TMI Blog2021 (5) TMI 1069X X X X Extracts X X X X X X X X Extracts X X X X ..... ued in 2015} which was not even in existence at the time of audit - The GN issued in the year 2003 was applicable for Equity Derivative Instruments and not for the Commodity Future Contracts. It was withdrawn with effect from 01.04.2009. Therefore, the EP's reliance on the GNs was misplaced - In the extant case, the SSWL recognised the revenue corresponding to the closing position of Futures Commodity Contract on daily basis without actual settlement of such contract. The risk and reward of the contract remained with the company. The EP failed to consider the basic principle of the transfer of risk and reward while auditing the SSWL's accounting policy on in revenue recognition. Non evaluation of risk of fraud in revenue recognition - HELD THAT:- The EP ignored to investigate the exponential rise in revenue to the tune of 1026% that evidently posed significant risk of material misstatement in the revenue of SSWL and would therefore have alarmed any prudent person to the risk of fraud in recognition of revenue, however the EP failed to consider such alarming signals - The contention of the EP that he did not presume the risk in revenue underlines the open admission of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot be taken as evidence of any significant interaction with TCWG. Moreover, these are not a part of the audit file, not much credence can be attached to them - If the EP felt that the limitations had been imposed on performing of the audit by constraints such as travel cost etc., then the EP could have chosen not to accept such audit engagement in accordance with SA 210, which he failed do. Accordingly, the reply and explanation of the EP is not acceptable and we hold him guilty of having violated SA 210. Non verification of balances of debtors and creditors - HELD THAT:- Trade receivables accounted for 20.57% in FY 2012- 13 and 13.58% in FY 2013-14 of the total assets of the Company, hence constituted a material class of account balances. However, aside from the fact that there was no audit documentation of the external confirmation, the EP's claim that he depended on SSWL for independent confirmations shows complete ignorance of Para 7 and A31 of SA 500 [SA 500 Audit Evidence ] read with Parn2 of SA 505, which emphasise that audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference. Accordingly, the procedu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... barred for Five 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, (Praveen Kumar Tiwari) Full-Time Member And (Smita Jhingran) Full-Time Member ORDER In the matter of CA Rakesh Puri, ICAI Membership No. 092728 under Section 132(4) of the Companies Act 2013 read with Rule 11(6) of National Financial Reporting Authority Rules 2018 1. This Order disposes of the Show Cause Notice ('SCN' hereafter) of even no. dated 18th August 2022, issued to CA Rakesh Puri, partner of Mis Y. D. Company (ICAI Firm registration no. 018846N), Ludhiana, who is a member of the Institute of Chartered Accountants of India ('ICAI' hereafter) and was the Engagement Partner ('EP' hereafter) for the statutory audit of Sun and Shine Worldwide Limited, Ahmedabad ('SSWL' or 'the company' hereafter) for the Financial Years ('FY' hereafter) 2012-13 and 2013-14. 2. This Order is divided into the following sections: A. Executive Summary ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l statements. 6. The Order finds that the Financial Statements of SSWL for both the FYs 2012-13 and 2013-14 were materially misstated wherein the amount of Revenue from Operations, in the Profit and Loss Statement was overstated by a very large amount as shown in the table below. Revenue from Derivative contracts was recorded by SSWL on the basis of daily carried over amount of the unsettled contracts without their actual closure or settlement on the exchanges which resulted in the aforesaid overstatement of revenue. Further, this erroneous accounting and misleading presentation also affected the corresponding 'Expenses' i.e., Purchase of Derivative contracts, in the Profit and Loss Statement, giving a false and inflated impression of the SSWL's scale of operation. The EP failed to perform audit procedures to identify these manipulations in the accounts showing his gross negligence, non-adherence to the standards of auditing and failure in questioning the management on such erroneous reporting, which resulted in giving a misleading picture to the investors and stakeholders. (Rs.in Crores) Particulars Financial Year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee the quality of service of the professions associated with ensuring compliance with such standards. NFRA is empowered under section 132 ( 4) of the Act to investigate into professional or other misconduct committed by any member or firm of chartered accountants in respect of the prescribed classes of bodies corporate or persons, to exercise the powers vested in a civil court while trying a suit and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 9. The statutory auditors, both individual and firm of chartered accountants, are appointed by the members of the companies under section 139 of the Act. The statutory auditors, including the audit firm, 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 (SQC) and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed under section 132 (4) (c) of the Act. 10. The SSWL, which was in the business of Commodity Futures Tradi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cause why action should not be taken against him for Professional Misconduct in respect of his performance as the EP on behalf of Mis Y.D. Co., for the Statutory Audit of SSWL for the FYs 2012-13 and 2013-14. 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 capacity; b. failure to report a material misstatement known to him to appear in a financial statement with which the EP 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; and e. failure to invite attention to any material departure from the generally accepted procedures of audit applicable to the circumstances. 