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TMI Blog2023 (7) TMI 1028X X X X Extracts X X X X X X X X Extracts X X X X ..... he inventory on test check basis, as claimed. The Audit File has only two sheets of paper out of which one gives the stock statement of inventory hypothecated to Bank of Baroda, and the other is a copy of the Certificate of Registration tor Modification of Charge issued by the RoC, Mumbai - EP has displayed lack of due diligence and gross negligence in his audit of inventories, and the charge relating to the EP s failure to obtain sufficient appropriate audit evidence in relation to the existence and condition of inventory, in compliance with SA 501, stands proven. Failure to evaluate the arm s length basis for transactions with related parties - HELD THAT:- As there is no testing of the arm s length pricing in the Audit File and the reply of the EP did not specifically answer the charge in the SCN, it is concluded that the EP did not comply with requirements of SA 550.Thus, the charge in the SCN stands proven. Failure to obtain external confirmation for the Trade Receivables Trade Payables - HELD THAT:- In the absence of documentation regarding balance confirmations from the debtors creditors and lack of any evidence of alternate procedures performed, it is obvious t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EP s failure to identify and communicate with T'CWG stands proven. Failure to determine materiality and performance materiality - HELD THAT:- In the absence of any evidence in the audit file and lack of any response from the EP, it is held that the charge related to his failure to determine materiality and performance materiality is established. Failure to document the sampling methodology adopted for substantive testing - HELD THAT:- The EP was charged with failure to obtain sufficient appropriate evidence to support his Opinion and report as required by SA 500. The Audit File has no documentation regarding extent of verification of the transactions, and whether the entire population was verified, or any sampling methodology was applied for the verification of the transactions such as sales purchases - In the absence of any evidence in the audit file, and lack of any satisfactory reply from the EP, it is held that the charge regarding the EP s failure to document the sampling methodology adopted for the substantive testing stands proven. Failure to determine that Engagement Quality Control Reviewer (EQCR) had been appointed - HELD THAT:- The reply of the EP i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reafter) and was the Engagement Partner ( EP hereafter) for the statutory audit of Women Next Loungeries Ltd (WNLL hereafter) for Financial Year 2017-18 (FY 2017-18 hereafter). 2. This order is divided into the following sections: A. Executive Summary B. Introduction Background C. Major lapses in the Audit D. Other lapses in the Audit E. Findings on the Articles of Charges of Professional Misconduct by Auditor F. Penalty Sanctions A. Executive Summary 3. National Financial Reporting Authority (NFRA) is India s independent regulator in respect of matters relating to accounting and auditing of prescribed class of entities which can be broadly described as Public Interest Entities or PIEs. 4. NFRA initiated action under Section 132(4) of the Companies Act, 2013 (the Act hereafter) for investigating into professional misconduct by the Engagement Partner (EP) CA Narayan Prasad Swami, partner of M/s Agarwal Jain Gupta, consequent on information received from the Office of Registrar of Companies, Mumbai (ROC), regarding investigation carried out by the office of Regional Director, Mumbai into the affairs of WNLL, listed on SME segment of Bombay Stock ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ual members or firms of chartered accountants. 8. The statutory auditors, both individual and firms of chartered accountants, are appointed by the members of companies under section 139 of the Act. The statutory auditors, including the Engagement Partners and Engagement Team that conduct the audit, are bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA hereafter), including Standards on Quality Control and Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty under section 132(4) of the Act. 9. NERA received from the Office of Registrar of Companies (ROC), Mumbai, a letter dated 25.11.2020 forwarding findings of an investigation carried out by the office of Regional Director, Mumbai into the affairs of WNLL under section 210(1 (a) and; 210(1) (c) of the Act. 10. The investigation by the ROC revealed that the company s books of accounts had been falsified and revenues inflated; that the auditors had not performed their duties as independent watchdog ; had not verified the assets and inventories; and had not qualified their report. 11. As per its A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t C D of this Order, which deal with major lapses and other lapses in audit respectively. C. Major Lapses in Audit C.1 Failure to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory 18. The EP was charged with failure to obtain sufficient appropriate audit evidence regarding the existence and condition of the inventory by not being in attendance at physical inventory counting as required under para 4 of the SA 501 1 . The inventory of WNLL was = 24.11 crore as at 31.03.2018 and constituted a material item as it amounted to more than 36 % of the balance sheet size of % 66.24 crore. 19. The EP in his reply to the SCN stated that With regards to the verification of inventory, due to high volume of inventories we had applied principles of auditing on test check basis for the said inventory and we formed our opinion on the basis of the verification done by us. In addition to conducting our tests we had also obtained management representation on the said matter. Further we have not noticed any negative remark in stock audit and stock statement provided in Bank... . 20. We find that the Audit File has no evidence of veri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose two locations represented approximately 42 percent of the issuer s inventory at year-end. In addition, the Firm failed to perform any procedures to test the existence of inventory held at other locations and in transit, which represented approximately 58 percent of the issuer s inventory at year-end. C.2. Failure to evaluate the arm s length basis for transactions with related parties. 