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TMI Blog2023 (8) TMI 261X X X X Extracts X X X X X X X X Extracts X X X X ..... untants Act, 1949. The acceptance of an invalid appointment letter for the Statutory Audit of the Branch, the conduct of the audit based on an invalid appointment, presenting convoluted logic and baseless reading of the law to justify the actions show the absence of professional skepticism and gross negligence on the EP's part. Therefore, the charges stand proven. Failure to comply with Standards on Auditing (SAs) - HELD THAT:- The Branch Auditors accepted the Statutory Branch Audit assigned by the Company and issued the Independent Branch Auditors' Report stating therein that it was conducted in accordance with the SAs specified under the Act. Since these branch audit reports are clearly referred to by Company's Statutory Auditor (CAS) in its report to the members of the Company, here is examined the extent of compliance with the applicable SAs by the Branch Auditor notwithstanding the violation of ethical standards, the Chartered Accountants Act, 1949 and of the Companies Act 2013 in accepting an invalid appointment as the Branch Auditor. The principles and procedures laid down in the SAs including professional skepticism, audit documentation, sufficiency and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tatements and the test of controls and based on the above contradictory evidence available, we observe that the unmodified opinion issued by the EP does not comply with SA 700. Hence, the charges stand proven. Non-Compliance with other SAs - HELD THAT:- Non-compliance with para 6, 7, 8, 9 10 of SA 300 as the EP failed in establishing an overall audit strategy and development of audit plan etc. in accordance with SA 300 - Non-compliance with para 5, 6 11 of SA 315 and para 1, 5 6 of SA 330 as the audit file lacks any documentation regarding the performance of risk assessment procedures for material misstatements at the financial statement level and assertion level and response to such risks etc. - Non-compliance with para 10, 11 14 of SA 320 for determining materiality, performance materiality and documentation thereof - Non-compliance with para 5, 6, 8, 14 15 of SA 450 in the absence of the evaluation of identified misstatements and uncorrected misstatements - Non-compliance with para 6 9 of SA 500 in not designing and performing audit procedures to obtain sufficient appropriate audit evidence and not evaluating the reliability of information produced by the compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to CA Mathew Samuel, partner of Mis K. Varghese Co., (ICAI Firm Registration No: 004525S), Kerala, who is a Professional Member of the Institute of Chartered Accountants of India and was the Engagement Partner for the statutory audit of one branch of Dewan Housing Finance Corporation Limited (DHFL), for the Financial Years 2017-18. This Order is divided into the following sections: A. Executive Summary B. Introduction and Background for the Order C. Major Lapses and Violations D. Articles of Charges of Professional Misconduct E. Penalty and Sanctions ACUTIVE SUMMARY 1. This Order is being passed as a result of an investigation by the National Financial Reporting Authority (NFRA) into the professional conduct of CA Mathew Samuel for his role as the Engagement Partner (BP) in the audit of one branch of DHFL. DHFL, a housing finance company listed on both NSE and BSE) and operating through a network of branches, was reportedly involved in financial fraud. NFRA took suo motu notice of the matter and carried out an Audit Quality Review (AQR) of the statutory audit of DHFL for FY 2017-18, conducted by Chaturvedi Shah (CAS), a Mumbai-based Chartered Accountant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce with such standards. NFRA has the powers of a civil court and is empowered under Section 132 (4) of the Act to investigate the prescribed classes of companies and impose penalties for professional or other misconduct of the individual members or firms of chartered accountants. 6. The statutory auditors, both individual and firm of chartered accountants, are appointed by the members of companies under Section 139 of the Act. The statutory auditors, including the Engagement Partners and the Engagement Team that conduct the audit, are bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA), including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed under Section132 (4) (c) of the Act. 7. Following media reports regarding the alleged siphoning of public money of around Rs.31000 crore and the Enforcement Directorate's reported action in April 2020 on an alleged banking fraud of about Rs.3700 crore by the promoter/ directors of DHFL, NFRA suo-motu initiated an AQR to probe into the role of the Statuto ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... professional duties, c. Failure to obtain sufficient information which is necessary for the expression of an opinion, or its exceptions are sufficiently material to negate the expression of an opinion, and d. Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances. 