2025 (1) TMI 18 - NFRA - Companies Law

Professional misconduct - Engagement Partner (EP) and Engagement Quality Control Reviewer (EQCR) failed to meet the requirements of the Standards on Auditing (SA) and provisions of the Companies Act 2013 during the audit of DB Realty Limited for the Financial Year 2015-16 - Section 132(4) of the Companies Act 2013 - Penalties and sanctions. HELD THAT - The EP and the EQCR have made a series of serious departures from the Standards and the Law, in conduct of the audit of DBRL for FY 2015-16. Based on the above discussion, it is proved that they had failed to exercise due diligence in performance of this audit. Based on the foregoing discussion and analysis, it is concluded that the EP and the EQCR have 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 (CA Act) as amended from time to time, and as detailed below a) The EP and the EQCR committed professional misconduct as defined by clause 7 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice is guilty of professional misconduct when he does not exercise due diligence or is grossly negligent in the conduct of his professional duties - This charge is proved as the EP and the EQCR failed to conduct the audit in accordance with the SAs and applicable regulations, failed to evaluate valuation reports and failed to perform engagement quality control review. b) The EP committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice is guilty of professional misconduct when he fails to obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion -This charge is proved as the EP failed to conduct the audit in accordance with the SAs. c) The EP committed professional misconduct as defined by clause 9 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice is guilty of professional misconduct when he fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances - This charge is proved since the EP failed to conduct the audit in accordance with the SAs. Penalties and sanctions - HELD THAT - Section 132(4) of the Companies Act, 2013 provides for penalties in a case 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 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 that imposition of a monetary penalty of Rs five lakhs. upon CA Chetan Desai; and Rs three lakhs upon CA Rakesh Rathi. In addition, they are debarred for a period of five years, and three years respectively 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. Conclusion - The EP and the EQCR failed to conduct the audit in accordance with the SAs and applicable regulations, failed to evaluate valuation reports and failed to perform engagement quality control review. Auditors must exercise due diligence, professional skepticism, and obtain sufficient audit evidence to support their audit opinions.

1. ISSUES PRESENTED and CONSIDERED

The judgment addresses the following core legal questions:

Whether the Engagement Partner (EP) and Engagement Quality Control Reviewer (EQCR) failed to meet the requirements of the Standards on Auditing (SA) and provisions of the Companies Act 2013 during the audit of DB Realty Limited for the Financial Year 2015-16.
Whether the EP and EQCR committed professional misconduct as defined under Section 132(4) of the Companies Act 2013.
Whether the EP and EQCR exercised due diligence and professional skepticism in their audit responsibilities.
Whether the EP and EQCR's actions constituted a failure to obtain sufficient audit evidence and evaluate significant judgments made by the audit team.
Whether the penalties and sanctions imposed by NFRA are appropriate and justified.

2. ISSUE-WISE DETAILED ANALYSIS

I. Lapse in Audit of Contingent Liabilities

Legal Framework and Precedents: The relevant standards include SA 200, SA 330, SA 500, and SA 220, which outline the auditor's responsibilities to exercise professional skepticism, perform appropriate audit procedures, and obtain sufficient audit evidence.
Court's Interpretation and Reasoning: The court found that the EP and EQCR failed to evaluate the guarantees and securities provided by DBRL, which were significant in size and impact on the financial statements.
Key Evidence and Findings: The EP reported guarantees as prejudicial in the CFS but not in the SFS, and there was a lack of documented evaluation of these guarantees.
Application of Law to Facts: The court applied the standards to determine that the EP and EQCR did not perform necessary audit procedures to evaluate the contingent liabilities.
Treatment of Competing Arguments: The EP's argument regarding exemption under section 186 was rejected as it did not absolve the responsibility to perform appropriate audit procedures.
Conclusions: The charges of failure to exercise professional skepticism and judgment were proved.

