TMI Blog2023 (7) TMI 889X X X X Extracts X X X X X X X X Extracts X X X X ..... ng deficiencies in Internal Control to Those Charged With Governance and Management - Failure to comply with SA 300, Planning an audit of Financial Statements - Lapses in constitution of Engagement Team (ET) and assigning responsibility among ET members (Additional Lapse on the part of the Audit Firm only). HELD THAT:- 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 - Independent Auditors of Public Limited Companies serve a critical public function of enabling the users of Audited Financial Statements to take informed economic decisions. Quality audits bolster stakeholder' s confidence in the credibility of financial reporting. In the instant case, the Auditors, chose to preserve their professional relationship with the promoters of the auditee company, instead of discharging their statutory duty to protect public interest by exercising professional skepticism and questioning the promoters' dubious activities and transactions leading to diversion of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adhusudan U A is debarred for a period of 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. d) Imposition of a monetary penalty of Rs Five Lakhs only upon CA Pranaav G. Ambekar. In addition, CA Pranaav G. Ambekar is debarred for a period of 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. - NF-23/14/2022 - - - Dated:- 12-4-2023 - Ajay Bhushan Prasad Pandey Chairperson, (Dr Praveen Kumar Tiwari)Full-Time Member And (Smita Jhingran) Full-Time Member Order In the matter of M/s ASRMP Co., CA A. S. Sundaresha, CA Madhusudan U A, and CA Pranaav G. Ambekar, under Section 132(4) of the Companies Act 2013. 1 This Order disposes of the Show Cause Notice ('SCN' hereafter) number NF-23/14/2022 dated 15th November 2022, issued to M/s ASRMP Co., Firm No: 018350S, Statutory Auditor ('Firm' hereafter) and CA A. S. Sundaresha, ICAI M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the transactions of Rs 6,958.91 crores entered fraudulently with MACEL, which were also not disclosed in the Related Party Disclosures in their entirety; failed to report understatement of loan by Rs 222.50 crores fraudulently given to MACEL and evergreening of loans through structured circulation of funds among group companies; failed to report fraudulent diversion of Rs 130.55 crores to a related party M/s Classic Coffee Curing Works; performed audit in a perfunctory manner resulting in non-reporting of misstatement of Rs 132.37 crores in the consolidated financial statements. They failed to perform appropriate audit procedure to identify misstatement of Rs 69. 77 crores in related party disclosure relating to purchase of coffee beans from MACEL. Thus, total material and pervasive misstatements amounted to Rs 7514.10 crores and in spite of that they falsely reported that the Financial Statements of CDGL for the FY 2018-19 gave a true and fair view. They also falsely reported that CDGL had an effective Internal Financial Control over Financial Reporting despite the complete absence of the same in CDGL. 5 Based on investigation and proceedings under section 132 ( 4) of the Comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dividuals and firm of Chartered Accountants, are appointed by the members of companies as per provision of section 139 of the Act. The Statutory Auditors, including the Engagement Partners ('EPs' hereafter) 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 ('SA' hereafter), including the Standards on Quality Control ('SQC' hereafter) and the Code of Ethics, the violation of which constitutes professional or other misconduct, and is punishable with penalty prescribed under section 132 (4) (c) of the Act. 8 On receipt of information from SEBI vide letters dated 01.04.2022 29.04.2022 sharing its investigation regarding diversion of funds worth Rs 3,535 crores (as on 31-07-2019) from seven subsidiary companies of Coffee Day Enterprises Limited, a listed company, to Mysore Amalgamated Coffee Estate Limited, an entity owned and controlled by the promoters of CDEL, NFRA started investigation into the role of the statutory auditor under its powers in terms of section 13 2 ( 4) of the Companies Act 2013. 9 Late V. G. Siddhartha ('VGS' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;s subsidiaries companies to the personal accounts of VGS, his relatives and entities controlled by him and/or his family members, as loans and advances that were never returned to MACEL/CDEL. 12 The modus operandi of the alleged diversion of funds discovered by the SEBI during its investigation was that VGS used to ask the Authorized Signatories to sign a bunch of cheques which were kept in his possession and used them as and when required . Such pre signed blank cheques of bank accounts of various Coffee Day Group companies were used for the diversion of funds. 13 CDGL, one of the 7 subsidiaries of CDEL, contributed the largest share of revenue and profits of CDEL, and is engaged in the business of retailing of coffee and other products under the brand name 'Coffee Day'; sale of coffee beans and other related products and services in respect of coffee vending machines; and selling coffee beans to domestic and overseas customers. Although an unlisted Public Company, CDGL had total equity of Rs 1,334.88 crores borrowing/deposit of Rs 534.40 crores as on 31.03.2018 and revenue from operations of Rs 1,777.04 crores during FY 2017-18 and, thus falls under the jurisd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CA Madhusudan U A and CA Pranaav G. Ambekar were 'Engagement Partners'. The Financial Statements and Independent Auditor's Report have been signed by CA A. S. Sundaresha. 