11. The EP was asked to reply to SCN by 05.01.2023 but was granted an extension of time following a request vide e-mail dated 04.01.2023. The EP submitted the reply on 04.02.2023. A Supplementary Audit File was also submitted by the EP along with the reply to the SCN wherein some additional documents (including the previous year's Trial Balance for FY 2016- 17 for the branch at Trivandrum, Audit Scope and Plan FY 2013-14, Cash Verification, and Loan Verification Sheets, etc.) were submitted. The EP did not avail of the offer of a personal hearing. The various charges levied in the SCN and the response of the EP to the charges are discussed in Part C of this Order. C. MAJOR LAPSES AND VIOLATIONS BY THE EP 12. The major lapses for which the EP was issued the SCN primarily relate to (i) accepting the audit engagement without ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... auditor is to be appointed under Section 139 .... if the intent of the language in Section 143(8) was to convey that the appointment of branch auditor shall be under the provisions of Section 139, then there was no need of using the words as such in the sentence. With the insertion of the words as such , meaning of the language in Section 143(8) changes altogether. The words appointed as such only meant appointable . b. If the intent of the law was to ensure appointment of branch auditor as per the provisions of Section 139, then there would have been no exemption for auditors for foreign branches either The Form ADT 1 prescribed under Rule 4(2) of Company (Audit and Auditors) Rules 2014, to be filed by a company on appointment of auditors, does not envisage appointment of branch auditors. If the intent of the law was to appoint branch auditors under Section 139, then there would have been provisions in ADT 1 for reporting to the government on appointment of auditors . c. ... appointment of a branch auditor would depend on the decision of the company auditor. For this reason the tenure of appointment would depend on the inability of the company auditor to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eting. In Section 143(8), the phrase appointed as such refers back to the requirement for the auditor to be qualified for appointment as an auditor of the company under this Act. In this case, as such shows that the branch auditor must be appointed in the capacity of an auditor qualified for appointment under the Act. This clearly means that the branch auditor must meet the requirements of the qualification for an auditor under the Act and must be appointed to the role of auditor under Section 139 of the Act. The use of as such clarifies that the auditor must be appointed specifically as an auditor of the company and that their qualifications for appointment must meet the requirements set out in the Act. There is no room for any other interpretation or to examine the intention of the law when the plain meaning of the law is sufficiently clear and not contradicting any other parts of the Act. It is also pertinent to refer to A Ramaiya's Guide to The Companies Act, 19th Edition, wherein it is explained that considering under the Act, the auditor of a company is appointed by shareholders, it follows that the above mentioned 2 position would continue and thus the decisio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omplied with. It is necessary for the incoming auditor to verify the relevant records of the Company and ascertain as to whether the Company has, in fact, complied with the provisions of the above sections . e. It is observed that the Resolution for Appointment of Auditor for the financial year 2017-18 passed at the 33rd Annual General Meeting of DHFL - held on 21-07-2017 read with the declaration of Voting Results of the resolution to ratify such appointment only refers to the appointment of CAS (Firm Registration No: 101720W) as the Statutory Auditors of the Company to audit the accounts of all the Company's offices including those of its zonal/ regional and branch offices for the financial year 2017-18. No other branch Statutory Auditors were appointed or ratified by the Company in the said meeting. Only CAS was appointed as the Statutory Auditor for the company as well as all its branches. Thus, the shareholders of the company approved only one Statutory Auditor (viz. Chaturvedi Sah) for the Company and its branches. Therefore, in absence of any valid appointment, EP's acceptance of the appointment as Statutory Auditor of the branches shows the absence of due dili ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Branch Auditor. The principles and procedures laid down in the SAs including professional skepticism, audit documentation, sufficiency and appropriateness of audit evidence, audit planning, materiality, engagement risk, nature, timing and extent of evidence-gathering procedures and reporting are all applicable in the branch audit as well, being an audit of historical financial information. Accordingly, the various violations of the SAs with which the EP was charged in the SCN are discussed in the following paragraphs. Non-Compliance with SA 210 Agreeing the Terms of Audit Engagements 19. The EP was charged with non-compliance with SA 210 4 and displaying an absence of professional scepticism and professional judgment in documenting the objective and scope of the audit, thereby violating SA 200 5 as well. SA 210 6 stipulates that the auditor shall agree to the terms of the audit engagement with management or Those Charged With Governance (TCWG) and that subject to paragraph 11 of the SA, the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable forms of a written agreement and shall include (a) the objective and scope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Act, the EP ignored that para 11 of SA 210 can be invoked only if the terms of audit engagement referred to in paragraph 10 of SA 210 such as the objective of the audit, the responsibilities of management, applicable financial reporting framework and expected form and contents of the audit report are prescribed by the Law, i.e., Section 143(8) of the Act, which is not the case. The EP cannot take shelter behind SA 600 8 , the purpose of which is to establish standards to be applied when a 'principal auditor' uses the work of another auditor. SA 600 is not a law or regulation that prescribes in sufficient detail the terms of the branch audit engagement. Hence, the contention that the details mentioned in para 10 of SA 210 are not required to be included in the engagement letter is baseless and not acceptable. 