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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 ..... it 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 aspects and demonstrated a serious lack of competence. The EP failed to exercise professional judgement & professional skepticism during audit of fraudulent borrowing of Rs 4,076.46 crores from Banks & Related Parties and use of such bo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer 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 Financial Reporting Authority is a statutory authority set up u/s 132 of the Companies Act 2013 ('Act' hereafter) to monitor implementation and enforcing compliance of the auditing and accounting standards and to oversee the quality of service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d (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 transferred from MACEL to the personal accounts of VGS, his relatives and entities controlled by him and/or his family members, whose outstanding balances receivable were Rs 3,238.95 crores as on 31-03-2019. On examination of the Financial Statements of MACEL, it transpired that MACEL did not have any business transactions with 6 of the 7 subsidiary companies except CDGL. It was also transpired that MACEL was used as a conduit to transfer funds from subsidiaries companies of CDEL to the personal accounts of VGS, his relatives and entities controlled by him and/or his family members, as loans and advances that were never returned to MACEL/CDEL. 13 The modus operandi of the alleged diversion of funds discovered during the SEBI investigation was that "VGS used to ask the Authorised Signatories to sign a bunch of cheques which were kept in his possession and used them as and whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the circumstances. 17 The Auditor sought 30 days extension of time for submitting response to SCN. Extension of time was allowed for 15 days. After availing the extension of time, the Auditor vide letter dated 18.12.2022 submitted a reply to the SCN. 18 M/s Lavitha & Associates is a proprietary firm registered with the ICAI carrying on the profession of chartered accountancy from Chikkamgaluru city in the state of Karnataka. The Audit Firm was the Statutory Auditor of MACEL for FY 2018-19 and CA Lavitha Shetty was the Engagement Partner for this audit engagement. The Firm was also Statutory Auditor of Coffee Day Hotels & Resorts Private Limited, a Coffee Day Group company, for FY 2018-19. 19 The SCN gave an opportunity of personal hearing to the Auditor, which she did not avail. Accordingly, this Order is based on examination of the facts of the matter, charges in the SCN, writt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndicated 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 of CDEL to promoters, their family members and entities controlled by them. 22 The financial statements indicated that majority of the related party borrowings were from subsidiary companies of CDEL (Table 2) and were further diverted to the personal accounts of promoter, their family members and entities controlled by them (Table 3). Table-2 Rs in crores MACEL's borrowings from subsidiary companies of CDEL (Related Parties) Sr No Name of company from funds whom were borrowed Balance as on 31.03.2019 as per FS MACEL Balance reduced fraudulently by issuing cheques without adequate balance in the account Total outstanding as on 31.03.2019 (1) (2) (3) (4) (5 3+4) 1 Tanglin Retail Realty Development Pvt Ltd 789.35 685.01 1,474.36 2 Coffee Day Global Ltd 64.82 222.50 287.32 3 Tanglin Development Ltd -11.68 474.00 462.32 4 Coffee Day Trading Ltd 0 125.00 125.00 5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o perform risk assessment procedures to provide a basis for the identification and assessment of Risks of Material Misstatement (RoMM) at the financial statements and assertion levels. As per para 5 of SA 3305 , the Auditor was required to respond to the assessed RoMM by performing appropriate audit procedures. In light of the fact that such huge borrowings and lendings involving related parties went unnoticed in audit, as there is no evidence in the Audit File that the Auditor had performed such procedures to identify RoMM due to suspected fraudulent diversion of funds, the SCN charged the Auditor with failure to identify and respond to the RoMM in non-compliance with SA 315 & 330. 25 SA 240 prescribes auditor's responsibilities relating to fraud in audit of financial statements. Para 10 of SA 240 provides that the objectives of the auditor are to identify and assess the RoMM in the Financial Statements due to fraud, obtain audit evidence and respond to identified or suspected risk. Para 12 of SA 240 requires the auditor to maintain professional skepticism recognizing the possibility of existence of material misstatement due to fraud. Para 3 2 ( c) of SA 240 further requires ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccounts of promoters, their relatives and entities controlled by them. 28 MACEL, in its Extra-ordinary General Meeting ('EGM' hereafter) held on 13.02.2019, had passed two special resolutions authorizing the Board of Directors to borrow money up to Rs 6,000 crores under section 180(1 )( c) of the Act and to make investment and grant loans up to Rs 6,000 