification process for 48.69% of total inventory is a good sample size to arrive at audit satisfaction is flawed and shows his poor understanding of the SAs. Para 7 of SA 530 Audit Sampling states that the auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level. Para 8 of SA 530 states that the auditor shall select items for the sample in such a way that each sampling unit in the population has a chance of selection. In the extant case, there is no sufficient evidence in the Audit File about the basis of selection of the sample of inventories. Further, the auditor's selection of sample is biased as it completely neglected all the inventories other than Soya Seed and Soya Doc. The EP failed to exercise professional skepticism in planning and performance of the audit of inventories and sidelined the possibility that the figures related to inventories may be materially misstated. In fact, the EP did not check and verify the stock statements and their reconciliation submitted to the bank by SCL as an alternative audit procedure. 25. In the light of above, we....
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....e to verify the ownership and valuation and evaluate the impairment testing of the investments made by SCL in its loss-making subsidiary and associate companies resulting in failure to comply with Section 143(3)(e) of the Companies Act 2013, SA 700 and SA 705. 28. As on 31.03.2018, SCL had investments of 36.29 crores. These investments include investment in the unquoted shares of its subsidiary, Sanwaria Energy Limited (SEL) (* 31.17 crores) and its associate Shreenathji Solvex Limited (SSL) (4.76 crores). The company valued these investments in unquoted shares at cost and had been holding these investments in the last three financial years at the same value. 29. Sanwaria Energy Limited incurred a loss of 58 lakhs in the FY 2017-18. Shreenathji Solvex Limited incurred a loss of 83 lakhs in the FY 2017-18, had accumulated loss of * 32.97 crores and had negative net worth (-15.97 crores) as on 31.03.018. As a result, the recoverable value of investment in the associate was reduced to ....0. 30. Para 8 of Ind AS-36 "Impairment of Assets" provides that an asset is impaired when its carrying amount exceeds its recoverable amount. Paragraphs 12 to 14 of Ind AS-36 detail indicati....
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....d the impairment testing of the investments as per Ind AS- 36 and reported this noncompliance. iii. Further, we find no evidence in the Audit File to show that the EP examined this noncompliance with Ind AS-36 from the point of view of reporting a "Misstatement" as per Para 13(i) of SA 200 and took this into account for expressing the audit opinion in accordance with SA 705. iv. In the personal hearing held on 05.07.2024, the EP submitted a copy of the sale deed dated 12.09.2008 in respect of the land owned by SSL and also purported working of the valuation of the land. Apart from not being a part of the Audit File, the copy of the sale deed dated 12.09.2008 in itself is a not a sufficient and appropriate evidence to establish the ownership of the land as it is not backed by some other evidence like a copy of land record with ownership details as on 31.03.2018 in the name of SSL. Therefore, we find the EP lacking in due diligence on this count. v. The EP's argument that Para 16 of SA 230 gives him the right to submit additional documents not documented in the audit file submitted to NFRA is flawed and not acceptable as the said Para 16 read with Para ....
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....s and other events in similar circumstances. Section 129 (3) of the Companies Act 2013 states that where a company has one or more subsidiaries, it shall, in addition to Financial Statements, prepare a Consolidated Financial Statement of the company. Para 16 of Ind AS-28 states that an entity with joint control of, or significant influence over, an investee shall account for its investment in an associate or a joint venture using the equity method. 39. However, SCL neither prepared the Consolidated Financial Statements in accordance with the requirement of Ind AS-110 nor accounted for the investment in associate company as per the requirements of Ind AS-28. 40. In his written reply, the EP submitted that "We were verbally promised by the management on the date of signing of standalone financials that the company will get consolidated financials signed by us once financial of the subsidiary and associates are ready to sign. The financials of the subsidiary company were signed by M/s Dubey Gupta and associates on 05/09/2018 Which was a date quite later than the date of signing of standalone financials of SCL. At the time of signing standalone financial statement, consolidated f....
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....f their annual financial statement. 42. In light of above, we, conclude that the EP was grossly negligent in performing evaluation and reporting the non-compliance of Ind AS-110 and Ind AS-28 by SCL and also failed to comply with the requirements of Section 143(3) (e) of the Companies Act 2013, SA 700 and SA 705. C.4 Lapses relating to audit of Revenue 43. The EP was charged with failure to perform adequate audit procedures to address the risk of misstatement due to fraud or otherwise in the revenue recognition in accordance with the requirements of SA 200, SA 240 and SA 315 and in obtaining sufficient appropriate audit evidence for verification of Revenue. 44. As per Para 15 of SA 200 (SA 200): Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, the auditors are required to plan and perform an audit with professional skepticism and Para 11 & 12 of SA 315 (SA 315): Identifying and Assessing the Risk of Material Misstatement through understanding the entity and its environment require the auditor to understand the entity, its environment and internal controls. Further, Para 25 of both the SA 240 (SA 240) The....