17 The SCN gave an opportunity of personal hearing to the Auditors, which they did not avail. Accordingly, this Order is based on examination of the facts of the matter, charges in the SCN, written replies of the Auditors and other materials available on record. General submissions by the Auditors 18 The Auditors have submitted that Standards on Auditing are not reference material to decide on charges of professional misconduct against an auditor and are a guidance to an auditor to act professionally while arriving at an opinion and have referred to para 5, A47 and A52 of SA 200. We have gone through the same and find this argument as strange. We notice that the legal mandate to adhere to the Standards is clearly laid down in section 143(9) 143(10) of the Act 2 Further, ICAI in its Implementation Guide on Reporting Standards issued in Nov 2010 had opined in response to question no-12 relating to the Auditor's responsibility paragraph that A key assertion that is made in this paragr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iting. It requires the auditor to comply with relevant ethical requirements, including those pertaining to independence, relating to financial statements audit engagements. SQC 1 requires the Audit Firm to establish policies and procedures designed to provide it with reasonable assurance that the firm, its personnel and, where applicable, others subject to independence requirements (including experts contracted by the firm and network firm personnel), maintain independence where required by the Code of Ethics. SQC 1 further states, inter alia, that The firm should establish policies and procedures for the acceptance and continuance of client relationships and 22 SA 220 required the Engagement Partner to form a conclusion on compliance with independence requirements that apply to the audit engagement. In doing so, the Auditors were required to: (i) Obtain relevant information from the firm and, where applicable, network firms, to identify and evaluate circumstances and relationships that create threats to independence; (ii) Evaluate information on identified breaches, if any, of the firm's independence policies and procedures to determine whether they create a threat t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ey have ensured that total fees from auditee did not exceed prescribed limits and where the amount forms large portions of total fees they have taken safeguards to mitigate the risk. 26 Regarding M/s ASRMP Co. and another audit firm M/s Sundaresha Associates, they stated that there are no common partners, except CA Megha Sundaresh Andani, daughter of CA A. S. Sundaresha, but both firms act independently and do not interfere with each other professionally. The Auditors further stated that they did not enter into any contingent fee arrangement with an auditee, ensured fees are not overdue except CCD group (Coffee Day Group) fees which is partially due on account of financial constraint faced by the group. They gave detailed responses regarding their compliance with section 141(3) of the Act and argued that they have complied with the Standards on Auditing and provisions of the Act. Analysis of reply 27 As per information obtained from the audit firms, CA A. S. Sundaresha has a sole proprietorship firm, namely M/s Sundaresh Co. Further, he was promoter and founder of M/s Sundaresha Associates, a partnership firm in practice since 10.11.1997, but he had retired from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Co. were statutory auditors of six Coffee Day Group companies ( except CDH RPL- as per serial no-5 in Table-I). These companies were involved in the diversion of Rs 3,380 crores i.e., 95.62% of total diverted amount of Rs 3,535 crores. Further, during the Financial Year 2018-19, M/s Sundaresha Associates provided audit and non-audit services to 27 Coffee Day group entities, M/s Sundaresh Co. provided audit and non-audit services to 29 Coffee Day entities including promoter's family members and M/s ASRMP Co. provided audit and non-audit services to four Coffee Day group companies. This indicates that M/s ASRMP Co. had accepted the audit engagement of CDGL from FY 2018-19 despite serious conflict of interest. The relationship of three related audit firms with Coffee Day Group indicates creation of self-interest and familiarity threat. The Auditors have admitted that CA A. S. Sundaresha is associated with Coffee Day Group for a very long time, therefore there is familiarity threat. Replies of the Auditors regarding steps taken to reduce self-interest threat and familiarity threat are mere general statements and without detailing specific steps taken to reduce such threa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 19 Page 9 of 46 and to maintain an attitude of Professional Skepticism. An auditor is required to be independent, aside from being in public practice ( as distinct from being in private practice), he must be without bias with respect to the client since otherwise he would lack that impartiality necessary for the dependability of his findings, however excellent his technical proficiency may be. It is of utmost importance to the profession that the general public have confidence in the independence of the Auditors. Public confidence would be impaired by any evidence that independence was actually lacking, and it might also be impaired by the existence of circumstances, which reasonable people might believe, are likely to influence independence. 33 In this case, the Auditors failed to perform appropriate audit procedures to evaluate and maintain their independence from CDGL. In spite of Auditors having independence threat, they accepted the audit engagement as statutory auditor of CDGL from FY 2018-19 by disregarding and grossly violating the principles of Independence mentioned in the Standards on Auditing and the Code of Ethics. In view of this, the charge stands proved that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2 when they submitted the Audit File. 35 It is mentioned that both emails dated 22.06.2022 19.07.2022 were sent on same email ID and as per their version, the first email went to the SPAM folder and the second email was delivered correctly. We note that the letter head of their letter dated 21.07.2022 has the address of 3rd floor, while stating that their address had been changed from 3rd floor to 1st floor. It appears from this, together with the claim of NFRA's first email going to the SPAM folder, that Diligence and Integrity, are absent in the Auditors' conduct and the entire chain of correspondences/events, was a deliberate ploy to delay the submission of Audit File, and gain some time to make changes in the Audit File as pointed out in the preceding para. It is thus evident that the Audit File was not assembled within the prescribed time and the Auditors made deliberate attempts to deceive NFRA by violating fundamental principles of professional behavior in total disregard of SA 200, SA220, SA 230 and SQC 1 and by tampering of Audit File till 05.08.2022. 