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TMI Blog2023 (10) TMI 1122X X X X Extracts X X X X X X X X Extracts X X X X ..... udit and performed alternative audit procedures to mitigate such risk (Para 8 of SA 505) but also considered this informing their audit opinion. Instead, it is found that the auditors have given unmodified opinion ignoring the restraint imposed by the management on their independent audit. The procedures referred to by the Auditors neither meet the requirements of alternate audit procedures, nor were appropriate or documented. Therefore, the Auditors responsible for carrying out the audit without due diligence and in a perfunctory manner. Failure in evaluation and attendance at physical verification of Inventory - HELD THAT:- There are no audit documentation regarding the physical count of the inventory. It is noted that SA 501 mandates an auditor to attend physical count of the inventory (para 4) and if it is impracticable to attend the physical count and not possible to apply alternative audit procedures, then the auditor is required to modify the audit opinion (para 7). In the case of LGIL, inventory constituted 49.85% of the current assets in FY 2017-18, 65.10% in FY 2018-19 and 65.53% in FY 2019-20, making it a significantly material item for the Auditors to attend its ph ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mere obtaining a certified copy from the management regarding utilisation of the IPO proceeds, does not relieve the Auditors from the responsibility of performing the required audit procedures. There is no evidence in the Audit File that the auditors had performed risk analysis of potential misstatements before the issuance of IPO (over statement of revenue / assets or understatement of expenses / liabilities to present rosy picture to the investors) and after realization of the IPO proceeds (misappropriation of the proceeds for purposes other than the declared purpose). The Auditors did not show the skepticism expected from them while reporting under CARO 2016 about proper utilization of money raised from the IPO, especially in light of the observed instances of artificial inflation of profits and reduction of liabilities by unilateral write-back of outstanding payables, and significant payments (44.29% of the IPO proceeds) to the related party from the IPO proceeds - the Auditors responsible for not performing the due audit procedures, for failure to obtain sufficient appropriate audit evidence for reporting under CARO 2016 about proper utilisation of IPO proceeds, and for their ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso responsible for the lapses discussed. Penalties and sanctions - HELD THAT:- Considering the fact that professional misconducts have been proved and considering the nature of violations and principles of proportionality, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, it is ordered: i. Imposition of a monetary penalty of Rupees Ten Lakhs upon the Audit Firm M/S Ashok Holani Co., the appointed Statutory Auditor ii. Imposition of a monetary penalty of Rupees Five Lakhs upon CA Rahul Jangir, the Engagement Partner. In addition, CA Rahul Jangir is debarred for three 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. - 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 Firm M/S Ashok Holani Co. and CA Rahul Jangir under Section 132(4) of the Companies Act 2013. 1. This Order disposes of the Show Cause Notice ('SCN' hereafter) no. W-23/42/2021 dated 07th December 2022 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd that LGIL had unilaterally written back substantial amounts of its liabilities and treated them as Other Income, which resulted in overstatement of profits by 2.31 crore (21% of the reported figures) in 2017-18 and understatement of losses by 5.89 crore (1 123%) in 2018-19 and 3.15 crore (283%) in 2019-20. 6. Although the Inventory constituted more than half of the current assets and therefore was material, the LGIL had, during FYs 2018-19 and 2019-20, adopted a flawed accounting policy to account for the finished goods at the estimated market price (and not at Lower of Cost or Net Realisable Value), therefore not complying with the provision of AS 2. The Auditors merely reported such material non-compliances through Key Audit Matters ('KAM' hereafter) in the FY 2019-20. The Auditors also failed to attend the physical count of inventory, which was required by the Standards. 7. Despite the presence of material and pervasive misstatements, the Auditors did not consider a modified opinion as per SA 705 1 for the FYs 2017-18 to 2019-20, rather they reported these matters through KAM in the FYs 2018-19 and 2019-20, which was not in compliance with SA 701 2 . 8. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee the quality of service of the professions associated with ensuring compliance with such standards. NFRA is empowered u/s 132(4) of the Act to investigate the prescribed classes of companies and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 13. The statutory auditors, both individual and firm of chartered accountants, are appointed by the members of a company u/s 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 SAS, including the Standards on Quality Control ('SQC' hereafter) and the Code of Ethics (the Code), the violation of which constitutes professional misconduct, and is punishable with penalty prescribed u/s 132(4)(c) of the Act. 14. LGIL was dealing in the business of manufacturing and trading of Tiles, and was a small and medium enterprise (SME) listed company at NSE and prepared its financial statements in accordance with the Accounting Standards ('AS ' hereafter) Framework, as it was not mandatory for the LGIL to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ary 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 any material departure from the generally accepted procedures of audit applicable to the circumstances. 