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TMI Blog2023 (7) TMI 1244X X X X Extracts X X X X X X X X Extracts X X X X ..... tablish and maintain a system of quality control to provide it with reasonable assurance that: a) The firm and its personnel comply with professional standards and regulatory and legal requirements; and b) The reports issued by the firm or engagement partners are appropriate in the circumstances. On examining pointwise reply it is found that all charges are proved except the charge relating to constitution of the Audit Committee. Therefore, CA Lavitha Shetty, Proprietor of the Audit Firm is also responsible for non-compliance with provisions relating to Quality Control Systems, Policies and Procedures of SA 220 and SQC 1. Articles of Charges of Professional Misconduct by the Statutory Auditor - HELD THAT:- The Auditor has made a series of serious departures from the Standards and the Law, in conduct of the audit of MACEL for FY 2018-19 - it is proved that the Auditor had issued unmodified audit opinion on the Financial Statements without reporting diversion of funds, evergreening of loans and committed other serious lapses during performance of audit. Based on the discussion and analysis, it is concluded that the Auditor has committed Professional Misconduct as define ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amgaluru, for the Financial Year ('FY' hereafter) 2018-19. 2 This Order is divided into the following sections: A. Executive Summary B. Introduction Background C. Major lapses in the audit: Failure in audit relating to fraudulent diversion of funds and related matters D. Other non-compliances with Laws and Standards E. Articles of Charges of Professional Misconduct by the Statutory Auditor F. Penalty Sanctions. A. EXECUTIVE SUMMARY 3 Pursuant to Securities and Exchange Board of lndia ('SEBI' hereafter) sharing in April 2022 its investigation regarding diversion of funds worth Rs 3,535 crores from seven subsidiary companies of Coffee Day Enterprises Limited ('CDEL' hereafter), a listed company, to Mysore Amalgamated Coffee Estate Limited ('MACEL' or 'the company' hereafter), an entity owned and controlled by the promoters of CDEL, NFRA initiated investigations under Section 132( 4) of the Act. 4 NFRA's investigations inter alia revealed that the MACEL's Auditor for the FY 2018-19 failed to meet the relevant requirements of the Standards on Auditing ('SA' hereafter) in a number of significant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of related party balances. The EP wrongly reported that MACEL was not required to be registered under section 45 IA of The Reserve Bank of lndia Act 1934 despite the fact that the principal business of MAC EL had changed from coffee grower to Non-Banking Finance Company on account of diversion of funds. Besides these, the EP violated a number of Standards on Auditing and also failed to report violation of Accounting Standards by MACEL. 6 Based on investigation and proceedings under section 132 (4) of the Companies Act and after giving her opportunity to present her case, NFRA has found the EP guilty of professional misconduct and imposes through this Order the following monetary penalties and sanctions with effect from a period of 30 days from issuance of this Order: a) Imposition of a monetary penalty of Rs Five Lakhs only upon CA Lavitha Shetty; b) In addition, CA Lavitha Shetty is debarred for a period of five years 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; B. INTRODUCTION BACKGROUND 7 National Fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sr No. Names of the Subsidiary Companies from which funds were diverted to MACEL Outstanding balance as on March 31, 2019 July 31, 2019 1 Coffee Day Global Ltd (CDGL) 65 1,112 2 Tanglin Retail Reality Developments Pvt Ltd(TRRDPL) 789 1,050 3 Tanglin Developments Ltd (TDL) (-) 12 620 4 Giri Vidhyuth (India) Ltd. (GVIL) - 370 5 Coffee Day Hotels and Resorts Pvt Ltd(CDH RPL) - 155 6 Coffee Day Trading Ltd (CDTL) - 125 7 Coffee Day Econ Pvt Ltd (CDEPL) - 103 Total 842 3,535 12 As per the Financial Statements of MACEL, Rs 3,535 crore was further transferr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Act. Based on an examination of the Audit File and other materials on record, NFRA issued a Show Cause Notice ('SCN' hereafter) to the Auditor on 03.11.2022 asking the Auditor to show cause by 03.12.2022 why penal provisions of section 132(4)(c) of the Companies Act 2013 should not be invoked for professional misconduct of: a) Failure to disclose a material fact known to the EP which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where the Statutory Auditor is concerned with that financial statement in a professional capacity. b) Failure to report a material misstatement known to the EP to appear in a financial statement with which the Statutory Auditor are concerned in a professional capacity. c) Failure to exercise due diligence and being grossly negligent in the conduct of professional duties. d) Failure 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, and e) Failure to invite attention to material departure from the generally accepted procedures of audit applicable to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ionship with subsidiary companies of CDEL except CDGL, the sole. buyer of Coffee beans produced by MACEL. As per the Financial Statements of MACEL for 2018-19, its borrowings of Rs 4,112.47 crores constituted 99.86% of total liabilities of Rs 4,118.18 crores, while 99.07% of its total assets of Rs 3,894.53 crores were the loans advances worth Rs 3,858.52 crores. MACEL had meagre Revenue from operations of Rs 