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TMI Blog2024 (12) TMI 166X X X X Extracts X X X X X X X X Extracts X X X X ..... pacity - This charge is proved as the EP failed to obtain sufficient and appropriate audit evidence to draw conclusions about the existence and valuation of the inventory, failed to perform his duty of evaluation and reporting the non-compliance of Ind AS-110 and Ind AS-28 related to consolidation of financial statements of SCL, failed to fulfil his duty related to the audit of investments. The EP committed professional misconduct as defined by Section 132 (4) of the Companies Act, read with Section 22 and clause 6 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that an auditor 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 obtain sufficient and appropriate audit evidence to draw conclusions about the existence and valuation of the inventory, failed to perform his duty of evaluation and reporting the non-compliance of Ind AS-110 and Ind AS-28 related to consolidation of financial statements of SCL, failed to fulfil his duty related to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... med by the EP - the manner in which the audit was conducted, failed to meet the requirements of the SAs, the Act and the Code of Ethics in a number of significant aspects which demonstrated gross negligence on the part of the EP. This can be gauged from the failure of the EP to critically assess the existence and valuation of inventories, failure to comment in the audit report about the non-consolidation of financial statements, failure to verify the impairment testing of the investments of SCL and failing to apply the mandatory SAs in the audit - it is concluded that the EP's failure to comply with the provisions of SAs, exhibit professional skepticism, and fulfill the necessary audit procedures led to significant deficiencies in the audit. This non-compliance, combined with the consequent reporting failures, constitutes a breach of professional responsibilities and statutory requirements. The EP's actions (or inactions) constitute a serious violation of audit standards, leading to significant repercussions for the integrity and reliability of the financial statements. The professional misconduct of CA Santosh Deshmukh has been detailed in the foregoing paragraphs of this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... port, any matter related to misstatement/ irregularities in the transactions. 5. M/s Khandelwal Kakani Co. was the statutory auditor of SCL and CA Santosh Deshmukh was the Engagement Partner (EP) for this statutory audit for the FY 2017-18. Accordingly, NFRA initiated proceedings under Section 132 of the Companies Act, 2013 for necessary action against the EP, CA Santosh Deshmukh 6. On examination of the Audit File and financials of subsidiary and associates of SCL and on being satisfied that sufficient cause existed to take action under sub-section (4) of Section 132 of the Companies Act, 2013, a Show Cause Notice (SCN hereafter) was issued to CA Santosh Deshmukh on 08.04.2024 asking him to show cause why action should not be taken against him for professional misconduct in respect of his performance as EP on behalf of M/s Khandelwal Kakani Co., the Statutory Auditor of SCL for the FY 2017-18. The EP, submitted his reply vide email dated 24.05.2024 and refuted all charges, requesting for a personal hearing. 7. The EP was granted a personal hearing on 13.06.2024 25.06.2024 where the EP did not appear. NFRA granted a final opportunity to the EP to appear on 05.07.2024, and the EP ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utory authority set up under section 132 of the Companies Act 2013 to monitor implementation 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. 11. The statutory auditors, both individuals and firms, are appointed by the members of companies under Section 139 of the Companies Act. The statutory auditors, including the Engagement Partners (EP), the Engagement Team and Review 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), 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 Section 132(4) of the Act. 12. Pursuant to information received from Securities and Exchange Board of India (SEBI) pertaining to the financial irregularities in the company, NFRA called for the Audit Files and other information from M/s Khandelwal Kakani Co, Statutory Auditor for SCL for the Financial Year (FY) 2017-2018 with a purpose to investigate into the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s from NFRA in the junk folder of his email and therefore could not reply. Considering the request of the EP, as a last opportunity, the EP was granted another extension vide NFRA email dated 24.06.2024 and the personal hearing was rescheduled to 05.07.2024. The EP was asked to confirm his presence in the rescheduled personal hearing to be held on 05.07.2024 at NFRA Office. The EP was also given the option of bringing his legal counsel. The EP was also called upon to submit the SQC Policy of the firm and the form ADT-3. The EP vide his reply dated 28.06.2024 stated that he and CA Vikram Gupte would attend the personal hearing. He also submitted the SQC Policy but failed to submit the ADT-3. Vide email dated 01.07.2024, NFRA reminded the EP that he could only be accompanied by a legal counsel. The EP appeared in the personal hearing on 05.07.2024 and submitted ADT-3 which he had filed with MCA on 03.07.2024, after NFRA had initiated the proceedings, indicating that had not filed this statutory return timely. During the hearing, the EP requested for one more hearing with his legal counsel. The request was considered, and vide NFRA email dated 15.07.2024, the hearing was posted to 06. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e considered for the valuation of the closing inventories of soya seed and paddy resulting in overvaluation of the soya seed inventories by approx. Rs 18.93 crores and of paddy inventories by Rs 13.30 crores. The SCN stated that this was in noncompliance with Ind AS-2 (Ind AS-2) Inventories and Ind AS-23 (Ind AS-23) Borrowing Costs , that the EP did not report this misstatement in his audit report and did not suitably modify his audit opinion in accordance with SA 705. 21. The SCN also observed that the EP did not obtain sufficient appropriate audit evidence regarding the existence and condition of inventory in accordance with Para 4 to Para 6 of SA 501. 22. In his response to the SCN, in reference to the inclusion of the finance cost in the valuation of the soya seed and paddy, the EP replied that: The Company was following a practice of including interest component as part of their closing stock valuation exercise considering inventory to be qualifying assets using explanation to definition of qualifying assets available in AS 16 of accounting standards rules 2006. The company also used a logic that raw material (soyabean and paddy) being seeds are seasonal and procurement of cro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... consist 48.69% (255.57 crore) of total stock as on 31.03.2018 as this was only possible for us to verify on that date. The Physical verification process conducted by the company was witnessed by our team for soya seed and soya DOC. Since we have witnessed the physical verification process for 48.69% of total inventory, which in our considered opinion is a good sample size, to arrive at audit satisfaction...... During audit quantity certification from the management was also obtained..... Since stock was verified on 31.03.2018 and tallying with the book stock, therefore, there was no question of reconciling the stock to the closing quantity arrived by the management . In the personal hearing held on 05.07.2024, the EP stated that they had only audited the soya division and not the rice division as they had planned to physically verify the rice division in the next year of audit. 24. We have considered the reply of the EP and find that the EP has failed to perform the audit procedures to ascertain and verify the existence, condition and the valuations of the inventories reflecting in the books of SCL as on 31.03.2018 for the following reasons: a) Valuation of inventories: i. Para 9 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f that company explicitly states that cost include interest cost on raw material where such raw material are stored for substantial period of time . However, there is no such mention in the policy of the SCL, indicating that the EP failed to analyse the matter applying the established standards and is now rationalizing his position by giving unacceptable arguments. iv. Therefore, the inclusion of the interest cost of 11% in arriving at the price considered for the valuation of the closing inventories of soya seed and paddy without supporting evidence resulted in overvaluation of the soya seed inventories by approx. 18.93 crores and of paddy inventories by 13.30 crores. This is not in compliance with Ind AS-2 and Ind AS-23 and therefore, we conclude that the EP failed to evaluate and report this non-compliance and misstatement. b) Verification of existence and condition of inventories: i. SCL largely had three processing plants/ factories situated at Mandideep, Itarsi and Kiratpur. These processing plants/ factories had 4 categories of inventories in form of raw material, work in progress, finished goods and trading stock as depicted in Table 3 below. The ET only verified the stock ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 013, SA 501 (SA 501): Audit Evidence-Specific Considerations for Selected Items and SA 705 (SA 705): Modifications to the Opinion in the Independent. Auditor's Report . 26. Lapses in the audit of inventory have been viewed seriously by International Regulators as well. (a) The US audit regulator PCAOB took a serious view of the non-performance by AMC Auditing, LLC of audit procedures pertaining to inventory and obtaining sufficient audit evidence. The PCAOB order PCAOB Release No. 105-2020-021 dated December 3, 2020 stating that because inventory observation procedures were not performed for most of the reported inventory, nor was sufficient evidence obtained or conclusions reached to evaluate Issuer B's representations about quantities and physical condition of inventory, Liu failed to obtain sufficient evidence for reported inventory during Issuer B's 2016 audit , suspended Mimi Liu, CPA for a period of one year. (b) The PCAOB (PCAOB) Release No. 105-2017-028 , in the matter of W.T. Uniack CPA, P.C. (firm) and William T. Uniack, CPA (respondent), revoked the firm's registration and barred the respondent from being an associated person of a registered public accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. 