TaxTMI 
TaxTMI 
2024 (12) TMI 226
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....und C. Major Lapses and Violations D. Findings on the Articles of Charges of Professional Misconduct E. Penalties and Sanctions A. EXECUTIVE SUMMARY 1) Reliance Commercial Finance Limited (RCFL) is a Non-Banking Finance Company (NBFC) listed on both the Bombay Stock Exchange and the National Stock Exchange. Price Waterhouse & Co Chartered Accountants LLP (PW) was initially appointed as the auditor of RCFL for FY 2018-19. The Director General of Corporate Affairs (DGCoA), Ministry of Corporate Affairs (MCA), Government of India, vide its letter dated 29.05.2020 informed the National Financial Reporting Authority (NFRA) that PW had filed a report to MCA under section 143(12) Under section 143(12) of Companies Act, 2013 auditor is required to report any fraud identified in the company of the Companies Act, 2013 (the Act) on 03.06.2019. PW then resigned from the audit on 11.06.2019, without issuing an audit report for FY 2018- 19. M/s Shridhar & Associates were appointed by the board of directors of RCFL on 28.06.2019 as statutory auditor of RCFL to fill the casual vacancy caused by the resignation of PW. M/s Shridhar & Associates issued its unmodified ....
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....n the financial statement (reporting of suspected fraud by the previous auditor) called for a modification of opinion. The audit report gives a clear impression to the users that the auditor fully agrees with and reiterates the inappropriate disclosure by the Company. The auditors also endorsed the company's legal interpretation that there was no fraud and based on that dismissed any suspicions of fraud even while the matter was pending with MCA. (Details in section C.2 of this Order). c) The auditors did not obtain sufficient appropriate evidence to conclude and report that there was no material uncertainty regarding the going concern status of RCFL. (Details in section C.3 of this Order). d) The auditors did not perform the audit procedures to ensure the reasonability of the Expected Credit Loss provision of Rs. 537 crore on loans of Rs.12,224 crore. (Details in section C.4 of this Order). e) Despite being aware of the report of suspected fraud by the previous auditor, the EP stated in the audit report that there were no matters falling under section 143(12). Therefore, the audit report to the members was misleading. The Auditors also failed to a....
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.... the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA) and the Code of Ethics, the violation of which constitutes professional misconduct. NFRA has the powers of a civil court and is empowered under Section 132(4) of the Act to investigate the prescribed classes of companies and impose penalties for professional or other misconduct of the individual members or firms of chartered accountants. 8) RCFL was required to prepare its Financial Statements for FY 2018-19 under Schedule III and other applicable provisions of the Act and Indian Accounting Standards (Ind AS) notified under the Companies (Accounting Standards) Rules, 2006. 9) Following the information from DGCOA, as described in the executive summary of this Order, we suo motu decided to examine the audit evidence that led the Audit Firm to issue an unmodified audit opinion. We called for the Audit File Vide NFRA letter dated 24.11.2021 and other information from the Audit Firm on 24.11.2021. After two extensions, the Audit Firm submitted the Audit File and other documents electronically through File Transfer Protocol (FTP) on 07.03.2022. From the Audit File, it w....
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....g this Order. C. MAJOR LAPSES AND VIOLATIONS 12) The major basis for charges in the SCN included client acceptance without complying with requirements of the law, failure to examine significant matters reported by previous auditors, use of Emphasis of Matter (EOM) in the Audit Report that violates SA 706, use of management experts in violation of SA 500, failure in the evaluation of the appropriateness of the going concern assumption, lapses in the verification of the expected credit loss etc. 13) Replies of the Auditors to the charges in the SCN are examined and discussed under the following broad categories. Only the violations/actions/omissions proved to result in one or more professional misconduct as per the articles of charges in the SCN are covered in this Order. C.1. Acceptance of Audit Engagement C.2. Emphasis of Matter in the Audit Report C.3. Going Concern C.4. Expected Credit Loss C.5 Matters Reported by the Previous Auditor and Violations of SA 240 C.6 Key Audit Matters C.7 Audit Documentation C.8 Role of the Audit Firm C.1 Acceptance of Audit Engagement 14) The Auditors were charged....
