Facts of the Case

The National Financial Reporting Authority (NFRA) initiated an investigation based on information received from the Ministry of Corporate Affairs regarding irregularities observed by the Financial Reporting Review Board (FRRB) of ICAI in the financial statements of Anshu's Clothing Ltd. (now known as Aditri Gems & Jewels Ltd.) for the Financial Year 2015-16.

During the relevant period, the company was a listed entity on the Bombay Stock Exchange and Metropolitan Stock Exchange. M/s S. Kansal & Associates acted as the statutory auditor, and CA Sachin Kansal served as the Engagement Partner.

Upon examination of the financial statements and audit records, NFRA found multiple instances of non-compliance with Accounting Standards, Standards on Auditing, and statutory requirements under the Companies Act, 2013. Consequently, a Show Cause Notice was issued under Section 132(4) of the Companies Act, 2013 alleging professional misconduct against the Engagement Partner.

 

Issues Involved

  1. Whether the auditor failed to report material misstatements in the financial statements of the company.
  2. Whether accrued interest on loans from banks and NBFCs was wrongly omitted from the accounts.
  3. Whether deferred tax assets were improperly recognized in violation of Accounting Standards.
  4. Whether the auditor failed to report non-compliance with Schedule III of the Companies Act, 2013.
  5. Whether the auditor violated Standards on Auditing relating to audit documentation, engagement quality review, audit engagement terms, and communication with those charged with governance.
  6. Whether such failures constituted professional misconduct under Section 132(4) of the Companies Act, 2013.

 

Petitioner’s Arguments (NFRA)

NFRA contended that:

1. Non-Provision of Interest Costs

The company failed to recognize accrued interest amounting to approximately ₹143.98 lakhs on loans obtained from banks and NBFCs.

Had the interest been properly accounted for, the reported loss of approximately ₹20.28 lakhs would have increased to approximately ₹164.26 lakhs, resulting in a material and pervasive misstatement in the financial statements.

The auditor failed to qualify the audit report despite knowledge of such material misstatement.

2. Improper Recognition of Deferred Tax Assets

The company recognized Deferred Tax Assets despite continuous losses and absence of convincing evidence regarding future taxable income.

Recognition of such assets violated Accounting Standard (AS) 22.

3. Failure to Disclose Inventory Cost Formula

The financial statements did not disclose the cost formula used for inventory valuation as mandated by AS 2.

4. Wrong Amortization of Expenses

Several expenses including preliminary expenses, listing expenses and other items were improperly shown as unamortized expenses contrary to AS 26 and AS 22.

5. Non-Compliance with Schedule III

The company failed to prepare financial statements in accordance with the prescribed format under Schedule III to the Companies Act, 2013.

6. Violation of Standards on Auditing

The auditor failed to:

  • Properly document audit procedures.
  • Assemble the audit file within the prescribed period.
  • Maintain engagement letters.
  • Appoint an Engagement Quality Control Reviewer (EQCR) despite auditing a listed company.
  • Communicate with Those Charged With Governance (TCWG).
  • Maintain adequate audit evidence supporting audit conclusions.

According to NFRA, these failures amounted to gross negligence and professional misconduct.

 

Respondent’s Arguments (CA Sachin Kansal)

The Engagement Partner submitted that:

Regarding Interest Accrual

  • Management was negotiating a one-time settlement with the lending bank.
  • Based on professional judgment, further interest liability was not expected to be payable.
  • The subsequent settlement supported the auditor's judgment.

Regarding Deferred Tax Assets

  • Recognition of Deferred Tax Assets was an unintended oversight.
  • The amount involved was comparatively small and did not materially affect the balance sheet.

Regarding Audit Report Qualification

  • Failure to appropriately modify the audit opinion was an inadvertent drafting error.
  • A combined reading of the audit report would reveal the auditor’s intended qualification.

Regarding Documentation and Other Lapses

  • Audit records were scattered and not compiled in accordance with auditing standards.
  • Communication with management occurred verbally.
  • Being a sole practitioner, appointment of an Engagement Quality Control Reviewer was difficult.

Mitigating Circumstances

The auditor pleaded for leniency on the grounds that:

  • He was newly qualified at the relevant time.
  • It was his first audit assignment involving a listed company.
  • There was no intention to misappropriate funds.
  • The errors were unintentional and resulted from lack of experience and knowledge.

 

Court Order / Findings

NFRA rejected the explanations furnished by the Engagement Partner and held that:

Failure to Report Material Misstatements

The omission of accrued interest resulted in a substantial understatement of losses and constituted a material misstatement which should have been reported by the auditor.

Violation of Accounting Standards

The auditor failed to identify and report violations relating to:

  • AS 1 – Disclosure of Accounting Policies.
  • AS 2 – Valuation of Inventories.
  • AS 22 – Accounting for Taxes on Income.
  • AS 26 – Intangible Assets.

Violation of Standards on Auditing

The auditor violated several Standards on Auditing including:

  • SA 200
  • SA 210
  • SA 220
  • SA 230
  • SA 260
  • SA 265
  • SA 320
  • SA 450
  • SA 540
  • SA 705

Lack of Audit Documentation

NFRA emphasized that inadequate audit documentation strikes at the very root of the audit process and undermines the reliability of the audit opinion.

Failure to Appoint EQCR

As the company was a listed entity, appointment of an Engagement Quality Control Reviewer was mandatory. Being a sole practitioner could not excuse non-compliance.

Professional Misconduct Established

NFRA concluded that the Engagement Partner failed to exercise due diligence, failed to obtain sufficient audit evidence, failed to report material misstatements, and failed to comply with applicable auditing and accounting standards.

Accordingly, the charges of professional misconduct were held proved.

 

Important Clarifications

NFRA's Observation on Auditor's Responsibility

An auditor cannot justify omission of liabilities merely because future settlement negotiations are ongoing.

Materiality Assessment

Even comparatively smaller accounting entries may become material when they significantly affect losses or financial position.

Audit Documentation

Audit documentation must be sufficiently detailed to enable an experienced auditor with no previous connection to understand:

  • Audit procedures performed.
  • Evidence obtained.
  • Conclusions reached.

Listed Company Audits

Engagement Quality Control Review is mandatory for listed entities and cannot be avoided merely because the auditor is a sole practitioner.

Professional Judgment Not Absolute

Professional judgment must be supported by contemporaneous audit evidence and proper documentation.

 

Sections Involved

Companies Act, 2013

  • Section 128
  • Section 129
  • Section 132(4)
  • Section 139
  • Section 143

Accounting Standards

  • AS 1 – Disclosure of Accounting Policies
  • AS 2 – Valuation of Inventories
  • AS 22 – Accounting for Taxes on Income
  • AS 26 – Intangible Assets

Standards on Auditing

  • SA 200
  • SA 210
  • SA 220
  • SA 230
  • SA 260
  • SA 265
  • SA 320
  • SA 450
  • SA 540
  • SA 705

Standard on Quality Control

  • SQC 1

 

Final Order

NFRA imposed the following sanctions:

Monetary Penalty

₹1,00,000 (Rupees One Lakh) upon CA Sachin Kansal.

Debarment

Debarment for one year from:

  • Being appointed as an auditor,
  • Being appointed as an internal auditor,
  • Undertaking any audit relating to financial statements,
  • Conducting internal audits of any company or body corporate.

The sanctions were directed to take effect after thirty days from the date of issuance of the order.


Link to download the order -https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2023/07/2023072723.pdf

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