1.71 crores interest income of Rs 2.33 crores only but its Finance cost on borrowings was Rs 55.38 crores which constituted 90.89% of the total cost of Rs 60.93 crores. The loss incurred by MACEL during the year was Rs 56.89 crores and MACEL had a negative net worth of Rs 223.65 crores. All the above stated borrowings (except bank borrowings of Rs 272.32 crores) and lending were interest free, repayable on demand and not supported by any Contract/ Agreement. The Financial Statements of MACEL indicated that it had abnormally high transactions in loans advances and balances with related parties, which were outside the normal course of business of the company, strongly indicating that MACEL was being misused by the promoters for diversion of funds from subsidiary companies o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... V G Siddhartha (VGS), Malavika Hegde (wife of VGS) partnership firm in which he/she is a partner 3,235.16 S V Gangaiah Hegde (Father of VGS) 2.31 Vasanthi Hegde (Mother of VGS) 1.48 Total 3,238.95 23 It can be observed from Tables-2 3 above that loans advances taken by the company were not for the business activities of the company, but were used for onward lending to the related parties, mainly promoters. Out of the total assets of Rs 3,894.53 crores, only Rs 36.01 crores appear to have been used for business activity, and remaining Rs 3,858.52 crores (99.07% of total assets) were given as Loans Advances, which was not in the normal course of business of MACEL, but were used for diversion of funds, resulting in material and pervasive misstatement on the Assets side of the Balance Sheet. 4 Similarly, out of the total liabilities of Rs 4,118.18 crores, borrowings accounted for Rs 4,112.47 crores (99.86%). Keeping in mind that only Rs 36.01 crores were used for business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions. The funds were payable on demand but no agreements had been signed. In respect of loans and advances given to group entities, he had admitted that the loans were payable on demand, that no agreements were signed and the account of the group was being maintained as a running account. These admissions, together with the financial information in Table-3, are strong indicators of fraudulent diversion of funds. Noting that had the Auditor applied professional judgment and skepticism to the admitted facts that no agreements were signed for the financial arrangements involving substantial funds, huge sum of loans were payable on demand, the group accounts were maintained as running account; and the management letter, she would have assessed the RoMM as high and designed performed appropriate audit procedures. The SCN charged the Auditor with non-compliance with SA 240. 27 The Auditor's above-mentioned lack of due diligence and gross negligence was also a violation of section 14 3 ( 12) of the Act under which the Auditor had the statutory duty to report the offence of fraud to the Central Government. However, the Auditor had reported 6 that no material fraud by or on the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arged with failure to evaluate recoverability of loans worth Rs 3,235.16 crores made to VGS (the then Chairman Managing Director of CDEL), his wife Mrs. Malavika Hegde and entities controlled by them ('VGS Others' hereafter) resulting in non-compliance with section 143(3)(e) of the Act and SA 500, Audit Evidence. 31 As per Accounting Standard (AS) 4 10 , which deals with Contingencies and events occurring after the Balance Sheet date, MACEL was required to assess the recoverability of loans given to VGS Others, however, MACEL did not do so. Further, MACEL had neither provided any probable loss on account of impairment of these loans nor disclosed anything about this matter in the Financial Statements. Thus, MACEL violated AS 4. 32 The Auditor had observed that MACEL was facing huge mismatch in short term payables with short term receivables. Director of MACEL replied vide letter dated 30.05.2019 that this was a temporary phenomenon and the company was confident of sorting out the issue and it could not impact on the liquidity crunch. He had attached net worth certificate of VGS issued by M/s Sundaresha Associates vide letter dated 05.03.2019 certifying net wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hout any agreement between the parties, accounts were maintained as a running account and were payable/receivable on demand. 36 In respect of compliance with SA 200, SA 315 SA 330, the Auditor replied that she had performed necessary audit procedures to understand the entity and to identify RoMM. However, after performing audit procedures, no RoMM was identified or assessed. (She referred to page no- 165-166, 169, 194-195 and 202 the Audit File forming part of Annexure to SCN). She further replied that huge volumes of advances made to related parties and consequent outstanding balances as reflected in the Financial Statements did not pose any risk of material misstatements as these were the effect of actual transactions; that she had obtained fair knowledge of the entity, its environment, financial reporting system and internal controls in the past years audits; that, as mentioned in SCN, the business group had around 10000 acres of coffee plantations and MAC EL had around 578 acres of coffee plantations. According to the Auditor, MACEL had impressed upon her that it played an important role in monitoring coffee plantations which were managed by the CCD group (Coffee Day Group ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of their business objectives cannot constitute any fraud. They were genuine recoverable amounts. She termed it as a case of liquidity crisis resulting from cash flow management which was under the control of VGS. It could be criticized as poor corporate governance but did not make it a fraudulent case. The Auditor further stated that the absence of agreement for advance transactions did not make it a case of transactions with fraudulent intentions. 