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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 ..... the following sections: A. Executive Summary B. Introduction & Background C. Lapses in the conduct ofaudit D. Article of Charges of Professional Misconduct by the EP E. Penalty & Sanctions A. EXECUTIVE SUMMARY 3. The National Financial Reporting Authority ('NFRA' hereafter) initiated action under section 132 (4) of Companies Act 2013 ('Act' hereafter) against CA Ratan Laxminarayan Rathi, the Engagement Partner, for professional or other misconduct in the statutory audit of Bilcare Limited for the FYs 2014-15, 2015-16 and 2016-17. This was following to the information received from Securities Exchange Board of India ('SEBI' hereafter), that the Financial Statements ('FS' hereafter) of Bilcare for the FYs 2014-15, 2015-16 and 2016-17, did not present a true and fair view as the company did not recognise the full interest cost on its Borrowings from banks, which were classified as Non-Performing Assets ('NPA' hereafter) by those banks. As Bilcare was listed on Bombay Stock Exchange ('BSE' hereafter) and therefore falls under NFRA domain[Vide Rule 3(1 )(a) of National Financial Reporting Authority Rules, 2018]. 4. As is set ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r and enforce compliance of the auditing and accounting standards and to oversee 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 prescribed classes of companies and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 10. The statutory auditors, both individuals and firms of Chartered Accountants, are appointed by the members of 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 Standards on Auditing, including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed u/s 132 (4) (c) of the Act. 11. NFRA took up investigation under section 132(4) of the Act after receipt of a letter dated 16.06.2022 from SEBI about understatement of losses by Bilcare due to non-recognition of interest cost on loans classified as NPA. 12. Vide NFRA letter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 any material departure from the generally accepted procedures of audit applicable to the circumstances. 14. The reply to the SCN was submitted by the EP on 04.08.2023. The EP also availed the opportunity of a personal hearing on 08.12.2023. During the personal hearing, the EP stated that he had submitted the complete replies and nothing had to be added. However, he requested to take a lenient view considering his age, illness and retirement from the profession. He further requested to compound the offence, if proven. 15. We have perused all the material on record including the written responses of the EP in response to the charges levelled against him. Our findings are discussed in the following paragraphs. C. LAPSES IN THE CONDUCT OF AUDIT Non-recognition of interest cost on Bank Borrowings classified as NPAs 16. The EP was charged with failure to evaluate the appropriateness of accounting policy adopted by the company for not recognising full interest cost on borrowings classified as NPA by the Banks. The company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... waived. Accordingly, the management decided to consider average rate of 10% (then Banking Lending Rate) for recognising interest cost to reflect true & fair view. Therefore, this accounting policy was sufficient compliance of AS 1 read with AS 29. The EP quoted various clauses of AS 1, 4, 5, 29 and Framework 2000, to establish that the management can deviate from the Fundamental Accounting Policies and can make its own accounting policies, provisions and estimates of the liabilities by disclosing it in the FS to reflect true and fair view. The EP added that, in the extant case, there was no present obligation on the company, as the company was under discussions with the banks regarding waiver of liability and decided to recognise the interest cost@ 10% against the legally agreed interest rates of 10.75% to 18% with the Banks, while the balance interest cost was disclosed as contingent liability. The EP also referred to a Management Representation letter in this regard. The EP further emphasized that Board of Directors was responsible for preparing the FS by using estimates and its best judgement to provide for the liability on account of interest on NPA accounts as explained abov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a number of ways, for example, by: a) payment of cash; b) transfer of other assets; c) provision of services; d) replacement of that obligation with another obligation; or e) conversion of the obligation to equity. An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights." c) As per Para 10.4 (b) of AS 29, A contingent liability is a present obligation that arises from past events but is not recognised because: i. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or ii. A reliable estimate of the amount of the obligation cannot be made. In the Ind AS framework, interest cost is to be dealt with the following provisions - Ind AS 109 'Financial Instruments', which inter alia deals with the recognition and measurement of financial liabilities such as Bank Borrowings, states that an entity shall remove a financial liability (or a part of a financial liability) from its balance sheet only when it is extinguished, i.e. when the obligation specified in the contract is discharged or cancelled or expired (Para 3.3.1). Para 4.2.1 and 5.3.1 requi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt in adoption of accounting policies is not acceptable, as such deviation can only be done within the provisions of the Framework. The contention of the EP that as per the management representation, it was in negotiation with the lending banks for restructuring of the loans, and therefore could not measure the liability, is not acceptable, as the company was required to measure the full liability until new terms of loans had been formally agreed with. We do not find any working of the EP regarding accounting of new liabilities in replacement of the restructured borrowings, in accordance with para 3.3.2 of Ind AS 109 in the financial year 2016-17 and as of Ind AS Transition Date of 1st April 2015. We note that the EP was aware of the material amount of Rs 114.32 crores of unrecognised financial liability on account of interest cost on the borrowings classified as NPA for FY 2016-17. Therefore, the EP was required to challenge the management about non-compliance with applicable financial reporting framework. The reporting of the matter as EoM by the EP was not in compliance with SA 705 and 706. Therefore, we hold the EP responsible for his failure to report such material misstatemen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plicated businesses and processes relevant to financial reporting, the