36 Further, as per para 8 of SA 230, the Auditors were required to prepare audit documentation that is suff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Page 11 of 46 completion memorandum and review summary provides their observations, significant matters and conclusions. 38 The Auditors also stated that CA A S Sundaresha has updated his system and that emails were configured to Outlook, hence they were able to receive the second email from NFRA; that their letter head contains old address as 3rd floor instead of 1st floor as the stationary containing old address was printed in bulk and now, they have got new stationary with correct address. 39 Along with reply to SCN, the Auditors have also submitted additional working papers (18 pages) for consideration stating that they have inadvertently missed certain evidence with respect to their Audit File as Test of Controls Test of Details documents were stored in separate folder pertaining to Internal Financial Controls. Analysis of reply 40 In terms of SA 230, modification in the audit file after the assembly period is allowed only to clarify any existing audit documentation arising from comments received during monitoring inspections performed by internal or external parties (para A24 of SA 230). The Auditor is required to document the specific reason of making them, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dence obtained; and (c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions. c) Paragraph 9 of SA 230: In documenting the nature, timing and extent of audit procedures performed, the auditor shall record: (a) The identifying characteristics of the specific items or matters tested; (b) Who performed the audit work and the date such work was completed; and ( c) Who reviewed the audit work performed and the date and extent of such review. d) Paragraph 14 of SA 230: The auditor shall assemble the audit documentation in an Audit File and complete the administrative process of assembling the final Audit File on a timely basis after the date of the auditor's report. e) Paragraph 16 of SA 230: In circumstances where the auditor finds it necessary to modify existing audit documentation or add new audit documentation after the assembly of the final audit file has been completed, the auditor shall, regardless of the nature of the modifications or additions, document:(a) The specific reasons for making them; and (b) When and by whom they were made and reviewed. f) The explanator ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 30 by failing to implement, communicate, and monitor adequate policies and procedures to provide the Firm with reasonable assurance that its personnel complied with PCAOB audit documentation standards including standards concerning documentation of the date audit work was completed, of the date audit work was reviewed, and of any changes to the work papers after the documentation completion date . For this misconduct, a civil money penalty in the amount of $1,000,000 was imposed on KPMG Assurance and Consulting Services LLP, and a civil money penalty in the amount of $75,000 was imposed on Sagar Pravin Lakhani besides suspending Lakhani from being an associated person of a registered public accounting firm for a period of one year, censuring both and requiring KPMG India to undertake and certify the completion of certain improvements to its system of quality control. 46 In another similar case of Deloitte Canada 8 relating to tampering of audit file, PCAOB observed PCAOB standards require auditors to prepare audit documentation that accurately reflects when audit work was completed and reviewed. Prior to November 2016, Deloitte Canada's electronic work paper system ( s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Audit File 9 to NFRA, through a duly notarized affidavit dated 05.08.2022 signed by CA A. S. Sundaresha., partner of the Firm, it was averred that The Audit File for the.financial year 2018-19 as defined in Para 6(b) of SA 230 has been submitted .... It is certified that the above information is true and complete in all respects, and nothing has been concealed . The Auditors are expected to know what constitutes Audit File as per SA 230 and accordingly, all audit work papers were expected to be available in the Audit File submitted to NFRA. The submission by the Auditors of additional documents now, subsequent to the submission of Audit File, to defend the charges in the SCN, points to the incorrect averments made in the affidavit submitted by the Firm. 49 Therefore, considering the provisions of the auditing standards and the affidavit filed by the Firm, we do not find any merit in the submission of the Auditors regarding the additional documents and we treat the same as an afterthought to cover up the deficiencies in the Audit. Further, this is additional evidence of tampering of the Audit File. 50 The clear evidence of the Auditors tampering with the Audit Fil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paid to MACEL 394.21 365.01 3 Interest received on advance paid 5.10 0.37 4 Repayment of advance by MACEL 266.54 321.94 5 Supplier advance balance on 31. 