23. The EP accepted the appointment letter issued by DHFL and issued the audit report without complying with the requirements of SA 210. Between 2015-16 and 2016-17, there was a significant change in the circumstances relating to the branch audit. In 2015-16 the AGM decided to have a separate branch auditor and company's auditor, while in subsequent years th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asis for a conclusion about the achievement of the overall objectives of the Audit; and evidence that a planned performance of the Audit was done in accordance with SAs and relevant legal and regulatory requirements. SA 230 lists enabling the conduct of quality control reviews and inspections in accordance with SQC 1; and enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements among the additional purposes that are served by the audit documentation. Para 7 of SA 230 emphasises the Timely Preparation of Audit Documentation i.e. in a manner contemporaneous with the events that are being sought to be documented. b. Apart from SA 230, there are other Sas also that require the documentation of events, data, evidence, opinions and conclusions. SA 230 makes it very clear that reliance can be placed only on the audit file as evidence of what was done. Para AS of SA 23 0 is explicit: Oral explanations by the auditor, on their own, do not represent adequate support for the work auditor performed or conclusions the auditor reached, but may be used to explain or clarify information contained in the audit documentation . Para 14 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... udit documentation. The EP cannot take shelter behind this provision to escape the responsibility regarding audit documentation. f. The above stipulations and explanations in the SAs make it clear that the audit documentation evidencing compliance with the requirements of the SAs in an audit needs to be completed before signing the audit report. Any changes permitted thereafter are either administrative or exceptional. The EP has not followed these mandatory requirements in maintaining the audit documentation. Any evidence added to the audit file in violation of the standards and after the prescribed archival period is not acceptable. The inevitable conclusion, in this case, is that the EP did not maintain the audit documentation in accordance with the SAs and SQC 1 27. The EP also contended that since it was not required to audit the financial statements of the branch office of DHFL, there was no straight jacket application of the provisions of SA 230 , which permitted the EP to adapt the standard as necessary in the circumstances when applied to audits of other historical financial information rather than financial statements. We find that while adaptations of SAs are p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s utmost disregard of the basic principles of SA 315 and the level of professional ignorance of the BP; b. Summary of the accounting policies, observations from previous audits, inspection reports, and internal audit reports (refer to SA 315); c. Proof of verification of trial balance items, including assets (substantive audit procedures); d. Procedures adopted to verify the loans sanctioned during the year and classification of loans as per regulatory norms (substantive audit procedures); and e. KYC verification, anti-money laundering verification, and security verification (substantive audit procedures). 30. The lack of sufficient documentation in an audit is not a mere technical and procedural formality but is a serious issue which strikes at the very root of the audit and may defeat the very purpose of the audit itself. Lack of sufficient documentation has been viewed seriously by national and international regulators as well. For example, in the matter of Bharat Parikh Associates Chartered Accountants, dated 19-03-2019, the US audit regulator PCAOB took a serious view on the lack of sufficient documentation and imposed penalties and sanctions for violations in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with failure to comply with SA 700 11 33. The EP denied the charges and stated that According to Rule 12 (1) of Company (Audit and Auditors) Rules 2014 . for the audit of the branches of a company, the responsibility of auditor as provided in Section 143(1)-143(4) are on the company's auditor and not on the branch auditor .... It was not an audit report of the company, nor was an audit report on the financial statements, and therefore was not falling within the scope of SA 700 . 34. The contentions of the EP, we find, are a flawed interpretation of the law. Para 2 of SA 200 12 makes it clear that the SAs are written in the context of an audit of financial statements by an auditor. They are to be adapted as necessary in the circumstances when applied to audits of other historical financial information. Branch auditors appointed under section 143(8) read with Section 139 of the Act are statutorily required to comply with the SAs since section 143(9) requires every auditor to comply with the SAs. The interpretation of Rule 12 (1) of Company (Audit and Auditors) Rules 2014 by the EP that ''for the audit of the branches of a company, the responsibility of aud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... how its impact was considered by the EP in the audit opinion. 