15. The EP was required to reply to SCN by 17.09.2022, but on his request, was granted e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the last day of expiry of the Futures Contract. However, the SSWL showed in its account the purchase and sales every day, without any actual sale / purchase transaction. This modus operandi has been explained by SEBI vide its order dated 14.09.2021in the same case [SEBI order dated 14.09.2021 is available at the website of SEBI and accessible through the link https://www sebi gov in/enforcement/orders/sen-2021/final-order-in-the-matter-of-sun-and-shine-worldwide-ltd- 52571.html (see para 2.9 at the page number 5 of the order) ] , where Mr. Anil Mistry, ex-Director of SSWL provided explanation for the business of the Company and its accounting as under The Company had started to deal in Commodity Future first time on 14/09/2012 wherein company bought 70 Lots of FUT COPPER 30-NOV-12. Further, at the end of the day of 14/09/2012 none of Lots were sold by the company and the open position was carried forward to the next day. Here company has treated buying of 70 Lots of FUT COPPER 30- NOV-12 as Purchase aggregating to Rs. 3,23,08,822.00 (Including Brokerage) and since it was not sold on the same day, the position was carried forward and the same was treated as sales aggregati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g entries were passed in the books of accounts of the company for the financial year 2013- 14. There is no change in the profit I loss of the company by recording above accounting entries in the book of accounts the company. Further, there was no bogus transaction of sales I Purchase recorded by the company in their books. All the entries recorded in the books of the company are based on Daily MTM Bills of broker Indo Thai Commodities Private Limited. By adopting such strange and flawed accounting policy, the company artificially inflated its reported values of purchase and sales of commodity futures. The resulting overstatement [As per point no 2 of SEBI letter no IVD/ID18/SK/PV/O W/l 1448/2020 dated 08.07.2020]. of reported sales and purchases figures, as compared to the actually executed trade values, which were verified by SEBI from the exchanges where the trades were executed and from the broker of the SSWL through which the trades were executed, are as under: (Rs in Crores) Particulars Financial Year Reported Figures# Overstatement* Sales 2012-13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct. Since as per the guidance note all contracts deemed to have been settled at the Daily settlement Price, therefore, as each contract is backed by the delivery it is deemed to be treated a purchase and sale on daily basis (as per my understanding since there is no clearcut guidelines for commodity exchange is available till date) and accordingly based on Guidance Note company has booked sale and purchase a shown in the daily contracts issued by the broker/exchange. Such a stand taken by the EP is completely untenable. The EP has not produced any circular from the exchange or SEBI in support of his contention that purchase and sales had to be booked on daily basis even when there was no actual sale or purchase during the day. In fact, SEBI in its letter to NFRA dated 08.07.2020 has questioned such flawed practice by SSWL and given a finding in its order [See para 21 of page number 40 of the SEBI order dated 14.09.2021] dated 14.09.2021 that by adopting such accounting practice, SSWL perpetrated fraud on investors and the securities market. Further, the EP has not shown any provision in the Guidance Note which requires to recognize revenue on the basis of deemed sale or pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... egard, it is relevant to note the requirement of Para 16 of AS 1 Disclosure of Accounting Policies which states that The primary consideration in the selection of accounting policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the profit or loss for the period ended on that date. By choosing an accounting policy that presented an outlandish picture of its operations, the SSWL failed in its duties to present a true and fair position of its operations and the EP failed in his duties to conduct proper audit checks. 22. The EP has claimed in his reply that he had obtained the accounting policy from the management but there is no evidence in the audit file to demonstrate that the EP had obtained from the company its accounting policy on revenue recognition and evaluated whether it was complying with the fundamental principles of accounting standards and whether it was capable of presenting a true and fair view of the affairs of the company. The EP has in this regard referred to his two letters to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g standards, including AU 150 and 230 . PCAOB for this misconduct among others, censured the Firm and revoked its registration permanently and Scott W. Hatfield, the Engagement Partner, was permanently barred from associating with any registered public accounting firm. C.2. Lack of Audit Documentation with respect to Revenue Recognition C.2.i. Non evaluation of risk of fraud in revenue recognition 23. SA 240 [ SA 240 The Auditor s Responsibilities Relating to Fraud in an Audit of Financial Statements ] deals with the auditor s responsibilities relating to fraud in an audit of FS. Para 26 of SA 240 requires the auditor to evaluate, based on a presumption that there is risk of fraud in revenue recognition, which type of revenue transactions lead to such risk. Further, Para 47 of SA 240 specifies the documentation to be done when the auditor concludes that such presumption is not applicable along with the reasons for such conclusion. Observing that the EP had prima facie failed to adopt such audit procedures, he was charged [ Vide Para 4.2B (b) of the SCN] with the failure to comply with Para 26 and 47 of SA 240. 