03.2019 64.82 3.46 54 The aforesaid advance of Rs 3 840.51 crores was also violative of Section 188 of the Act read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules 2014 because under these provisions, prior approval of the company was required to enter into purchase of goods from related parties amounting to 10% or more of turnover of CDGL. CDGL was required to pass a resolution in the general meeting for grant of supplier advance of Rs 3 840.51 crores to MACEL as it exceeded 10% of its turnover of Rs 1794.29 crores. Further, as per section 188 of the Act, approval of the Board of Directors was also required for entering into such transactions. There is no evidence in Audit File that the auditor verified whether CDGL complied with these statutory provisions. On ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her requires auditor to evaluate the business rationale ( or lack thereof) of the significant transactions that are outside the normal course of business or otherwise appear unusual and evaluate whether such transactions may have been entered into to engage in fraudulent financial reporting or to conceal misappropriation of funds. There is no evidence in Audit File of performing any audit procedure to comply with SA 240. The Auditors failed to comply with SA 240 in respect of supplier advance given to MACEL, which was outside the normal course of business and was unusual. There is no evidence in Audit File that any questions were asked from the Audit Committee, TCWG and Management about these suspicious fraudulent transactions. The Auditors did not perform audit with professional skepticism judgement at all. 58 The Auditors had the statutory duty to report the offence of fraud to the Central Government under Section 143 (12) of the Act. Grant of omnibus approval by Audit Committee for abnormal amount of supplier advance to MACEL and its subsequent payment in the garb of supplier advance without any business rationale were clear indications of diversion of funds, in the nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re to perform appropriate audit procedures to verify whether CDGL had complied with Ind AS 32 Ind AS 109 in relation to loans given to MACEL 15 CDGL did not classify loans given to MACEL as financial assets in accordance with Ind AS 32. The loan given to MACEL was shown as 'Other Assets' under 'Current Assets' treating it as a supplier advance in its books though a major portion was loan camouflaged as supplier advance for supply of coffee beans, and was required to be classified as 'Financial Assets' in terms of definition of financial assets and provisions of presentation given at para 11 15 of Ind AS 32. Further, CDGL did not recognize impairment loss allowance did not write off non-recoverable portion of loans given to MACEL (Rs 287.32 crores) as per Para 5.5.1 and para 5.4.4 of Ind AS 109, although MACEL did not have the financial strength to repay the loans. This resulted in CDGL violating Ind AS 32 and Ind AS 109. The Auditors were required under section 143(3)(e) of the Act, to report whether, in their opinion, the financial statements comply with the accounting standards. They had reported that the Financial Statements comply with the Ind AS ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action with any related party and that they had tested that transactions with related parties had been carried out at 'Arm's length'; that there was no adverse indication, hence nothing was recorded in Audit File; that terms conditions of RPTs are mentioned at note no. 38(E) of FS; that all RPTs were conducted in ordinary course of business; that audit procedure did not reveal any fraud and that they had obtained reasonable assurance that FS were free from Order in the matter of CDGL (A Coffee Day Group Company) FY 2018-19 Page 19 of 46 misstatements. Accordingly, they claimed to have complied with section 14 3 (3 )( e) of the Act, SA 200, SA 240, SA 315 and SA 550. 66 In respect of compliance with Ind AS 32 and Ind AS 109, the Auditors have stated that supplier advance is intended to be settled against supply of coffee and original intention in this case was not to provide loan but the advance was provided in the nature of current account and the balance outstanding was cleared in subsequent year; therefore, the advance to MACEL was not classified as financial assets in terms of provisions of Ind AS 32. Further, loans of MACEL were recovered fully during the year. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard approval and without any agreement. Such fraudulent diversion of funds, had serious repercussion on the financial health of the company in terms of liquidity, repayment of loans, payment to creditors and distribution of profits to the shareholders etc. the importance of the same can be understood from the fact that there is a separate Standard on Auditing (SA 240) prescribing the Auditor's responsibilities relating to fraud in an audit of financial statements besides the Auditors having a statutory duty to report fraud to the Central Government under section 143(12) of the Act and CARO 2016. The auditors should have performed the audit with professional skepticism and questioned such diversion of funds which also amounted to fraud, but the Audit work papers do not evidence the same. Had they applied professional skepticism, perhaps they may have detected this fraudulent diversion of funds and reported in their audit report. But by not showing due diligence and professional skepticism, they foreclosed the possibility of detections of such fraudulent diversion of funds. We further find gross failure of the Auditors in identification of Risk of Material Misstatements associate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icate their failure in discharging the statutory duty cast upon them under The Companies (Auditors Report) Order 2016. 71 The Auditors were appointed as the Statutory Auditor of CDGL from FY 2018-19, and this being the first year of audit, the Auditors were expected to perform detailed audit procedures to understand related party relationships, transactions and outstanding balances in accordance with auditing standards, which they did not do. 72 We do not find any merit in the Auditors reply that they performed test to check that RPTs were carried out on Arm's length basis and that they did not record it in Audit File as there was no adverse observations. In this connection, para AS of SA 230, Audit Documentation provides that oral explanation by the auditor, on their own, do not represent adequate support for the work performed by the auditor or conclusions reached, but may be used to explain or clarify information contained in the audit documentation. Since nothing was recorded in the Audit File regarding performing such tests, we find the reply of the Auditors an afterthought to cover up their gross failure in performing audit of important and sensitive area of relat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ors did not question the management and did not perform any audit procedures to obtain sufficient and appropriate audit evidence to determine whether CDGL's decision in this regard was in accordance with the provisions of Ind AS 109. 