2023 (8) TMI 262 - NFRA - Companies Law

Professional Misconduct - Failure to maintain Audit File and to co-operate with NFRA - Misuse of Emphasis of Matters for issuing a modified audit opinion - Erroneous Application of Financial Reporting Framework by the Company - Failure to report the company's non-compliance with the provision of AS 5 and the Framework (issued 2000) - Deferred Tax Assets failure to report non-compliance with AS 22 - Failure to report or address errors in Cash Flow Statement - Significant Accounting Policies not as per applicable accounting standards - Penalties and sanctions. Failure to maintain Audit File and to co-operate with NFRA - HELD THAT - Absence of audit documentation or failure to submit the Audit File to NFRA, is a clear evidence that the auditor failed to obtain reasonable assurance about whether the financial statements as a whole were free from material misstatement and that the auditor's opinion issued through the Independent Audit Report dated 20.05.2015 was without any basis and unreliable and hence, invalid. Accordingly, serious view is taken that of the failure of the EP to respond to NFRA's repeated communications and conclude that the EP by not responding to the proceedings undertaken by NFRA, has violated Section 132 (4) of the Act, 2013, which is a 'professional or other misconduct' in terms of Section 132 (4) (c) of the Act, 2013, read with Clause (2) of Part III of Schedule I of the Chartered Accountants Act, 1949. Misuse of Emphasis of Matters for issuing a modified audit opinion - HELD THAT - It is clear that the EP misused the Emphasis of Matter part of the Audit Report to include matters that should have been evaluated separately and considered for effecting modification to the audit opinion under para 6 of SA 705 Para 6 of SA 705 clearly states that auditor should modify the opinion when he concludes that the financial statements are not free from material misstatements or if he is not able to obtain sufficient appropriate audit evidence for the same. Resorting to EoM para in the matters detailed is a clear violation of provisions of SA 706. Erroneous Application of Financial Reporting Framework by the Company - HELD THAT - The Company was required under Section 211 of the Companies Act, 1956 to prepare Financial Statements in the form provided in part 1 of the Revised Schedule VI to the Companies Act, 1956 - The EP failed to report these-non- compliances in the Auditor's Report. Failure to report the company's non-compliance with the provision of AS 5 and the Framework (issued 2000) - HELD THAT - In Note 30 to the Financial Statements, the company has only disclosed the adjustment relating to waiver of balances and its accounting treatment. However, it has not disclosed the terms of concessions, revised loans balances, repayment period, and rate of interest of One Time Settlement with the lenders. As per para 25 of the Framework, qualitative characteristics of Financial Statements are the attributes that make the information provided in financial statements useful to users. Two of the qualitative characteristics are 'understandability' and 'relevance' given in para 26 and 27 of the Framework. In view of these requirements, the company should have disclosed the important terms of One Time Settlement with lenders, which it did not do. The EP has not pointed out the error in his audit report. This indicates lack of professionalism on his part and his failure to report the company's non-compliance with AS 5 is proved. Deferred Tax Assets failure to report non-compliance with AS 22 - HELD THAT - The company had been in loss for the current reporting period FY 2013-15 and the previous reporting period FY 2012-13. Moreover, it is not clear from the financial statements whether the conditions for the recognition of deferred tax assets were met. EP should have exercised professional scepticism and challenged the management's judgement of recognising the deferred tax assets in the absence of virtual certainty of profits and concrete evidence of sufficient taxable income to realise the same. The EP has therefore failed to report non-compliance with the provisions of AS 22 regarding deferred tax assets as there is no comment in the Auditor's report. Failure to report or address errors in Cash Flow Statement - HELD THAT - The company has used Indirect Method to arrive at cash flows from operating activities in the Cash Flow Statements, whereby net profit or loss is to be adjusted for the effects of transactions of non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows - In this case, Net Profit before Tax is derived after considering the non-cash income relating to waiver of interest and leased rental charges by the lenders. However, these items being non-cash items should have been adjusted to arrive at 'Cash flow from Operating Activities'. Since the same has not been done, the Cash Flow from Operating Activities has been inflated - Further, waiver of principal amount of Rs 9.74 crores is shown as Increase/(Decrease) in other reserves in the Cash Flow Statement. Since waiver of principal amount is a non-cash transaction, it should have been excluded from Cash Flow Statement as per para 40 of AS 3 As this has not been reported by EP, the failure to report and address the errors in cash flow statement stands established. Significant Accounting Policies not as per applicable accounting standards - HELD THAT - Employee Benefit Expense of financial statements states that the provision for gratuity fund and leave encashment is made on ad hoc basis and not as per the actuarial valuation as required by AS 15. In contrast, in note 2(i) in Significant Accounting Policies, it is stated that the estimated liability for the employee benefits is determined in accordance with the requirements of AS 15 and liability for gratuity is determined and charged to Profit and Loss account based on valuation by independent actuary. The EP did not report these contradictory disclosures and non-adherence of provisions of AS 15, which shows lack of due diligence on his part. Penalties and sanctions - HELD THAT - In view of the fact that the EP has not only shown blatant disregard to the Standards on Auditing in conducting audit of a company that affects public interest, but has also shown scant regard to the legal process undertaken by NFRA under Section 132 (4) of the Companies Act, 2013 we take a serious view of his professional misconduct, which assumes further importance in light of the fact that he had long association with the company being its statutory auditor for five financial years from FY 2012-13 to FY 2017-18. As per information available in Annual Report for FY 2013-15, EP was paid Rs 12,20,000 (which included audit fees of Rs 8,00,000 and limited reviews of Rs 4,00,000 and Rs.20,000 for other services). Considering that the professional misconducts by the EP have been proved and considering the nature of the violations and principles of proportionality, we, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, order i. Imposition of a monetary penalty of Rs.5,00,000 (Rupees Five Lakhs) on the EP, CAT. Raghavendra, proprietor of M/s T. Raghavendra Associates. ii. Debarment of CAT. Raghavendra, proprietor of M/s T. Raghavendra Associates, for ten 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 maintain and submit the Audit File.
2. Misuse of Emphasis of Matters for issuing a modified audit opinion.
3. Erroneous Application of Financial Reporting Framework by the Company.
4. Failure to report the company's non-compliance with the provision of AS 5 and the Framework.
5. Deferred Tax Assets: failure to report non-compliance with AS 22.
6. Failure to report or address errors in Cash Flow Statement.
7. Significant Accounting Policies not as per applicable accounting standards.

