2023 (8) TMI 62 - NFRA - Companies Law

Professional Misconduct - Failure to obtain audit evidence regarding the existence and condition of inventory - Failure to identify the related party and related party transactions - Failure to obtain external confirmations for the Trade Receivables Trade Payables - Failure to Plan the audit and failure to understand the entity and its environment - Failure to identify the TCWG and failure to communicate with TCWG - Failure to report Non-Compliance with laws regulations - Failure to determine the materiality and performance materiality - Failure to document the sampling methodology adopted for substantive testing - Failure to appoint the Engagement Quality Control Reviewer (EQCR) - Penalty Sanctions. Failure to obtain audit evidence regarding the existence and condition of inventory - HELD THAT - The Audit File does not contain any evidence of the sampling methodology used in audit. Paragraph 7 of SA 501 requires that if attendance at physical inventory counting is impracticable, the auditor shall perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory - The EP has displayed gross negligence in his audit of the inventories. In view of this, it is clear that the EP did not comply with the requirements of SA 501 in so far as it relates to his obligations in respect of inventory. Hence, the charge relating to EP s failure to comply with SA 501 stands proven - Failure to identify the related party and related party transactions - HELD THAT - The EP s submission in the present case makes it clear that the EP has not exercised any professional judgement and scepticism in relation to identification of the related parties even when 100% sales were being made to a single customer who had been already identified as a Related Party earlier in the financial year 2013-14 - It is thus concluded that the charge relating to EP s failure to identify the Related Party and Related Party transactions stands proven. Failure to obtain external confirmations for the Trade Receivables Trade Payables - HELD THAT - The EP has acknowledged that no external confirmations from debtors creditors were carried out. The reply of the EP makes it clear that the management had imposed a limitation on the scope of the auditor. Limitations imposed by management may have other implications for the audit, such as for the auditor s assessment of fraud risks and consideration of engagement continuance as per Para A9 of SA 705 . However, no assessment of fraud risk having been done by the EP is evident from the audit file, nor has he furnished evidence of the additional procedures being performed in the absence of external confirmation procedures - Denial of contact details of debtors creditors to EP should have aroused the suspicion of the auditor for further procedures which evidently did not happen, and the EP failed to verify balances in violation of SA 505 - It is concluded that the charge regarding failure to obtain balance confirmation from creditors and debtors stands proven. Failure to Plan the audit and failure to understand the entity and its environment - HELD THAT - The replies of the EP are irrelevant to the charges, since as per para 11 of SA 300 the Audit Plan has to be documented which has not been done. In addition to para 11, detailed procedures regarding documentation are given in paras Al7 to A19 of SA 300 which are referred to in Para 11 of SA 300 and are required to be followed, which was not done. The reply also makes it clear that the EP has a serious lack of knowledge regarding the basic requirements of an audit. In view of the above, it is concluded that the charge regarding the failure on the part of the auditor to plan the audit and failure to understand the entity and its environment, stands proven. Failure to identify the TCWG and failure to communicate with TCWG - HELD THAT - In the Audit File there is no documentation of identification, determination and communication with TCWG. Communication with TCWG needed to be formalized in some manner for its evidentiary value and also to ensure compliance with SA 260. In view of this, it is concluded that the EP s failure to identify and communicate with TCWG is established. Failure to report Non-Compliance with laws regulations - HELD THAT - The EP in his submission has nowhere commented on the documentation in relation to the consideration of laws and regulations in the audit of WNLL for FY 2016- 17, as required under para 29 of SA 250, which says that the auditor shall document identified or suspected non-compliance with laws and regulations and the results of discussion with management and, where applicable, those charged with governance and other parties outside the entity. Though the EP has stated that defaults were not material to qualify the report, we find that materiality has not been defined in the Audit File. Therefore, the charge regarding the failure to report the non-compliance with laws regulations stands proven. Failure to determine the materiality and performance materiality - HELD THAT - The EP was charged with the failure to determine the materiality, as required under Para 10 of SA 320, for the financial statements as a whole; and performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing, and extent of further audit procedures as required under para 11 of SA 320 - The EP in his reply has nowhere commented on the observation on materiality. In absence of any proper reply or evidence submitted by the EP, it is concluded that the charge relating to his failure to determine the materiality and performance materiality stands proven. Failure to document the sampling methodology adopted for substantive testing - HELD THAT - In the absence of any reference being made to audit documentation in the reply to the SCN, the charge relating to failure to document the audit sampling methodology adopted (extent of verification of sales purchases transaction) during the course of audit stands proven. Failure to appoint the Engagement Quality Control Reviewer (EQCR) - HELD THAT - The EP was charged with failure to determine the appointment of EQCR of WNLL for FY 2016-17. This was in violation of SA 220, as WNLL is a listed company, and the auditor was required to determine that EQCR had been appointed in terms of Para 19(a) of SA 220 - In his reply to SCN, the EP has stated that a team of four persons was deputed for carrying out the audit of the Company and the same was led by a Chartered Accountant having experience of around 5 years. It is evident from the reply of the EP and the Audit File that no EQCR was appointed. In the absence of any documentation about the EQCR and no reference about the EQCR by the EP in his written and oral submissions, it is concluded that the charge regarding failure to determine the appointment of EQCR stands proven. 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 - 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 to facilitate its users. As detailed in the foregoing paragraphs of this Order, substantial deficiencies in audit on the part of CA Hemant Khator establish his professional misconduct. Despite being a qualified professional, CA Hemant Khator has not adhered to the SAs and has thus not discharged the duty cast upon him. Under the circumstances, we proceed to impose sanctions keeping in mind the deterrence, proportionality, and the signalling value of sanctions. Considering that professional misconducts have been proved and considering the nature of violations and principles of proportionality, we, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, order a) Imposition of a monetary penalty of Rs. Two Lakhs upon CA Hemant Khator; b) In addition, CA Hemant Khator 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 audit evidence regarding the existence and condition of inventory.
2. Failure to identify related parties and related party transactions.
3. Failure to obtain external confirmations for trade receivables and trade payables.
4. Failure to plan the audit and understand the entity and its environment.
5. Failure to identify and communicate with those charged with governance (TCWG).
6. Failure to report non-compliance with laws and regulations.
7. Failure to determine materiality and performance materiality.
8. Failure to document the sampling methodology adopted for substantive testing.
9. Failure to appoint the Engagement Quality Control Reviewer (EQCR).