76 Therefore, we hold that the charge on this count stands proved and uphold that the Auditors have violated section 143(3)(e), 143(12) of the Act, CARO 2016 and SA 200, SA 240, SA 315, SA 330 and SA 550. C.4 Lapses in audit relating to fraudulent understatement of advance to MACEL by Rs 222.50 crores and failure to detect evergreening of loans. 77 The Auditors were charged with failure to perform risk assessment procedure to identify, assess and respond to Risk of Material Misstatements in the Financial Statements due to fraud, in relation to fraudulent understatement of supplier advance to MACEL by Rs 222.50 crores. MACEL had issued several cheques in March 2019 for repayment of supplier advance of Rs 222.50 crores to CDGL. These cheques remained unrealised on 31.03.2019 and were cleared in the next FY i.e., 2019-20, by evergreening of loan through structured circulation of funds among Coffee Day group companies. 78 MACEL had issued ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lances. As such the Auditors were charged to have violated SA 200, SA 240, SA 315 and SA 330 Reply of the Auditors. 80 While denying the charge, the Auditors have stated that they were not having access to books of accounts of MACEL; that CDGL has a regular practice of providing advance for coffee purchase and as a part of risk assessment procedure they ensured that the cheques were not stale cheques and were realised in the subsequent period; that they ensured that there is no risk of misstatement and question of fraud does not arise; that investigations by various agencies never concluded the same as fraud nor did the banks flag these transactions as suspicious; and that they were not required to enquire into the source of funds. Accordingly, they have complied with the Act and the auditing standards. They have stated that section 143(1) provides certain rights to the auditor and does not cast any duty on the auditor, accordingly the question of violation of section 143(1) of the Act does not arise. Analysis of reply 81 We find that CDGL received four cheques of Rs 65.50 crores in March 2019 (FY 2018- 19) from MACEL, which were cleared on 04.04.2019 by evergreenin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch then paid Rs 6 crores to MACEL, which then paid Rs 5 crores to CDGL and so on ...... There was no economic substance in these transactions. 84 Similar evergreening through circulation of funds could be observed from bank statement of CDGL with Karnataka Bank as well and the Auditors have claimed that they have verified realization of cheques in the bank statement of CDGL. MACEL on 30.03.2019 issued six cheques of total amount of Rs 105.00 crores favoring CDGL. On 04.04.2019 the account was credited with Rs 22.70 crore from MACEL's own bank ale in Yes Bank. This was followed by a series of circular transactions, on the same day, between MACEL and CDGL, starting with MACEL paying Rs. 20 crores to CDGL, followed by CDGL paying the same amount to MACEL and so on, to enable clearance of six cheques amounting to Rs 105 crores issued to CDGL on 30.03.2019. Further, on 30.04.2019, MACEL got Rs 24 crores from CDGL, which was used on the same day for clearance of five cheques issued to CDGL on 31. 03.2019 for total amount of Rs 20 crores. 85 In light of glaring lack of evidence to support a valid business reason for the round-trip transfers of funds and clear indications that CD ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly to CDGL in three installments and CCCW repaid Rs 80 crores to CDGL in four installments. All these transactions were done on the same day. Thus, the CCCW repaid the advance received from the CDGL with the additional funds received from CDGL through a series of circular transactions but the end use of the money originally given as capital advance to Kumar Hegde in 2018-19 remains unknown. 88 The Audit File indicates that FS of CCCW and Standalone Financial Statements of CDGL were manipulated during the course of audit with the active involvement of the Auditors. The audit work sheet named 'Analysis', has two different figures of loan recoverable from CCCW at two different rows i.e., Rs 80.12 crores at row no-7 and Rs 130.67 crores at row no-32. There is a difference of Rs 50.55 crores between these two lines. The probable reason for the difference is evident from audit work sheet named 'Capital Advance Mar 19', which has list of advances given for capital goods worth Rs 91.74 crores. The list does not include the name of CCCW, but in the summary, Rs 50.55 crores is reduced by writing 'loan to partnership firm'. This indicated that loan to CCCW was manip ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e off non-recoverable portion of loans given to CCCW (Rs 130.55 crores) as per Para 5.5.1 and para 5.4.4 of lnd AS 109, although CCCW did not have the financial strength to repay the loans. This resulted in CDGL violating Ind AS 109. The Auditors were required under section 143(3)(e) of the Act, to report whether, in their opinion, the financial statements comply with the accounting standards. They had reported that the Financial Statements complied with the Ind AS specified under section 133 of the Act. Thus, they were charged with violation of section 143(3)(e) of the Act. 92 Furthermore, the Auditors were also charged with failure to exercise due diligence while performing audit of Internal Financial Control over Financial Reporting. They did not perform adequate audit procedure in relation to fraudulent diversion of funds to related parties, evergreening of loans through round tripping of funds and non-recoverability of loans from related parties as discussed in Charges no. C.3, C.4 and C.5. As per SA 315, the auditor is required to obtain an understanding of the control environment. There is no evidence in Audit File that the Auditors had conducted any Test of Controls. For ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore signing of audit report. Accordingly, at the time of finalization of audit, there was no indicator of impairment, and therefore question of impairment loss or write off does not arise. 