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TMI Blog2024 (3) TMI 27X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the CA Act, which states that a CA is guilty of professional misconduct when he fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where he is concerned with that financial statement in a professional capacity . This charge is proved as the EP failed to disclose in his report the material non-compliances by the company as explained in Para 16-22 above. (b) The EP committed professional misconduct as defined by clause 6 of Part I of the Second Schedule of the CA Act, which states that a CA is guilty of professional misconduct when he fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity . This charge is proved as the EP failed to disclose in his report the material non-compliances by the company as explained in Para 16-22 above. (c) The EP committed professional misconduct as defined by clause 7 of Part I of the Second Schedule of the CA Act, which states that a CA is guilty of professional misconduct when he does not exercise due diligence or is grossly neglige ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ionality and deterrence against future professional misconduct, we in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, hereby order: I. Imposition of a monetary penalty of Rs 3,00,000/- upon CA Ratan Laxminarayan Rathi; II. In addition, CA Ratan Laxminarayan Rathi is debarred for 2 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 Ratan Laxminarayan Rathi, ICAI Membership No. 014739 under Section 132(4) of the Companies Act 2013 read with Rule 11(6) of National Financial Reporting Authority 2018 1. This Order disposes of the Show Cause Notice ('SCN' hereafter) no. NF-23/18/2022 dated 04.07.2023, issued to CA Ratan Laxminarayan Rathi, proprietor of Mis R.L. Rathi Co. (ICAI Finn registration no. 108719W), Pune, Maharashtra, who is a member of the Institute of Chartered Accountants of India ('ICAI' hereafter) and was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 706 [Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report] . 6. The EP also failed to obtain sufficient appropriate audit evidence to verify the revenue, which is an item fraught with risk of fraud. In addition, the EP did not carry out proper audit of Related Party Transactions ('RPTs' hereafter) of Bilcare including loans advances which were as high as 106.87% of the revenue. Moreover, with respect to granting of loans advances to the related parties, the EP issued a false Companies (Auditor's Report) Order ('CARO' hereafter) report. 7. The Standards require the EP to determine appointment of Engagement Quality Control Reviewer ('EQCR' hereafter), but the EP failed to do the same. 8. Based on our investigation and proceedings under section 132 (4) of the Companies Act and after giving him opportunity to present his case, we find the EP guilty of professional misconduct and impose through this Order a monetary penalty of Rs 3,00,000/- (Rupees Three Lakhs only). In addition, the EP is debarred for 2 years (Two years) from being appointed as an auditor or internal auditor or from undertaking any a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AS' hereafter) [Applicable financial reporting framework was the 'Indian Accounting Standards (Ind AS)' prescribed by Ministry of Corporate Affairs under Companies (Indian Accounting Standards) Rules 2015 (as amended thereafter)] as notified by Ministry of Corporate Affairs. On examination of the Audit Files and other documents, it was observed that the audit had prima facie been conducted in disregard of most of the SAs and relevant requirements of the Act. Despite this, the EP had issued an unmodified audit opinion in his Independent Auditor's Report. 13. On being satisfied that a sufficient cause existed to take action under sub-section (4) of section 132 of the Act, an SCN was issued to the EP on 04.07.2023, asking him to show cause why action should not be taken for Professional Misconduct in the Statutory Audit of Bilcare for the FYs 2014-15 to 2016-17. The EP was charged with professional misconduct of: a) failure to disclose a material fact known to him, which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement, where he is concerned with that financial statement in a professional capacit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Particulars/ FY 2014-15 2015-16 2016-17 Total long-term borrowings [As per Annexure A to Note no. 5 and Annexure A to Note no. 13{a) of the FS of the FY2014-15, 2015-16 and 2016-17] 949.23 842.08 714.42 Default in repayment of borrowings [ [As per Annexure A to Note no. 5 and Annexure A to Note no. 13{a) of the FS of the FY2014-15, 2015-16 and 2016-17] 877.31 490.18 380.22 Recognised interest cost 103.18 53.07 41.23 Interest cost disclosed as contingent liability (A) 56.5 62.46 - Non-recognised/ non-disclosed interest cost [As per page no. 19 of work paper FY16-17_F008 and EoM para in the Auditor's Report of the FY 2016-17] (B) - - 114.32 C=A+B 56.5 62.46 114.32 Reported Loss after Tax (D)** ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te waiver of interest cost thereon. Accordingly, the company was complying with the applicable accounting policies. For FY 2016-17, the EP stated that the management was confident of getting waiver of interest cost and principal amounts, therefore