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TMI Blog2022 (9) TMI 1481X X X X Extracts X X X X X X X X Extracts X X X X ..... which are neither recorded nor evidenced. Non-recognition of interest costs on Borrowings classified as NPAs - HELD THAT:- The EP has overlooked this important lapse in the accounts of the company, which has resulted not merely in understating the costs, but also overstating the profits of the company and thereby misstating financial statements of the company, which do not reflect true and fair view of financial statement as required by Section 129 of CA-13. But attitude of the EP is not that of accepting this mistake, but of flatly denying all charges on grounds which show that he has no understanding of the Ind AS or the SAs, which is fundamental for any auditor specially those auditing PIE. Lapses in Audit Documentation - HELD THAT:- The EP believes that there was no reason to maintain audit evidence and documentation on material issues and therefore based his opinion merely on discussions with the management. This cavalier and irresponsible attitude is alarming and shows the EP's lack of knowledge of the Standards and Procedures. This approach and attitude of EP militates against the fundamental objectives of SA 230, para 10 of which requires an auditor to documen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the preparation and presentation of its annual financial statements. 3. M/s. S. Prakash Aggarwal Co. (Firm) was the statutory auditor of VWL and CA Som Prakash Aggarwal was the Engagement Partner (EP) for this statutory audit for FY 2019-20. To examine the case, the EP was requested on 11.11.2021, to submit the Audit File and SQC 1 1 ' Policy of the Firm. The sequence of events thereafter is briefly listed below a) In response, on 08.12.2021, the EP furnished a part audit file along with main points of SQC1 Practice and Procedure followed by the Firm. b) On 21.12.2021, a reminder was sent to the EP asking him to submit the complete audit file and SQC1 Policy of the Firm. The EP sought extension of time of 30 days and was granted time till 20.01.2022. c) On 20.01.2022, the EP submitted the SQC1 Policy of the Firm and some part of the audit file stating that some audit documents available in hard form are of poor quality and their copies were blurred, would be filed after getting digitalized with the help of specialist. d) On 04.02.2022, a questionnaire pertaining to the statutory audit of VWL was sent to the EP requiring him to submit his reply latest b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g of Interest Costs pertaining to Borrowings classified as NPAs: 5.1 Indian Accounting Standard (Ind AS) 109, Financial Instruments (Ind AS 109) mandates classification and measurement of financial liabilities including Interest Costs thereof, till such financial liability is extinguished (Para 3.3.1, 4.2.1, 5.1 and 5.3 of Ind AS 109). The company had borrowings of ₹ 135.65 crores as on 31.03.2020 and ₹ 155.29 crores as on 31.03.2019. It recognized total Interest Costs of ₹ 4.16 crores in FY 2019-20 and ₹ 21.08 crores in FY 2018-19. On perusal of Note 33(a)(i) of Notes to Accounts for the FY 2019-20, it is seen that the company did not recognize the full amount of Interest Costs in its financial statements for FY 2019-20. 5.2 Even if Interest Costs on these Borrowings were to be considered at ₹ 21.07 crores, as disclosed by the company in the previous FY i.e. 2018-19, in place of ₹ 4.16 crores for FY 2019-20, then the potential impact was understatement of Interest Costs and Current Liabilities by at least ₹ 16.91 crores. Such an understatement of costs leads to an overstatement of profit. In the instant case, the reported PBT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scribed in previous paragraphs, the following other serious lapses were noticed in the conduct of audit by the EP, which are in violation of Standards on Auditing (SAs): (i) Absence of audit documentation for non-recognition of Interest Costs on the Borrowings classified as NPAs by the lending banks. Absence of documentation challenging the Management for such erroneous accounting treatment. (ii) Poor quality of Audit documentation that makes it difficult for an experienced auditor, having no previous connection with the extant audit engagement to understand the rationale for such accounting treatment. (iii) Absence of audit evidence in the form of direct confirmations in respect of outstandings from banks. (iv) Absence of crucial audit evidence in this case like loan agreements, correspondences with banks etc. (v) Absence of any evidence regarding determination of Those Charged with Governance (TCWG 3 ) within the entity and the communications made with them, if any. (vi) Non-engagement of Engagement Quality Control Reviewer (EQCR) for VWL, which is a significant non-compliance with the SAs 4 . Therefore, EP has not complied with most of the SAs an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... just for adopting alternatives. 8.2 In response to Point 3 of the SCN, wherein it was pointed out that the EP did not discharge his professional duties in accordance with the SA 200 and other SAs, the EP replied that- Attention is invited to Para 7 of SA 200 which states that the SAs contain objectives, requirements and application and other explanatory material that are designed to support the auditor in obtaining reasonable assurance . An auditor gains clarity and support from SAs to undertake his assignment objectively. It is a supporting document. How to do an audit is not specified in the SAs. An auditor has to device his own methods and processes. An auditor has to find ways and means to obtain reasonable assurance about the financial position presented in the financial statements. SAs only provide principles. NFRA seemed to be proposing to judge the quality of audit work undertaken by the Respondent based on the principles stated in the SAs alone without considering the facts and figures in the financial statements in contention . 8.3 In response to Point 3.3 of the SCN pointing out failure to exercise professional scepticism in key areas of financial r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elf. Judgment made by the Respondent was not only based on working papers available in writing, but also based on outputs from several discussions with company management which is integral to forming an opinion . The EP further submitted that- Observations in Paras (a) to (i) under the heading Audit Documentation and Audit Evidences do not establish that the audit report issued by the Respondent was deficient in any manner. The lone point in debate is the correctness of accounting of interest in 2019-20 and appropriateness of audit opinion in this regard. This is a very technical point strictly decided with reference to the principles in Ind AS 109 Appendix A. There is no need of any detailed working note or working paper as support to form a view on a principle of accounting, based on Ind AS 109. The NFRA has erred in its perception that an audit opinion not backed by a working note in the working papers, has some kind of deficiency what has to be tested is the correctness of the audit opinion based on the explanations offered by the Respondent. If an audit