97 The Auditors have denied the charge relating to Internal Financial Control. Citing para 5 <!--?f guidance note on audit of cash and bank balance issued by ICAI, they stated that there is no such expectation from the auditor; that they have verified bank reconciliation statement & staff advance and referred to relevant audit work papers in Audit File; that they do not conduct quarterly audit of CDGL but conduct limited review and as part of annual audit, verified balance confirmations on test check basis. They have however admitted that for major components of FS i.e., revenue, procurements and fixed assets, Test of Controls and Test of Details documents were not available in Audit File submitted to NFRA, but stated that they had conducted the test of controls and test of details in these areas also, but stored the documents in separate folder pertaining to IFC and attached some documents with the reply to SCN. They also stated that they have complied with section 143(3)(i) of the Act and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CW, but they failed to identify this round tripping of funds from their scrutiny of CDGL's bank statement with Corporation Bank and also failed to report this diversion of funds to the Central Government u/s 143(12) of the Act and in the Independent Auditor's Report. 101 The Auditors attempted to justify the difference in loan amounts due to the manipulation of balances with CCCW and DFFCPL by claiming that the loan was given to DFFCPL on behalf of CCCW. This is contradictory to the agreement between CCCW Kumar Hegde in which it is recorded that CCCW paid Rs 130.55 crores advance to Kumar Hegde. Further, such a huge amount of loan cannot be paid to anyone other than the loanee without proper documentation. As a result, we conclude that the Auditors' reasoning for the presence of two sets of FS of CCCW is baseless and an afterthought to cover up the deficiencies in their Audit. 102 The Auditors have not explained why the FSs of CCCW were not signed by any CCCW officer or even an officer of CDGL, which was the major partner of CCCW. Regarding the absence of the signing partner's ICAI membership number and the auditor firm's ICAI firm registration number on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions and safe custody of cheque books etc. The Audit File shows no evidence of Auditors having performed any such procedures. 105 The above analysis shows that the Auditors failed to exercise professional skepticism while performing audit of internal financial control. They failed to identify complete absence of IFC, which was evident from evergreening of loans through structure circulation of funds and round tripping of funds, that too all with related parties. These lapses are tantamount to turning a blind eye to the ruse that lay before them. The Auditors should know that transactions with related parties have high risk of fraud. The Auditors could not give any reply as to how they used the Internal Audit Reports while performing audit of CDGL. 106 Internal financial control over financial reporting is designed and implemented to prevent, and detect fraudulent transactions. However, based on the above analysis, we find that controls were totally absent in CDGL in release of supplier advances loans, and banking transactions and there was total management override of controls in these areas. Any significant deficiencies or material weaknesses in internal controls must be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to Management or TCWG about disbursement of this abnormally high capital advance. 110 Further, Capital advance of Rs 75.03 crores to DFFCPL was outstanding on 31.03.2019, but only Rs 24.54 crores was shown in the Financial Statements. The Audit File shows that Rs 50.55 crores was converted from 'capital advance to DFFCPL' into 'loan to CCCW'. The Auditors were charged with not questioning or seeking justification for this conversion and not exercising due diligence while conducting audit of this capital advance, and thus violated SA 200, SA 240, SA 315, and SA 330. Reply of the Auditors 111 The Auditors have denied the charge stating that CDGL was into coffee business, mainly through cafes and used to purchase furniture from DFFCPL in ordinary course of business. Accordingly, the Auditors have claimed that section 188 of the Act was not applicable on these transactions; that even though the transaction is beyond the limit approved by the Audit Committee, the same was carried out in the ordinary course of business and purchases were within the approved limit; and that since the advance to DFFCPL was covered by the general limit of Rs 4,000 crore approved ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to DFFCPL. 115 From the above analysis, it is inferred that the Auditors failed to exercise due diligence while conducting audit of capital advance. Accordingly, we find that the Auditors have violated SA 200, SA 240, SA 315 and SA 330 and not reported the noncompliance of section 188 and 177 of the Act. D. OTHER NON-COMPLIANCES WITH LAWS AND STANDARDS In addition to the major lapses covered under section C of the order, the Auditors were also charged with following lapses in the audit: a) Failure to report non compliances with section 134(1) of the Act. b) Failure to comply with SA 700, Forming an Opinion and Reporting on Financial Statements. c) Failure to comply with SA 250, Consideration of Laws and Regulations in an Audit of Financial Statements. d) Failure to comply with SA 260, Communication with Those Charged With Governance (TCWG) SA 265, Communicating deficiencies in Internal Control to Those Charged With Governance and Management. e) Failure to comply with SA 300, Planning an audit of Financial Statements. Reply of the Auditors 116 The Auditors have denied their wrongdoings and professional misconduct in all the charges mentioned in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gning by the persons authorized by the Board are prerequisites before an auditor makes a report on such approved signed financial statements. Further, the reliance on the Doctrine of Indoor