31. Given the above-mentioned requirements of the standards, the EP was required to verify the ownership and valuation of these investments in SEL and SSL. Further, in view of the loss-making nature of SEL and SSL, the EP was required to check/evaluate the impairment testing of the investments. However, no sufficient evidence of such working is found in the Audit File. 32. In his written reply, the EP stated that after the question raised by you (NFRA) in show cause notice we realised that the documentation of work performed for audit of investments was not part of the audit file. By virtue of procedure/right given to us in para 16 (which is appended below) of SA 230 along with application guidance available in para A24(which is appended below this) we do hereby present our views and additional documents considered by us at the time of audit but not documented in audit file earlier . 33. The EP further submitted that Shreenathji Solvex Limited owned a land whose market value was 55.65 crore and therefore no devaluation/ impairment in value of investment was so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sly. 35. In the light of above, we, find the reply and explanation of the EP clearly as an attempt to justify non-performance of his professional duties and an afterthought to mislead NFRA. The EP clearly failed to fulfil his duty related to the audit of investments. We, therefore, find the EP to have been grossly negligent in performing his duty in accordance with of Section 143(3)(e) of the Companies Act 2013, SA 700 and SA 705. 36. Negligence in performing audit procedures related to the audit of investments has been viewed seriously by international regulators too. For example, PCAOB in its order dated 23.01.2024 PCAOB Release No. 105-2024-002 , in the matter of Tyson Holman, CPA, and Anna Hrabova, CPA, censured Tyson Holman, CPA, barred Holman from being an associated person of a registered public accounting firm; imposed a $65,000 civil money penalty on Holman; censured Anna Hrabova, CPA; limiting Hrabova's activities in connection with any audit for a period of one year and imposed a $30,000 civil money penalty on Hrabova for inter alia failure to obtain sufficient appropriate audit evidence with respect to Issuer's investments. C.3 Lapses relating to Consolidated Fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tement on which we have given report. In the personal hearing held on 05.07.2024, the EP submitted the resignation letter dated 26.10.2018 and the ADT- 3 filed by EP on 03.07.2024. 40. We find that for the following reasons, the reply and explanation given by the EP are misleading and an afterthought: i. There is no evidence in the Audit File to show that the EP had made any communication with the TCWG/Management of the company with respect to the Consolidated Financial Statements. Further, there is no evidence in the Audit File of any submissions made by the management related to Consolidated Financial Statements including in the Management Representation Letter given to the auditor. ii. The firm resigned from the statutory audit of SCL on 26.10.2018. There is no mention in the Audit File of the verbal assurance received by the EP that the Consolidated Financial Statements would be submitted later. The contention of the EP that the non- preparation and non-submission of the Consolidated Financial Statements led to the resignation of the firm from the assignment is not substantiated by the resignation letter of the firm in which it was stated that the firm was resigning from the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... L which is a trading and manufacturing company, the EP was required to work and document in respect of the following areas: Understanding of business entity relevant industry. Understanding of business environment of the company. Internal controls governing the generation of revenue. Verification of whether the company had instituted adequate cutoff procedures in relation to sales and sales returns so as to ensure that the transactions pertaining to a period are recorded in that period and not in a preceding or subsequent period by examining the despatch documents pertaining to a few days immediately before the year-end and verifying that the related sales invoices have been recorded as sales of the current year. Verification of the trade receivables to check that they are realized by the company through ledger scrutiny and its corroboration with the bank statements. Verification of the inter unit/plant sales and its treatment in the Financial Statements in accordance with applicable financial reporting framework Assessment of Management's performance vis- -vis the company's expectations, as may be available in the Budgets. Verification of the other income of SCL (Income fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... crores) but the sample invoices relating to control testing of revenue in respect of basmati rice and Soya Doc are not evidenced in the Audit File. The sample invoices Audit files\4. Performing Audit\16.Revenue From Operation\Sale Invoices referred to by the EP in personal hearing held on 05.07.2024 do not pertain to testing of internal controls on revenue and are a general dump of invoices. Further, in order to check the controls related to revenue, the EP was required to do a complete back testing of sales invoice starting from purchase contracts/agreements, purchase orders, sales invoices, dispatch order and delivery notes. The samples Audit files\4. Performing Audit\16.Revenue From Operation\Sample Sale Invoice referred to by the EP merely refer to invoice number and no reference of other credentials viz. details of purchase contracts/agreements, purchase orders, sales invoices, dispatch order are seen in such sample invoices in the Audit File. Further, there is nothing in the Audit File to show that the auditor verified the controls related to rebate/discount viz-a- viz the re- bate/discount policy of the company. The control testing as claimed by EP is found to be thoroughly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed. Further, Para 17 of SA 200 states that the auditor shall plan and perform an audit with professional skepticism recognising that circumstances may exist that cause the financial statements to be materially misstated. 54. Para 5 of SA 315 states that the auditor shall perform risk assessment procedures to provide a basis for the identification and assessment of risks of material misstatement at the financial statement and assertion levels. Para 6 of SA 315 states that the risk assessment procedures shall include (a) Inquiries of management and of others within the entity who in the auditor's judgment may have information that is likely to assist in identifying risks of material misstatement due to fraud or error; (b) Analytical procedures; and (c) Observation and inspection. 55. The SCN stated that the trade receivables of SCL (₹916.03 crores) formed a material part of the Balance Sheet (52.89%) and 18.12% of the revenue from operations (₹5054.73 crores). The trade receivables turnover ratio was approximately 6.15 times or approximately 60 days. Also, 100% of the trade receivables were unsecured but no provisioning for doubtful debts was done in respect the trade ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ivables in crores 1 UWI Infra Pvt. Ltd. 145.98 15.94% 2 UAC Commodities Pvt. Ltd. 153.14 16.72% 3 U.R. ARC Pvt. Ltd. 27.28 2.98% 4 Other parties (approx. 950) 589.62 64.36% Total 916.03 100% The Audit File contain the balance confirmation received only from UWI Infra Pvt. Ltd, UAC Commodities Pvt. Ltd. and U.R. ARC Pvt. Ltd. There is no audit evidence that letters were written for balance confirmation to more than 950 debtors who accounted for over 64% of the trade receivables. Even in the case of the three debtors for which confirmation were available, there is no evidence that letters seeking confirmations were sent by the EP to these three debtors. There is no document in the Audit File to show how the samples were selected for external confirmations and the rationale of selection of these samples etc. A reasonable sample selection provides a basis for the auditor to draw conclusions about the population from which the sample is drawn. A skewed sample selection, as in the present case, compromises the integrity and objective of the audit. 60. There is no sufficient evidence in the Audit File to prove the claim of the EP that he reviewed the financial statements of last four year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. In the extant case, the EP did not show professional skepticism in carrying out the required risk assessments procedures and in test of controls. Accordingly, we find that the EP failed to comply with SA 200 and SA 315 in performance of the audit of trade receivables. 64. Negligence in performing audit procedures related to the audit of trade receivables has been viewed seriously by international regulators too. For example, PCAOB in its order dated 20.03.2024 PCAOB Release No. 105-2024-01323 PCAOB Release No. 105-2024-001 , in the matter of CHOI Chung Chuen, MA Hong Chao, and DONG Chang Ling, censured CHOI Chung Chuen, MA Hong Chao, and DONG Chang Ling, barred Choi and Ma each from being an associated person of a registered public accounting firm, limited Dong's activities in connection with any audit for a period of one year and imposed civil money penalties in the amounts of $75,000 on Choi, $50,000 on Ma, and $25,000 on Dong for failure to exercise due care and professional skepticism and obtain sufficient appropriate audit evidence to support Issuer's net accounts receivables and doubtful accounts. C.6 Failure related to forming an opinion on Financial Statements wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on Financial Statements without obtaining reasonable assurance about whether the financial statements as a whole were free from material misstatement. Accordingly, the EP failed to comply with the requirements of SA 700. 71. Failure in forming an opinion on Financial Statements without obtaining Sufficient Appropriate Audit Evidence has been viewed seriously by international regulators too. For example, in the Matter of Haynie Company, PCAOB in its order dated 23.01.2024 PCAOB Release No. 105-2024-001 , censured the firm, Haynie Company and imposed $400,000 civil money penalty for inter alia failing to obtain sufficient appropriate audit evidence to provide a reasonable basis for the Firm's audit opinions, and to conduct the 2019 Audits with due care and professional skepticism. C.7 Failure related to Audit Documentation 72. The EP was charged with failure to prepare sufficient audit documentation in accordance with the requirements of SA 230 SA 230: Audit Documentation . Para 8 of SA 230 requires an auditor to prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand: (a) The nature, timing, an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SA 230 to prepare documentation that provides sufficient and appropriate record for the basis of auditor's report and evidence that the audit was planned and performed in accordance with SAs. 77. Audit documentation is a crucial aspect of the audit process as it provides a detailed record of the audit procedures performed, the evidence obtained, and the conclusions reached. It ensures that an experienced auditor, with no prior connection to the audit, can understand the nature, timing, and extent of the audit work. The EP's failure to prepare adequate audit documentation, as required by SA 230, highlights a significant lapse in meeting professional standards. This failure undermines the integrity of the audit and demonstrates gross negligence, leading to professional misconduct. Proper documentation is essential for maintaining transparency, accountability, and the overall quality of the audit. 78. Non-documentation of the work performed is clear evidence that the work has not been performed. It is apposite to note the following observations of the Australian Audit Regulator ASIC: Firms often assert that our findings relate to documentation deficiencies in their Audit File. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 30 as they failed to adequately document the audit work papers. 81. In light of the foregoing, we find the explanation of the EP unacceptable and conclude that the EP was grossly negligent in performing his duty in accordance with SA 230. C.8 Failures relating to determination and communication with Those Charged With Governance (TCWG) 82. The EP was charged with failure to determine TCWG, communicate with TCWG about the responsibilities of the auditor, overview of planned scope, timing of the audit and deficiencies in Internal Control and to maintain audit documentations of such activities in accordance with the requirements of SA 260 (SA 260): Communication with Those Charged with Governance and 265 (SA 265): Communicating Deficiencies in Internal Control to Those Charged with Governance and Management 83. Responding to the charge, the EP replied that the minutes of meeting were not documented, however, the meetings have happened and can be verified from the language of management representation letter available in Audit File where management is referring to the queries raised by the EP during audit and discussion. 84. There is no sufficient evidence in the Audit File to show tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Section 143 (9) of the Companies Act, 2013. C.10 Lapses relating to Related Party Transactions, Advances and Materiality 91. The EP was charged with failures related to related party transactions, advances and materiality. In view of the written responses of the EP and submissions made during the personal hearing held on 05.07.2024, these charges are not pursued further. D. Articles of charges of Professional Misconduct by the Auditor 92. As discussed in the foregoing paragraphs, the EP has made a series of serious departures from the Standards and the Law, in his conduct of the audit of SCL for FY 2017-2018. We, therefore, conclude that the EP has committed Professional Misconduct as defined under Section 132 (4) of the Companies Act, 2013 in terms of Section 22 of the Chartered Accountants Act 1949 (CA Act) as amended from time to time, and as detailed below: i. The EP committed professional misconduct in terms of by Section 132 (4) of the Companies Act, read with Section 22 and clause 5 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that an auditor is guilty of professional misconduct when he fails to disclos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d Accountants Act 1949 (as amended from time to time), which states that an auditor 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 rules as well as due to his failure to report the material misstatements and non-compliances of the Company in the financial statements, as explained in the paras 17 to 90 above. v. The EP committed professional misconduct as defined by Section 132 (4) of the Companies Act, read with Section 22 and clause 9 of Part I of the Second Schedule of the Chartered Accountants Act 1949 (as amended from time to time), which states that an auditor is guilty of professional misconduct when he 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 EP failed to conduct the audit in accordance with the SAs but reported in his audit report that the audit was conducted as per SAs as explained in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dit 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. 97. As per the information furnished by CA Santosh Deshmukh vide his email dated 23.05.2024, the statutory audit fees of SCL for the FY 2017-18 was ₹ . 98. The professional misconduct of CA Santosh Deshmukh has been detailed in the foregoing paragraphs of this Order. Considering the proved professional misconducts and keeping in mind the nature of violations, principles of proportionality and deterrence against future professional misconduct, we, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, hereby order imposition of monetary penalty of 5,00,000/- (Rupees Five Lakhs) and also debars CA Santosh Deshmukh for 1 (One) year 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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