opinion is suspected to be flawed or erroneous, then the Auditor can rely up on working notes and working pap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n account, future cash flows associated with loan would naturally be according to contractual rate of interest. However when a borrower is unlikely to settle his loan obligations at contractual terms, because of financial problems, expected future cash flows associated with the loan will not be according to contractual terms, but based on the amount at which it will be settled. Therefore the proposition in the SCN that company should have provided interest cost, is the result of improper understanding of the EIR method in Ind AS 109. NFRA has not specified whether the explanation of the Respondent is unacceptable, because it disputes the interpretation of the Respondent about the principles of EIR method OR because of any other reason. If the former is the case, then NFRA shall seek expert views on this technical point before alleging misconduct against the Respondent. If not, the NFRA shall specify the other reason if any for the Respondent to reply . 8.7 In response to Point 4.2.1 of the SCN regarding Non-implementation of quality control procedures at the engagement level including non-appointment of EQCR, the EP replied that- contents in Para 4.2.1 on non-appointment o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t did not document it. 9. Analysis and Findings 9.1 Non-compliance with the Standards (i) We have gone through all the materials on record and the written submissions of the EP dated 23.2.2022 and 27.7.2022. The SAs and Ind AS are mandatory for the preparers of accounts and the statutory auditors in the preparation and audit of financial statements of listed entities. It is a flawed understanding of the EP, when he speaks of auditing standards not being thumb rules, but a set of principles for audit, which allow auditors to adopt alternative processes. His reply on this aspect has been listed in para 8.1 above. The EP does not understand that the present-day standard setting has undergone a paradigm shift wherein sufficient application guidance and other explanatory material is available in SAs and Ind AS apart from the principles of the standards, which are required to be mandatorily followed. All auditing and accountancy professionals should be seized of these. (ii) Section 143(9) of the Companies Act, 2013 mandates that Every auditor shall comply with the auditing standards. Again, Para 18 of SA 200 requires that the auditor shall comply with all SAs relev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the management about this OTS, but did not document the discussions or document the proposed One Time Settlement scheme. (ii) The EP in his reply dated 23.02.2022, relied on a Management Representation Letter (MRL) dated 24.06.2020 for non-recognition of interest costs on borrowings classified as NPAs by the lender banks. But as discussed in para 5.3 above, the MRL was not in line with the SAs, as it gave no plausible explanation as to why the interest costs were not accounted for, it was not on the letter head of the company and also the name or designation of the signing authority was not available. The MRL in its Para 3(iv) stated that provision for interest on bank borrowings not made as bank has classified bank borrowings as NPA. Above all, Para 13(e) of the MRL talks about inventory records as on 30.09.2020 while the MRL itself was dated 24.06.2020, i.e. two days before signing of the Audit Report by the EP. Quoting Para 13(e) of the MRL- Inventory records have been properly reconciled, with the financial records and all the inventories as at 30th September 2020 are the property of the company and have been valued as per the existing and consisting accounting policy of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (v) Thus, we find that the EP has overlooked this important lapse in the accounts of the company, which has resulted not merely in understating the costs, but also overstating the profits of the company and thereby misstating financial statements of the company, which do not reflect true and fair view of financial statement as required by Section 129 of CA-13. But attitude of the EP is not that of accepting this mistake, but of flatly denying all charges on grounds which show that he has no understanding of the Ind AS or the SAs, which is fundamental for any auditor specially those auditing PIE 6 . 9.3 Lapses in Audit Documentation (i) On the issue of insufficiency of audit documentation, excerpts of the EP's replies are available at Para 8.4. Instead of explaining as to why his audit file is devoid of the requisite documentation, he has turned around and stated that NFRA is not in possession of any evidence to show that he had not discussed issues with the management. The EP blatantly goes on to say that he did not follow a system of minuting meetings. The EP further says that NFRA is grossly wrong in assuming that audit documentation is what will prove the correct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as explained in paras 9.1 to 9.4 above. ii. CA Som Prakash Aggarwal committed professional misconduct as defined by Section 132(4) of the Companies Act, read with Section 22 and clause 6 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that a CA is guilty of professional misconduct when he fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity . This charge is proved as CA Som Prakash Aggarwal failed to disclose in his report the material misstatements made by the Company in the area of non-recognition of interest costs pertaining to Borrowings classified as NPAs by the lender banks as explained in the paras 9.1 to 9.4 above. iii. CA Som Prakash Aggarwal committed professional misconduct as defined by Section 132(4) of the Companies Act, read with Section 22 and clause 7 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that a CA is guilty of professional misconduct when he does not exercise due diligence or is grossly negligent in the conduct of h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Companies Act views proved cases of professional misconduct is evident from the fact that a minimum punishment is laid down by the law. While determining the penalty in this case, several factors have been considered. 11.2 Audited financial statements are the basic inputs for innumerable transactions in the economy. A breakdown, or severe damage, to the trust and confidence that the public and investors have in financial statements, would have ramifications that go far beyond the limited activities of an auditee company. 11.3 An auditor has a societal mandate to provide an independent and true opinion on the financials of the entity audited by him, so as to inspire trust and confidence in the financial system. As professionals, auditors are expected to judge the significance of the operations of the entity they audit and accordingly calibrate their approach and procedures. The auditor's duty of exercising due diligence is owed to the users of the financial statements. The objective of general-purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making d ..... X X X X Extracts X X X X X X X X Extracts X X X X
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