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....d obtained the knowledge of entity along with its operating environment through entity's previous financial statements and other available information and gave reference to some audit working papers. He further submitted that they have also performed control testing on various aspects of internal control system and gave reference to some audit working papers. Also, the audit team, he stated, had performed audit procedure like performance of verification of Sales Invoice along with supporting document and reconciliation of revenue with the GST and VAT Returns. 49. We find that for the following reasons, the reply and explanation given by the EP are an afterthought and therefore not acceptable: i. There is nothing in the Audit File to support the claim made by the EP about his under- standing of the business of SCL, its production process, process of procurement of raw materials etc, even though it was the first year of his audit assignment. ii. The control testing document, as referred by the EP, is merely a checklist of internal controls related to the revenue, without any details of the audit procedure performed. iii. There is no sufficient eviden....
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.... sufficient evidence in the Audit File to show that that the auditor verified the Statement of D'Mat account, contract notes with the bank statement of SCL. 50. In the light of above, we, conclude that the EP was grossly negligent in performing audit procedures to verify the Revenue of SCL. As revenue forms a critical component of the financial statements of any entity, the failure of the EP to adequately test the controls and perform due audit procedures in respect of revenue has rendered the audit perfunctory. Accordingly, we find the EP having failed to comply with SA 200, SA 240 and SA 315 and in obtaining sufficient appropriate audit evidence for verification of Revenue. 51. Negligence in performing audit procedures to verify the critical item like Revenue has been viewed seriously by international regulators too. For example, PCAOB in its order dated 08.02.2012 PCAOB Release No. 105-2012-001, in the matter in the Matter of Ernst & Young LLP, Jeffrey S. Anderson, CPA, Ronald Butler, Jr., CPA, Thomas A. Christie, CPA, and Robert H. Thibault, CPA,, censured Ernst & Young LLP, barred Jeffrey S. Anderson, CPA and Robert H. Thibault from being associated with a registered....
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....statement of trade receivables submitted to banks to rule out the chances of any material misstatement in the financial statements due to fraud or error. Further, no working paper is found in the Audit File indicating that the EP had obtained and verified any justifiable explanation for slow realization of the trade receivables, nor were there any documents relating to pursuance of realization of trade receivables as per the credit policy of the company. 56. Responding to the charges in the SCN, the EP in his written reply stated that "the audit team has exercised professional skepticism while performing the audit. This can be viewed from working papers such as "fraud risk document", confirmations that were sought from trade receivables and around 40% of receivables were confirmed by the Audit. Ledger scrutiny was also performed for major trade receivables"... "We have reviewed the audited financial statement of last 4 years and noted that there are no bad debts and have not made any provision bad debts. The same also confirmed by the management and stated in the point 48 of MRL appended below. Therefore, there is not credit loss in trade receivable...." 57. With respect to t....
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.... in normal course of business, shows absence of professional skepticism and blind acceptance of what was stated by the management. While such a representation letter serves as a formal acknowledgment of the management's responsibilities with regard to debtors, it does not relieve the EP of his responsibility for performing audit procedures to obtain sufficient appropriate audit evidence which forms the basis for the expression of audit opinion on the financial information. 61. In view of the fact that 100% of the trade receivables of SCL were unsecured and no provisioning for doubtful debts was done with respect to them, ageing analysis of the trade receivable, analysis of the credit terms of the company, significantly overdue debts, debts whose collection is barred by statute of limitation etc. was critical in the audit of trade receivables. However, no sufficient evidence of such working is found in the Audit File. In the absence of performance of such critical audit procedure, there is no audit assurance about the possibility of diversion of funds and the trade receivables being inflated. 62. The contention of the EP that he did not verify the statement of trade receiv....
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....cordance with the requirements of the provisions of SA 700. 66. Para 10 to 14 of SA 700 requires that the auditor shall form an opinion on whether the Financial Statements are prepared in accordance with the requirements of the applicable financial reporting framework. While forming an opinion on the financial statements, the auditor shall obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement by obtaining sufficient appropriate audit evidence. 67. In the extant case, as explained in the foregoing paragraphs, instances of material misstatements have been enumerated for which the EP failed to obtain sufficient appropriate audit evidence, but he certified that the Financial Statements of SCL for the FY 2017-18 (except for liability towards employees gratuity on estimated basis) were reflecting True and Fair view. Further, as enumerated, SCL lacked adequate internal financial controls over financial reporting, for example non consolidation of the Financial Statements in FY 2017-18 and non-evaluation of the impairment requirement with respect to the investments. Despite this, the EP in his Report on the Internal Financial....
