2021 (5) TMI 1069 - NFRA - Companies Law

Professional misconduct - Overstatement in reporting of Sales and Purchase figures - evaluation of the accounting policy for revenue recognition has improper audit planning - failing to understand the nature of the entity - non-verification of account balances of debtors and creditors - non-communication with the Those Charged with Governance (TCWG) - Non-appointment of Engagement Quality Control Review partner - Imposition of a monetary penalty off Rs.Five Lakhs upon CA Rakesh Puri - CA Rakesh Puri is debarred for Five years 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. Failure in evaluation of Accounting Policy relating to Recognition of Revenue - HELD THAT - The EP has been inconsistent in his replies. It is not clear how he obtained guidance from the GN on derivative accounting issued in 2015 which was not even in existence at the time of audit - The GN issued in the year 2003 was applicable for Equity Derivative Instruments and not for the Commodity Future Contracts. It was withdrawn with effect from 01.04.2009. Therefore, the EP's reliance on the GNs was misplaced - In the extant case, the SSWL recognised the revenue corresponding to the closing position of Futures Commodity Contract on daily basis without actual settlement of such contract. The risk and reward of the contract remained with the company. The EP failed to consider the basic principle of the transfer of risk and reward while auditing the SSWL's accounting policy on in revenue recognition. Non evaluation of risk of fraud in revenue recognition - HELD THAT - The EP ignored to investigate the exponential rise in revenue to the tune of 1026% that evidently posed significant risk of material misstatement in the revenue of SSWL and would therefore have alarmed any prudent person to the risk of fraud in recognition of revenue, however the EP failed to consider such alarming signals - The contention of the EP that he did not presume the risk in revenue underlines the open admission of his gross negligence and lack of due diligence in the face of such contradictions between the reported and actual state of affairs in the Company, which the auditor failed to identify and report and therefore his defence of his actions is baseless. Such a huge increase in revenue as indicated above warranted a risk assessment and therefore, the EP had to document the rationale behind non-presumption of the risk in revenue in compliance with Para 47 of SA 240. Failure to check contract notes of the commodity trades - HELD THAT - The audit documentation in the Audit File regarding contract notes. Notwithstanding the same, if the reply of the EP to SEBI is to be believed, then there were glaring procedural deficiencies, as the contract notes were selected by the company and not by the EP. The sampling approach of the EP was also not in compliance with the Para 7 and 8 of SA 530 SA 530 Audit Sampling , which specify appropriate sample size and its selection method. Improper planning of audit - HELD THAT - The saying that good planning is success half done is quite relevant in the conduct of audit as well. As per SA 300 and 315, the BP was duty bound to understand the business of the entity, assess the specific risks to the entity and plan his audit to mitigate such risks. However, in the present case, there is no evidence or documentation in the audit file to show that the EP took any steps to understand the business of SSWL and to plan the audit. Failure to ensure existence of preconditions for the audit - HELD THAT - Evidently, the EP allowed himself to work under conditions of scope limitation. The contention of the EP that low quantum of audit fee i.e.,Rs and non-bearing of travelling expenses by the company cannot be an excuse for non-performance of the statutory duty. There are no document which shows that any communication occurred between the EP and Mr. Anil Mistry, the Director of the Company. Absent any interaction with the key management, audit committee etc., it is difficult to accept that the EP had understood the business of the entity and its internal controls. The EP s reference to the two letters written by him to the Audit Committee on 1.8.2013 and 31.7.2014 to claim that he understood the business of the entity cannot be accepted as these letters were written at the time of submitting the draft financial statements and cannot be taken as evidence of any significant interaction with TCWG. Moreover, these are not a part of the audit file, not much credence can be attached to them - If the EP felt that the limitations had been imposed on performing of the audit by constraints such as travel cost etc., then the EP could have chosen not to accept such audit engagement in accordance with SA 210, which he failed do. Accordingly, the reply and explanation of the EP is not acceptable and we hold him guilty of having violated SA 210. Non verification of balances of debtors and creditors - HELD THAT - Trade receivables accounted for 20.57% in FY 2012- 13 and 13.58% in FY 2013-14 of the total assets of the Company, hence constituted a material class of account balances. However, aside from the fact that there was no audit documentation of the external confirmation, the EP's claim that he depended on SSWL for independent confirmations shows complete ignorance of Para 7 and A31 of SA 500 SA 500 Audit Evidence read with Parn2 of SA 505, which emphasise that audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference. Accordingly, the procedure claimed to have been adopted by the EP was devoid of independence, as he left the responsibility of obtaining confirmations to the entity and not to himself. Non-communication with Those Charged with Governance (TCWG) - HELD THAT - The audit committee is only a sub-group of TCWG and not TCWG in itself. As per Para 6 (a) of SA 260, TCWG is defined as the person(s) or organization(s) (e.g., a corporate trustee) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process. For some entities, those charged with governance may include management personnel, for example, executive members of a governance board of a private or public sector entity, or an owner-manager. Therefore, communication of the EP with TCWG was not in accordance with provisions of SA. Non-appointment of Engagement Quality Control Reviewer (EQCR) - HELD THAT - Since SSWL is a listed company, the EP was required to determine that EQCR was appointed. Article of Charges of Professional Misconduct by the Engagement Partner (EP) - HELD THAT - The Engagement Partner (EP) has made a series of serious departures from the Standards and the Law, in his conduct of the audit of SSWL for FY s 2012-13 and 2013-14. Based on above discussion, it is proved that the EP had issued unmodified opinion on the Financial Statements without any basis. The poor quality of Audit, the cover up in terms of submission of additional documents that did not exist in Audit File, incomplete documentation and attempt to mislead through false and evasive replies further compound the professional misconduct on the part of the EP. Based on the foregoing discussion and analysis, it is concluded that the EP has committed Professional Misconduct as defined under Section 132 ( 4) of the Companies Act 2013 in terms of section 22 of the Chartered Accountants Act 1949. Penalty Sanctions - HELD THAT - Considering the proved professional misconduct and keeping in mind the nature of violations, principles of proportionality and deterrence against future professional misconduct, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, it is hereby ordered I. Imposition of a monetary penalty of Rs. Five Lakhs upon CA Rakesh Puri; II. In addition, CA Rakesh Puri is debarred for Five years 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