40 Responding to the charge relating to non-compliance with section 143(12) of the Act, the Auditor replied that use of words if Auditor .... has reason to believe .... in section 143(12) of the Act means that expectation of law from the Auditor is not that she would detect every potential fraud and report. According to the audit conducted by her, no fraud or misappropriation of assets was observed. An auditor is not skilled to detect fraud. She further stated that the family of VGS holding 91 % shares, carried out the transactions hence the issue was not about absence of internal control. 41 Responding to the charge relating to violation of PMLA, the Auditor replied that she had no knowledge that these transactions were frau ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 58.52 crores for its business purpose. The Auditor has admitted that during the audit for FY 2018-19, she had completely relied upon management explanations that huge amounts of borrowings from related parties and lending to related parties were for furtherance of coffee business of the associated entities. MACEL was not a financial institution therefore routing of such huge amounts through it cannot be considered as transactions in the ordinary course of business of MACEL, as it did not have any business relationship with the said associated entities. Therefore, before relying on the management explanation, the Auditor was required to evaluate the business purpose behind such huge borrowings and lending transactions with related parties, which was not done. 45 The Audit work papers quoted by the Auditor have been perused. Page 165-167 of the Audit File is a certified copy of resolution passed in EGM authorising the Board of Directors to borrow and lend money up to Rs 6,000 crores. However, pursuant to the EGM resolution, the Board of Directors did not pass any resolution for approval of the borrowings and lending transactions, which were undertaken by MACEL. Section 179(3) of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 48 The audit work papers relied upon by the Auditor as having details of performing risk assessment procedures have also been perused. Page 168 of the Audit File is a statement prepared by MAC EL containing some basic details about the company like nature of business and operational heads of the company. Page 169 is a statement prepared by MACEL regarding assessment of risk in the area of sales, purchase, estate works and bank accounts. These documents do not contain any details about risk assessment procedure performed by the Auditor to identify, assess and respond to RoMM due to fraud. Page 170 to 193 contain information obtained from MACEL relating to shareholders list and Director's details and declarations. Page 194 195 contain Internal Financial Control Policy prepared by MACEL containing high level general information about segregation of duties, authorization approval, custodial security arrangement and review reconciliation. No specific information about these areas is mentioned in these documents prepared by MACEL. The Auditor has not evaluated these documents. Therefore, the contention of the Auditor of having performed risk assessment procedure is factual ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y business purpose, without Contract/Agreement and without obtaining any security. Therefore, this fraud could have been easily noticed by the Auditor. She failed to report this offence of fraud to the Government of lndia and thus violated section 143(12) of the Act. The Auditor has also violated CARO, as she reported that no fraud was noticed during the course of audit. 51 In respect of the Auditor's reply relating to violation of PMLA that as per her knowledge, these transactions were not fraudulent and there is no finding by any authority that such transactions fall within the definition of section 420 of IPC or section 3 of PMLA, it has already been discussed that the fraudulent diversion of funds were visible from the Financial Statements of MACEL. The Auditor was required to exercise professional judgement to identify fraudulent transactions and make audit report accordingly. Diversion of funds to personal accounts of promoters, their relatives and entities owned/controlled by them is clear proof of cheating and dishonesty, and thus falls under section 420 of IPC thereby attracting section 3 of PMLA. We find that the Auditor has failed to report this violation in the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness assets , as claimed by the Auditor in her reply. There is no evaluation of recoverability of such business assets in the Audit File. Therefore, this part of the reply is an afterthought to cover up negligence during the conduct of the Audit. 56 As already discussed in preceding paras that funds were fraudulently diverted to 'VGS Others' without any business objective of MACEL, which did not have any business relationship with VGS Others. Therefore, there is no merit in the reply that funds were given for furtherance of business objectives of MACEL. 57 Para 11 of AS 4 states 'The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph IO is not met, unless the possibility of a loss is remote ' . The Auditor has stated that this case falls under the category of remote possibility of loss , without substantiating this conclusion in the Audit File. Therefore, we find this reply is also an afterthought to cover up her failure to evaluate recoverability of loans given to 'VGS Others'. 