22. The EP was charged with failure to evaluate the basis of arm s length pricing for the transactions entered with Related Parties as no documentation in this regard was found in the audit file. It was noticed that approximately 54% of the total sales for FY 2017-18 had been made to M/s Shiv Apparel which is identified in the audit file as a partnership firm in which one of the partners, Premila Bhanushali, was the wife of Bhavesh T Bhanushali, Managing Director of WNLL. Though identified as a related party in the list of related parties in the audit file and the Annual Report for FY 2017-18, the auditor failed to perform the risk assessment procedure relating to the related party transactions with M/s Shiv Apparel, as mandated in para 18 of SA 550. 23. The EP, in his reply to the S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and with failure to perform any alternative procedure in the absence of confirmation from debtors and creditors in accordance with Para 12 read with AL8 and A19 of SA 505 6 . Trade Receivables (% 40.06 crore) and Trade Payables (2 19.37 crore) were 60.48% and 29.24% respectively of the balance sheet size, which is clearly significant. 27. The EP, in his reply to the SCN as well as during the personal hearing, stated that the balance confirmations were pending on the date of completion of the audit on 30.05.2018. However, there is no evidence in the Audit File of balance confirmations having been sought from debtors or creditors. 28. In light of the materiality of these transactions, the absence of documentation regarding balance confirmations from the debtors creditors and lack of any evidence of alternate procedures performed, it is obvious that the auditor has failed to comply with SA 505, and the charge regarding EP s failure to obtain sufficient appropriate audit evidence regarding the trade receivables trade payables, stands proven 29. The importance of external confirmation can be best evidenced by referring to the Satyam case 7 in which the Auditing Firm Price ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... specifically respond to the charge on the failure to report on the non-provisioning for 2 9.17 crores of doubtful debts despite the requirement in AS 4. During the personal hearing also, he did not offer any substantive comments on the non-provisioning in respect of doubtful debts. 32. WNLL had identified = 9.17 crore of debts as doubtful debts as at 31.03.2018 which was 22.89% of the trade receivables as on that date and failed to make any provision for these doubtful debts. The EP also failed to report this omission in the Independent Auditor s Report dated 30.05.2018 signed by him even though it was a significant amount. Had this provision been made by WNLL the profit of 2 2.56 crore would have turned into loss of 7 6.61 crore. Hence, the effect of this omission on the true and fair position of the financial statements was material. 33. Accordingly, we hold that the charge regarding the failure to report on the non- provisioning in respect of doubtful debts stands proven. 34. In a similar case ' PCAOB, the US Regulator, revoked the registration of the EP, Martin Lundie, and imposed a monetary penalty of $ 65000. Martin Lundie served as the engagement partner for EY ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ork environment. Further we had relied upon the explanations provided by the management of the Company to understand the business activities of the Company. 37. The reply of the EP is not accepted since it is not supported by any evidence. No documentation is found in the Audit File submitted, in relation to Audit Planning and Audit Strategy for understanding the nature of the entity and its environment. Consequently, no basic understanding of the entity has been recorded in the Audit File. Also, as part of entity s risk assessment process the auditor is required as per para 15 of SA 315 to understand whether the entity has a process for identifying business risks relevant to financial reporting objectives, estimating significance of the risks, assessing likelihood of occurrence and deciding how to address those risk. There are no such papers in the audit file. 38. In the absence of appropriate evidence in the Audit File, we are constrained to conclude that the auditor has failed to plan the audit and has also failed to understand the entity and its environment as mandated by the SAs. 39. In this regard, we note that in the audit of Capstone's 13 by Seale and Beers, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... D.4 Failure to document the sampling methodology adopted for substantive testing 45. The EP was charged with failure to obtain sufficient appropriate evidence to support his Opinion and report as required by SA 500 16 . The Audit File has no documentation regarding extent of verification of the transactions, and whether the entire population was verified, or any sampling methodology was applied for the verification of the transactions such as sales purchases. 46. The EP has not responded to the charges. 47, In the absence of any evidence in the audit file, and lack of any satisfactory reply from the EP, we hold that the charge regarding the EP s failure to document the sampling methodology adopted for the substantive testing stands proven. D.5 Failure to determine that Engagement Quality Control Reviewer (EQCR) had been appointed 48. The EP was charged with failure to determine that the EQCR had been appointed for the audit of WNLL for FY 2017-18, which was in violation of SA 220 17 The WNLL being a listed company, the auditor was required to determine that EQCR had been appointed in terms of Para 19(a) of SA 220. 49. The EP in his reply to SCN has st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... one as per SAs mandated under section 143 of the Act and committed the lapses and omissions as explained and proved in part C D above (as per Section 22 and Clause 9 of the Second Schedule to the CAs Act). F. Penalty Sanctions 53. Section 132(4) of the Companies Act, 2013 provides for penalties 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. 54. Independent Auditors of Public Listed Companies serve a critical public function of enabling the users of Audited Financial Statements to take informed decisions. Absent a robust system of auditing, investors, creditors, and other users of financial statements would not be able to get the true and fair picture of the state of affairs of the company. The best of systems fail, if the professionals implementing the system do not perform their job. This could lead to a serious failure of the financial system which could ultimately result in a breakdown in trust and confidence of investors and the public at large. Thus, the auditor is duty bound to examine and ascertain the integrity o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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