9911796707
TMI Blog2024 (12) TMI 166X X X X Extracts X X X X X X X X Extracts X X X X ..... Introduction & Background C. Lapses in the Audit D. Articles of Charges of Professional Misconduct by the EP E. Penalty & Sanctions A. Executive Summary 3. National Financial Reporting Authority (NFRA) is India's independent regulator, in respect of matters relating to accounting and auditing, of prescribed classes Rule 3 of NFRA Rules, 2018 of entities broadly described as 'Public Interest Entities' (PIEs). 4. NFRA initiated action under section 132 (4) of Companies Act 2013 ('CA-2013' or 'Act' hereafter) against the Auditor of Sanwaria Consumer Limited for professional or other misconduct in relation to statutory audit for FY 2017-18, pursuant to information received from Securities and Exchange Board of India (SEBI) pertaining to the financial irregularities in the company and the failure of the auditor to qualify or emphasize in his independent audit report, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment due to fraud or otherwise in the revenue recognition (C.4). f. The EP was grossly negligent in preparing sufficient audit documentation in accordance with the requirements of SA 230(C.7). g. The EP failed to communicate deficiencies in internal control to Those Charged with Governance (TCWG) (C.8). 9. Based on the proceedings under Section 132 (4) of the Companies Act and after giving the EP opportunities to present his case, we find the EP guilty of professional misconduct. Accordingly, this Order imposes upon CA Santosh Deshmukh a 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. B. Introduction & Background 10. The National Financial Reporting Authority is a statutory 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 wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th which a CA is concerned in a professional capacity. c. Failure to exercise due diligence and being grossly negligent in the conduct of professional duties. d. Failure 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. e. Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances. 15. Vide his reply dated 23.05.2024 to the SCN, the EP requested for being heard in person. Vide NFRA email dated 04.06.2024, the EP was granted an opportunity of being heard on 13.06.2024. As no confirmation was received from the EP with respect to attending the personal hearing, vide email dated 11.06.2024, the EP was granted another opportunity of being heard on 25.06.2024. The EP vide email dated 21.06.2024 requested for a further extension of 15 days stating that he found the emails 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... crores. The breakup of these inventories is as follows: TABLE 1 S. No Item Rs. in crore 1 Raw Material 328.03 2 Work in Progress 2.73 3 Finished Goods 151.46 4 Stores and Spares 3.87 5 Packing Materials 3.09 6 Stock in Trade 35.70 19. Of the total inventories as on 31.03.2018, raw material (62.49%) and finished goods (28.85%) formed the largest part of the total inventories. The raw material mainly consists of Soya Seed (Rs.191.06 crores) and Paddy (133.97 crores) and the finished goods mainly consist of Soya DOC (Rs.38.22 crores) and Basmati Rice (Rs.117.21 crores). The details are as follows: TABLE 2 S. No Item Quantity in MT Rate per MT in Rs. Rs. in crore 1 Soya Seed 44956 42500 191.06 2 Paddy 33494 40000 133.97 3 Soya DOC 10921 35000 38.22 4 Basmati Rice 14652 80000 117.21 20. On examination of the Financial Statements of SCL and the Audit File for the FY 2017- 18, it was observed that an interest cost of 11% was added while arriving at the price 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 inventor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. The SCL generally sales basmati rice only after seasoning of one year thus making it certain to be qualifying assets as it is ready to be used only after one year of procurement...... SCL was following this practice consistently since last many years, the net impact on current year (2017-18) financial after removing impact of overvaluation of opening inventory on account of interest works out to be Rs. 4.21 crore. This amount is below the materiality level. Therefore, applying our professional judgement we had not qualified the same. Further, in the personal hearing held on 05.07.2024, the EP while reiterating the above statement, also quoted and submitted the accounting policy of another such company to justify the inclusion of borrowing cost in the valuation of rice. 23. In reference to obtaining sufficient appropriate audit evidence regarding the existence and condition of inventory, the EP replied that: "The Engagement team members visited two plant locations - Mandideep Soya Unit and Itarsi Soya Unit which 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 conduct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is lower". There is no mention about the inclusion of borrowing cost for valuation of inventories in the said policy. There is no evidence in the Audit File to show if the EP had verified/concluded that the Paddy and Soya seeds are qualifying assets based on established criteria. There is nothing in the Audit File to support the claim made by the EP about his understanding of the client business, its production process and ageing of its inventory, the process of procurement of raw materials etc. or any efforts on the part of EP to obtain any report of technical expert that substantiates the claim of the EP. In fact, the MRL given by management of SCL states that "Rice" (not the paddy) is time aged to get better price in the market and therefore, the conten- tion of the EP that paddy is seasoned by SCL is not acceptable. iii. The submission of the accounting policy of another company by the EP in the personal hearing held on 05.07.2024 to support his stand regarding inclusion of interest costs in valuation of Paddy and Soya is rejected as the policy of that company explicitly states that "cost include interest cost on raw material where such raw material are stored for substanti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g unit in the population has a chance of selection. In the extant case, there is no sufficient evidence in the Audit File about the basis of selection of the sample of inventories. Further, the auditor's selection of sample is biased as it completely neglected all the inventories other than Soya Seed and Soya Doc. The EP failed to exercise professional skepticism in planning and performance of the audit of inventories and sidelined the possibility that the figures related to inventories may be materially misstated. In fact, the EP did not check and verify the stock statements and their reconciliation submitted to the bank by SCL as an alternative audit procedure. 25. 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 evidence claimed by the EP are neither sufficient nor appropriate to draw conclusions about the existence and valuation of the inventory. 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 501 (SA 501): Audit Evidence-Specific Consi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The company valued these investments in unquoted shares at cost and had been holding these investments in the last three financial years at the same value. 29. Sanwaria Energy Limited incurred a loss of 58 lakhs in the FY 2017-18. Shreenathji Solvex Limited incurred a loss of 83 lakhs in the FY 2017-18, had accumulated loss of * 32.97 crores and had negative net worth (-15.97 crores) as on 31.03.018. As a result, the recoverable value of investment in the associate was reduced to ....0. 30. Para 8 of Ind AS-36 "Impairment of Assets" provides that an asset is impaired when its carrying amount exceeds its recoverable amount. Paragraphs 12 to 14 of Ind AS-36 detail indications of an impairment loss. If any of those indications are present, an entity is required to make a formal estimate of the amount recoverable. Para 12 (h) (i) of Ind AS- 36 states that a higher carrying amount of the investment in the separate Financial Statements as compared to the carrying amounts in the Consolidated Financial Statements of the investee's net assets is an indicator that the asset may be impaired. Para 59 of Ind AS-36 provides that, if the recoverable amount of an asset is less than its car ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ported working of the valuation of the land. Apart from not being a part of the Audit File, the copy of the sale deed dated 12.09.2008 in itself is a not a sufficient and appropriate evidence to establish the ownership of the land as it is not backed by some other evidence like a copy of land record with ownership details as on 31.03.2018 in the name of SSL. Therefore, we find the EP lacking in due diligence on this count. v. The EP's argument that Para 16 of SA 230 gives him the right to submit additional documents not documented in the audit file submitted to NFRA is flawed and not acceptable as the said Para 16 read with Para A24 of SA 230 states that modification to the Audit File can be done as a result of an internal monitoring or any external inspections only. Whereas in the extant case, NFRA, instituted disciplinary proceedings under section 132(4) of the Act by issue of the SCN to the EP and therefore the contention of EP on this ground is rejected. The addition of an audit working paper to the Audit File after the issue of an SCN by the regulatory authority is an act of rectification which may amount to tampering of the Audit File which is viewed seriously. 35. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ind AS-110 nor accounted for the investment in associate company as per the requirements of Ind AS-28. 40. In his written reply, the EP submitted that "We were verbally promised by the management on the date of signing of standalone financials that the company will get consolidated financials signed by us once financial of the subsidiary and associates are ready to sign. The financials of the subsidiary company were signed by M/s Dubey Gupta and associates on 05/09/2018 Which was a date quite later than the date of signing of standalone financials of SCL. At the time of signing standalone financial statement, consolidated financial statements were neither ready and nor presented to us." "Thus, situation was not envisaged and documented in the audit file of standalone financials. The consolidated financials were neither prepared nor signed by any person. This situation has led to resignation of our firm from the assignment. We had decided to resign from assignment since SCL did not get it's further results reviewed and also consolidated financial statement were not prepared by them. Moreover, the non- consolidation does not affect true and fair view of the standalone financial ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in obtaining sufficient appropriate audit evidence for verification of Revenue. 44. As per Para 15 of SA 200 (SA 200): Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, the auditors are required to plan and perform an audit with professional skepticism and Para 11 & 12 of SA 315 (SA 315): Identifying and Assessing the Risk of Material Misstatement through understanding the entity and its environment require the auditor to understand the entity, its environment and internal controls. Further, Para 25 of both the SA 240 (SA 240) The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements & SA 315 requires the auditor to identify and assess the Risk of Material Misstatement ('ROMM' hereafter), due to fraud or otherwise, at the Financial Statement level as well as at assertion level for classes of transactions, account balances and disclosures. 45. In the FY 2017-2018, SCL reported a total revenue of 5066.57 crores, consisting of Revenue from operations (5054.73 crores) and Other Income (* 11.84 crores). 46. In accordance with the requirements of SA 200, SA 240 and SA 315, while au ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EP are an afterthought and therefore not acceptable: i. There is nothing in the Audit File to support the claim made by the EP about his under- standing of the business of SCL, its production process, process of procurement of raw materials etc, even though it was the first year of his audit assignment. ii. The control testing document, as referred by the EP, is merely a checklist of internal controls related to the revenue, without any details of the audit procedure performed. iii. There is no sufficient evidence of any analytical procedure performed by the EP for plausible relationships among financial and non-financial data through trend analysis, ratio analysis etc. iv. There is no sufficient evidence in the Audit File to show that the EP had checked and verified the inter-unit plant sales. v. The EP referred to certain sample sale invoices to substantiate the testing of internal controls on revenue. These sample sales invoices are related to sales of items like bar- dana, iron scrap, oil etc. whose contribution in the total revenue is negligible. Out of bas- the total revenue from operations (Rs.5054.73 crores) of SCL for the FY 2017-18, mati rice contributed ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 51. Negligence in performing audit procedures to verify the critical item like Revenue has been viewed seriously by international regulators too. For example, PCAOB in its order dated 08.02.2012 PCAOB Release No. 105-2012-001, in the matter in the Matter of Ernst & Young LLP, Jeffrey S. Anderson, CPA, Ronald Butler, Jr., CPA, Thomas A. Christie, CPA, and Robert H. Thibault, CPA,, censured Ernst & Young LLP, barred Jeffrey S. Anderson, CPA and Robert H. Thibault from being associated with a registered public accounting firm; censured Ronald Butler, Jr., CPA and Thomas A. Christie, CPA and imposed civil money penalties in the amounts of $2,000,000 on E&Y, $50,000 on Anderson, $25,000 on Thibault, and $25,000 on Butler for failures to properly evaluate a material component i.e., revenue of Issuer's financial statements. C.5 Failure related to audit of Trade Receivables 52. The EP was charged with failure to obtain sufficient appropriate audit evidence and identify and assess the risks of material misstatement in accordance with the requirement of SA 200 and 315. 53. Para 15 of SA 200 states that the auditor shall plan and perform an audit with professional skepticism recognisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons that were sought from trade receivables and around 40% of receivables were confirmed by the Audit. Ledger scrutiny was also performed for major trade receivables"... "We have reviewed the audited financial statement of last 4 years and noted that there are no bad debts and have not made any provision bad debts. The same also confirmed by the management and stated in the point 48 of MRL appended below. Therefore, there is not credit loss in trade receivable...." 57. With respect to the question of slow realization of debtors, the EP submitted the data of the receivable cycle for previous 5 years of SCL and stated that as the receivable cycle was improving since last three years, there was no reason to question about slow realisation. 58. In response to the question of verification of the statement of trade receivables submitted to banks, the EP submitted that the requirement of reconciliation of trade receivables with statements submitted to bank have started after onset of CARO 2020 which has become effective from audit of year 2022-23 and therefore the EP has not performed these procedures. 59. We find that the breakup of the total trade receivable (*916.03 crores) as on 31 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lection is barred by statute of limitation etc. was critical in the audit of trade receivables. However, no sufficient evidence of such working is found in the Audit File. In the absence of performance of such critical audit procedure, there is no audit assurance about the possibility of diversion of funds and the trade receivables being inflated. 62. The contention of the EP that he did not verify the statement of trade receivables submitted to banks as the requirement of reconciliation of trade receivables with statements submitted to bank has started after onset of CARO 2020 is not tenable and is an afterthought as considering the materiality of trade receivables of SCL (* 916.03 crores), the EP ought to have carried out, under the requirement of the SAs, this basic and critical audit procedure of verifying the trade receivables with the statement submitted to banks. The reference to requirement of CARO 2020 is not relevant here. 63. Professional skepticism i.e., a questioning mind and a critical assessment of audit evidence is crucial in performing audit including identifying and assessing the risks of material misstatement, performing tests of controls and substantive proced ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -18 (except for liability towards employees gratuity on estimated basis) were reflecting True and Fair view. Further, as enumerated, SCL lacked adequate internal financial controls over financial reporting, for example non consolidation of the Financial Statements in FY 2017-18 and non-evaluation of the impairment requirement with respect to the investments. Despite this, the EP in his Report on the Internal Financial Controls, opined that the company has, in all material respects, an adequate internal financial controls system over financial reporting. 