58 Further, the Auditor did not evaluate the competence of the CA Firm which issued the net w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Auditor did not exercise the necessary professional skepticism to determine whether these transactions posed a risk of material misstatement due to fraud. 62 In view of above analysis, we find that this charge is proved that the Auditor has violated section 143(3)(e), 143(12) of the Act, CARO, SA 200, SA 240, SA 250, SA 315, SA 330, SA 500 and failed to report violation of section 179(3), 180(1)( c) and 186 of the Act by MACEL. C.2 Lapses in audit relating to accounting of related party borrowings and bank borrowings resulting in misstatements by Rs 2,363.34 crore due to fraud 63 The Auditor was charged with failure to perform risk assessment procedure to identify and assess Risk of Material Misstatements due to fraud and failure to exercise professional skepticism while performing audit of related party balances which were fraudulently understated by another accounting fraud involving issuance of cheques showing repayment of related party loans in FY 2018-19 (March 2019). Such cheques were cleared in FY 2019-20 by evergreening of loans through structured circulation of funds among Coffee Day Group entities. This resulted in her failure to evaluate report materia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ormation in the Financial Statements. The clearance of large numbers of cheques by circulating significantly lower bank balance, popularly known as 'Ever Greening of Loans', was an indicator of the severe financial crisis in MACEL and fraudulent intentions of MACEL to misstate the Financial Statements. 66 There is no evidence in the Audit File that the Auditor had performed any risk assessment procedures to identify risk of misstatement 12 due to fraudulent conversion of related party borrowings into bank borrowings. This was despite the fact that note no-5 to the Financial Statements clearly depicted a credit balance in bank accounts of Rs 1,713.57 crores with foot note that it represents payments made by the MACEL, which were yet to be cleared by the bank. 67 One of the important substantive audit procedures is to examine the Bank Reconciliation Statement. Evergreening of loans through structured circulation of funds shows that the Auditor did not exercise due diligence while performing an audit of BRS. 68 The Auditor was required 13 to perform the audit with Professional Skepticism recognizing the possibility that a material misstatement due to fraud could exi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... off dues before year end to achieve a cleaner Balance sheet is the motivation for a management to undertake such transactions. An auditor would not be able to see any fraudulent intent in issuance of such cheques. Further, management had not revealed the reality to the Auditor during audit. Accordingly, to her, no amount of professional skepticism would help the auditor to suspect the management's fraudulent intent over such practice. 73 The Auditor has stated that allegation of fraudulent intentions of MACEL for evergreening of loans was based on study of the details of funding in 2019-20 to clear the cheques issued in 2018- 19. The process followed in audit is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement. While drawing attention to para 10 to 15 of SA 700 relating to the Auditor's responsibility relating to forming audit opinion, she argued that it does not include any mandatory responsibility on an auditor to examine the manner in which funds were managed by the company in the subsequent year to clear the cheques issued in the year under audit. That is not in the scope of a Statutory Auditor, in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of amounts, correctness of time of recognition, completeness of transactions with associated documents, classification, presentation and disclosures in FS through a detailed process achieved through on ground actions in an exercise involving verification, validation, examination, discussion and inspection etc. The Auditor claimed that it is not humanly possible to record the whole of the process adopted by an auditor in her working papers, nor is there any such requirement in SA 230, Audit Documentation. However, the Auditor had documented the procedure followed in her own way for compliance of SA 23 0 and SA 315. The process of examination by the Auditor did not result in identification of risk of any material misstatement. 79 The Auditor further stated that there is no provision in law to hold an auditor guilty for professional misconduct because she has erred in her judgment in the application of provisions in SA 240 or SA 200. Standards of Auditing are not reference material to decide on charges of professional misconduct against an auditor; on the contrary they are guidance to an auditor to act professionally. 