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TMI Blog2023 (8) TMI 62X X X X Extracts X X X X X X X X Extracts X X X X ..... o obtain sufficient appropriate audit evidence regarding the existence and condition of inventory - The EP has displayed gross negligence in his audit of the inventories. In view of this, it is clear that the EP did not comply with the requirements of SA 501 in so far as it relates to his obligations in respect of inventory. Hence, the charge relating to EP s failure to comply with SA 501 stands proven - Failure to identify the related party and related party transactions - HELD THAT:- The EP s submission in the present case makes it clear that the EP has not exercised any professional judgement and scepticism in relation to identification of the related parties even when 100% sales were being made to a single customer who had been already identified as a Related Party earlier in the financial year 2013-14 - It is thus concluded that the charge relating to EP s failure to identify the Related Party and Related Party transactions stands proven. Failure to obtain external confirmations for the Trade Receivables Trade Payables - HELD THAT:- The EP has acknowledged that no external confirmations from debtors creditors were carried out. The reply of the EP makes it clear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith laws and regulations and the results of discussion with management and, where applicable, those charged with governance and other parties outside the entity. Though the EP has stated that defaults were not material to qualify the report, we find that materiality has not been defined in the Audit File. Therefore, the charge regarding the failure to report the non-compliance with laws regulations stands proven. Failure to determine the materiality and performance materiality - HELD THAT:- The EP was charged with the failure to determine the materiality, as required under Para 10 of SA 320, for the financial statements as a whole; and performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing, and extent of further audit procedures as required under para 11 of SA 320 - The EP in his reply has nowhere commented on the observation on materiality. In absence of any proper reply or evidence submitted by the EP, it is concluded that the charge relating to his failure to determine the materiality and performance materiality stands proven. Failure to document the sampling methodology adopted for substantive testing - ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Khator is debarred for two 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. - No. NF-23/30/2021/2 - - - Dated:- 28-4-2023 - Dr. Ajay Bhushan Prasad Pandey Chairperson, Dr. Praveen Kumar Tiwari Full Time Member And Smita Jhingran Full Time Member ORDER In the matter of CA Hemant Khator, ICAI membership No.117596, under section 132(4) of the Companies Act, 2013 read with Rule 11(6) of National Financial Reporting Authority Rules 2018 1. This order disposes of the Show Cause Notice (SCN hereafter) of even no. dated 06.10.2022, issued to CA Hemant Khator, partner of M/s GSV Co. (Firm Registration No. 123334W), Surat, who is a member of the Institute of Chartered Accountants of India (ICAI hereafter) and was the Engagement Partner (EP hereafter) for the statutory audit of Women Next Loungeries Ltd (WNLL hereafter) for Financial Year 2016-17. 2. This order is divided into the following sections: A. Executive Summary B. Introduction Background C. Major lapses in the Audit D. Other lapses in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al audit of the functions and activities of any company or body corporate. B. Introduction Background 8. NFRA is a statutory authority set up under section 132(4) of the Act to monitor and enforce compliance with the auditing and accounting standards and to oversee the quality of service of the professions associated with ensuring compliance with these standards. NFRA is empowered under section 132(4) of the Act to investigate the prescribed classes of companies, exercise specified powers of a civil court and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 9. The Statutory Auditors, both individual and firms of chartered accountants, are appointed by the members of companies under section 139 of the Act. The Statutory Auditors, including the Engagement Partners that conduct the audit are bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA hereafter), including Standards on Quality Control (SQC) and Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty specified under section 132(4) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble to the circumstances. 12. The EP was required to reply to SCN by 05.11.2022, but vide e-mail dated 05.11.2022, requested for extension of 30 days to submit his reply. NFRA granted extension to submit reply by 24.11.2022. The EP submitted his reply on 23.11.2022. An opportunity of personal hearing was also given to the EP, who appeared before the Executive Body, NFRA on 02.02.2023. During the personal hearing, the EP reiterated his written submissions. 13. We have considered the written and oral submissions of the EP in respect of each charge contained in the SCN. Our findings are discussed in Part C D of this Order which relate to major lapses and other lapses in audit respectively. The charge related to auditors appointment being invalid has been dropped, based on our consideration of the information and explanations provided by the auditor and other relevant information that has come to our notice subsequently. C. Major Lapses in the Audit C.1 Failure to obtain audit evidence regarding the existence and condition of inventory 14. The EP was charged with failure to obtain sufficient appropriate audit evidence regarding the existence and condition of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce sheet of the Company. Therefore, we find that the EP has displayed gross negligence in his audit of the inventories. In view of this, it is clear that the EP did not comply with the requirements of SA 501 in so far as it relates to his obligations in respect of inventory. Hence, the charge relating to EP s failure to comply with SA 501 stands proven. 17. The importance of inventory verification cannot be overemphasized. We note that in a similar case the PCAOB 2 , the US regulator, revoked the registration of the Audit Firm (AMC Auditing LLC) and barred the EP (Alexandria Yi, partner of AMC Auditing) from being associated with a registered public accounting firm for a period of one year. The PCAOB in its order 3 stated that The Firm did not perform sufficient appropriate procedures to test the existence of inventory, such as making or observing physical counts of the inventory and applying appropriate tests of intervening transactions but instead relied on the predecessor auditor s performance, at the time of the original 2016 audit, of a year-end physical inventory observation and inventory test counts at two locations. In 2016, inventory at those two locations represent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eedom Holding Corp 4 , USA, the PCAOB has stated that the auditor must evaluate whether related party transactions have been properly accounted for and disclosed in the financial statements. PCAOB further stated that during the audit of Freedom Holding Corp, Engagement Partners failed to evaluate financial statement disclosures in compliance with PCAOB auditing standards and imposed monetary penalty of $35,000 each on two partners of the audit firm and penalty of $25,000 on the engagement quality review partner. 