crores under section 186 of the Act. There was no evidence in the Audit File that in compliance with the above EGM resolution, the Board of Directors had approved any resolution for borrowing and making loans & advances, as required under section 179(3) of the Act. There was also no evidence in the Audit File regarding the approval of Members of the company and 6 Para X of Annexure -A (CARO report) of lndependent Auditor report dated 05-06-2019. Board of Directors in respect of funds borrowed and funds given as loans & advances prior to 13.02.2019. The Auditor was therefore charged with failure to verify whether MACEL had complied with the provision of sections 179(3), 180(1)( c) and 186 of the Act. 29 Diverting funds fraudulently to the personal accounts of promoter, his relatives and entities controlled by him and/or his ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ever, examination of the Audit File shows that no such audit procedures were performed. Even the net worth certificate does not contain all annexures and hence was incomplete. It appears that the Auditor did not exercise due diligence while evaluating the recoverability of these loans. Thus, the Auditor was charged to have violated SA 500 and section 143(3)(e) of the Act as she had reported that Financial Statements comply with the Accounting Standards. Reply of the Auditor 34 While denying the charge, the Auditor has stated that charge of diversion of funds was a misinterpretation drawn in the backdrop of death of VGS and was an ex post facto analysis. According to her, CDEL is a respected group and the Auditor had no reasons to suspect honesty, integrity and ability of the management. 35 The Auditor further stated that she had obtained reasonable understanding about the nature of the entity and its operations; that audit evidence are available at page no 170 to 195 of the Audit File forming part of Annexure to SCN; that she obtained audit evidence regarding amount received from group companies and advances granted to other group entities and the same was available at point 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... granted by MACEL were not for business objectives. Certainly, it was not possible for the respondent to form any such conclusion at that point of time when respondent did the audit for 2018-19". 37 While not disputing the facts given in Table 2 & 3 regarding related party borrowings and advances made, the Auditor replied that she would not be able to agree or disagree with the narratives used in SCN that funds were diverted to personal accounts of promoter because such findings can emerge only from an investigation and are not capable of being detected within the scope of a Statutory Auditor. 38 While responding to the charge relating to failure to verify whether borrowings & lendings were approved by the Board of Directors in accordance with section 179(3) of the Act, the Auditor replied that there is no reporting obligation on auditor under section 179(3) & 180 of the Act, and the responsibility of providing reasonable assurance was duly discharged in this case and she also stated that: "Kindly appreciate that the financial statements that are duly approved by the Board of Directors of the company is the evidence that all the transactions in it including the loans and advanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecause of events that happened after the audit of MACEL, which influenced the NFRA. She further stated that as per para 11 of AS 4, the case falls under the category of "remote possibility of loss, as per the judgement of the Auditor during the course of the audit. 43 Regarding the net worth certificate of VGS issued by Mis Sundaresha & Associates, the Auditor claimed that she did not feel the need of hundred percent coverage of advances from the net worth of VGS alone, because the funds were deployed in recoverable business assets, according to management explanations. Regarding competence & capabilities of the expert, the Auditor stated that M/s Sundaresha & Associates, being a respected CA firm with long and credible track record in the state of Karnataka, the Auditor did not require to follow any additional procedure to evaluate the capability of this CA firm. She further stated that as per para 6(c) of SA 620, M/s Sundaresha & Associates, being an audit and accounting firm, is not covered in the definition of Management's expert. Therefore, para 8 of SA 500 regarding evaluation of the competence, capabilities and objectivity of M/s Sundaresha & Associates (management expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 134(1) of the Act, which inter alia provides that financial statements shall be approved by the Board of Directors. The reply of the Auditor that the approval of financial statements by the Board of Directors of the company is evidence that all the transactions in it have the stamp of approval of the Board of Directors is astonishing and reflects a total lack of understanding of what an 'authorisation of transaction' by the Board means. Such a flawed understanding by the Auditor who is entrusted to check adherence to Standards and the Laws, is alarming and disconcerting. It appears that the Auditor has furnished this absurd reply to cover up her deficiency during performance of this Audit. 