24. We find that the EP was the audito ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EBI from the broker as well as the stock exchanges (ICEX, NCDEX and MCX- the stock exchanges on which the trading was claimed by the Company) clearly indicated the extent of variation between the actual amount of the trade executed and the trade reported by the Company, but the EP failed to perform this basic audit test. Such lapses on the part of the EP are grave as he failed to identify, assess and document the basic premises to verify the revenue. The following table depicts the glaring difference between the trading figures reported by the company vis-a-vis stock exchange and broker. #As per Financial Statement of SSWL. There is difference in the reported figures quoted by SEBI vis-a-vis the figures reported through the annual report available in the public domain. We have relied on the figures available in the annual reports. ## As conveyed by SEBI vide its letter dated 08.07.2020 c. The contention of the EP that he did not presume the risk in revenue underlines the open admission of his gross negligence and lack of due diligence in the face of such contradictions between the reported and actual state of affairs in the Company, which the auditor failed to identif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fied the Contract note and in my statement to SEBI, it has also been informed. So far, the sampling of the Contract note is concern, we have given certain dates to the accounting persons and over and above those dates we told them to provide the contract notes on some random basis so that at least it will cover a significant number of transactions. After verification, my audit concern person has collected all the contract notes (a copy of the same are attached herewith) and verified the same with the accounts . We note that there is clear contradiction between his reply to SEBI and the replies furnished to NFRA, which establishes that the EP is trying to cover up his non-performance of required audit procedures. Further, there is no mention of the contract notes in the audit file. The EP submitted copies of some contract notes along with reply to SCN, which are rejected as an afterthought. Accordingly, we hold the EP responsible for failure to comply with the provisions of SA 530 that led to non-verification of the artificially inflated revenue figures of the company. Part-D D.1 Improper Audit Planning and Non-understanding of the nature of the entity D.1.i. Impr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssed risks. In contrast to such requirement, we note that the WPs referred by the EP were merely a general checklist used for the work to be performed during the audit. Such list was generic and the auditor did precious little to even customise such list as per the nature of business of SSWL. The EP neither made efforts to assess the risks specific to SSWL, nor did he design the audit procedures to mitigate such risks. Therefore, the WP(s) referred to by the EP were completely devoid of the requirements of SA 300 and SA 315. This is further substantiated by an example, the WPs referred to by the EP have a requirement of test checking of Cost of Raw Material Consumed Cost of Stores and Spares, but SSWL was dealing in Commodity future contracts, where there could not be any scope for Raw Material or Stores and Spares etc. Hence, the checklist was a stereotype and a cut and paste job. Obviously, such documents were of no help to the EP's case. 33. The EP also responded that, Point no 2 on page no. 96 and 156 of the show cause notice clearly indicate that the nature of business was discussed and based on that discussion, we have prepared our audit planning and prepared ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure to develop an appropriate audit plan for the audit of Web:XU Inc.'s ( WebXU ) and concluded that the the Firm violated PCAOB rules and auditing standards with respect to an audit and a quarterly review of one issuer audit client. Specifically, the Firm in conducting its audit of the financial statements of WebXU for the year ended December 31, 2011, failed to properly assess the risks of material misstatement. As a result, the Firm failed to properly identify significant risks in connection with the 2011 WebXU audit. The Firm also failed to properly establish an overall strategy for the audit and develop an audit plan that included planned risk assessment procedures and planned responses to the risks of material misstatement. In addition, the Firm failed to perform sufficient audit procedures that addressed the risks of material misstatement. PCAOB for this misconduct among others, censured the Firm, revoked its registration permanently, and imposed a civil money penalty of $12,500 upon the firm. D.1. ii. Failure to ensure existence of preconditions for the audit 37. The BP was charged [Vide Para4.1.3 of the SCN] with not visiting the premises of SSWL during th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mr. Anil Mistry, Director of the Company either on phone or through correspondence on e- mail. (The said point is stated in question 9 on page no. 19 of show cause notice) Even I have written letters to the Audit Committee before conclusion of the audit drawing the significant changes or matter of attention which are required. One of such correspondence is available on page no. 184 and 185 of the show cause notice . 40. Evidently, the EP allowed himself to work under conditions of scope limitation. The contention of the EP that low quantum of audit fee i.e.,Rs and non-bearing of travelling expenses by the company cannot be an excuse for non-performance of the statutory duty. We did not find any document which shows that any communication occurred between the EP and Mr. Anil Mistry, the Director of the Company. Absent any interaction with the key management, audit committee etc., it is difficult to accept that the EP had understood the business of the entity and its internal controls. The EP s reference to the two letters written by him to the Audit Committee on 1.8.2013 and 31.7.2014 to claim that he understood the business of the entity cannot be accepted as these letters were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nfirmation letters were sent. However, in the present case as the number of parties are very few, it was sent to all such parties. 