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.... during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions. 73. Para 9 of SA 230 states that in documenting the nature, timing and extent of audit procedures performed, the auditor shall record (a) The identifying characteristics of the specific items or matters tested; (b) Who performed the audit work and the date such work was completed; and (c) Who reviewed the audit work performed and the date and extent of such review. 74. In his written reply, the EP denied the charges and submitted that the audit working papers were duly documented and referred to various paras of his reply to the SCN. 75. Our analysis of the EP's reply and other related material shows that: i. The Audit File lacked many significant and critical working papers such as: a. Documents related to audit of inventory viz., consolidated working of the inventory category wise and plant wise etc. b. Documents related to determination and communication with TCWG, Minutes of the meetings amongst the members of Engagement Team (ET) with management and TCWG. c. Working papers related to verification of the ....
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....orming conclusions. Where this detail has not been documented, our presumption is that the work has not been performed. We have used this approach for several years and it is consistent with the approach applied globally by other audit regulators and in most firm internal quality review programs Refer Page 7 of ASIC Audit Inspection Report - Report 743 October 202226 SA 260: Communication with Those Charged with Governance. (Emphasis supplied) 79. In the matter of Bharat Parikh & Associates Chartered Accountants, dated 19.03.2019, the US audit regulator PCAOB took a serious view of the lack of sufficient documentation and imposed penalties and sanctions for violations including insufficient documentation. The PCAOB order states that "....Audit documentation must contain sufficient information to enable an experienced auditor, having no previous connection with the engagement to: (a) understand the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, and (b) determine who performed the work and the date such work was completed as well as the person who reviewed the work and the date of such review..... the documentation for ....
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.... 260 and SA 265. There is no sufficient evidence in form of minutes of the meeting held between the EP and the TCWG. The MRL issued by the management cannot be said as an evidence of the meetings and of the determination, communication with TCWG. Further, there is no sufficient evidence that the EP raised significant audit issues like the impairment requirement of the investments of SCL, the issue of non-consolidation of the financial statements to the TCWG. 85. In the light of above, we conclude that the EP has failed to exercise due diligence and was grossly negligent in not identifying and communicating with TCWG, overview of planned scope, timing of the audit and deficiencies in Internal Control etc. Consequently, the EP failed to comply with the requirements of SA 260 and SA 265. 86. Failure to appropriately communicate with Audit Committee (which is a part of the TCWG) has been viewed seriously by international regulators too. For example, PCAOB, the US audit regulator, charged the public accounting firm L.L. Bradford & Company, LLC (Audit Firm) for its failure to communicate with the audit committee during the audit of WebXU Inc.'s ("WebXU"). It stated that the "Fi....
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.... 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 obtain sufficient and appropriate audit evidence to draw conclusions about the existence and valuation of the inventory, failed to perform his duty of evaluation and reporting the non-compliance of Ind AS-110 and Ind AS-28 related to consolidation of financial statements of SCL, failed to fulfil his duty related to the audit of investments as explained in paras 17 to 42 above. ii. The EP committed professional misconduct as defined by Section 132 (4) of the Companies Act, read with Section 22 and clause 6 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that an auditor 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 obtain sufficient and appropriate audit evidence to draw conclusions about the ....
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....ed as per SAs as explained in paras 17 to 90 above. E. Penalty and Sanctions 93. Independent Auditors of Publicly Listed Companies are expected to demonstrate sufficiency and appropriateness of audit work in every aspect of the critical building blocks of an audit of Financial Statements of a PIE. Failure of the auditor to meet the requirements envisaged under the Law and Professional Standards on Auditing are conspicuous in this audit engagement performed by the EP. 94. As is set out in this Order, the manner in which the audit was conducted, failed to meet the requirements of the SAs, the Act and the Code of Ethics in a number of significant aspects which demonstrated gross negligence on the part of the EP. This can be gauged from the failure of the EP to critically assess the existence and valuation of inventories, failure to comment in the audit report about the non-consolidation of financial statements, failure to verify the impairment testing of the investments of SCL and failing to apply the mandatory SAs in the audit. We therefore conclude that the EP's failure to comply with the provisions of SAs, exhibit professional skepticism, and fulfill the necessary audi....