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TMI Blog2021 (5) TMI 1069X X X X Extracts X X X X X X X X Extracts X X X X ..... Introduction & Background C. Major lapses in the audit D. Other lapses in the audit E. Article of Charges of Professional Misconduct by the Engagement Partner (EP) F. Penalty & Sanctions A. EXECUTIVE SUMMARY 3. The National Financial Reporting Authority ('NFRA' hereafter) received information from Securities and Exchange Board of India ('SEBI' hereafter) pertaining to overstatement in reporting of Sales and Purchase figures to the tune of Rs.1417 crores in the Financial Statements of Sun and Shine Worldwide Limited (SSWL), Ahmedabad for the FYs 2012-13 and 2013-14. Accordingly, an investigation under Section 132(4) of the Companies Act 2013 ('Act' or 'CA- 2013' hereafter) was initiated by NFRA for professional misconduct, if any, by the Engagement Partner (EP) CA Rakesh Puri in the audit of SSWL and the audit files were called for from the EP, who had performed the statutory audit of the SSWL for five years from 2010-11 to 2014-15 4. The SSWL [SSWL 's CIN is LS1100GJ1994PLC022388 and it was earlier known as Robinson Worldwide Trade Limited and presently functioning in the name of Johnson Pharmacare Limited] was dealing in the Commodity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1791.02 1310 Purchases 2012-13 159.13 146 2013-14 1790.94 1417 # As per Financial Statement of SSWL * As conveyed by SEBI vide its letter dated 08.07.2020 From December 2012 onwards, around the same time that SSWL started reporting its inflated purchase and sales figures, the price of the SSWL scrip on BSE jumped to Rs 42 and from then onwards the price kept on increasing, reaching around Rs 85 in February 2014 and thereafter the price started declining, again falling to Rs.25 .55 in August 2014. The SSWL published its financial statements which contained manipulated sales and purchase figures till March 2014. This Order observes that such accounting manipulation had serious adverse effect on public interest, as reflected in the share price movements, and holds that the failure of the EP to properly audit such figures is a clear evidence of his gross negligence and professional misconduct. It is relevant to mention that SEBI has charged SSWL and its Directors with violating various provisions of SEBI Act, 1992 and of Securities Contracts (Regulations) Act, 1956 and after conducting of investigation, passed an order on 14.09.2021 restraining them from accessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt in Rs.) Particulars [ As conveyed by SEBI vide its letter dated 08.07.2020.] 2012-13 2013-14 Overstatement of Sales 146 Crores 1310 Crores Overstatement of Purchase 146 Crores 1417 Crores 11. SSWL was required to prepare its Financial Statements ('FS' hereafter) for the FYs 2012-13 and 2013-14 in accordance with applicable provisions of the Companies Act 1956 ('CA-1956' hereafter) and the Accounting Standards ('AS' hereafter) notified under the Companies (Accounting Standards) Rules, 2006. 12. Mis Y.D. & Co. was the statutory auditor of SSWL for FYs 2012-13 & 2013-14 and CA Rakesh Puri was the EP for these audit engagements. Vide NFRA letter dated 09.08.2021, the Audit File along with other information were called from the EP, who submitted these on 31.08.2021. As part of the investigation, a Questionnaire dated 04.02.2022 was also sent to the EP and his response was received on 26.04.2022. Another letter dated 15.06.2022 was sent to the EP requiring him to certify the completeness of Audit File submitted to NFRA through an affidavit, which was received on 25.06.2022. 13. On examination of the Audit Files, it was prima facie observed that even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... based on the information and records available and circumstances prevailed at that time. 17. An opportunity of personal hearing was given to the EP, who appeared before the Executive Body, NFRA on 17.10.2022 when the submissions made by him during the hearing were placed on record. During the personal hearing, the EP reiterated his written submissions as mentioned in his reply vide letter dated 29.09.2022 and further explained his replies. 18. We have perused the written and oral responses of the EP and all other material on record and now proceed to deal with the charges levelled in the SCN. The major lapses in audit on the part of the EP relating to evaluation of the accounting policy for revenue recognition has been discussed in Part 'C' of this order. Other lapses viz., improper audit planning, failing to understand the nature of the entity, non-verification of account balances of debtors and creditors, non-communication with the Those Charged with Governance ('TCWG' hereafter) and non-appointment of Engagement Quality Control Review partner ('EQCR' hereafter) have been discussed in Part 'D' of this order. Part C C.1 Failure in evaluation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany has got Daily MTM Bill/Ref no. DLYMTM/11-1709 from broker where in 70 Lots of FUT COPPER 30- NOV-12 which were carried forward from previous day was brought forward and the same was treated as Purchase in the books of the company i.e. Purchase aggregating to Rs. 3, 19, 69,000.00 and correspondingly since it was not sold on that day the position was carried forward which was treated as sales aggregating to Rs. 3,17,20,500.00. * The same process of accounting was going on till the date of actual settlement of open position of 70 Lots of FUT COPPER 30-NOV-12. That is how turnover of the company was built up and Purchase aggregating to Rs. 159.13 Crores and Sales aggregating to Rs. 159. 