Summary

Issues Involved:
1. Overstatement of Sales and Purchases
2. Failure to Evaluate Accounting Policies
3. Lack of Professional Skepticism
4. Non-Compliance with Standards on Auditing (SAs)
5. Gross Negligence and Professional Misconduct
6. Improper Audit Planning
7. Non-Verification of Account Balances
8. Non-Communication with Those Charged with Governance (TCWG)
9. Non-Appointment of Engagement Quality Control Reviewer (EQCR)
10. Penalty and Sanctions

Detailed Analysis:

1. Overstatement of Sales and Purchases
The National Financial Reporting Authority (NFRA) received information from the Securities and Exchange Board of India (SEBI) about the overstatement of sales and purchase figures by Rs. 1417 crores in the financial statements of Sun and Shine Worldwide Limited (SSWL) for FYs 2012-13 and 2013-14. The financial statements were materially misstated due to erroneous accounting practices, which led to an inflated impression of the company's operations. The Engagement Partner (EP), CA Rakesh Puri, failed to identify these manipulations, showing gross negligence and non-adherence to auditing standards.

2. Failure to Evaluate Accounting Policies
The EP failed to evaluate whether the accounting policy for revenue recognition conformed to required standards. SSWL's accounting practice involved recording daily carried-over amounts of unsettled contracts as revenue, which was incorrect. The EP's reliance on outdated or non-applicable guidance notes was misplaced, and he failed to document any policy of management regarding the accounting of commodity futures contracts.

3. Lack of Professional Skepticism
The EP did not exercise professional skepticism in questioning management representations. He failed to consider the fundamental principles of revenue recognition, particularly the transfer of risks and rewards, which resulted in the acceptance of materially misstated financial statements.

4. Non-Compliance with Standards on Auditing (SAs)
The EP did not comply with several Standards on Auditing (SAs). He failed to:
- Evaluate the risk of fraud in revenue recognition (SA 240).
- Document the rationale for the absence of fraud risk (SA 240).
- Verify contract notes of commodity trades (SA 530).
- Plan the audit effectively (SA 300).
- Understand the nature of the entity (SA 315).
- Ensure the existence of preconditions for the audit (SA 210).
- Obtain external confirmations for account balances (SA 505).
- Communicate effectively with TCWG (SA 260).
- Appoint an Engagement Quality Control Reviewer (EQCR) for the audit of a listed company (SA 220).

5. Gross Negligence and Professional Misconduct
The EP's actions were deemed grossly negligent and amounted to professional misconduct. He failed to disclose material facts, report material misstatements, exercise due diligence, and obtain sufficient information necessary for expressing an opinion. His conduct violated various clauses of the Chartered Accountants Act, 1949.

6. Improper Audit Planning
The EP did not plan the audit in accordance with SA 300 and SA 315. The work papers referred to by the EP were generic checklists that did not reflect the specific risks and nature of SSWL's business. The EP failed to customize the audit procedures to address the unique aspects of SSWL's operations.

7. Non-Verification of Account Balances
The EP did not independently verify the balances of debtors and creditors. He relied on SSWL to collect external confirmations, which is against SA 505. There was no documentation in the audit file regarding such confirmations, and the EP did not adopt alternative procedures in the absence of responses.

8. Non-Communication with Those Charged with Governance (TCWG)
The EP failed to establish effective two-way communication with TCWG as required by SA 260. He did not determine TCWG properly and relied on one-way communication with the audit committee, which is insufficient for effective governance oversight.

9. Non-Appointment of Engagement Quality Control Reviewer (EQCR)
The EP did not appoint an EQCR for the audit of SSWL, a listed company, as required by SA 220. His justification that there were no significant transactions is false and reflects a poor understanding of auditing standards.

10. Penalty and Sanctions
Finding the EP guilty of professional misconduct, the NFRA imposed the following sanctions:
- A monetary penalty of Rs. Five Lakhs upon CA Rakesh Puri.
- Debarment for five years 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.

These sanctions aim to uphold the integrity of the auditing profession and ensure adherence to standards, thereby protecting the interests of investors and the public. The order becomes effective 30 days from the date of issue.