46 It is an undisputed fact that all borrowings and lendings were without any written Contract/ Agreement and were repayable on demand. There is no material on record whether any security was obtained before giving such huge amounts of loans/advances. Despite knowing these adverse indicators, the Auditor did not evaluate business rationale of huge borrowing and lending transactions with related parties. Needless to say, every Auditor should be aware that related party transactions have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ements of FY 2018-19 as required under SA 315, which she failed to do. 49 The Auditor had admitted that she could not identify any Ro MM during the course of the audit and did not assess and respond to any RoMM. This is an admission that she relied on management explanation only. She failed in her duty as she did not perform sufficient and appropriate audit procedure to identify, assess and respond to Ro MM due to fraud. This is tantamount to turning a blind eye to the ruse that lay before her. With reference to the reply that diversion of funds can emerge only from an investigation and is not capable of being detected by a Statutory Auditor, it is relevant to mention that diversion of funds was evident from the Financial Statements and other information accessible to the Auditor as already analysed by us in the preceding paras. However, the Auditor did not exercise professional skepticism during the course of audit to identify, assess and respond to the Ro MM. It is appropriate to note that SA 240 was issued in 2009, at least a decade ago before the date of this Audit, but the Auditor has displayed little understanding or application of this SA. We therefore find that the Auditor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Assets (Coffee Plantations), Methodology of Valuation of Shares in Companies and Computation of Net Worth. Valuation of coffee plantations was done at fair market value, based on Agriculture and Valuation reports of Mr. P. K. Ramesh, registered valuer in respect of some plantations. Valuation of shares of listed companies i.e., CDEL, Mindtree Limited and SICAL Logistics Limited, was done on market price prevalent on 31.03.2018, valuation of shares of CDGL was done based on valuation report, valuation of shares of M/s Shankar Resources Private Limited was based on market price of its investment and valuation of shares of M/s Devadarshini Info Technologies Private Limited was done according to fair valuation model adopted by this company. 54 There is no evaluation of this net worth certificate in the Audit File. The net worth certificate available in the Audit File is of five pages and does not contain its annexures. The Auditor did not reply about the absence of annexures in the Audit File. It shows that the Auditor has simply obtained a copy of the net worth certificate and did not evaluate the appropriateness of the methodology used for computation of net worth. It shows that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ertificate is neither accounting nor auditing service. It is a kind of valuation service. M/s Sundaresha & Associates, though a CA Firm, issued the net worth certificate as a valuation expert. Valuation certificates were also the basis of the net worth certificates. In the net worth certificate, many of the assets of VGS were valued at fair value, which is specialized area of valuation and not accounting & auditing job. Therefore, the Auditor was duty bound to evaluate competence and capability of M/s Sundaresha & Associates, besides the methodology and assumptions used in calculation of fair value of assets, which she failed to do. 60 From the above analysis, it is clear that the Auditor has not given any importance to this important aspect of assessment of recoverability of loans of Rs 3,235.16 crores from V GS & others. She simply obtained some documents and placed them in the Audit File, evidencing that the Audit was performed in a perfunctory manner, and professional skepticism was completely absent here. 61 The Auditor should consider, among other things, gaining an understanding of the business purpose of the transactions and examining supporting documents like agreements, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with fraudulent intention of suppressing true balances of borrowings from related parties and presenting a sound financial position. This accounting fraud resulted in understatement of the Related Party Borrowings by Rs. 1,713.74 crores (Rs 2,038.54 crores of cheques issued - Rs 324.80 crores of receipts) and overstatement of Bank Borrowings by Rs 1,713.74 crores in the Balance Sheet. 64 It can be observed from Table 4 that MACEL had a nominal bank balance but issued cheques of Rs 2,038.54 crores. Similarly, cheques for Rs 324.80 crores were received in 2018-19 but were not credited in the Corporation Bank account in the same year. These cheques were used to effect a series of circular transactions in 2019-20 aimed at evergreening of loans. As detailed in preceding paragraphs, this resulted in MACEL showing Rs. 1,713.57 crores as 'Credit balance in bank accounts'. By such fraudulent reporting, MACEL had converted related party borrowings into bank borrowings in the Financial Statements resulting in material and pervasive misstatements in the Balance Sheet as it constituted 49.50% of total liabilities of Rs 4,118.18 crores. 