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....pers at the planning stage are not dated and signed and hence there is no evidence that the work is carried out after the receipt of NOC. 19) Based on the above facts and evidence, we observe that the following requirements of the Chartered Accountants Act, Code of Ethics, SA 300 (SA 300) - Planning an Audit of Financial Statements and the Quality Policy under SQC-1 were violated by the Auditor: a. Clause 8 of Part-1 of the First Schedule to the Chartered Accountants Act, 1949 states that a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he accepts a position as auditor previously held by another chartered accountant without first communicating with him in writing. The Code of Ethics 2009 makes it clear that "the object of the incoming auditor, in communicating with the retiring auditor is to ascertain from him whether there are any circumstances which warrant him not to accept the appointment". This objective will be met only upon receiving the return communication from the previous auditor. The Code also states that in case there is a delay in receiving the reply from the outgoing auditor "the auditor appointed can act, afte....
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....MCA has sought certain information on this matter and the Company is in process of providing the same." 22) The Auditors included an EoM paragraph in their audit report which states as follows: "We draw attention to Note No. 44 (i) of the standalone Ind AS financial statements referring to filing of Form ADT-4 under Section 143(12) of the Companies Act, 2013 to the Ministry of Corporate Affairs (MCA) by the previous auditor. Based on the views of the Company and supported by legal opinions there were no matters attracting the said section." 23) In this regard, the Auditors were charged with: a) Issuing an EoM on a disclosure which was not fit for referring in an EOM, since the subject matter was not properly presented or disclosed in the financial statements and was factually incorrect. The Auditors were also charged with using EoM for giving an opinion on the subject matter of the disclosure. b) Failure to state that the audit opinion is not modified in this respect, as required by SA 706 (Revised). c) Failure to challenge the management about non-disclosure of adjusting or non- adjusting events as envisaged by Ind AS 10 (Ind AS 10), Events after R....
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....ised by the previous auditor did not fall under section 143(12), the issues pointed out by the resigned auditor (PW) were such that they could result in accounting adjustments such as write-off of the company's assets due to the dubious nature of the loans granted, litigation expenses, compliance cost, loss of goodwill, action by lenders etc. There is no disclosure in the financial statements of an estimate of such financial impact nor is there a statement that such an estimate cannot be made. There is no evidence in the Audit File of EP's examination of any of the above-mentioned matters. b. Section 143(12) mandates that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government. Further, Rule 13 of the Companies (Audit and Auditors) Amendment Rules, 2015 and Form ADT - 4 provide the manner of reporting and SA 240 provides the basic requirements while auditing. These provide that the auditor reporting ....
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....d a report under section 143(12) of the Act with the Ministry of Corporate Affairs after resigning from office in June 2019, while in fact, the previous auditor had submitted the report on 03.06.2019 before resigning on 11.06.2019. This shows gross negligence by EP. e. The EoM shows the Auditor's reliance on the legal opinion because it endorses the examination by legal experts appointed by the Company. However, the EP submitted in his reply to the SCN that he did not rely on the legal opinion. This is contrary to his EoM and noting in the Audit File which reads as ".... In light of that, we have relied on the legal opinion and concluded that 143(12) is not attracted". Such a reliance, placed on the legal opinion at the time of the audit, was not in compliance with the requirements of SA 500, Paragraph 8, which require that when audit evidence has been prepared using the work of a management expert, the auditor shall obtain an understanding of the work of that expert along with evaluation of the appropriateness of that expert's work as audit evidence for the relevant assertion. No such evaluations were carried out by the auditors. Therefore, the Auditors did not ha....