19. The reply to the SCN was submitted by the Auditors on 30.01.2023. CA Rahul Jangir and CA Ashok Holani also appeared before the Executive Body of NFRA on 28.03.2023 availing the opportunity of personal hearing offered to them in the SCN. During the personal hearing, they reiterated their written submissions as mentioned in their reply dated 30.01.2023. 20. We have perused the audit files and the written and oral responses of the Auditors. Our findings are discussed in section C and D of this Order, C LAPSES IN THE AUDIT Lapses in evaluation of writing-back of liabilities 21. The Auditors were charged with failure to apply professional skepticism and for inappropriate reporting by the LGIL of extinguishment of liabilities unilaterally without entering into settlement with the counter party (creditors) and subsequent recognition of the amounts involved as 'Gains' under 'Other Income, thereby ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he income from the above was in accordance with Generally Accepted Accounting Principle ('GAAP ' hereafter). As per GAAP assets or settlement 'liabilities resulting from operating activities of an entity ... The Auditors stated that these were usual business transactions; that there was no evidence of any material misstatement or misrepresentation; and that the management was of the opinion that these dues were no longer payable and therefore retaining of the same could lead to overstatement of liabilities in the FS. The Auditors added that as per accounting Framework for the preparation and presentation of Financial Statements issued in 2000 ('Framework 2000' hereafter), an obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights. In this case, creditors had not claimed their dues for a long time, as no complaint was filed by any of the creditors for such claims, and therefore the same was treated as waiving of their dues. 23. Para 10.2 of AS 29 4 defines Liability, as a present obligation for the enterprise that arises from past events and settlement of which is expected in an outflow of resources, emb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the auditors have given unmodified opinion ignoring the restraint imposed by the management on their independent audit. The procedures referred to by the Auditors neither meet the requirements of alternate audit procedures 8 , nor were appropriate or documented. Therefore, we hold the Auditors responsible for carrying out the audit without due diligence and in a perfunctory manner. 25. Non-evaluation of accounting policy and accounting treatment has been viewed seriously by International Regulators as well. For example, the Public Company Accounting Oversight Board ('PCAOB' hereafter), the US Regulator 9 , censured and imposed monetary penalty of $ 47,500 collectively on the firm and respondents in the matter of BDO Auditores, S.L.P. (Firm), Santiago Safi Figueras, and Jos Ignacio Alg s Fern ndez (Respondents), for their failure inter alia to report the departure of the company from US GAAP related to the extinguishment of certain and noted that ...failing to appropriately address PMG's apparent departure from GAMP including (a) by failing to document any evaluation of the effects of that departure on PMG's financial statements as a whole and (b) by faili ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in digital form rather than as part of the audit file. The Auditors added that, the mere absence of documents from the audit file does not establish violation of the provision of SA 315. Further, every information in respect of valuation and disclosures was available in the FS and they had reported through KAM, so that the stakeholders could get true picture. The Auditors further stated that they had not only asked the management for cost formulae but also verified that the FIFO method was used for valuation of raw material. The Auditors agreed that mandatory disclosures as per AS 2 required disclosure of the cost formula but the company had failed to do so . However, they did not consider it as a material fact after discussing and verifying with the management and satisfying themselves that the company had properly valued the inventory using the FIFO method. The Auditors also added that they had carried out examination of records, valuation, disclosures and analytical review procedures and attended the stock count. These documents were further verified and checked with other supporting documents, like inward with purchase invoice, outward with sale invoices, consumption ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s viz., stock valuation sheet/ calculation sheet etc. on 30.01.2023 are deemed afterthought and not accepted. 