documentation may be simple in form and relatively brief(It is not necessary to document the entirety of the auditor's understanding of the entity and matters related to it. A145. The extent of documentation may also reflect the experience and capabilities of the members of the audit engagement team. A146. For recurring audits, certain documentation may be called forward, updated as necessary to reflect changes in the entity's business or processes." The EP also submitted that in addition to the statutory audit, other audits were also conducted by the different auditors viz. Internal Audit, Cost Audit, Secretarial Audit and periodical audits by the department of Sales tax, Excise and VAT etc., and during the same, he did not observe any suppressions of information, fraud, leakage of revenue, mismanagement, material misstatement or otherwise in the financial statements. The company always maintained sufficient internal controls to block the areas of fraud. Such experience and the honesty of management could not be documented. The EP also replied that Bilcare being a listed company, quarterly/half-ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the documentation should include the key elements of the understanding obtained by the auditor, including those on which the auditor based the assessment of risk of material misstatement. Such documentation was not done by the EP. The EP's long association with the company and his experience of honesty and integrity of the management cannot relieve him of the duty of exercising professional skepticism, as Para A22 of SA 200 states that nevertheless, a belief that management and those charged with governance are honest and have integrity does not relieve the auditor of the need to maintain professional skepticism or allow the auditor to be satisfied with less-than persuasive audit evidence when obtaining reasonable assurance. It is also noted that para 18 and 19 of SA 200 requires the auditor to comply with all the relevant SAs and understand the entire text of SAs including application and other explanatory material. It is evident, therefore, that the EP failed to perform audit in accordance with SAs in so far as audit of revenue is concerned. 27. Non-evaluation of revenue has been viewed seriously by International Regulators as well. For example, the PCAOB, the US Regula ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the Approvals and Resolutions of the audit committee were not shared with the EP, but it was duly verified; that there was also no adverse remark in the Secretarial Audit Report and the board of the directors had given a declaration in the annual report that RPTs were in the ordinary course of business and at arm's length basis, therefore not against the interest of the company. 31. SA 550 deals with auditor's responsibilities in respect of related parties. There are specific accounting and disclosure requirements for related party relationships, transactions and balances to enable users of the financial statements to understand their nature and actual or potential effects on the FS (Para 3). The auditors have 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 r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ement team obtained, sufficient appropriate audit evidence for significant items reported in the financial statements, including related party transactions and expenses. Inappropriate Opinion on the Financial Statement for the FYs 2014-15 to 2016-17 34. The EP was charged for not obtaining sufficient appropriate audit evidence, as per Para 11 of SA 700, to form an opinion that the Financial Statements as a whole were free from material misstatements and reflect a true & fair view. The EP was charged with issuing unmodified opinion on the FS for the FYs 2014-15 to 2016-17, despite the existence of material misstatements due to partial recognition / non-recognition of interest cost on borrowings classified 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g sufficient appropriate audit evidence for the verification of revenue and RPTs, the EP could not issue unmodified opinion. The understanding of the EP is also misplaced in respect of Para 18 of SA 700 referred to by him in his reply. This para states that "if the financial statements prepared in accordance with the requirements of a fair presentation framework do not achieve fair presentation, the auditor shall discuss... ". Since the FS were not prepared in accordance with the AS/ Ind AS framework, therefore, para 18 is not relevant to the EP's case. 37. Regarding the inclusion of EoM paragraph, we note that SA 706 stipulates that an EoM paragraph shall refer to only that information 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sh to use other firms to facilitate engagement quality control reviews... This provision is made to provide an alternative to the smaller firms to comply with the mandatory requirements of SQC 1 and SA 220, and not to provide any exemption. Accordingly, the contention of the EP that provisions of EQCR is discretionary, cannot be accepted. Further, the contention of the EP to consider the appointment of KPMG as EQCR is also misplaced, as KPMG was engaged in the FY 2016-17 for the transition work of AS framework to Ind AS framework and not for the EQCR purpose. Such replies of the EP show his complete misunderstanding, and are not be expected from a person who claims to be in 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 fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ined 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 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 sufficie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of-(]) not less than one lakh rupees, but which may extend to five times of the fees received, in case of individuals; and (II) not less than five lakh rupees, but which may extend to ten times of the fees received, in case of firms. (B) debarring the member or the firm from-{!) being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate; or (II) performing any valuation as provided under section 247, for a minimum period of six months or such higher period not exceeding ten years as may be determined by the National Financial Reporting Authority. 53. As per the information furnished by CA Ratan Laxminarayan Rathi vide email dated 20.12.2023, the audit fees of Bilcare for the FYs 2014-15 to 2016-17 was.........in each FY (including consolidated FS audit work). Total professional fees received by Mis R.L. Rathi & Co. from Bilcare Limited for the FYs 2014-15 to 2016-17 was...........in each FY. 54. Considering the proven professional misconduct, the nature of violations, principles of proportionality and deterrence against future professional misco ..... X X X X Extracts X X X X X X X X Extracts X X X X
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