65 Bank statements show that MACEL was using ele ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs 2,038.54 crores were mere book entries without adequate bank balance and/or bank credit limit. The Auditor did not perform any audit procedure and did not report these apparently fictitious accounting entries and thus violated section 143(1) of the Act. 70 Accordingly, the Auditor was charged with non-compliance with SA 200, SA 240, SA 315, section 143(1), 143(12) of the Act and the CARO. Reply of Auditor 71 While denying the charge, the Auditor did not dispute the facts. She replied that uncleared/unrealised cheques on 31-03-2019 were pipeline bank entries and she could not see any wrong intent of the management. Credit balance in bank accounts were properly shown and disclosed in the Financial Statements, conveying correct message that the company has tight financial position. She further replied that she had examined the bank statements of FY 2019-20 with the limited objective of verifying clearance of pipeline bank cheques. She argued that examination of source of funds used for clearance of these cheques was not required for audit of FY 2018-19, therefore she did not do so. The Auditor further argued that allegation evergreening of loans and circular transactions, with r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... while undertaking the audit of2018-19. 76 The Auditor replied that disclosure of Related Party Transactions ('RPT' hereafter) was in compliance with AS 18. She argued that 'credit balance in bank accounts' represented by uncleared cheques, is not the same as bank borrowing. It is just a book balance. According to her, allegation of conversion of related party liabilities into bank liabilities has no merit and there is no material misstatement in the Financial Statements. She argued that she had not found any fraud from these transactions therefore there was no case for reporting u/s 143(12) of the Act. 77 With reference to use of traditional method of cheques payment at year end for payment of related party loans as against the normal method of electronic payment, the Auditor argued that alternative mode of cheque payment was proper cash flow planning in the background that the company faced liquidity crisis. She referred to para A4 of SA 240 and mentioned that these transactions do not fall in the scope of "recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives" or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 03.2019, it had issued cheques of Rs 1,879.17 crores in favour of these companies and brought down the outstanding loan from Rs 2,893.25 crores to Rs 1,014.08 crores. This is depicted in Table-5 hereunder: Note-* Gross amount of cheques issued in FY 2018-19 to TRRDPL was Rs 826 crores, which was cleared in FY 2019-20. MACEL had also received cheques of Rs 140.99 crores from TRRDPL in FY 2018-19, which were realised in FY 2019-20. Therefore, net amount has been shown. 82 These cheques were cleared/realised in FY 2019-20 by evergreening of loans through structured circulation of funds. One example of such circulation of funds for clearance of cheques of Rs 1,175 crores (relating to Karnataka Bank account) is given here. MACEL's bank ale no xxxxxxxx at Karnataka Bank had credit balance of Rs 43,790.92 only as on 31.03.2019, and there was no sanctioned bank credit limit for this bank account. However, eleven cheques for total amount of Rs 125.00 crores were issued favoring CDGL, four cheques of total amount of Rs 350 crores were issued to TDL, eight cheques of total amount of Rs 650 crores were issued to TRRDPL, and five cheques of total amount of Rs 50 crores were issued to GVIL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere was no sanctioned bank credit limit for this account. On 04.04.2019, MACEL received credit of Rs 30 crores (from related parties including CDGL), thereafter, this fund was used on the same day for clearance of three cheques valuing Rs 65.50 crores issued to CDGL on 30.03.2019. These bank transactions were done one by one in a circular manner by circulating funds between MACEL and CDGL in smaller amounts on the same day. 84 It can be observed from the bank statements, that all the cheques of Rs 2,363.34 crores were cleared in the same fraudulent manner by circulating smaller amount to create transactions of larger amount. There is no doubt that promoters of MACEL had pre-meditated plan to misrepresent liabilities in the Financial Statements of MACEL and subsidiaries of listed company for FY 2018-19 by issuing cheques before year end which would only be cleared in next financial year by evergreening of related party loans through structured circulation of funds in April/May 2019. From the above analysis, it is crystal clear that this accounting fraud was orchestrated to conceal the fact that funds belonging to the listed company (CDEL) have been diverted to a promoter owned enti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts', provides that in order to form an audit opinion, the Auditor is required to conclude whether she has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatements whether due to fraud or error. Evergreening of loans through circulation of funds was