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....e performed in the evaluation of the going concern assumption. 28) On going through the audit file we find that at WP A42-1, there is a clear finding that "The company's ability to meet its obligations is significantly dependent on material uncertain events... due to above significant event, we have given material uncertainty para related to going concern.". Despite this, the Auditors denied the charges and submitted that "... there is an error in our documentation in WP A 42-1 where we have documented that "The company's ability to meet its obligations is significantly dependent on material uncertain events....... due to above significant event, we have given material uncertainty para related to going concern. The facts are that there were no material uncertain events since the Company had already initiated Intercreditor Agreement (ICA) for the resolution of its debt which proposal was accepted by more than 75% of the lenders of RCFL..." 29) The above submission of the Auditors are unacceptable and an afterthought due to the following reasons: a. Apart from the above mentioned documentation in the Audit File, regarding going concern the EP in his pr....
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....esulting into operating loss for the year and temporary liquidity mismatch. The Company has taken steps to meet such temporary liquidity mismatch by securitisation of its loan portfolio. The Company has also engaged with all its lenders to enter into an Inter-Creditor Agreement (ICA) for the resolution of its debt in accordance with the circular dated June 7, 2019 issued by the Reserve Bank of India on Prudential Framework for Resolution of Stressed Assets. Majority of our lenders have already entered into the ICA. The Company is confident of implementing its Resolution Plan during Financial Year 2019-20. In view of the steps taken by the Company, the accounts of the Company have been prepared on "Going Concern" basis." There is no evidence of independent examination of these contentions of the management, as required by Para 16 of SA 570 (Revised). Though the ET obtained the cash flow forecast prepared by the management, it did not perform any audit procedure to evaluate the reliability of the underlying data and adequacy of the assumptions. The ET neither obtained nor analysed any detailed maturity profile (fortnightly and monthly) of assets and liabilities over the next 12 month....
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....the Auditor evaluate the contents and assumptions of the ICA. d. Apart from the three events or conditions noted by the ET, there were other conditions affecting the going concern Paragraph A3 of SA 570(Revised), which were not considered by the Auditors. The Capital to Risk Assets Ratio (CRAR) of the company was below the minimum regulatory requirement as prescribed by RBI. Breach of the capital adequacy norm has the potential to affect the going concern of the Company since its continued existence was contingent on meeting the CRAR requirements. The regulatory proceedings consequent to the reporting of suspected fraud by the previous auditor was another event affecting the going concern. These events were neither disclosed in the notes to the financial statements on the going concern nor assessed by the Auditors in perspective. e. Thus, the requirements of SA 570 (Revised), as stated above, were not met by the Auditor. 31) We further observe that note no. 55 of the Financial Statements on the going concern assumption does not fully disclose the events or conditions and the mitigation plan. The disclosure note does not list all the significant events or condit....
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....il monetary penalty of $ 10000 on the firm. Bravos was barred from being an associated person of a registered public accounting firm 34) Based on the above discussion, we conclude that the Auditors did not obtain sufficient appropriate evidence to conclude and report that there was no material uncertainty regarding the going concern status of RCFL. Hence the charges in paragraph 27 stand proved. C.4 Expected Credit Loss (ECL) 35) The value of 'Loans given to borrowers' shown in the financial statements of RCFL as on 31st March 2019 amounts to 12,223.86 crores in the balance sheet which constitutes around 90% of its balance sheet size. The Auditors were charged with the following regarding the verification of ECL on these loans. a. Failure to obtain sufficient appropriate audit evidence to verify whether the ECL estimate and its related disclosures in the financial statements were reasonable and whether the financial statements were materially misstated. b. Failure to report the absence of adequate provision for originated credit-impaired loans as per Ind AS 109. c. Failure to exercise professional skepticism in accordance with the require....