they did not provide for any interest cost on the borrowings classified as NPA and disclosed this fact in the FS. In addition to the same, he reported this matter through EoM. The EP also added that there was no reason for him to doubt the honesty and fair judgements of the management about the outcome of negotiations, and that subsequently on 31.03.2023, the company had paid all the bank loans/ FD holders etc. in cash and sold the entire undertaking as a going concern. Therefore, the EP stated that there was no misstatement in the FS in the FYs 2015-16 and 2016- 17, as the management had used due diligence and fair estimates for not recognising interest cost in the FS. 18. We observe that interest cost on the borrowings classified as NPA should be treated as liability and not as contingent liability, and recognized on accrual basis unless settled/ extinguished, as per the following provisions of AS Framework applicable for FY ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... val and/or replacement of financial liability as the outcome of restructuring of loans is to be dealt with as follows: In the case of restructuring of loans, an existing financial liability could only be extinguished and new financial liability recognised, if there were 'significant modifications' in the terms of the existing loan agreements (para 3.3.2 of lnd AS 109). 'Substantial modification' of the terms has defined in Para B3.3.6 of appendix B of lnd AS 109 as, the terms are substantially different if the discounted present value of the cashflows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least JO per cent different from the discounted present value of the remaining cashflows of the original financial liability . 20. Partial recognition/ non-recognition of interest cost is in contravention of the provisions of AS/ Ind AS framework as explained above. Therefore, the company had to recognise the liability of full interest cost on the borrowings, even though classified as NPA by the lenders, until the borrower company is legally released from its contractual li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ailure to consider modifying his report in view of such material misstatements, as elaborated in para 34 to 39 of this Order. 22. 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 [PCAOB Release No. 105-2022-003] , in the matter of BMKR LLP (Firm) and CPA Joseph Mortimer (Respondent), revoked the registration of the Firm for two years; imposed monetary penalty of$ 30,000 collectively on the firm and the respondent; and barred the member from being associated with a registered public accounting firm for their failure inter alia to properly evaluate the accounting for certain significant transactions of the company not being in conformity with US GAAP. Perfunctory Audit of Revenue 23. The EP was charged with failure in obtaining sufficient appropriate audit evidence for the verification of revenue and non-compliance with the provisions of SAs 200, 240 and 315. The company had revenue to the tune of, 255 crores tot 331 crores. SA 200 required the EP to plan and perform the audit with professional s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any had only two representations from the promoter group and rest all were independent directors; the company was using SAP software for accounting; most of the trade receivables were being realised between 45 to 90 days depending on the terms of contract etc.; and performed cut-off procedures for verification of revenue as stated in the checklist on sales. 25. We observe that to verify revenue, the auditors are required to perform and document, at least the below mentioned audit procedures in line with the requirements of SAs 200, 240 and 315: Understanding of business entity relevant industry, Understanding of business environment of the company, Understanding of Internal controls governing the generation of revenue, Evaluation of accounting policy being followed by the company in line with the applicable accounting framework, Verification of sales through the customers contracts, credit terms and reconciliation of the same through the cash flow to the bank accounts and through statutory returns, Verification of the periodic revenue figures like daily, monthly, quarterly, half-yearly etc., Assessment of periodical Cash Flow Statements prepa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e inter a/ia to obtain sufficient appropriate audit evidence about whether the revenue was properly valued and recorded in the proper period. Non-evaluation of Related Parties Transactions A. False reporting under CARO 28. The EP was charged with false reporting in clause 3 of CARO, 2015 and 2016 in report of loans and advances granted to related parties. The EP had reported that ... the Company has not granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 189 of the Companies Act ... , even though, the company had granted the loans, as in the given table below, and the same was also documented [Refer to page no. 8 9 of workpaper FYl516_F005] by the EP in the Audit File. FY Type of Related Party Transactions Purchases Sales Sundry Expense Income Fixed Assets Finance (Loans advances) Total Revenue % of Revenue 2014-15 5.48 16.27 2.69 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave the responsibility to perform audit procedures to understand, identify, assess