44. We have examined the replies of the EP. Trade receivables accounted for 20.57% in FY 2012- 13 and 13.58% in FY 2013-14 of the total assets of the Company, hence constituted a material class of account balances. However, aside from the fact that there was no audit documentation of the external confirmation, the EP's claim that he depended on SSWL for independent confirmations shows complete ignorance of Para 7 and A31 of SA 500 [SA 500 Audit Evidence ] read with Parn2 of SA 505, which emphasise that audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference. Accordingly, the procedure claimed to have been adopted by the EP was devoid of independence, as he left the responsibility of obtaining confirmations to the entity and not to himself. 45. The contention of the EP that Since, it a standard format of the account confirmation, we do not keep a copy of the same is unacceptable. As para 8 of SA 230 [SA 230 Audit Documentation ] relating to audit documentation does not p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed on Standards on Auditing could save the EP from improper reporting on the Financials of SSWL. 48. We note that PCAOB [PCAOB release No. 105 2011-002 dated 05.04.2011] , the US Regulator, matter, charged the public accounting firms Price Waterhouse, Bangalore, Lovelock Lewes, Price Waterhouse Co., Bangalore, Price Waterhouse, Calcutta, and Price Waterhouse Co., Calcutta (collectively, PW India ) for its failure to obtain external confirmation during the audit of Satyam and noted that the For both the 2006 and 2007 audits, the Satyam engagement team did not maintain control of the accounts receivable confirmation request process, and instead relied on Satyam's management to send confirmation requests. The Satyam engagement team received no responses to these confirmation requests but made no attempt to follow up on the nonresponses with second confirmation requests . PCAOB for this misconduct among others, censured the Audit Firm, imposed a civil money penalty of $1,500,000 jointly and severally on Price Waterhouse, Bangalore, and Lovelock Lewes. D.3 Non-communication with Those Charged with Governance (TCWG) 49. The EP was charged [Vide Para 4.4 of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the EP with TCWG was not in accordance with provisions of SA considering the following: a. As per para 7 of SA 260, the EP was required to determine TCWG in the first place. For the same, the EP could seek help from paragraphs A5-A12 of SA 260 which elaborates determination of TCWG depending on the diversity of governance structures of different organisations. However, no such working on the part of the EP to determine TCWG was found in the audit file. b. Further, in case of communicating with the audit committee, Para 8 of SA 260 also required the EP to determine if governing body was also required to be communicated with. There is no audit documentation in the audit file regarding any such process performed by the EP. c. Even the communication with the audit committee, referred to in the reply of the EP, was not part of the audit file, but the EP made the same available at the time of replying to NFRA questionnaire. Further, the EP is misquoting the referred communication as Management Representation Letter and also as communication with the TCWG, which reflects his poor understanding of the Standards on Auditing. d. In view of the above, the reply and explanation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s violated Auditing Standard No. 7, Engagement Quality Review (''AS 7''). PCAOB for this misconduct among others, censured the Firm, and imposed a civil monetary penalty of $5000. E. Article of Charges of Professional Misconduct by the Engagement Partner (EP) 55. As discussed in the foregoing paragraphs, the Engagement Partner (EP) has made a series of serious departures from the Standards and the Law, in his conduct of the audit of SSWL for FY s 2012-13 and 2013-14. Based on above discussion, it is proved that the EP had issued unmodified opinion on the Financial Statements without any basis. The poor quality of Audit, the cover up in terms of submission of additional documents that did not exist in Audit File, incomplete documentation and attempt to mislead through false and evasive replies further compound the professional misconduct on the part of the EP. Based on the foregoing discussion and analysis, we 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' hereafter) as amended from time to time, and as detai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e. F. Penalty Sanctions 56. It is the duty of an auditor to conduct the audit with professional scepticism and due diligence and report his opinion in an unbiased manner. Statutory audits provide useful information to the stakeholders and public, based on which they make their decisions on their investments or do transactions with the public interest entity [As defined in Rule 3 of NFRA Rules 2018] 57. Without a credible Audit, Investors, Creditors and Other Users of Financial Statements would be handicapped. The entire corporate governance system would fail and result in a breakdown in trust and confidence of investors and the public at large if the professionals in charge of audit do not perform their job with professional scepticism and due diligence and adhere to the standards. 58. Section 132(4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proven cases of professional misconduct are to be viewed, is evident from the fact that a minimum punishment is laid down by the law. 59. The EP in the present case was required to ensure compliance with SAs to achieve the necessary audit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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