07 Crores were recorded in the books of accounts of the company. * The accountant of the company had recorded all the MTM Bills in the books of accounts of the company with assumptions that all the transactions are entered by the company are on day to day basis and those needed to be recorded in the books of accounts of the company. 5 Vide Para 4.2 A of the SCN 6 As elaborated on page no 4 of Relevant finding in the matter of the FS of SSWL conveyed by SEBI vide letter dated 08.07.2020. 7SEBI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat: a) The EP has been inconsistent in his replies. It is not clear how he obtained guidance from the GN on derivative accounting issued in 2015} which was not even in existence at the time of audit. b) The GN issued in the year 2003 was applicable for Equity Derivative Instruments and not for the Commodity Future Contracts. It was withdrawn with effect from 01.04.2009. Therefore, the EP's reliance on the GNs was misplaced. c) The GNs of 2015 and 2003 were neither documented in the audit file, nor was there any policy of management stating that SSWL had used any such guidance in the accounting of commodity futures contracts. We observe that the GN issued in 2003 deals with computation of Mark-to-Market Margin by the Client. Para 31 of GN states that " ...For computation of 'Mark-to-Market Margin', all outstanding contracts, whether Long or Short, of a Clearing Member in an equity index/stock futures contract are deemed to have been settled at the Daily Settlement Price ......... ". Para 31 of the guidance note evidently uses daily deemed settlement only for the purpose of computation of margin money and it can by no means be interpreted to mean that the trades ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontract remained with the company. The EP failed to consider the basic principle of the transfer of "risk and reward" while auditing the SSWL's accounting policy on in revenue recognition. 21. The EP also argued that there was no guidance available for accounting of commodity future contracts. We find that this is incorrect. AS 30, Financial Instruments: Recognition and Measurement, was issued by the ICAI in 2007. It was recommendatory in nature for the first two years commencing on or after 1.4.2009 and mandatory on or after 1.4.2011. Subsequently, in the wake of the financial crisis and the attendant modifications in the accounting standards undertaken by the accounting standard setting bodies, the status of AS 30 was modified. The preparers of the financial statements were encouraged to follow the principles enunciated in AS 30, subject to the condition that if there were any other notified standards or regulatory requirements, then they would prevail over the accounting treatment contained in AS 30. Accordingly, there was no dearth of guidance on accounting treatment of financial instruments, and it was open to the SSWL to consider relevant provisions of AS 30 in the accou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ious adverse effect on public interest, as reflected in the share price movements, and we hold that the failure of the EP to properly audit such figures is a clear evidence of his gross negligence and professional misconduct. The statement of the EP that, "I have followed the principle of Institute .... so that there will not be any mis-statement and there will not be any over/under statement of profit/loss and the statement of Affair (Balance Sheet) reflects the true and fair view" cannot be accepted in light of what has been discussed above. As pointed out earlier, there was overstatement of sales up to the extent of 1310 crores (i.e., overstatement by 1099% in FY 2012-13 & 272% in FY 2013-14), which is a material misstatement as per Para 13 (i) of SA 200[Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing]" We note that Public Company Accounting Oversight Board11[PCAOB release No. 105-2009-003 dated 08.02.2012] ('PCAOB' hereafter), the US Regulator, charged S.W. Hatfield, C.P.A. (the "Firm") for its failure to evaluate the correctness of revenue during the audit of Epicus Communications Group, Inc. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the recognised commodity exchange and registered broker and all transactions are made through banking channel and hence it is not presumed any risk. Even you should appreciate that even SEBI has not found any such kind of indication of fraud which has occurred in the company. The said facts are properly documented on page no. 184 to 185 of the show cause notice." The reply of the EP is not supported by the facts and is liable to be rejected in view of the following; (Amount in Rs Cr.) Particulars[As per Annual Report of SSWL] 2012-13 2013-14 % Increase Revenue from operations 159.07 1791.02 1026% Purchase of Stock in Trade 159.13 1790.94 1025.5% The EP ignored to investigate the exponential rise in revenue to the tune of 1026% that evidently posed significant risk of material misstatement in the revenue of SSWL and would therefore have alarmed any prudent person to the risk of fraud in recognition of revenue, however the EP failed to consider such alarming signals. b. There is no documentation in the Audit File evidencing verification