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....alculations. b. Verification of the forward-looking information used by the management and whether the management's use of such information reflected a proper consideration of expectations of future developments and that the length of the forecast period was appropriate. Several of the Borrowers had issues with their going concern status, as noted by the previous auditor. There was no examination of how these events have impacted the 'significant increase in credit risk' criteria underlined by Ind AS 109. c. Whether the management's decisions on the range of scenarios and scenario weightings captured the appropriate extent of ECL required by Ind AS 109, including the effect of possible economic conditions. d. There is no evidence of the challenge of the ECL model and the underlying data sources. Given the high-risk factors and complexity of the ECL estimates the Auditors were required Para 14 of SA 540 to assess the need for employing experts in verifying ECL. However, there is no documentation in the Audit File regarding the skills and competencies of the ET members who were conversant with ECL calculations. There is no evidence of the in....
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....f Ind AS 109 should have been worked out considering the credit impairment. But no such accounting is made in the accounts, leading to understatement in ECL. 38) Based on the above, we conclude that the Auditors did not perform the audit procedures as claimed in their response to SCN. There is insufficient evidence to ensure the reasonability of the ECL of Rs. 537 crore on loans of Rs. 12,224 crore. Therefore, the charge in Para 35 above stands proved. 39) Such lapses in challenging the management and absence of professional skepticism are viewed seriously by audit regulators across the world. In the matter of K.R. Margetson Ltd. and Keith R. Margetson PCAOB Release No. 105-2023-023 September 12, 2023, the US audit regulator PCAOB imposed sanctions on an auditor for failure to appropriately evaluate the reasonableness of a discount rate used in developing the valuation estimate. The sanctions included revocation of registration of the firm, restrictions in acting as EP and a civil money penalty of $30,000. In the matter of Martin Lundie, CPA PCAOB Release No. 105-2022-040 December 22, 2022 (Partner, EY Canada), PCAOB imposed sanctions for failing to sufficiently test the assu....
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.... They also submitted that the audit report on Internal Financial Control had been qualified because of the Company's weak loan appraisal process. 42) We observe that as detailed in Section C3 of this order, the EoM in the audit report evidences that the auditor fully agrees and reiterates the disclosure made by the Company that there are no matters falling under section 143(12). The EoM shows the Auditor's endorsement of the company's legal interpretation dismissing any suspicions of fraud, while the Auditors knew that the matter was under MCA's purview. The action of the auditors amounts to agreeing with RCFL's irregular legal determination and ruling out suspected fraud, and hence inappropriate reporting since the matter was not concluded by the regulator, i.e., MCA. Thus, we do not accept the Auditor's submission that they have only drawn attention to the fact and have not concluded on the matter. Had it been the case, the audit report should have been qualified, instead of mention in the EoM, since the impact of fraud, if any, could not be ascertained by the Auditor, before it was concluded by MCA. 43) We also note that the Auditors, under their st....
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....procedure was not commensurate with the level of risk and the weak control environment in the auditee company. d) The Auditors qualified the report on Internal Financial Control over Financial Reporting basis material weakness in controls observed in the loan appraisal process. RCFL had been sanctioning loans to financially weak companies without any business rationale, indicating management override of controls. It was also noted that there was a significant rise in the quantum of loans sanctioned during the year as compared to the previous year. The working capital term loan increased from approximately Rs. 2900 crore as of 31.03.2018 to Rs.8600 crore as of 28.02.2019. However, the Auditors failed to assess and document the impact of such material weakness on the related financial statement assertions. There is no evidence that the potential risks of misstatements on financial statement assertions were ruled out based on substantive procedures. Paragraph 17 of SA 330 Also, Paragraph 33 of SA 240 requires the Auditors to perform audit procedures to respond to the identified risk of management override of controls, which the Auditors did not do. e) The Auditors su....
