2017 (2) TMI 465 - HC - Indian Laws

Professional misconduct - default of audit party - Chartered Accountants Act - wrong method of valuation of inventory - Held that - At the time of hearing the stand taken by the respondent was that PCL was a trading company and followed Weighted Average Cost Method, which was in contravention of Accounting Standard-2 (AS-2), which specifically laid down the method of valuation of inventory as cost or market value whichever is less. But the committee held that it was not taking cognizance of the same since the method of valuation of inventory, albeit wrong, was consistently followed by the company. However the committee highlighted that classification of the inventory ought to have been disclosed in the notes to the accounts. The committee further noted that during the period January 01, 1996 to December 31, 1996 huge payments were made by PCL on behalf of AIL but no disclosure of the same was made by the auditor in the report as contemplated by law. Further, there were suspicious adjustment entries between AIL and PCL which ought to have raised a doubt about the genuineness of the transactions and ought to have been detected and reported by the respondent. Suffice it to highlight that in paras 26 and 27 of the report the Committee highlighted the modus operandi adopted by PCL and AIL to form a loop with no cash flow coming in, but sales, stocks and receivables increases. The obligation of the auditor concerning transactions which are merely book entries was highlighted i.e. the duty of the auditor to enquire whether the transactions were prejudicial to the interest of the company being not discharged by the auditors. The Committee also highlighted that as an auditor it was the obligation of the respondent to comment about the internal control procedures of the company. With reference to AAS-3 and AAS-4, the Committee further brought out the obligations of the auditor to be discharged in the course of the audit. The Committee has also highlighted the duties of the auditor to maintain the working papers and documents and noted that in spite of repeatedly directed to do so, the respondent did not produce the papers and took the plea that since the year 2003 he had surrendered the certificate of practice, therefore he was not keeping the past record. The report of the Disciplinary Committee is based on the accounting standards to be followed and breach thereof. Having not filed any response to the report of the Disciplinary Committee, and finding the report to be suffering from no infirmity, as did the Council accept the same, so do we. Indeed, the respondent is guilty of committing professional misconduct falling within clauses 5, 6, 7 and 8 of Part 1 of the 2nd Schedule to the Chartered Accountants Act, 1949. Keeping in view the scam which has taken place and the seriousness of the indictment of the respondent we accept the recommendation of the Council and levy the penalty of removing the name of the respondent from the register of members of the Institute of Chartered Accountants for a period of 5 years.

Issues Involved:
1. Allegations of professional misconduct against the respondent.
2. Examination of the auditor's duties and responsibilities.
3. Findings of the Disciplinary Committee.
4. Evaluation of the respondent's defense and response.
5. Determination of penalties and sanctions.

Issue-wise Detailed Analysis:

1. Allegations of Professional Misconduct Against the Respondent:
A complaint dated December 26, 2000, was received from the Assistant General Manager, State Bank of India, New Delhi, against G.S.Jauhar & Co., alleging professional misconduct by the respondent, a partner of the firm. The complaint highlighted various acts of commission and omission by the respondent while auditing M/s. Pertech Computers Ltd. (PCL), including the overstatement/understatement of stocks, debtors, inflation of sales, and manipulation of accounts. The respondent admitted to being in charge of the audit team.

2. Examination of the Auditor's Duties and Responsibilities:
The Disciplinary Committee noted that the respondent was the statutory auditor of PCL since its inception and also audited the balance sheet for the year ending December 31, 1996. The Committee emphasized that the auditor's role was to certify the balance sheet and ensure compliance with accounting standards. The Committee highlighted that the respondent failed to comment on significant financial irregularities, including suspicious adjustment entries and huge payments made by PCL on behalf of AIL without proper disclosure.

3. Findings of the Disciplinary Committee:
The Disciplinary Committee submitted a report on February 03, 2010, concluding that the respondent was in connivance with the management of PCL to defraud the bank and the public. The Committee noted the following key findings:
- The respondent failed to detect and report the overstatement of stocks and debtors.
- The method of inventory valuation used by PCL was contrary to Accounting Standard-2 (AS-2).
- The respondent did not maintain proper working papers and documentation as required by AAS-3 and AAS-4.
- The respondent did not inquire into transactions that were merely book entries, as mandated by Section 227(1A)(b) of the Companies Act, 1956.

4. Evaluation of the Respondent's Defense and Response:
The respondent submitted a written statement of defense on April 05, 2004, arguing that an auditor cannot be held responsible for preventing fraud by a company. The respondent also disputed the findings of the special audit report by M/s. G.Jai & Associates. However, the respondent did not produce the required working papers and documents, claiming that he had surrendered his certificate of practice in 2003. The Committee repeatedly directed the respondent to produce these documents, but he failed to comply.

5. Determination of Penalties and Sanctions:
The Committee concluded that the respondent failed to diligently carry out his duties as an auditor and helped the management to defraud the bank and the public. The Committee recommended removing the respondent's name from the register of members of the Institute of Chartered Accountants for a period of 5 years. The Court accepted the Committee's recommendation, finding no infirmity in the report, and held the respondent guilty of professional misconduct under clauses 5, 6, 7, and 8 of Part 1 of the 2nd Schedule to the Chartered Accountants Act, 1949.

Conclusion:
The reference was disposed of with the Court upholding the findings of the Disciplinary Committee and imposing a penalty of removing the respondent's name from the register of members of the Institute of Chartered Accountants for a period of 5 years.

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