80 While denying the charges relating to violation of sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tements for FY 2018-19 and reduced the loans given to promoter owned MACEL by same amount on the basis of the cheques received from MACEL. In the next financial year i.e., 2019- 20, these cheques were cleared in a series of circular transactions among related parties. Such as: On 10.04.2019, MACEL received Rs 90 crores from CDGL which started a series of sham payments on the same day in a circular manner for clearance of four cheques of Rs 350 crores issued to TDL on 31.03.2019 eight cheques of Rs 650 crores issued to TRRDPL on 30.03.2019. For example, Rs 90 crores received from CDGL was paid by MACEL to TDL, which then paid Rs 90 crores to GVIL, which then paid Rs 90 crores to MACEL, which then paid Rs 50 crores to GVIL, which then paid Rs 50 crores to MACEL, which then paid Rs 90 crores to TDL, which then paid Rs 90 crores to GVIL, which then paid Rs 90 crores to MACEL, which then paid Rs 90 crores to TDL, which then paid Rs 90 crores to GVIL, which then paid Rs 90 to MACEL, which then paid Rs 90 crores to TRRDPL, thereafter Rs 90 crores was paid by TDL to MAC EL, which then paid Rs 80 crores to TDL, and so on ....... . 83 Similar instances were also noticed in the following ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e cheques were issued for repayment of related party loans. The accounting effect of these pipeline entries was that related party loans were reduced and bank liabilities were increased in the balance sheet as on 31-03-2019. Therefore, in our view, the Financial Statements of MACEL conveyed a false message that MACEL's loan liabilities from related parties were less by Rs 2,038.54 crores and liability towards bank was higher by the same amount, thus the Balance Sheet did not give true and fair view of its state of affairs, which the Auditor failed to report in her Audit Report. 86 Further, the Auditor has claimed that during the audit of2018-19, she had verified bank statement of 2019-20 to verify clearance of cheques issued/received in 2018-19 but not cleared/received as on 31-03-2019. According to her, verifying the source of funds for clearance of these cheques was not required for the Audit of 2018-19. For analysis of this reply, we show in Table 6 an excerpt of the bank statement of MACEL on 10-04-2019: 87 It is surprising that the Auditor while looking at debit entries (withdrawal) in this bank statement for verification of cheques issued but not cleared, did n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect the amounts recorded in the financial statements . 90 The Auditor, in her reply to not recognising the apparent fraud has drawn attention to para 13 of SA 240 providing that unless the auditor has reason to believe the contrary, the auditor may accept records and documents genuine . It is surprising how the Auditor did not see the contents of the preceding para 12 of SA 240, which provides that the auditor shall maintain professional skepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor's past experience of the honesty and integrity of the entity's management and those charged with governance . The Auditor evidently did not exercise professional skepticism while performing audit of bank transactions and relied on her wrong impression that promoters were honest and had good reputation. 91 The admission by the Auditor that her process of examination did not result in identification of RoMM, is a proof that her process of examination of RoMM lacked depth and professional skepticism so as to completely overlook an obvious, visible evergreening of loans through circulation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contained in their Requirements section and are represented by use of shall . Further, section 143(9) of the Act also states that Every auditor shall comply with the auditing standards . (Emphasis supplied). 94 Regarding non-adherence with section 14 3 (1 )(b) of the Act with reference to structured circulation of funds, we note that this was intentionally done by MACEL to misstate the Financial Statements as it did not result in net cash flow and remained only book entries, therefore resulting in fictitious accounting entries as per section 14 3 (1 )(b) of the Act. 95 We observe that the Auditor has not given any reply in respect of the charge relating to failure to exercise due diligence during audit of Bank Reconciliation Statement (' BRS' hereafter), which has many deficiencies like realisation of Rs 164.58 crores appearing in BRS but not found in bank statements, discrepancy in cheque number between BRS and bank statements, cheques bearing dates of FY 2019-20 were accounted for in FY 2018-19, same cheque number used for multiple payments of different amounts, same cheque number has different dates at different places and difference between instrument date ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her when forming an overall conclusion as to whether the financial statements are consistent with her understanding of MACEL. As a prudent audit procedure, she was required to critically analyze the finance cost bank borrowings with the assets used for business activity of MACEL. Professional Skepticism should have aroused suspicion in her mind that something was amiss. As per para 32( c) of SA 240, she was required to evaluate whether there was any fraud in recognition of finance cost (being unusual in nature). Examination of Audit File shows that she did not perform any audit procedure or question the TCWG and Management about the same, and was therefore charged to have violated SA 200, SA 240, SA 315 SA 520. 100 Further, as per para 4.2 of AS 5, Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly. Finance cost was not for ordinary activity of MACEL, hence was required to be treated as extraordinary item, if at all it was justifiable. As per Division I of Schedule III of the Act and para 8 of AS 5, extraord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordingly there is no violation of section 143(2) and 143(3)(e) of the Act. Analysis of reply 104 MACEL is a small company having Revenue from Operation of Rs 1.71 crores only. Its total business assets were Rs 36.01 crores only in the form of Tangible assets, Inventories, Cash and Cash equivalent and Other Current Assets. Whereas its Balance Sheet size was Rs 3,894.53 crores mainly on account of Rs 3,858.51 crores loans given to related parties, with whom MACEL did not have any business relations. Therefore, the loans given to the related parties were beyond the normal course of business. 