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....re sanctioned in violation of the lending policy, with several deviations including deficiencies in documentation, the assertion of 'rights' also remains questionable. 44) Based on the above, we observe the absence of required professional skepticism on the part of the Auditor, leading to insufficient audit procedures. Professional skepticism includes questioning inconsistencies, investigating contradictory evidence, and questioning the reliability of responses to inquiries and other information obtained from management. Audit evidence comprises both information that supports and corroborates management's assertions and any information that contradicts such assertions. In forming an opinion, the Auditor shall consider all relevant audit evidence, regardless of whether it appears to corroborate or contradict the assertions in the financial statements Paragraph 26 of SA 330. On perusal of the reply and WPs in this regard, we note that the Auditors ignored several pieces of evidence that contradict the management assertions regarding the suspected fraud. Despite being aware of the report of suspected fraud by the previous auditor, the EP stated in the audit report that ....
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.... the audit itself. 51) 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 "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 each of those audits was insufficient to demonstrate the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, including in those areas of the audits involving significant risks. For the FY 2016 and 2017 Issuer A audits, the documentation also failed to demons....
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....m and its personnel comply with professional standards and regulatory and legal requirements; and (b) The reports issued by the firm or engagement partners are appropriate in the circumstances. This SA is premised on the basis that the firm is subject to SQC 1. " Standard on Quality Control (SQC) 1 delineates the responsibilities of the Firm regarding audit quality. Audit quality is the foundation of any statutory audit. Further, SAs, such as SA 200, SA 220, SA 230, SA 260 (Revised), SA 610(Revised), SA 620 and SA 700(Revised) refer to SQC1 when it comes to specific aspects of audit such as documentation, communication with those charged with governance, engagement of Auditor's expert, evaluating the adequacy of internal audit function of the Company, and general quality aspects and SAs, which are subordinate legislations, lay down the following in clear terms: a. Responsibility for the overall quality of all the audit engagements, by ensuring that the firm's personnel comply with applicable laws, SAs and ethical requirements and issues reports appropriate to the situation, rests with the firm SQC- lays down these core principles a Firm must adhere to ensure minimu....
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....ed in SQC-1. Moreover, while SQC 1 applies at the firm level, individual audit engagements continue to be joint and several responsibility of the firm and the EP, given the requirements in the Companies Act. Had the Audit Firm discharged its supervisory responsibilities timely and effectively such major lapses in the audit could have been avoided. 58) We note that globally also this is the accepted position. The PCAOB (US Audit Regulator) orders quoted by NFRA in its various disciplinary orders underline this fact. For instance, The PCAOB, PCAOB Release No. 105-2012-001 February 8, 2012 for charges including violations of auditing standards related to the audit of financial statements of Medicis Pharmaceutical Corporation and subsidiaries, imposed civil money penalties of $2,000,000 to the firm Ernst & Young LLP, $50,000 to Jeffrey S. Anderson, the Partner with final responsibility of the subject matter audit engagement, $25,000 to Robert H. Thibault, the independent review partner, and $25,000 to Ronald Butler, the second partner, supervised by Anderson. The partners were also barred from being associated with a registered public accounting firm. In another case, the PCAOB In t....
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....n the discussion and analysis, we conclude that the EP and the Audit Firm have committed Professional Misconduct as defined in the Act, as below: a) M/s Shridhar & Associates and the EP CA Ajay Vastani committed professional misconduct as defined by Section 132(4) of the Companies Act, 2013, read with Section 22 and Clause 5 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, 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 Auditors failed to disclose in their report the material non- compliances the Company made as explained in sections C.2 to C.5 and C.8 above. b) M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 6 of Part I of the Second Schedule of the Chartered Accountants A....
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....of the Companies Act, 2013, read with Section 22 and Clause 9 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he "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 failed to conduct the audit in accordance with the SAs as explained in Paras C.1 to C.8 above but falsely reported in their audit report that the audit was conducted as per SAs. f) M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 8 of Part I of the First Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he "fails to communicate with outgoing Auditor". This charge is proved since the Auditors failed to accept the audit in accordance with the law as explained in Para C.1 and C.8 above. 61) Therefore,....