22. The EP s submission in the present case makes it clear that the EP has not exercised any professional judgement and scepticism in relation to identification of the related parties even when 100% sales were being made to a single customer who had been already identified as a Related Party earlier in the financial year 2013-14. We, therefore, conclude that the charge relating to EP s failure to identify the Related Party and Related Party transactions stands proven. C.3 Failure to obtain external confirmations for the Trade Receivables Trade Payables 23. Both Trade Receivables of Rs 14.93 crore and Trade Payables of Rs 13.78 crore were Rs.39.81% and 36.75% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... galore, as well as Lovelock Lewes (member firms of Price Waterhouse International Limited) and the activities and operations of Price Waterhouse India were restricted for six months besides other actions. 26. We note that the EP has acknowledged that no external confirmations from debtors creditors were carried out. The reply of the EP makes it clear that the management had imposed a limitation on the scope of the auditor. Limitations imposed by management may have other implications for the audit, such as for the auditor s assessment of fraud risks and consideration of engagement continuance as per Para A9 of SA 705 7 . However, no assessment of fraud risk having been done by the EP is evident from the audit file, nor has he furnished evidence of the additional procedures being performed in the absence of external confirmation procedures. Denial of contact details of debtors creditors to EP should have aroused the suspicion of the auditor for further procedures which evidently did not happen, and the EP failed to verify balances in violation of SA 505. Hence, we conclude that the charge regarding failure to obtain balance confirmation from creditors and debtors stands pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce as per para 11 of SA 300 the Audit Plan has to be documented which has not been done. In addition to para 11, detailed procedures regarding documentation are given in paras Al7 to A19 of SA 300 which are referred to in Para 11 of SA 300 and are required to be followed, which was not done. The reply also makes it clear that the EP has a serious lack of knowledge regarding the basic requirements of an audit. In view of the above, we conclude that the charge regarding the failure on the part of the auditor to plan the audit and failure to understand the entity and its environment, stands proven. 30. In the audit of Capstone's 9 by Seale and Beers, LLC, PCAOB, the US Regulator, stated that the auditor had failed to properly plan the audit, including failing to assess the risks of material misstatement and to identify any significant risk at the financial statement and assertion level. Respondents also failed to obtain, or ensure that the engagement team obtained, sufficient appropriate audit evidence for significant items reported in the financial statements, including related party transactions and expenses. Further, the EP failed to exercise due professional care and prof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cument non-compliances with laws regulations noticed by him during audit. In his statement dated 05.11.2019 made before Assistant Director/Inspector, office of Regional Director, Western Region, Mumbai, the EP has admitted that the company was not complying with the statutory compliances regularly. 37. The EP in his reply to SCN has stated that Yes, we have admitted the fact that the Company was not particular in complying with some of the statutory provisions. We have also mentioned and disclosed the same in the Tax Audit Report for the FY. 2016-17 at page no I of 3ca report about default in payment of Provident Fund, Sales tax, TDS, Service tax etc. In our opinion, such defaults were not so material as to qualify the report. 38. We find that the EP in his submission has nowhere commented on the documentation in relation to the consideration of laws and regulations in the audit of WNLL for FY 2016- 17, as required under para 29 of SA 250 11 , which says that the auditor shall document identified or suspected non-compliance with laws and regulations and the results of discussion with management and, where applicable, those charged with governance and other parties outsi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SCN, the charge relating to failure to document the audit sampling methodology adopted (extent of verification of sales purchases transaction) during the course of audit stands proven. D.6 Failure to appoint the Engagement Quality Control Reviewer (EQCR) 45. The EP was charged with failure to determine the appointment of EQCR of WNLL for FY 2016-17. This was in violation of SA 220 14 , as WNLL is a listed company, and the auditor was required to determine that EQCR had been appointed in terms of Para 19(a) of SA 220. 46. In his reply to SCN, the EP has stated that a team of four persons was deputed for carrying out the audit of the Company and the same was led by a Chartered Accountant having experience of around 5 years. It is evident from the reply of the EP and the Audit File that no EQCR was appointed. In the absence of any documentation about the EQCR and no reference about the EQCR by the EP in his written and oral submissions, we conclude that the charge regarding failure to determine the appointment of EQCR stands proven. 47. We note that in the case of Donahue Associates LLC, an audit firm, the registration was revoked and monetary penalty of $5,000 impose ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Public Listed Companies serve a critical public function of enabling the users of Audited Financial Statements to take informed decisions. Absent a robust system of auditing, investors, creditors, and other users of financial statements would not be able to get the true and fair picture of the state of affairs of the company. The best of systems fails if the professionals implementing the system do not perform their job. This could lead to a serious failure of the financial system which could ultimately result in a breakdown in trust and confidence of investors and the public at large. Thus, the auditor is duty bound to examine and ascertain the integrity of Financial Statements of such entities 16 in larger public interest. 51. The EP in the present case was required to ensure compliance with SAs to achieve the necessary audit quality and lend credibility to financial statements to facilitate its users. As detailed in the foregoing paragraphs of this Order, substantial deficiencies in audit on the part of CA Hemant Khator establish his professional misconduct. Despite being a qualified professional, CA Hemant Khator has not adhered to the SAs and has thus not discharged the du ..... X X X X Extracts X X X X X X X X Extracts X X X X
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