68. The EP in his written reply denied these charges and stated that the conclusions drawn on financial statements were ensuring true and fair view of financial statements except as mentioned in the report. 69. The reply of the EP makes light of the compliance requirements of the SAs in light of the errors and omissions mentioned in the foregoing paragraphs of this Order. The EP has clearly failed in obtaining sufficient appropriate audit evidence by failing to perform test of controls, risk assessment procedures and analytical procedures and therefore failing to obtain reasonable assurance about whether the financial statements a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng papers such as: a. Documents related to audit of inventory viz., consolidated working of the inventory category wise and plant wise etc. b. Documents related to determination and communication with TCWG, Minutes of the meetings amongst the members of Engagement Team (ET) with management and TCWG. c. Working papers related to verification of the related party transactions like the approval of the board and audit committee of SCL, the documents related to verification of arm's length price etc. d. Working papers related to valuation of investments of SCL. e. Working papers related to audit of trade receivable viz the working related to analysis of SCL's receivable cycle, analysis of expected credit loss etc. f. Resignation letter and the ADT-3 submitted by the EP to RoC after resigning as auditor of SCL. ii. The Audit Work Papers did not have the caption of work paper, date, signature of preparer, and reviewer. iii. Most of the Audit Work Papers submitted to us do not meet any of the basic requirements of Para 8 and 9 of SA 230. 76. The above position clearly demonstrates the EP's gross negligence in the preparation of audit documents and cond ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gement to: (a) understand the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, and (b) determine who performed the work and the date such work was completed as well as the person who reviewed the work and the date of such review..... the documentation for each of those audits was insufficient to demonstrate the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, including in those areas of the audits involving significant risks. For the FY 2016 and 2017 Issuer A audits, the documentation also failed to demonstrate who performed the work and the date such work was completed. Additionally, in each of the Issuer A and Issuer B audits, the audit documentation was insufficient to demonstrate which aspects of the audit and which audit documentation Bharat Parikh reviewed." 80. The Executive Counsel to the Financial Reporting Council (FRC), the UK Audit Regulator, in the matter pertaining to Deloitte LLP and John Charlton in the audit of Mitie Group plc. for the year ended 31 March 2016, imposed a financial sanction of Two Million Pounds, a published statement in the form ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been viewed seriously by international regulators too. For example, PCAOB, the US audit regulator, charged the public accounting firm L.L. Bradford & Company, LLC (Audit Firm) for its failure to communicate with the audit committee during the audit of WebXU Inc.'s ("WebXU"). It stated that the "Firm also violated a PCAOB rule that requires a registered public accounting firm to communicate, in writing, to the audit committee The PCAOB, for this misconduct among others, censured the Firm, revoked its registration, and imposed a civil money penalty of $12500. C.9 Failure to report non-compliances with provisions of the Companies Act 2013 87. The EP was charged with failure to comply with Section 143 (9) Section 143 (9): Powers and duties of auditors and auditing standards of the Companies Act, 2013 which requires that every auditor shall comply with the SAs. 88. Responding to the charge, the EP reiterated his earlier statements and stated that he deemed himself compliant with the provisions of the Companies Act, 2013 including accounting standards and auditing standards applicable in India. 89. As explained in the above paragraphs, it is clearly evident that the EP failed to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the audit of investments as explained in paras 17 to 42 above. iii. The EP committed professional misconduct as defined by Section 132 (4) of the Companies Act, read with Section 22 and clause 7 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 "does not exercise due diligence and is grossly negligent in the conduct of his professional duties". 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 its fin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investments of SCL and failing to apply the mandatory SAs in the audit. We therefore conclude 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. 95. Section 132(4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed, is evident from the fact that a minimum punishment is laid down by the law. 96. Section 132(4) (c) of the Companies Act 2013 provides that National Financial Reporting Authority shall, where professional or other misconduct is proved, have the power to make order for: (A) imposing penalty of (I) not less than one lakh rupees, but which may extend to five times of the fees re ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