36. We also note that such lapses relating to the verification of documents during the audit are viewed seriously by audit regulators. For example, a Chartered Accountant, in the audit of a Bank branch, did not verify the securities for debts and was held guilty of professional misconduct of absence of due diligence and gross negligence. (AN.Kapur -vs.- R.N. Budhiraja; Page- 374 of Vol. IX (1) of the Disciplinary Cases- !CAI Council's decision dated 11th and 12th April 2008). 37. There is also no determination of materiality thresholds in the audit file. In the absence of documented conclusions, determination of materiality and assessment of the risk of misstatements and the test of controls and based on the above contradictory evidence available, we observe that the unmodified opinion issued by the EP does not comply with SA 700. Hence, the charges in para 32 above stand proven. Non-Compliance with other SAs 38. The EP was charged with non-compliance with other SAs which include a. Non-compliance with para 6, 7, 8, 9 10 of SA 300 13 as the EP failed in establishing an overall audit strategy and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for branches . In the absence of any documentation in the audit file, the contention is only an afterthought and hence not admitted. c. Non-compliance with para 10, 11 14 of SA 320 18 for determining materiality, performance materiality and documentation thereof. The EP submits that there is no noncompliance since the report of the EP to the company's auditor mentions that from the point of view of determining materiality, expenses above 1% of revenue were considered for verification as a bench mark, and where there would be misstatement 2% was the bench mark. Citing Para A7 of SA 230 which states it is unnecessary for the auditor to document separately (as in a checklist, for example) compliance with matters for which compliance is demonstrated by documents included within the audit file the EP states that the audit file on record sufficiently demonstrates the process adopted by the Respondent . The replies show EP's disregard for professional standards and absence of professional behaviour on EP's part. Proper determination, application and revision of materiality are very basic to an audit. Para 5 of SA 320 makes it clear that The concept of mater ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... auditor were applied to draw the required sample data. The audit sampling in this case had provided a reasonable basis for the respondent auditor to draw conclusions about the population from which the sample was selected and hence the charges are denied. We find that the conditions in the appointment letter do not evidence basis for EP's work and conclusions. The SAs casts a responsibility 22 on the auditor to design and perform audit procedures to obtain sufficient appropriate audit evidence on which to base the audit opinion. The terms dictated by the company cannot substitute this responsibility. There is no evidence that any of the sampling and the related procedures as detailed in SA 530 have been complied with by the EP, while the audit opinion is based on sample testing. In the absence of any evidence to show compliance with the determination of sample design, sample size and audit procedures performed on it, the contentions of the EP are not accepted. D. ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT BY THE EP 39. Given the above-mentioned actions of commissions and omissions, it is established that CA Mathew Samuel did not comply with the stipulations in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a case where professional misconduct is proved. The law lays down a minimum punishment for such misconduct. 41. The financial statement includes material information from the Branches of the Company, where a substantive part of the lending activities is carried out. 42. A Branch Statutory Auditor is duty-bound to examine and ascertain the integrity of the underlying information forming Financial Statements of such entities 23 in the larger public interest. 43. The EP in the present case was required to ensure compliance with SAs to achieve the necessary audit quality and lend credibility to the reports issued to facilitate the Company's Auditor to form their opinion on the Financial Statements. As detailed in this order starting from the acceptance of the Audit to the conduct and conclusion of the audit, there were substantial deficiencies in the Audit and abdication of responsibility on the part of EP, CA Mathew Samuel, which establishes the professional misconduct. Despite being a qualified professional, we find that the EP, CA Mathew Samuel has not adhered to the Standards of Audit. On the contrary, the EP has tried to cover up the deficiencies by resorting to argu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above sections of the Companies Act 1956 are sections 139 and 140. 4 SA 210, Agreeing the Terms of Audit Engagements. 5 Para 15 and 16 of SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing. 6 Para 9, 10 and 11 of SA 210 7 The sample engagement letter in appendix 1 of SA 210 may be referred. 8 SA 600 - Using the Work of Another Auditor 9 Standard on Quality Control (SQC) l, Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements. 10 Para 10 to 12 of SA 700, Forming an Opinion and Reporting on Financial Statements 11 Para 11 of SA 700 12 SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing. 13 SA 300, Planning an Audit of Financial Statements. 14 Para 7 of SA 300 15 Para 9 of SA 300 16 SA 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment. 17 SA 330, The Auditor's Responses to Assessed Risks 18 SA 320, Mat ..... 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