32. As admitted by the Auditors, we also did not find any audit documentation regarding the physical count of the inventory. We note that SA 501 mandates an auditor to attend physical count of the inventory (para 4) and if it is impracticable 15 to attend the physical count and not possible to apply alternative audit procedures, then the auditor is required to modify the audit opinion (para 7). In the case of LGIL, inventory constituted 49.85% of the current assets in FY 2017-18, 65.10% in FY 2018-19 and 65.53% in FY 2019-20, making it a significantly material item for the Auditors to attend its physical count, but they failed to do the same. As per section 143 (9) of the Act, it is the statutory duty of the auditor to comply With the SAS and Para 18 of SA 200 also requires the auditor to comply with all the SAS relevant to the audit. Failure to attend the physical count of the inventory was a serious non-compliance of SA 501 and the provisions of the Act. 33. Considering the above, the charge that the Auditors did not comply with the provisions of SA 200, 230, 315 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in payments of statutory dues and write back of significant payable amounts etc.) with TCWG, had applied additional audit measures to mitigate the risk arising due to these findings, and, as these findings were significant, therefore they had included them in the KAM. 37. As per Para 17 and 18 of SA 701, the auditor shall communicate with TCWG those matters that are determined by him as KAM and document the same. As per Para 12, the auditor shall not include those matters in KAM on account of which he is required to modify the opinion. However, we do not find any working in the audit files in respect of inclusion of the matters in the KAM, nor communication of these matters with TCWG prior to their inclusion in the KAMI Therefore, the Auditors were not in compliance with the requirements of SA 701. 38. While responding to the charge of two different reporting through KAM, the Auditors stated that 'uploading of annual report with the stock exchanges is the responsibility of the LGIL, not of the company auditor and the audit report available on NSE are uploaded by the LGIL We were not aware that the company had re-drafted KAM and uploaded the same . ' When enquired ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ribes the following situations where modification to the Auditor's opinion is required: a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or (Ref: Para. A2-A7) b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement. (Ref: Para. A8-A12) Para A3 and A4 of SA 705 state that a misstatement in the FS will arise when the selected accounting policies are not consistent with the applicable FRF. Para A 12 of SA 705 states that, examples of inability to obtain sufficient appropriate audit evidence include When the management prevents the auditor from requesting external confirmation of specific account balances. 43. We have observed earlier that the accounting policy regarding unilateral extinguishment of liabilities and valuation of finished goods was not in accordance with the FRF, and the Auditors were restrained from obtaining external confirmation in respect of extinguishment of liabilities. Therefore, the Auditors could not conclude that they had obtained sufficient ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om the responsibility of performing the required audit procedures. There is no evidence in the Audit File that the auditors had performed risk analysis of potential misstatements before the issuance of IPO (over statement of revenue / assets or understatement of expenses / liabilities to present rosy picture to the investors) and after realization of the IPO proceeds (misappropriation of the proceeds for purposes other than the declared purpose). The Auditors did not show the skepticism expected from them while reporting under CARO 2016 about proper utilization of money raised from the IPO, especially in light of the observed instances of artificial inflation of profits and reduction of liabilities by unilateral write-back of outstanding payables, and significant payments (44.29% of the IPO proceeds) to the related party from the IPO proceeds. These potential risks were not assessed by the Auditors to identify and assess the risk of material misstatements by designing and performing enhanced audit procedures to mitigate such assessed risk (Para 25 and 28 of SA 3 15). We did not find audit documentation by the Auditors addressing these risks, nor any assessment of the utilisation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted parties (Para 5). There is emphasis on the susceptibility to fraud risk requiring documentation of discussion among the Engagement Team ('ET' hereafter) addressing such risk (Para 1 2) and requirement of enquiry with the management regarding the identification of related parties, including changes from the prior period; nature of the relationships between the entity and these related parties; the type and purpose of the transactions with these related parties during the period (Para 13). The auditor is also required to obtain sufficient appropriate audit evidence to verify that related party transactions are on an arm's length basis (Para 24) and obtain management representation letter regarding identification of related parties and RPTs and that management have appropriately accounted for and disclosed the RPT in the financial statements as per applicable framework (Para 26). We do not find any audit documentation by the Auditors in respect of verification of the RPTs, except for obtaining the list of Related Parties and their transactions. It is also observed that the Auditors are frequently mentioning of keeping the data in the digital files, which could easil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... requirements as per Para Il of SA 220 21 , which requires an EP to form a conclusion on compliance with the independence requirements and (ii) violating Para 19(a) of SA 220 which requires an EP to determine the appointment of EQCR for the statutory audit of a listed company, and (iii) failure to document his conclusions on compliance with the independence requirements and consultations undertaken during the course of audit engagement as per para 24. 