2023 (7) TMI 1028 - NFRA - Companies Law

Professional Misconduct - violation of the Standards of Auditing - failure to plan the audit and understand the entity and its environment - failure to determine the materiality and performance materiality - failure to identify and communicate with TCWG - failure to evaluate the arm s length pricing for the related party transactions that amounted to 54% of the total sales - failure to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory that constituted over 36% of the balance sheet - failure to obtain confirmation of balances from debtors creditors that accounted for over 60% and 29% respectively of the balance sheet - failure to report the non provisioning for Trade Receivables that accounted for nearly 23% of the Trade Receivables - failure to determine the appointment of Engagement Quality Control Reviewer (EQCR). Failure to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory - HELD THAT - The Audit File has no evidence of verification of the inventory on test check basis, as claimed. The Audit File has only two sheets of paper out of which one gives the stock statement of inventory hypothecated to Bank of Baroda, and the other is a copy of the Certificate of Registration tor Modification of Charge issued by the RoC, Mumbai - EP has displayed lack of due diligence and gross negligence in his audit of inventories, and the charge relating to the EP s failure to obtain sufficient appropriate audit evidence in relation to the existence and condition of inventory, in compliance with SA 501, stands proven. Failure to evaluate the arm s length basis for transactions with related parties - HELD THAT - As there is no testing of the arm s length pricing in the Audit File and the reply of the EP did not specifically answer the charge in the SCN, it is concluded that the EP did not comply with requirements of SA 550.Thus, the charge in the SCN stands proven. Failure to obtain external confirmation for the Trade Receivables Trade Payables - HELD THAT - In the absence of documentation regarding balance confirmations from the debtors creditors and lack of any evidence of alternate procedures performed, it is obvious that the auditor has failed to comply with SA 505, and the charge regarding EP s failure to obtain sufficient appropriate audit evidence regarding the trade receivables trade payables, stands proven. Failure to report non-provisioning for doubtful debts - HELD THAT - The EP was charged with the failure to report non-provisioning for doubtful debts even though the company had disclosed 9.17 crores of debts as doubtful and did not make any provision in the accounts for the doubtful debts as per para 4.2 of the AS 4. The EP was also required to comply with para 6 of the SA 540, which states that the objective of the auditor is to obtain sufficient appropriate audit evidence whether in the context of the applicable financial reporting framework the accounting estimates are reasonable and related disclosures in the financial statements are adequate - The EP in his reply to SCN did not specifically respond to the charge on the failure to report on the non-provisioning for 2 9.17 crores of doubtful debts despite the requirement in AS 4. During the personal hearing also, he did not offer any substantive comments on the non-provisioning in respect of doubtful debts - the charge regarding the failure to report on the non- provisioning in respect of doubtful debts stands proven. Failure to Plan the audit and failure to understand the entity and its environment - HELD THAT - No basic understanding of the entity has been recorded in the Audit File. Also, as part of entity s risk assessment process the auditor is required as per para 15 of SA 315 to understand whether the entity has a process for identifying business risks relevant to financial reporting objectives, estimating significance of the risks, assessing likelihood of occurrence and deciding how to address those risk. There are no such papers in the audit file. In the absence of appropriate evidence in the Audit File, we are constrained to conclude that the auditor has failed to plan the audit and has also failed to understand the entity and its environment as mandated by the SAs. Failure to identify and communicate with Those Charged With Governance (TCWG) - HELD THAT - In the absence of any evidence indicating identification of, and communication with, the TCWG, it is evident that the provisions of SA 265 have not been complied with by the EP and it is concluded that the charge related to the EP s failure to identify and communicate with T'CWG stands proven. Failure to determine materiality and performance materiality - HELD THAT - In the absence of any evidence in the audit file and lack of any response from the EP, it is held that the charge related to his failure to determine materiality and performance materiality is established. Failure to document the sampling methodology adopted for substantive testing - HELD THAT - The EP was charged with failure to obtain sufficient appropriate evidence to support his Opinion and report as required by SA 500. The Audit File has no documentation regarding extent of verification of the transactions, and whether the entire population was verified, or any sampling methodology was applied for the verification of the transactions such as sales purchases - In the absence of any evidence in the audit file, and lack of any satisfactory reply from the EP, it is held that the charge regarding the EP s failure to document the sampling methodology adopted for the substantive testing stands proven. Failure to determine that Engagement Quality Control Reviewer (EQCR) had been appointed - HELD THAT - The reply of the EP is not acceptable since there is no documentation in the audit file regarding the engagement of EQCR and the details of reviews carried out by the EQCR. Hence, the charge regarding the failure to determine that EQCR had been appointed, stands proven. Thus, it is established that the EP, CA Narayan Prasad Swami, did not comply with the stipulations in the Chartered Accountants Act, 1949 (CAs Act) regarding the statutory audit engagement and showed gross negligence and lack of due diligence in performing the same. In addition, the EP, CA Narayan Prasad Swami has not ensured audit quality and was grossly negligent in his professional duties by not adhering to the requirements laid down by the relevant SAs. This has led to the issuance of an audit report that is not backed by valid audit evidence and is lacking quality in the audit work. Penalty Sanctions - HELD THAT - Section 132(4) of the Companies Act, 2013 provides for penalties where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed, is evident from the fact that a minimum punishment is laid down by the law. Considering that professional misconducts have been proved and considering the nature of violations and principles of proportionality, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, it is ordered that a) Imposition of a monetary penalty of Two Lakhs upon CA Narayan Prasad Swami. b) In addition, CA Narayan Prasad Swami is debarred for two 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. Failure to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory.
2. Failure to evaluate the arm's length basis for transactions with related parties.
3. Failure to obtain external confirmation for the Trade Receivables & Trade Payables.
4. Failure to report non-provisioning for doubtful debts.
5. Failure to plan the audit and understand the entity and its environment.
6. Failure to identify and communicate with Those Charged With Governance (TCWG).
7. Failure to determine materiality and performance materiality.
8. Failure to document the sampling methodology adopted for substantive testing.
9. Failure to determine that Engagement Quality Control Reviewer (EQCR) had been appointed.