of such transactions from any broker or exchange or through bank reconciliation. On the contrary we find that the inf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... had checked the contract notes on a sample basis. The sample was selected by the company, and I had not sought any specific sample I trade related contract notes. " We did not find any audit documentation in the Audit File regarding contract notes. Notwithstanding the same, if the reply of the EP to SEBI is to be believed, then there were glaring procedural deficiencies, as the contract notes were selected by the company and not by the EP. The sampling approach of the EP was also not in compliance with the Para 7 and 8 of SA 530[SA 530 "Audit Sampling"], which specify appropriate sample size and its selection method. Para 7 of SA 530 states that, "The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level." Para 8 of SA 530 states that, "The auditor shall select items for the sample in such a way that each sampling unit in the population has a chance of selection." As the sampling was not done by the EP, he failed in his responsibility to ensure an appropriate sample size reflecting the population and reduce the sampling risk to an acceptable level. 28. The EP further stated in his reply to NFRA that "We have verified the Contrac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant industry, applicable regulatory structure etc. at macro level and gaining an understanding of nature of the entity, its operations, its ownership, its governance & capital structure and applicable financial reporting framework etc. at the entity level. However, no audit documentation reflecting the work of the EP to understand the nature of the business of the entity was found in the audit file. 31. The EP responded to the charge by referring to some of the WPs and stated that " ... I strongly believe that while doing the audit of the entity the SA 300 has been complied with to the best possible manner so that there will not be any material misstatement of the financial report and an opinion will be framed after taking the professional judgements". 32. The scope of SA 300 and 315 is quite comprehensive and stipulates that the auditor plan the audit commensurate to the nature and complexity of the business of the entity and identify and assess the risk of material misstatement. This should cover planning of the time duration, assessment of risks specific to the entity and designing of the audit procedures to mitigate such assessed risks. In contrast to such requirement, we n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d signature of the person who checked and verified making the whole exercise of preparing the WPs an eyewash. The EP has also referred to Page no 182 and 183 of the SCN in support of his understanding regarding the transactions being carried out by SSWL and policies adopted by it. However, it is observed that these WPs were not found in the audit file, rather provided as an Annexure to the replies submitted by the BP in response to NFRA Questionnaire. Therefore, these WPs are an afterthought and cannot be accepted. 35. The saying that good planning is success half done is quite relevant in the conduct of audit as well. As per SA 300 and 315, the BP was duty bound to understand the business of the entity, assess the specific risks to the entity and plan his audit to mitigate such risks. However, as discussed above, there is no evidence or documentation in the audit file to show that the EP took any steps to understand the business of SSWL and to plan the audit. 36. We note that PCAOB [PCAOB release No. 105-2015-41 dated 03 12.2015.] , the US Regulator, charged L.L. Bradford & Company, LLC (the "Firm") for its failure to develop an appropriate audit plan for the audit of Web:XU I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the preconditions do not exist. Considering the above, the EP and the audit firm were required, before accepting the audit, to assess whether the limitations of lack of time and financial constraints in accessing the premises of the entity could present a restrictive precondition and impose significant limitations on the EP to perform audit functions including check of internal controls, authenticity of the credentials of the company and active communication with the management and TCWG. 39. TheEP responded that, "Since, Iam based at Ludhiana and the company is based at Ahmedabad, the visit to the place of company is very much time consuming and the financial position of the Company is not very sound and even my fees is also so low that even I cannot bear the travelling expenses. Moreover, since the transactions of the company are also not very significant and to save the cost, we have used the technology and shared the details on email and if required through post". The EP further stated "Since, I have not visited the entity, I have not met with any of the Director but Interact with Mr. Anil Mistry, Director of the Company either on phone or through correspondence on e- m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al confirmation independent of SSWL in accordance with Para 2 of SA 505, which he failed to do. b. The EP failed to document the external confirmation process is evident from the fact that no documentation was found in the Audit File regarding such letters to the parties. c. The EP did not adhere to Para 12 of SA 505 by not adopting alternative procedures in case of non-receipt of confirmations from debtors and creditors. 