Management is misplaced as this Doctrine is applicable to third parties, not having access to the internal records of a company. The Auditors should have obtained a certified copy of the Board resolution approving the Financial Statements and authorizing the Directors to sign the Financial Statements and should have kept the same in the Audit File before its assembly. The Auditors did not do the same. Thus, this charge is proved that the Auditors did not ensure compliance with section 134(1) of the Act by CDGL. 123 SA 700 - Based on our earlier findings on each charge in the preceding paragraphs it is clear that the replies of the Auditors are not satisfactory. By not taking into account the large-scale fraudulent transactions of huge amounts while making audit conclusions, the Auditors violated SA 700 and failed to draw attention to the presence of material misstatements of Rs 7514.10 crores in the Financial Statements of CDGL. Thus, the charge that the Auditors violated SA 700 is proved ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we find that the Auditors' reply is not satisfactory and, the charge that the Auditors have violated SA 260 and SA 265 is proved. 126 As per SA 300, an Audit plan should include nature, timing and extent of planned risk assessment procedures. The Audit plan available in the Audit File does not contain any details of planning relating to risk assessment procedures. The quality of performance of an audit largely depends upon the quality of audit strategy and audit plan. We find that the Auditors were deficient in developing an effective audit plan. Therefore, this charge is proved that the Auditors have violated SA 300. Failure to comply with SA 210, Agreeing the terms of audit engagements, SA 510, Initial Audit Engagements - Opening Balances and Failure to comply with SA 720, The Auditor's Responsibilities relating to Other Information. 127 The Auditors were charged with non-compliance with SA 210, SA 510 and SA 720. Having considered the replies, we drop these charges. E. OMISSION AND COMMISSION BY THE AUDIT FIRM In addition to being jointly responsible for the lapses in audit performed by the EP and other members of the engagement team, the Audit Fir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... engagement partner'. The firm should establish policies and procedures requiring that: (a) The identity and role of the engagement partner are communicated to key members of the client's management and those charged with governance. (b) The engagement partner has the appropriate capabilities, competence, authority and time to perform the role; and (c) The responsibilities of the engagement partner are clearly defined and communicated to that partner. 132 As per Table-4, the Audit firm had bifurcated the responsibility of one engagement among three partners ( one signing partner and two engagement partners), which is against the principle of SQC-1 resulting in noncompliance with SQC 1. Further, there is no term like 'signing partner' in any of the SAs. The responsibilities of each partner have not been clearly defined in the audit plan. Designations were recorded for the areas to be covered like Article Assistant, Engagement Partner, External Reviewer, Junior Partner, Senior Partner, Audit Assistant and Partner. Name of the persons are not recorded, making it impossible to know who performed which audit activity. Further, there were no members in the enga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this case the audit firm, appointed one signing partner and two EPs. CA A. S. Sundaresha was appointed signing partner and Madhusudan and Pranaav were shown as EPs in the audit plan. Madhusudan and Pranaav have not disputed this position in their reply. Therefore, we hold that CA A. S. Sundaresha, as well as Madhusudan and Pranaav were members of engagement team and are jointly and severally responsible for all lapses. The audit firm is also responsible for lack of due diligence in this regard for constituting their Engagement Team with multiple EPs in violation of SQC 1. 136 The Audit Firm did not furnish any reply relating to External Reviewers mentioned in the audit plan. There is no concept of external reviewer in the Standards. 'External' person can be associated with the engagement team in three ways; (a) An Auditor can use the work of an auditor's expert if expertise in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence. Both the so-called external reviewers (CA Pradeepa Chandra C. and CA Chaitanya G. Deshpande) are not covered in this definition as there is no record in the Audit File that they had perfor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the engagement team the Audit Firm was also charged with various omissions and commissions attributed to the Auditors in section C and D above. Para 2 of SA 220 and para 3 of SQC 1, stipulate that Quality Control Systems, Policies and Procedures are the responsibility of the Audit Firm. The Audit Firm was charged with failure to establish and maintain a system of quality control to provide it with reasonable assurance that: a) The firm and its personnel comply with professional standards and regulatory and legal requirements; and b) The reports issued by the firm or engagement partners are appropriate in the circumstances 140 Responding to the charge, the Audit Firm stated that: a) They have issued audit report after taking into account the provisions of the Act, Ind AS prescribed u/s 133 and Standards on Auditing u/s 143(10) of the Act. They have taken management representation letter for various aspects relating to this engagement and reported u/s 143(2) of the Act. b) They rely on the replies in forgoing para in respect of NFRA's observation on alleged non-compliance with accounting and auditing standards. c) They confirmed the Report on other legal and re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and Auditing Standards have the force of law and are required to be mandatorily complied with from the date of their respective applicability, while conducting statutory audits. 