Summary:

1. Failure to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory:
The Engagement Partner (EP) did not attend the physical inventory counting and relied solely on management representation. The audit file lacked evidence of verification, violating SA 501. This failure was proven as the inventory constituted more than 36% of the balance sheet.

2. Failure to evaluate the arm's length basis for transactions with related parties:
The EP did not document the evaluation of arm's length pricing for transactions with related parties, specifically M/s Shiv Apparel, which accounted for 54% of total sales. This non-compliance with SA 550 was proven as the EP failed to perform risk assessment procedures.

3. Failure to obtain external confirmation for the Trade Receivables & Trade Payables:
The EP did not obtain direct confirmations from debtors and creditors, nor did he perform alternative procedures. Trade Receivables and Trade Payables were significant at 60.48% and 29.24% of the balance sheet, respectively. The charge of non-compliance with SA 505 was proven.

4. Failure to report non-provisioning for doubtful debts:
The EP failed to report non-provisioning for 9.17 crores of doubtful debts, which was 22.89% of trade receivables. This omission was material as it would have turned the company's profit into a loss. The charge was proven as the EP did not comply with AS 4 and SA 540.

5. Failure to plan the audit and understand the entity and its environment:
The EP did not document the audit plan or strategy and failed to understand the entity's business risks as required by SA 300 and SA 315. The absence of documentation in the audit file led to the conclusion that the EP did not comply with the standards.

6. Failure to identify and communicate with Those Charged With Governance (TCWG):
The EP did not identify or communicate with TCWG as required by SA 260 and SA 265. The audit file lacked evidence of such communication, and the EP admitted to not attending any meetings of the audit committee or AGM/EGM. This charge was proven.

7. Failure to determine materiality and performance materiality:
The EP did not determine materiality or performance materiality for the financial statements, violating SA 320. The absence of any response from the EP and lack of evidence in the audit file led to the charge being proven.

8. Failure to document the sampling methodology adopted for substantive testing:
The EP did not document the sampling methodology for verifying transactions such as sales and purchases. The audit file lacked evidence of the extent of verification, leading to the charge of non-compliance with SA 500 being proven.

9. Failure to determine that Engagement Quality Control Reviewer (EQCR) had been appointed:
The EP did not ensure the appointment of an EQCR for the audit of WNLL, violating SA 220. The audit file lacked documentation of the EQCR's engagement and reviews, leading to the charge being proven.

Findings on the Articles of Charges of Professional Misconduct by Auditor:
The EP, CA Narayan Prasad Swami, was found guilty of gross negligence and lack of due diligence, violating the Chartered Accountants Act, 1949. Specific failures included not exercising due diligence, not obtaining sufficient information, and not highlighting material departures from generally accepted audit procedures.

Penalty & Sanctions:
A monetary penalty of INR 2,00,000 was imposed on CA Narayan Prasad Swami. Additionally, he was debarred for two years from being appointed as an auditor or internal auditor or from undertaking any audit in respect of financial statements or internal audit of any company or body corporate. The order becomes effective 30 days from the date of issue.