visible from bank statements, which are claimed to have been verified by the Auditor. However, she failed to consider the same while forming the audit opinion. Accordingly, we find that the Auditor was grossly negligent in making conclusions and forming an audit opm10n. 89 The Auditor's plea that the use of traditional method of issuance of cheques for circulation of funds to group entities as against the electronic payment system adopted for other business transactions, was done to maintain proper cash flow, cannot be accepted. Especially when we see that a large number of such cheques are issued at the end of the financial year with insufficient balance in the bank accounts. The Auditor herself has relied on para A4 of SA 240 in her reply, which deals with instances of fraudulent financial reporting and techniques used for the same. Quoting two items from para A4 of S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... respect of contention of the Auditor that SAs are not reference material for deciding misconduct of an auditor, we notice that auditor is duty bound to comply with SAs in terms of section 143(9) &143(10) of the Act14. Further, ICAI in its Implementation Guide on Reporting Standards issued in Nov 2010, had opined in response to question no-12 relating to the Auditor's responsibility paragraph that "A key assertion that is made in this paragraph is that the audit was conducted in accordance with the SAs. SA 20015 , which in a way is the ''parent standard" on auditing, prohibits the auditor from representing compliance with SAs in the auditor's report unless the auditor has complied with the requirements of this SA and all other SAs relevant to the audit. This is a very broad and onerous assertion for an auditor to make. If during a subsequent review of the audit process, it is found that some of the audit procedures detailed in the SAs were not in fact complied with, it may tantamount to the auditor making a deliberately false declaration in his report and the consequences for the auditor could be very serious indeed". In this case, the Auditor in its Independent Audi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity of MACEL. The Auditor was also charged with violation of section 143(2) & 143(3)(e) of the Act, as finance cost was an extraordinary expense but was shown as ordinary finance cost resulting in violation of Division I of Schedule III of the Act and Accounting Standards 516. 98 MACEL has recognized finance cost of Rs 55.38 crores in FY 2018-19, which constituted 90.89% of total expenses of Rs 60.93 crores. Total bank borrowing of the company was Rs 405.64 crores on 01-04-2018 and Rs 272.32 crores on 31.03.2019. Borrowed money was not used for the business activity of the company but diverted to related parties. Out of the total assets of Rs 3,894.53 crores, 99% were loans & advances given worth Rs 3,858.51 crores, leaving assets of only Rs 36.02 crores to be used for business activities of MACEL. Though the finance cost of borrowed fund was recognized, the corresponding interest income on loans and advances given to promoters and other related parties was not realized, resulting in material and pervasive misstatement in the Profit and Loss Statement by a large proportion of finance cost. 99 As per para 5 of SA 315, the Auditor was required to perform risk assessment procedures ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Companies (Accounts) Rules, 2014. The Auditor was therefore charged to have violated section 143(2) & 143(3)(e) of the Act. Reply of Auditor 101 While denying the charge, the Auditor has stated that she had no role to play in deciding whether advances granted by the company would earn interest or not. MACEL was required to pay interest on money borrowed whereas in respect of advances made by MACEL, there was no contractual obligation on the borrowing entities to pay interest. Therefore, interest expenses accounted for was not in violation of any law nor was it inconsistent with accounting principles in force. According to her, there was no misstatement. 102 The Auditor has further argued that the directors had appropriate powers to enter into those transactions. The Auditor has no authority to challenge the transactions undertaken by the directors, without having appropriate evidence to challenge them. According to the Auditor, NFRA's view is unjustified, as it is based on the events occurred and information emerged, after the audit was completed by the Auditor. The Auditor further replied that she had reported in the CARO report that advances made by the company wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be ultimately borne by MACEL, when the borrowed money was not used by MACEL, but lent out to related parties mostly at zero interest. In fact, interest expenses should have been at least recovered from those entities which had ultimately used the funds borrowed by MACEL, which was not done. In that context, we find that interest expense of Rs 55.38 crores has resulted in misstatement in the Profit and Loss Statement of MACEL. 