43. Responding to the charges in the SCN, the EP stated that "We perform the external confirmation independently only, in this case also we have prepared the confirmation and only sent the seal covers to dispatch to parties. Since we have not received the confirmation, we have perform the alternative audit procedure and verified the subsequent transaction, which found to be satisfactory. In this case as soft copy of accounting software is kept as a working.file, the same has not been documented. Since, it a standard format of the account confirmation, we do not keep a copy of the same. Moreover, a list of parties was normally maintained by firm to whom confirmation letters were sent. However, in the present case as the number of parties are very few, it was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Para 14 read with Para A2 l of SA 230 "Audit Documentation"].And SA 230. 47. In view of above, the reply and explanation of the EP cannot be accepted, and we conclude that: i. The EP neither adopted the Audit Procedure of external confirmation of balances of the debtors and the creditors, nor adopted the alternate Audit Procedures. It is only when the EP was questioned through NFRA questionnaire and the SCN, he came up with some replies in support of his carrying out these procedures. As no Audit Documentation was found in support of his stand, his replies are deemed an afterthought and cannot be accepted. ii. The EP's claim that the external confirmation was done through the SSWL, shows his complete disregard for it being done independently of the entity and does not add the required credibility and value to the Audit. iii. By failing to make independent verification, the EP lost the benefit of external confirmation, through which he could have sensed the degree of grave misstatement in purchase and sales. Proper application of Audit Procedures based on Standards on Auditing could save the EP from improper reporting on the Financials of SSWL. 48. We note that PCAOB [PC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e duty bound to consider the same and inform the management about the same. " The EP Further stated that "The two-way communication does not mean that for each and every letter TCWG will respond to the auditor. It is a matter of circumstances and interest which is to be informed by each other for the better conduct of the audit. The relevant para of SA are reproduced herewith (A2 and A3 of SA 260)" 51. We have examined the reply of the EP and note that the audit committee is only a sub-group of TCWG and not TCWG in itself. As per Para 6 (a) of SA 260, TCWG is defined as the person(s) or organization(s) (e.g., a corporate trustee) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process. For some entities, those charged with governance may include management personnel, for example, executive members of a governance board of a private or public sector entity, or an owner-manager. Therefore, communication of the EP with TCWG was not in accordance with provisions of SA considering the following: a. As per para 7 of SA 260, the EP was required to det ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Standards on Audit. As per para 19 (a) of SA 220, in case of a listed company, appointment of EQCR is compulsory. Further, the contention of the EP that there were no significant transactions in the company is false because he himself has claimed to have verified revenue to the tune of Rs.1,791.01 crores for FY 2013-14. Secondly, presuming there were no significant transactions cannot be an excuse for non-adherence to the audit procedures because the standards require appointment of EQCR in case of a listed company. Therefore, we cannot accept the explanation of the EP in this regard. 54. We note that PCAOB [PCAOB release No. 105-2015-040 dated 03.12.2015] , the US Regulator, charged the public accounting firm Stein & Company, LLP (Audit Firm) for its failure to ensure the engagement quality review in the audit of Health Talk Live, Inc. ("Health Talk") and concluded that the "The Firm improperly issued the audit report without obtaining an engagement quality review and concurring approval of issuance and thus violated Auditing Standard No. 7, Engagement Quality Review (''AS 7'')." PCAOB for this misconduct among others, censured the Firm, and imposed a civil mon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies". This charge is proved as the EP failed to conduct the audit in accordance with the SAs and applicable regulations, failed to report the material misstatements in the financial statements arising from overstatement of purchase and sales figures and failed to report non-compliances made by the Company, as explained in Para 19 to54 above. v. The EP committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when he 'Jails 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 and applicable regulations as well as due to his total failure to report the material misstatements and non-compliances made by the Company in the financial statements, as explained in the Para 19 to54 above. F. Penalty & Sanctions 56. It is the duty of an auditor to conduct the audit with professional scepticism and due diligence and report his opinion in an unbiased manner. Statutory audits prov ..... X X X X Extracts X X X X X X X X Extracts X X X X
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