105 MACEL's total borrowings were Rs 4,112.47 crores, of which a major part was from related parties. Since the assets used for the business activities of MACEL amounted to only Rs 36.01 crores, remaining borrowings of Rs 4,076.46 crores (Rs 4112.47 crores Rs 36.01 crores) were diverted to related parties without any business rationale. Therefore, diversion of funds was clearly visible from the Balance Sheet signed by the Auditor. 106 MACEL recognised huge interest expenses of Rs 55.38 crores, whereas interest income of Rs 2.34 crores only was recognised in its Profit and Loss S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of transaction determines whether a transaction is distinct from ordinary activity of the enterprise. In this case interest expense did not arise in the course of ordinary activity of MACEL but due to borrowing meant to siphon off funds by the promoters, therefore this is a rare occasion and such interest expense was to be classified as extraordinary expense. 110 Division I of Schedule III of the Act prescribes the format of the Profit and Loss Statement, which has been followed by MACEL. This format includes one line item 'Extraordinary Items'. MACEL has shown NIL amount against this line item. MACEL did not classify interest cost of Rs 55.38 crores as extraordinary item in the Profit and Loss Statement, thus violated Division I of Schedule III of the Act and AS 5. The Auditor did not report this violation in her Audit Report. In view of above analysis, we find that the Auditor has violated section 143(2) and 143(3)(e) of the Act. C.4 Lapses in audit relating to misstatement of Rs 909.99 crores in Cash Flow Statement 111 The Auditor was charged with failure to report material misstatement of Rs 909 .99 crores in Cash Flow Statement resulting in violation of se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Accounting Policies, and Section 129( 5) of the Act. The Auditor finally stated that according to the substance of the advance transactions, it was proper to present them as Cash Flow from Operating Activities. Analysis of Reply 114 Para 3 and 4 of AS 3 describe the importance of Cash Flow Information as A cash flow statement, when used in conjunction with the other financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events. Historical cash flow information is often used as an indic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Cash Outgo on account of loans/advances of Rs 59.09 crores made to related parties, it is observed that these were not included in cash equivalent, therefore these were Investment Activities as per its definition quoted above. MACEL did not have any operational/business relations with other coffee estates managed by associate entities; thus this amount was not used for main revenue-producing business activities of MACEL. 119 Further, as per normal business practice an 'Advance' is given to a supplier of goods or service as a part payment, to be adjusted at the time of final settlement or excess amount, if any, to be refunded at the time of final settlement after delivery of goods or service. Whereas 'Loan' is money given by one person to another with a clear understanding that the recipient of the money will return the money to the lender after a certain period of time normally with interest. In this case, money given by MACEL to other entities was not for supply of any goods or services to MACEL, therefore such Cash Out Flow cannot be treated as Advance given for principal revenue-producing activities of MACEL. Accordingly, this Cash Flow of Rs 59.09 crores does ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in which VGS was major shareholder. There is no evidence in the Audit File regarding the Auditor's evaluation whether or not these were prejudicial to the interest of the company or its members. 124 Further, these transactions and balances were required to be disclosed m the Financial Statements as per para 23 and 24 of AS 18, Related Party Disclosures. MACEL did not make such disclosures in Note no.16 on Related Party Disclosures in the Financial Statements and thus violated AS 18. The Auditor did not report this violation, and was therefore charged to have violated section 143(2) and 143(3)(e) of the Act. Reply of the Auditor 125 While admitting that Audit File does not contain anything regarding evaluation of whether guarantees given were against the interest of the company, the Auditor stated that there is no obligation on the Auditor to evaluate the guarantees from that angle as per clause (iii) and (iv) of the CARO. According to her, this was at worst an error of judgement. This along with non-inclusion of transactions in related party disclosures were admitted by her and she requested to be pardoned. Analysis of reply 126 Issuance of corporate guara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tor was required to modify her audit report in case of material misstatements in the Financial Statements, which she failed to do. 130 In view of the above analysis, we find that this charge is proved that the Auditor violated section 143(2) and 143(3)(e) of the Act. C.6 Lapses in making audit conclusions and forming audit opinion (consolidated misstatements of point no (C.1) to (C.5) above, Rs 