108 Diversion of interest-bearing loan proceeds to promoters/their entity without any interest was a proof of fraudulent intention of promoters to recognize loss in the Profit and Loss Statement of MACEL and therefore it was an unusual transaction. The Auditor was duty bound as per SA 240 to evaluate such unusual transaction, which she failed to do. Further, disclosure given in CARO report relating to interest free nature of advances made, does not absolve the Auditor from her responsibility to report misstatement in the Profit and Loss Statement, which is required to be reported in the Independent Auditor's Report as per SA 700. 109 Para 9 of AS 5 states "Virtually all items of income and expense included in the determination of net profit or loss for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y by Rs 59.09 crores. Reply of Auditor 112 The Auditor has partially admitted the charge relating to wrong presentation of cash flow from short-term borrowing in Cash Flow from Operating Activities. According to her, out of Rs 850.90 crores, Rs 68 crores represented borrowings and deserved to be included under 'Cash Flow from Financing Activities' and remaining amount represented changes to operating assets/liabilities like advances received and advances given, and therefore correctly classified under 'Cash Flow from Operating Activities'. The Auditor further stated that the admitted mistake may be pardoned as an inadvertent presentation error. 113 In respect of charge relating to loans/advances made to third parties, the Auditor denied the charge stating that advances were given for furtherance of their business objectives associated with several coffee estates managed by associate entities and accordingly these advances were related to operations. She further contended that they were not loans. The Auditor stated that the term 'Advance' and 'Loan' are interchangeably used in AS 3, which is misleading and accepted that loans given would certainl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nformation and its classification are clearly prescribed in AS 3, which were to be complied by MACEL. In her reply, the Auditor has admitted wrong presentation of cash flow from short-term borrowing of Rs 68 crores in 'Cash Flow from Operating Activities' in place of 'Cash Flow from Financing Activities'. Accounting and analysis of Cash Flow is an important aspect of Auditing. The reply of the Auditor asking it to be treated as an inadvertent error in presentation, smacks of her casual approach. 117 For the remaining borrowings of Rs 782.90 crores (Rs 850.90 crores-Rs 68 crores), the Auditor has contended that these represented changes to operating assets/liabilities like advances received and advances given, and therefore correctly classified under 'Cash Flow from Operating Activities. In fact, these were borrowings, and these qualify as Cash Flow from Financing Activities, as per the definition quoted above. It was further seen that these borrowed funds of Rs 782.90 crores were not used for principal revenue-producing activities of MACEL, but used for fraudulent diversion of funds to the entities, with whom MACEL did not have any operational/business relation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in AS 3. 121 It is clear the MACEL did not comply with AS 3. Section 129(5) of the Act provides that "Without prejudice to sub-section(1), where the financial statements of a company do not comply with the accounting standards referred to in sub-section (]), the company shall disclose in its financial statements, the deviation from the accounting standards, the reasons for such deviation and the financial effects, if any, arising out of such deviation". MACEL did not disclose noncompliance with AS 3 in its Financial Statements, and thus violated section 129(5) of the Act. The Auditor did not report this non-compliance in her Audit Report. 122 Therefore, we find that the reply is not satisfactory and this charge stands proved that the Auditor violated section 143(2) and 143(3)(e) of the Act. C.5 Lapses in evaluation of corporate guarantee and creation of charge on the assets of the company (Rs 130 crores) 123 The Auditor was charged with failure to evaluate appropriateness of contingent liabilities of Rs 130 crores created due to the fact that MACEL gave corporate guarantees and created charges on the assets of the company in respect of loan of Rs 5 crores taken by Mrs. Malvika ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder or under any order made under sub-section (11) and to the best of his information and knowledge, the said accounts, financial statements give a true and fair view of the state of the company's affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed." 128 We observe that The Company's (Audit Report) Order 2016 is an order issued under section 143(11) of the Act. Therefore, CARO is only one of the criteria for consideration while making an audit report, besides Provisions of the Act, Rules made thereunder and provisions of Accounting Standards & Auditing Standards, to decide about truthfulness and fairness of the Financial Statements. Accordingly, before making a conclusion, the Auditor was duty bound to evaluate whether issuance of these corporate guarantees by MACEL and creation of charges on the assets of MACEL, were not prejudicial to the interest of the company, which she failed to do. 129 Further, non-disclosure of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndamental to the understanding of users of the Financial Statements. The Auditor had