II. Modified Audit Opinion

Legal Framework and Precedents: SA 705 outlines when an auditor should modify an opinion in the auditor's report.
Court's Interpretation and Reasoning: The court found that the EP misled users by qualifying the audit report for an immaterial amount while not addressing significant matters in the Emphasis of Matter paragraphs.
Key Evidence and Findings: The audit report was qualified for Rs 1.92 lakhs, which was not material, while ignoring significant items.
Application of Law to Facts: The court determined that the EP did not comply with SA 705 in modifying the audit opinion.
Treatment of Competing Arguments: The EP's justification for the qualification was not supported by audit evidence.
Conclusions: The charge of misleading users of financial statements was proved.

III. Lapses in Audit of Loans and Advances

Legal Framework and Precedents: The relevant standards include SA 200, SA 315, SA 330, SA 550, and SA 540, which require auditors to assess risks and obtain sufficient audit evidence.
Court's Interpretation and Reasoning: The court found that the EP and EQCR failed to evaluate the business rationale and recoverability of loans and advances.
Key Evidence and Findings: The EP relied on management assertions without performing appropriate audit procedures.
Application of Law to Facts: The court applied the standards to determine that the EP and EQCR failed to obtain sufficient audit evidence.
Treatment of Competing Arguments: The EP's reliance on management assertions and exemption under section 186 was not accepted.
Conclusions: The charges of failure to exercise professional skepticism and judgment were proved.

IV. Lapses in Audit of Investments

Legal Framework and Precedents: The relevant standards include SA 200, SA 315, SA 330, SA 500, and SA 540, which require auditors to obtain sufficient audit evidence and evaluate the competence of valuation experts.
Court's Interpretation and Reasoning: The court found that the EP and EQCR failed to perform appropriate audit procedures and obtain sufficient evidence during the audit of investments.
Key Evidence and Findings: The EP relied on valuation reports without evaluating their appropriateness.
Application of Law to Facts: The court determined that the EP and EQCR did not comply with the standards in auditing investments.
Treatment of Competing Arguments: The EP's reliance on management assertions and valuation experts was not supported by audit evidence.
Conclusions: The charges of failure to perform appropriate audit procedures were proved.

V. Failure to Perform Duties of Engagement Partner

Legal Framework and Precedents: SA 220 outlines the responsibilities of the Engagement Partner in directing and supervising the audit.
Court's Interpretation and Reasoning: The court found that the EP failed to direct and supervise the audit engagement adequately.
Key Evidence and Findings: There was no evidence of the EP's involvement during critical stages of the audit.
Application of Law to Facts: The court applied SA 220 to determine that the EP did not fulfill his responsibilities.
Treatment of Competing Arguments: The EP's claim of involvement was not supported by audit documentation.
Conclusions: The charge of failure to perform duties as Engagement Partner was proved.

VI. Lapses in Engagement Quality Control Review

Legal Framework and Precedents: SA 220 requires the EQCR to perform an objective evaluation of significant judgments made by the audit team.
Court's Interpretation and Reasoning: The court found that the EQCR failed to perform an appropriate review of significant judgments.
Key Evidence and Findings: There was no evidence of the EQCR's review of significant audit work papers.
Application of Law to Facts: The court determined that the EQCR did not comply with SA 220 in evaluating the audit team's judgments.
Treatment of Competing Arguments: The EQCR's claim of review was not supported by audit documentation.
Conclusions: The charge of failure to perform appropriate review was proved.

3. SIGNIFICANT HOLDINGS

Verbatim Quotes: "The EP and the EQCR failed to conduct the audit in accordance with the SAs and applicable regulations, failed to evaluate valuation reports and failed to perform engagement quality control review."
Core Principles Established: Auditors must exercise due diligence, professional skepticism, and obtain sufficient audit evidence to support their audit opinions.
Final Determinations: The EP and EQCR were found guilty of professional misconduct and were sanctioned with monetary penalties and debarment from audit activities for specified periods.

The judgment underscores the importance of adherence to auditing standards and the consequences of professional misconduct in the auditing profession.

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