11,393.69 crores) 131 The Auditor was charged that she did not consider material misstatements of Rs 11,393.69 crores [loans advances (liabilities)-Rs 4076.46 crores, loans advances (assets)- Rs 3,858.52 crores, fraudulent conversion of related party borrowings into bank borrowings Rs 2,363.34 crores, incorrect recognition of finance cost-Rs 55.38 crores, overstatement of cash flow from operating activities- Rs 909.99 crores and issuance of corporate guarantee and creation of charge on the assets of the company-Rs 130 crores without any rationale], while making audit conclusions and forming audit opinion, and thus violated SA 700, Forming an Opinion and Reporting on Financial Statements, which required the Auditor to conclude as to whether the Auditor has obtained reasonable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting to non-funded related party transactions, the Auditor admitted that this matter inadvertently escaped disclosure. 136 The Auditor replied that both these admitted misstatements had no impact on the Balance Sheet or on the Profit and Loss Statement. They affected either Cash Flow Statement or the Related Party Transactions (RPT) disclosures. While drawing attention to para 2 of SA 320 relating to description of the term 'Material', the Auditor contended that admitted misstatement of Rs 68 crores in Cash Flow Statement is not one which could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements, for the triviality of amount as compared to overall cash flow of the entity. She further contended that misstatement of Rs 130 crores in RPT disclosure had no significant impact because these were non-funded obligations and only contingent in nature. The Auditor argued that these two omissions would not have constituted material misstatement going by the principles of SA 320. Analysis of reply 137 The import of the Auditor's reply is that all transactions have been recorded accounted for and as such th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elevant financial information that the actual scale of operation of MACEL was very small compared to the funds received through it as a conduit, it is clear that misstatement of Rs 11,393.69 crores in the Financial Statements of MACEL were material misstatements. It is baffling that the Auditor did not find materiality in these staggering figures. In the presence of such pervasive misstatements, the Financial Statements of MACEL for FY 2018-19 did not give true and fair view of its Financial Position as on 31.03.2019, Financial Performance and Cash Flows for the FY 2018-19. Despite this, the Auditor had falsely reported that the Financial Statements of MACEL for FY 2018-19 gave true and fair view of its Financial Position, Financial Performance and Cash Flow. We find that the Auditor was grossly negligent in forming the Audit Opinion, and equally absurd in defending that position, and therefore we conclude that this charge is proved that the Auditor violated SA 320 SA 700. D. Other Non-compliances with Laws and Standards In addition to the lapses detailed in Section- C of the Order, the Auditor was also charged with the following lapses in her audit: a) Lapses in audi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a copy of the minutes pursuant to NFRA's SCN and attached a copy of the same as part of replies to SCN. 144 The Auditor asserted that she had relied on para 22 of SA 570 in making a professional judgement on the going concern issue and accordingly, included it in the EOM only. 145 The Auditor asserted that obtaining external confirmations is not mandatory, that the external confirmations obtained by the Company are intended by SA 505 and that Bank Statements available with the Company are better audit evidence than mere balance confirmations. 146 In respect of the charge relating to delay in submission of audit files or submission of incomplete files, the Auditor has replied that the reasons for the same need to be looked at more objectively by NFRA instead of making surmises. (SA 230) 147 The Auditor believes that obtaining written representations is not mandatory as per SA 580. However, she has referred to certain work papers of having obtained written representations. Analysis of reply 148 The Auditor has completely failed to understand the ultimate implications of fraudulent transactions in a closely held entity belonging to the promoters of the listed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... para A27 of SA 570. These paragraphs require the Auditor to issue modified opinion in the form of either 'Qualified Opinion' or 'Disclaimer of Opinion', if the management is unwilling to make clear disclosure about the going concern assessment. Therefore, she should have considered above provisions when the MACEL's management was not willing to provide clear disclosure regarding going concern when there were circumstances indicating uncertainty about the company's ability to continue as a going concern. 153 SA 505 - While agreeing with the Auditor's averment that obtaining external confirmations is not mandatory, we observe that there is again a serious 'Knowledge Gap' about the relationship between reliability of audit evidence and its source, and audit evidence obtained directly by the auditor is more reliable than that obtained indirectly and so on. It is astonishing to read the Auditor's averment regarding superiority of audit evidence in the form of bank statements versus bank balance confirmations. The Auditor has failed to learn from the recent episodes of catastrophic accounting frauds which remained undetected due to deficient au ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat all charges are proved except the charge relating to constitution of the Audit Committee. Therefore, CA Lavitha Shetty, Proprietor of the Audit Firm is also responsible for non-compliance with provisions relating to Quality Control Systems, Policies and Procedures of SA 220 and SQC 1 as mentioned in the paragraphs above. F. Articles of Charges of Professional Misconduct by the Statutory Auditor: 161 As discussed in the preceding paragraphs, the Auditor has made a series of serious departures from the Standards and the Law, in conduct of the audit of MACEL for FY 2018-19. Based on the above discussion, it is proved that the Auditor had issued unmodified audit opinion on the Financial Statements without reporting diversion of funds, evergreening of loans and committed other serious lapses during performance of audit. Based on the foregoing discussion and analysis, we conclude that the Auditor has committed Professional Misconduct as defined in Section 132 (4) of the Companies Act, read with section 22 the Chartered Accountants Act 1949 (the CA act), as amended from time to time, and listed as below: i. The Auditor committed professional misconduct as defined in clause ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... statements, as explained in Section C, D and E above. v. The Auditor committed professional misconduct as defined in clause 9 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when she 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 Auditor failed to conduct the audit in accordance with the SAs as explained in Section C, D and E above. 162 PCAOB 19 in a similar matter of diversion of funds to a related party, observed that The transactions between one of the Issuer's wholly-owned Chinese subsidiaries ( Subsidiary ) and a Chinese purchasing agent ( Agent '') involved the Subsidiary's transfers of loan proceeds to the Agent as prepayments to buy equipment and materials that the Agent never delivered. The loans were obtained from Chinese lenders for the purpose of making these purchases. While the Agent returned a portion of the prepayments some in unusual same-day, round-trip transfers it did not return most of them .... By failing to adequately respond to the known fraud risks, M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cism, and failed to obtain sufficient appropriate audit evidence in connection with Issuer A's identification, accounting, and disclosure of related party relationships and transactions ... . . . . Specifically, as part of her risk assessment procedures, she was required to obtain an understanding of the design and implementation of Issuer A's internal control over financial reporting ( ICFR '') in connection with related parties, to evaluate the design of those controls that were relevant to the audit, and to determine whether those controls had been implemented. Gore failed to perform any of these procedures during the 2016 Audit . This case resulted in debarment and imposition of monitory penalty on the auditors. 164 In a matter relating to impairment allowance for loans in the case of Grant Thornton LLP, PCAOB21 had observed Grant Thornton, among other things, failed to exercise due professional care, including appropriate professional skepticism, and failed to obtain sufficient appropriate audit evidence concerning the reported value of Bancorp's net loans, the effectiveness of Bancorp's controls relating to its allowance for loan . . . . . . . . ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , but which may extend to five times of the fees received, in case of individuals; and (II) not less than ten lakh rupees, but which may extend to ten times of the fees received, in case of firms; (B) debarring the member or the firm from (I) being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate; or (II) performing any valuation as provided under section 247, for a minimum period of six months or such higher period not exceeding ten years as may be determined by the National Financial Reporting Authority. 169 As per information furnished by M/s Lavitha Associates vide letter dated 28.07.2022 and dated 07.02.2023, the statutory audit fee of MACEL for FY 2018-19 was Rs.... Further, the Audit Firm received total professional fees of Rs..... from Coffee Day Group entities in respect of services rendered for FY 2018-19. Total professional fees received the Audit Firm during FY 2018-19 was Rs..... 170 Considering the proved professional misconduct, the nature of violations and principles of proportionality, we, in exercise of powers unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k. Misstatements can arise from error or fraud . The term Pervasive is defined in para S(a) of SA 705, Modifications to the Opinion in the Independent Auditor's Report, as, A term used, in the context of misstatements, to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial statements are those that, in the auditor's judgment: (i) Are not confined to specific elements, accounts or items of the financial statements; (ii) If so confined, represent or could represent a substantial proportion of the financial statements; or (iii) In relation to disclosures, are fundamental to users' understanding of the financial statements . 5 SA 330, Auditors Response to Assessed Risk. 6 Para X of Annexure -A (CARO report) of lndependent Auditor report dated 05-06-2019. 7 Section 420 of IPC states, 'Whoever cheats and thereby dishonestly induces the person deceived to deliver any property to any person, or to make, alter or destroy the whole or a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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