given unmodified audit opinion and did not consider the misstatements of Rs 11,393.69 crores and evergreening of loans while making audit conclusion and forming the Audit Opinion. Accordingly, the SCN charged the Auditor with violation of SA 320 & SA 700. Reply of Auditor 134 The Auditor has denied the charge and stated that the amounts shown as misstatement in SCN do not meet the criterion of misstatements as defined in para 4( a) of SA 45017 . According to the Auditor, to identify misstatements, it is necessary to compare the reported figure and the figure that should have been reported with respect to each element of misstatements, be it in amounts wrongly recognized, wrongly measured, wrongly classified or wrongly disclosed in the Financial Statements. She contended that SCN has not determined misstatements in this manner, therefore determination of misstatements is flawed. 135 The Auditor further replied that there is no error in amounts, presentation, classification and disclosures in respect of assets, liabilities and interest cost. While responding to charge relating to misstatement in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage". It has already been proved that entire borrowings & lending transactions were fraudulent with ulterior motive to divert funds to promoters. Misstatements relating to Finance Cost & Cash Flow Statement have also been proved (It is also partially admitted by the Auditor) and misstatement in issuance of corporate guarantee has also been admitted by the Auditor. These misstatements were clearly the result of fraud or error and their identification in the SCN is in place. The Auditor's reply is a desperate attempt to hide her gross negligence in making audit conclusions and forming an Audit Opinion. 138 The Auditor has further contended that the admitted misstatements of Rs 198 crores (Rs 68 crores + Rs 130 crores) are not material. The Auditor did not respond to non-determination of materiality during the course of audit, which is clearly a non-compliance with SA 320. Further, MACEL had revenue of Rs 1.71 crores, negative net worth of Rs 223.65 crores and assets of Rs 36.01 crores only that were apparently used for business activity of MACEL as rest of the assets ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons associated in assessing efficacy of internal controls and that she had ensured proper authorization of transactions. The issue of cheques by the de facto management was not a matter of absence of internal control but the desire of the majority shareholders. Further, she has asserted that the company did not suffer any losses because of internal financial control issues. 141 In relation to violation of RBI requirements on registration of NBFC, the Auditor stated that the MACEL's transactions were only advances and not loans or financial assets which would be considered in evaluating whether an entity is a NBFC. 142 There were several errors/omissions in the presentation and disclosures in the financial statements vis-a-vis the requirements of Schedule III (Division I) of the Act. While the Auditor accepted these errors/omissions she also said that these were clerical oversight, inconsequential and not with intent of misstatement. Hence, she asked to be pardoned. 143 The Auditor asserted that compliance with section 134 (1) of the Act i.e., approval by the Board of Directors, mentioning the names of the signatories etc. is the responsibility of the Company Management and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ods/services were in substance 'loans' or 'financial assets' but camouflaged as non-financial assets to avoid the regulatory requirements of financial services sector regulator viz. RBI. The Auditor's much needed professional skepticism was starkly absent here also, as is the case in many other areas discussed in this Order. 150 Presentation and disclosures in financial statements are as important as recognition and measurement aspects of the financial statements. When the errors/omissions relate to sensitive items such as borrowings, related party transactions/outstanding amounts, these cannot be wished away as clerical or inconsequential errors/omissions. The Auditor needs to exercise due professional care, which was not the case here. 151 The Auditor's attempt to shirk her responsibility to undertake basic checks like whether the Financial Statements signed by her are approved by the Company's Board, is unacceptable. This is not the professional attitude of an Independent Auditor. 152 In respect of non-compliance with Auditor's responsibilities under SA 570, there is a 'Knowledge Gap' on the part of the Auditor thereby failing to meet t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dit Firm was charged with various omissions and commissions observed in the audit, as discussed in the preceding paragraphs, for its role as the statutory auditor appointed under section 139 of the Act. 158 The Audit Firm was also charged with failure to comply with para 2 of SA 220 and para 3 of SQC 1, which stipulate that Quality Control Systems, Policies and Procedures are the responsibility of the Audit Firm. The Audit Firm was also charged with failure to establish 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. 159 Responding to this charge, CA Lavitha Shetty, Proprietor of the Audit Firm stated that "the Audit Firm in this case is the proprietary firm of the respondent, therefore it has no independent existence separate from the proprietor. Therefore, no additional or separate charges on the Audit Firm is tenable". 160 While replying to individual charges, the Auditor denied all the articles of charges. We have already examined th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cond Schedule of the CA Act, which states that an EP is guilty of professional misconduct when she "does not exercise due diligence or is grossly negligent in the conduct of her professional duties". 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 diversion of funds, circulation of funds and failed to report non-compliances made by the Company, as explained in Section C, D and E above. iv. The Auditor committed professional misconduct as defined in clause 8 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 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 Auditor failed to conduct the audit in accordance with the SAs and applicable regulations as well as failed to obtain sufficient appropriate audit evidence resulting in her total failure to report the material misstatements and non-compliances made by the Compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r seeks and the Board grants consent for him to associate with a registered firm, prohibited him from serving as an engagement partner or engagement quality reviewer on issuer audits for a one year period after the Board grants consent for him to associate with a registered firm; imposed a civil money penalty of $25,000; and required Klenner to complete forty hours of continuing professional education ("CPE"), in addition to any CPE required in connection with any professional license, before filing a petition for Board consent to associate with a registered firm. 163 Similarly, failures to perform audit procedures and exercise professional skepticism in related parties transactions and internal control over financial reporting have invited serious action by audit regulators in other jurisdictions too. For example, in case of Cheryl L. Gore, CPA and Stanley R. Langston, CPA, PCAOB20 had observed that "Gore failed to obtain sufficient appropriate audit evidence and to perform sufficient procedures concerning whether Issuer A 's financial statements accurately disclosed its related party transactions"... .. "Gore failed to exercise due professional care, including professional s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... being an associated person of a registered public accounting firm. G. PENALTY & SANCTIONS 166 Section 132( 4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed, is evident from the fact that a minimum punishment is laid down by the law. 167 The Auditor was required to ensure compliance with Standards on Auditing, Laws and Regulations to achieve the necessary audit quality and lend credibility to Financial Statements to facilitate its users. As detailed in this order, substantial deficiencies in Audit, abdication of responsibility and inappropriate conclusions on the part of the Auditors establish her professional misconduct and lack of due diligence. Despite being a qualified professional, the Auditor has not adhered to the Standards and have thus not discharged the duty cast upon her. 168 Section 132(4)(c) of the Companies Act 2013 provides that National Financial Reporting Authority shall, where professional or other misconduct is proved, have the power to make order for (A) imposing penalty of (I) not less than one lakh rupees, but wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isions about the courses of action that are appropriate in the circumstances of the audit engagement'. Professional skepticism is defined at para 13 (I) of SA 200 as - 'An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence'. Para 15 of SA 200 provides that 'The auditor shall plan and perform an audit with professional skepticism recognising that circumstances may exist that cause the financial statements to be materially misstated'. 4 The term Material is referred in AS 25, Interim Financial Reporting, as, 'information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information'. The term Misstatement is defined in para 13(i) of SA 200 as, "A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstateme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of receivables (commonly known as provision for bad and doubtful debts) is governed by this Standard". Loans being financial assets are covered in this standard. Para 5 .1 of AS 4 provides "The accounting treatment of a contingent loss is determined by the expected outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements". As per para 10 of AS 4, "The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if (a) it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and (b) a reasonable estimate of the amount of the resulting loss can be made". As per para 11 of AS 4, "The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of a loss is remote". 11 SA 500, Audit Evidence. 12 Please refer para 5 of SA 315. 13 Please refer para 15 of SA 200 and para 12 of SA 240. 14 Secti ..... X X X X Extracts X X X X X X X X Extracts X X X X
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