Summary:

1. Failure to Obtain Audit Evidence Regarding the Existence and Condition of Inventory:
The Engagement Partner (EP) was charged with failing to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by not attending the physical inventory counting. The EP's justification that the firm was appointed post-year-end and relied on management's representation was not supported by evidence in the audit file. The EP's actions were deemed grossly negligent, violating SA 501 standards.

2. Failure to Identify Related Parties and Related Party Transactions:
The EP failed to identify M/s Shiv Apparel as a related party despite it constituting nearly 100% of WNLL's net sales. The EP's reliance on previous audit reports and management's representation without further probing was found to be grossly negligent and lacking professional skepticism.

3. Failure to Obtain External Confirmations for Trade Receivables and Trade Payables:
The EP did not obtain direct confirmations from debtors and creditors, citing management's refusal to share contact details. This limitation imposed by management should have prompted further audit procedures, which the EP failed to perform, violating SA 505 standards.

4. Failure to Plan the Audit and Understand the Entity and Its Environment:
The EP did not document the audit plan or strategy as required by SA 300. The EP's responses did not address the specific requirements for audit documentation, indicating a lack of understanding of basic audit requirements.

5. Failure to Identify and Communicate with TCWG:
The EP failed to identify and communicate with those charged with governance (TCWG) as required by SA 260. The EP's claim of verbal communication with the managing director was unsupported by documentation, violating SA 260 standards.

6. Failure to Report Non-Compliance with Laws and Regulations:
The EP admitted that the company was not complying with statutory provisions but did not document these non-compliances as required by SA 250. The EP's failure to define materiality in the audit file further supported the charge.

7. Failure to Determine Materiality and Performance Materiality:
The EP did not determine materiality and performance materiality for assessing risks of material misstatement, violating SA 320. The EP's lack of response or evidence to support compliance with this standard 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 or extent of verification of transactions. The invoices submitted later were not part of the original audit file, indicating a failure to comply with SA 500 standards.

9. Failure to Appoint the Engagement Quality Control Reviewer (EQCR):
The EP did not appoint an EQCR for WNLL, a listed company, violating SA 220. The absence of any documentation or reference to an EQCR in the audit file confirmed this failure.

Penalty & Sanctions:
The National Financial Reporting Authority (NFRA) imposed a monetary penalty of Rs. Two Lakhs on CA Hemant Khator and debarred him 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. This order will become effective 30 days from the date of issue.