Facts of the Case

Reliance Commercial Finance Limited (RCFL), a listed Non-Banking Financial Company (NBFC), was subjected to statutory audit for the Financial Year 2018-19. The previous statutory auditor, Price Waterhouse & Co Chartered Accountants LLP (PW), reported suspected fraud under Section 143(12) of the Companies Act, 2013 and subsequently resigned from the audit engagement before issuing the audit report.

Following the resignation, M/s Shridhar & Associates was appointed as the statutory auditor to fill the casual vacancy. The audit firm, through Engagement Partner CA Ajay Vastani, issued an unmodified audit opinion on the financial statements of RCFL on 14 August 2019 while including an Emphasis of Matter paragraph relating to the fraud report filed by the previous auditor.

Based on information received from the Ministry of Corporate Affairs and examination of the audit file, NFRA initiated proceedings and issued a Show Cause Notice alleging professional misconduct and violations of auditing standards and statutory requirements.

 

Issues Involved

  1. Whether the auditors accepted the audit engagement without complying with professional requirements regarding communication with the previous auditor.
  2. Whether issuance of an unmodified audit opinion along with an Emphasis of Matter paragraph was appropriate in the circumstances.
  3. Whether sufficient and appropriate audit evidence was obtained regarding the going concern status of RCFL.
  4. Whether adequate audit procedures were performed in relation to Expected Credit Loss (ECL) provisions.
  5. Whether the auditors properly assessed and responded to fraud risks despite the previous auditor's fraud reporting under Section 143(12).
  6. Whether the conduct of the audit complied with the Standards on Auditing, the Companies Act, 2013 and the applicable Code of Ethics.

 

Petitioner’s Arguments (NFRA)

NFRA contended that:

  • The engagement partner accepted the audit assignment without first communicating with the previous auditor and without waiting for a reasonable response period.
  • The auditors improperly issued an Emphasis of Matter instead of modifying the audit opinion despite the nature of disclosures concerning suspected fraud.
  • The auditors failed to obtain sufficient appropriate audit evidence regarding the company's ability to continue as a going concern.
  • Adequate procedures were not performed to evaluate the Expected Credit Loss provision on a substantial loan portfolio.
  • Despite knowledge of the suspected fraud reported by the previous auditor, the auditors failed to appropriately assess fraud risks and conduct responsive audit procedures.
  • The auditors inadequately examined end-use of loans, possible diversion or siphoning of funds, management override of controls, and business rationale behind lending transactions.
  • The audit failed to comply with the Standards on Auditing and resulted in an unreliable audit opinion.

 

Respondents’ Arguments

The Audit Firm and the Engagement Partner filed written and oral submissions in response to the Show Cause Notice and defended the audit procedures performed during the engagement.

The respondents maintained that the audit opinion issued was justified based on the information and explanations available to them and sought to explain their audit approach, reliance on management representations, disclosures in the financial statements, and other audit procedures undertaken during the course of the engagement.

 

Court Order / Findings

NFRA held that the Audit Firm and the Engagement Partner failed to comply with the requirements of the Standards on Auditing, the Companies Act, 2013 and the applicable ethical standards.

NFRA recorded the following findings:

1. