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2017 (2) TMI 465 - DELHI HIGH COURT

2017 (2) TMI 465 - DELHI HIGH COURT - TMI - Professional misconduct - default of audit party - Chartered Accountants Act - wrong method of valuation of inventory - Held that:- At the time of hearing the stand taken by the respondent was that PCL was a trading company and followed Weighted Average Cost Method, which was in contravention of Accounting Standard-2 (AS-2), which specifically laid down the method of valuation of inventory as cost or market value whichever is less. But the committee he .....

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by law. Further, there were suspicious adjustment entries between AIL and PCL which ought to have raised a doubt about the genuineness of the transactions and ought to have been detected and reported by the respondent. - Suffice it to highlight that in paras 26 and 27 of the report the Committee highlighted the modus operandi adopted by PCL and AIL to form a loop with no cash flow coming in, but sales, stocks and receivables increases. The obligation of the auditor concerning transactions wh .....

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The Committee has also highlighted the duties of the auditor to maintain the working papers and documents and noted that in spite of repeatedly directed to do so, the respondent did not produce the papers and took the plea that since the year 2003 he had surrendered the certificate of practice, therefore he was not keeping the past record. - The report of the Disciplinary Committee is based on the accounting standards to be followed and breach thereof. Having not filed any response to the r .....

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ving the name of the respondent from the register of members of the Institute of Chartered Accountants for a period of 5 years. - CHAT.A.REF 2/2013 - Dated:- 3-2-2017 - MR. PRADEEP NANDRAJOG & MR. YOGESH KHANNA JJ. Petitioner Represented by: Mr.Rakesh Agarwal, Advocate with Mr.Pulkit Agarwal, Advocate Respondents Represented by: None PRADEEP NANDRAJOG, J. 1. A complaint dated December 26, 2000 was received by the Council from the Assistant General Manager, State Bank of India, New Delhi agai .....

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that various financial institutions and banks, including the complainant bank (acting in a consortium), sanctioned and granted various capital facilities from time to time to PCL in respect of its business of marketing computers and software. That as per terms of the sanction of the capital it was incumbent upon PCL to ensure that drawings on the account were covered by the advance value of the stock hypothecated to the complainant bank. Various banks and financial institutions had also extended .....

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d adopted a modus operandi, being, booking as sales of software reported developed by PCL was shown to third parties who would in turn show delivery to AIL as a purchaser and from AIL sales were shown to PCL. This loop was repeated many times. IDBI estimated the value of current assets generated through the said process to the tune of ₹ 362 crores being only paper entries, required to be written off. In these circumstances the consortium became suspicious and directed to carry out a specia .....

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ars in question did not correctly reflect the financial position of the company. 3. The complaint was forwarded to the respondent who submitted a written statement of his defence on April 05, 2004, taking the stand that an auditor cannot be held responsible for preventing fraud by a company. The respondent also disputed the report submitted by M/s.G.Jai & Associates. The response was submitted for rejoinder to the complainant who filed the rejoinder on August 09, 2004. Respondent was handed .....

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and manipulation of accounts and that the auditor failed to comment on the same, which in turn established that the auditor was in connivance with the management of the company to defraud the bank and the public. That the respondent was the statutory auditor of PCL since inception and lastly audited the balance sheet for the year ending December 31, 1996. Further, the respondent was the statutory auditor of AIL for the years 1985-86 to 1991-92. The Committee noted that the complainant failed to .....

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he officers of the complainant. Respondent s stand that he was not to look into the statements and his role was to certify the balance sheet only was noted by the Committee. 5. The Committee noted the following findings given by the special auditor in regard to the stock:- 2. Stocks 2.1 Analysis/review of the sales to certain parties accounts (whose accounts are clubbed under the supplier s sub ledger) revealed that SWT sales have been, inter alia, made to the certain selected parties during the .....