Summary:

1. Failure to maintain and submit the Audit File:
The Engagement Partner (EP) failed to submit the Audit File and the Quality Control Policies of the audit firm despite repeated requests and extensions. This non-cooperation led NFRA to conclude that either no such documents existed or the EP was unwilling to cooperate. This is considered professional misconduct under Section 132(4)(b) of the Companies Act, 2013, which grants NFRA powers of a Civil Court for discovery and production of documents.

2. Misuse of Emphasis of Matters for issuing a modified audit opinion:
The EP misused the Emphasis of Matter (EoM) paragraph to cover up misstatements in the financial statements. Matters such as non-provision of interest on loans, doubtful capital advances, and old trade receivables were included in the EoM paragraph instead of modifying the audit opinion. This is a violation of SA 706, which mandates that EoM should only include matters that are appropriately disclosed in the financial statements and are fundamental to users' understanding.

3. Erroneous Application of Financial Reporting Framework by the Company:
The company erroneously applied the provisions of the Companies Act, 2013, while the Companies Act, 1956, was applicable for the reporting period. The EP failed to report this non-compliance, which is considered gross negligence.

4. Failure to report the company's non-compliance with the provision of AS 5 and the Framework:
The company's waiver of principal amount due to One Time Settlement (OTS) was incorrectly credited to the Capital Reserve account instead of being recognized as income in the Statement of Profit and Loss. The EP failed to report this error, indicating a lack of professionalism and failure to report the company's non-compliance with AS 5.

5. Deferred Tax Assets: failure to report non-compliance with AS 22:
The company recognized deferred tax assets without virtual certainty of sufficient future taxable income, which is a violation of AS 22. The EP failed to challenge the management's judgment and did not report this non-compliance.

6. Failure to report or address errors in Cash Flow Statement:
The company inflated its Cash Flow from Operating Activities by not adjusting non-cash items such as waiver of interest and lease rental charges. The waiver of the principal amount was also incorrectly included in the Cash Flow Statement. The EP failed to report these errors.

7. Significant Accounting Policies not as per applicable accounting standards:
The company's provision for gratuity fund and leave encashment was made on an ad hoc basis, contrary to the actuarial valuation required by AS 15. The EP did not report these contradictory disclosures, indicating a lack of due diligence.

Penalty & Sanctions:
NFRA imposed a monetary penalty of Rs. 5,00,000 on the EP and debarred him for ten 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 after 30 days from the date of its issue.