and respond to the risks of material misstatement arising from the entity's related party relationships and transactions, as fraud may easily be committed through related parties (Para 5). There is emphasis on the susceptibility to fraud risk requiring documentation of discussion among the Engagement Team addressing such risk (Para 12) 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, where the management has made an assertion in the FS to the effect that RPTs are conducted on terms equivalent to those prevailing in an arm's length transaction (Para 24) and obtain management representation letter regarding identification of related parties and RPTs and that management have appropriately ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as NI-A. In this matter, the EP included in his Audit Report of the FY 2016-17 an Emphasis of Matter paragraph, which was also in contravention of the requirements of SA 706. 35. The EP replied that, ...we were forming an opinion on the whole set of financial statements taken together, and not on a component or element of those financial statements, and our opinion was formed in the context of the overall 'materiality' of those financial statements. In view there of we submit that there was no material misstatement and that the financial statements for the FYs 2015-16 and 2016-17 did reflect true and/air view to comply with the provisions of SA 700. The EP added that substantial NPA loans were settled with many banks during FY 2015-16, therefore as per the company's estimates and judgements, they determined not to recognise the interest cost on the NPA loans in the FY 2016-17. The EP added with the support of para 18 of SA 700 that on the basis of management representation letter; discussion with the audit committee; restructuring of loans; and disclosures of the same in the financial statements, there was no material misstatement in the FS. Thus, there was su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n which is not materially misstated and presented or disclosed in the FS (para 6). It is also stipulated that inclusion of an EoM paragraph in the auditor's report is not a substitute for issuing of modified opinion (Para A3). Therefore, an EoM paragraph can only be incorporated by the auditor when he obtains sufficient appropriate audit evidence, and concludes that the matter is not materially misstated and appropriately presented or disclosed in the financial statements. The EP had included in the Independent Auditor's Report of the FY 2016-17 the EoM para on non-recognition of interest cost on the borrowings classified as NPA, which was a misstatement and therefore could not be included in EoM. 38. The EP relied heavily upon the management and was consistently taking recourse to the management disclosures and representations etc., without applying professional skepticism, which shows the negligent attitude of the EP. When the law and the standards are clear, there is no reason for the auditor to place blind reliance on the management representations, and not to apply professional scepticism. 39. Considering the above, the charge that the EP issued inappropriate aud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... practice for over 29 years. 43. Considering the above, we find that the EP was grossly negligent in his failure to determine the appointment of EQCR in compliance with the provisions of SA 220. 44. Failure to appoint an EQCR has been viewed seriously by International Regulators as well. For example, the PCAOB, the US Regulator [PCAOB Release No. 105-2017-042] , censured and imposed monetary penalty of$ 10,000 on the firm and respondents in the Matter of Brace Associates, PLLC and Kari Brace, CPA, for their failure inter alia to comply with the requirements of Engagement Quality Review. Non-submission of Audit File for the FY 2014-15 45. The EP was charged with non-submission of the audit file for the FY 2014-15, as the EP failed to submit the audit files to NFRA despite two reminders. As per the requirement of SA 230, an auditor is compulsorily required to document and assemble the audit file for every specific assignment within the prescribed time limit and keep it safeguarded. 46. The EP replied that the audit of Bilcare Limited for the FY 2014-15 was concluded and signed by him on 29th May 2015, and this date is more than seven years from the date of first no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sly negligent in the conduct of his professional duties . This charge is proved as the EP failed to exercise due diligence in the audit of the company in accordance with the SAs and applicable regulations, as explained in Para 16-44 above. (d) The EP committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when he 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 EP failed to conduct the audit in accordance with the SAs and applicable regulations and failed to analyse and report the appropriateness of accounting policy for recognition of interest cost on NPA loans in the financial statements as explained in Para 16-44 above. (e) The EP committed professional misconduct as defined by clause 9 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when he fails to invite attention to any material departure from the generally accepted procedure of audit applicab ..... 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