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; 7403 lacs. 4.3.12 Valuation of Stocks PCL uses weighted average cost (for the main group) for valuing the various stocks. This cost is arrived by determining the weighted average cost of opening stock plus purchases during the year. Moreover, the weighted average cost as determined at the end of year as per the audited accounts is applied throughout the year. For instance, in the current stock statements (January to June 1997), the weighted average cost as determined for the year ended 31.12.1 .....

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since inception, the respondent should have had an understanding of the design of the accountant and the internal control system of the company. The committee highlighted that balance sheets of PCL, with reference to the notes to the accounts, showed the method of valuation of Inventory as Weighted Average Cost Method, whereas in Schedule 7 - Inventories, it was stated : valued at cost or market value whichever is less . The committee opined that both disclosures were contrary to each other. Th .....

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ny. However the committee highlighted that classification of the inventory ought to have been disclosed in the notes to the accounts. The committee further noted that during the period January 01, 1996 to December 31, 1996 huge payments were made by PCL on behalf of AIL but no disclosure of the same was made by the auditor in the report as contemplated by law. Further, there were suspicious adjustment entries between AIL and PCL which ought to have raised a doubt about the genuineness of the tra .....

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n stock. Further, in the later years, namely, from 1988-89 onwards that the increase in stock was always higher than the net profit. 27. The modus operandi which was adopted by PCL and AIL was booking as sales of a software reportedly developed by PCL to an outsider party which in turn would be passed on to AIL as purchaser which again would be supplied to PCL as sales. In this process, this loop getting repeated many times but there was no cash flow while the sales and stock/receivables kept on .....

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her transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company. 29. However, it is apparently clear that the respondent as Statutory Auditors of the Company for all these years was unable to assess the modus operandi of these transactions which were in the nature of book entry only even though the same was a statutory requirement within the meaning of Section 227(1A)(b) of the Companies Act, 1956, which makes it incumbent on the A .....

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nder question. Moreover, on perusal of the audit reports for all these years, it has been observed that the respondent also did not comments about the internal control procedures of the Company. The respondent did not apply the necessary checks which is expected of an auditor in the circumstances which were prevalent at that time and did not carry out the comprehensive checks about the actual funds having been received by the Company and about the profits whether they were actually in existence .....

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are necessary, the auditor should document the presence of such risk factors and the auditor s response to them. 50. The auditor must document matters which are important in providing evidence to support the audit opinion, and the working papers must include the auditor s reasoning on all significant matters which require the auditor s judgment, together with the auditor s conclusion thereon. Because of the importance of fraud risk factors in the assessment of the inherent or control risk of ma .....

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ve. 2. Documentation, for purposes of this Standard, refers to the working papers prepared or obtained by the auditor and retained by him, in connection with the performance of his audit. 3. Working papers: .. aid in the planning and performance of the audit; .. aid in the supervision and review of the audit work; and .. provide evidence of the audit work performed to support the auditor s opinion. 32. In view of above, it is very clear that the auditors are required to maintain the working pape .....

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ooks of accounts and other papers of the Company from the Complainant. The Committee had given necessary directions to the Complainant to procure these documents from the Official Liquidator of the Company which they were not able to produce even after adjourning the matter number of times. The Committee felt that even in the absence of these documents, there were sufficient papers on record to show that the respondent had not been able to diligently carry out his role as the auditor of the Comp .....

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ation due to fudging of Books of Accounts were in public domain and the Respondent as the Statutory Auditor ought to have retained his working papers in those circumstances. Moreover, the Regulation 14 of the Chartered Accountants Regulations, 1988 specify a period of 10 years or more for entertaining a complaint or information but in the said matter the Committee observed that this complaint is not barred as per the Chartered Accountants Regulations, 1988. 35. The Committee felt that an auditor .....

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with the other companies revealed that the Respondent ought to have applied his professional skepticism and should not have accepted these transactions as genuine. Moreover, in view of the Committee, the manner in which the transactions were booked in the books of accounts of the Company ought to have raised an alarm that the financial statements were suspected to have material misstatements which as a prudent auditor, the respondent did not try to assess and accordingly failed in his duties to .....

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