54. The Auditors replied that their firm had designated Senior Partner Mr. Ashok Holani as EQCR for the audit of LGIL; that matters concerning the audit of LGIL were discussed in meeting of partners and professional staff; and that the work done in audit is left for review of Senior Partners. For compliance of independence requirements, they replied that the Firm's personnel are prohibited from having a financial or business relationship with entities of which a list is prepared and made available to the concerned personal from time to time so they may evaluate their independence . Vide an email dated 08.08.2023, CA Ashok Holani has also confirmed that he was the EQCR for the statutory audit of LGIL for the FYs 2017-18 to 2019 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is answered in the negative or with a qualification (subsection 4); complying with the auditing standards (subsection 9); and reporting to the Central Government matters which he believes involve the offence of fraud (subsection 12). Para 2 of SA 220 and Para 3 of SQC 1 stipulate that Quality Control Systems, Policies and Procedures are the responsibility of the Audit Finn that has an obligation 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. Para 5 of SQC 1 makes it applicable to all the firms. SQC 1 establishes standards and provides guidance regarding a firm 's responsibilities for its system of quality control for audits and reviews of historical financial information, and for other assurance and related service engagements. 60. The Audit Firm responded that our firm is a small firm and had four partners in the FY 2017-18, 2018-19 and three partners in the FY 2019-20. The firm has its SQC 1 policy, which is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 175,000 for its failure inter alia to perform all necessary audit procedures, and its violations of PCAOB standards concerning the performance, supervision, documentation of the audit, and quality control standards. E. ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT BY THE AUDITORS 64. As discussed in the foregoing paragraphs, the Auditors have made a series of serious non-compliances of the Standards on Auditing and the Law in their conduct of the audit of LGIL for the FYs 2017-18 to 2019-20. The Auditors had issued unmodified opinion on the Financial Statements despite existence of material misstatements in FS. The poor quality of Audit, the cover up in terms of submission of additional documents that did not exist in Audit File, incomplete documentation and attempt to mislead through untenable replies, further compound the professional misconduct on the part of the Auditors. Based on the foregoing discussion and analysis, we conclude that the Auditors committed Professional Misconduct in terms of section 22 of the Chartered Accountants Act 1949 ('CA Act' hereafter) as amended from time to time, as defined under Section 132 (4) of the Companies Act 2013, and as det ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applicable regulations, as explained in the para 21 to 58 above. v. The Auditors committed professional misconduct defined by clause 9 of Part I of the Second Schedule of the CA Act, which states that an auditor is guilty of professional misconduct when they 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 Auditors failed to conduct the audit in accordance with the SAS as explained in the para 21 to 58 above. F. ADDITIONAL ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT SPECIFIC TO THE A UDIT FIRM 65. In addition to above, the Audit Firm has committed Professional Misconduct as defined in Section 132 (4) of the Act read with section 22 of the CA Act, as amended from time to time, by failing to exercise due diligence and being grossly negligent in the conduct of professional duties in respect of matters explained at Section D above and thus, violated the SAS mentioned in the foregoing paragraphs and SQC I. 66. Therefore, we conclude that all the charges of professional misconduct in the SCN stand proved based on the evidences in the Audit File, the Aud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... verification of inventory. They failed to perform the required audit procedures with due professional skepticism and report the material misstatement. The Firm, M/S Ashok Holani Co. has also failed to exercise appropriate control and monitoring of the work of the EP and the ET during the audit engagement and has abdicated its responsibility to ensure audit quality as per professional standards. Under the circumstances, we proceed to impose sanctions, keeping in mind the deterrence, proportionality, and the signalling value of the sanctions. 70. As per information furnished by M/S Ashok Holani Co. vide email dated 27.04.2023, the statutory audit fees of LGIL for the FYs 2017-18, 2018-19 and 2019-20 was respectively. Total professional fees received by the audit firm during the FYs 2017-18, 2018-19 and 2019-20 was respectively. Total professional fees earned hv the EP, CA Rahul Jangir during the FYs 2017-18, 2018-19 and 2019-20 was respectively. 71. Considering the fact that professional misconducts have been proved and considering the nature of violations and principles of proportionality, we, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, orde ..... X X X X Extracts X X X X X X X X Extracts X X X X
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