143 The Auditors have stated that the issue of SCN is based on belief/suspicion and not on conclusive evidence. We do not agree with this. The SCN was based on facts of the matter and the documents in the Audit File submitted by the Auditors. The words 'believe/suspicious' were used in the SCN to convey a prima-facie view in the SCN, to be further probed and established with an open mind after offering an opportunity in the interest of natural justice to the Auditors to rebut the charges and provide their reply to the SCN. No conclusions were reached before analysis of the reply of the Auditors. 144 There is also no truth in the Auditors contention that no investigation was conducted by NFRA. The SCN was issued after duly examining the material contained in the Audit File and other materials on record in accordance with Rule 11 of the NFRA rules 2018 and the conclusion reached in this Order are based on due consideration of the Auditors' replies on each point of charge in the SCN. G. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce or 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 regulations, failed to report the material misstatements in the financial statements arising from diversion of funds circulation of funds and failed to report non-compliances made by the Company, as explained in Section C and D above. iv. The Auditors committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that an EP is guilty of professional misconduct when he ''fails to obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion . This charge is proved as the Auditors failed to conduct the audit in accordance with the SAs and applicable regulations as well as due to his total failure to report the material misstatements and non-compliances made by the Company in the financial statements, as explained in the Section C-3 to C-6 and Section - D above. v. The Auditors committed professional misconduct as defined by clause 9 of Part I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d risks, Marcum 's engagement team breached its duty to perform the Audits with the due professional care and professional skepticism required by PCAOB standards. The team also failed to adequately understand the business rationale (or the lack thereof) for the significant unusual transactions and failed to obtain sufficient appropriate audit evidence to support Marcum 's opinion on the Issuer's financial statements . For this misconduct, PCAOB censured Audit firm Marcum LLP ( Marcum ); imposed a civil money penalty of $250,000 on Marcum; prohibiting Marcum from audit works for a period of three years. PCAOB also imposed a penalty of $25,000 on the Engagement partner John E. Klenner besides barring him from being an associated person of a registered public accounting firm. 150 Similarly, failures to perform audit procedures and exercise professional skepticism in related party transactions and internal control over financial reporting have invited serious action by audit regulators in other jurisdictions too. For example, in case of Cheryl L. Gore, CPA and Stanley R. Langston, CPA, PCAOB 19 had observed that Gore failed to obtain sufficient appropriate audit evid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement. ..... . . ... MarcumBP failed to implement, effectively apply, and appropriately monitor quality control policies and procedures sufficient to provide reasonable assurance concerning the Firm's independence . In this case, PCAOB censured audit firm, imposed monetary penalty and required audit firm to undertake a review of its policies, procedures, staffing, and training with respect to auditor independence. 153 Similarly, in AWC (CPA) Limited, WONG Chi Wai, CPA, and WONG Fei Cheung, CPA, PCAOB observed As the engagement partner, Albert Wong was responsible for AWC's compliance with independence requirements. Although Albert Wong knew at the time of the Kandi 2012 Audit that Mui had accepted a Power-of-Attorney from Kandi in order to handle the New York State agency matter, he failed to evaluate whether Mui's activities on Kandi's behalf constituted prohibited non-audit services that would impair Mui's independence, as well as AWC's and its associated persons. Albert Wong took, or omitted to take, actions during the Kandi 2012 Audit, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... integrity in all areas of their work. 159 These Auditors were required to ensure compliance with Standards on Auditing, Laws and Regulations to achieve the necessary audit quality and lend credibility to Financial Statements to facilitate its users. As detailed in this Order, substantial deficiencies in Audit, abdication of responsibility and inappropriate conclusions on the part of the Auditors establish their professional misconduct and lack of due diligence. Despite being qualified professionals, the Auditors have not adhered to the Standards and have thus not discharged the duty cast upon them 160 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 la.kh rupees, but which may extend to five times of the fees received, in case of individuals; and (II) not less than ten lakh rupees, but which may extend to ten times of the fees received, in case of firms; (B) debarring the member or the firm from (I) being appointed as an auditor or internal auditor or undertaking any audit in respect of financia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... monetary penalty of Rs Five Lakhs only upon CA Pranaav G. Ambekar. In addition, CA Pranaav G. Ambekar is debarred for a period of 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. 163 This order will become effective after 30 days from the date of issue of this order. Foot Notes 1 As defined in Rule 3 of the NFRA Rules 2018 2 Section 143(9) of the Act provides that every auditor shall comply with the auditing standard. Further proviso to section 143(10) of the Act provides that until any auditing standards are notified, any standard or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards. 3 SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing 4 SA 220, Quality Control for an Audit of Financial Statements specific engagements, designed to provide it with reasonable assurance that it will undertake or continue relationships and engagements only where i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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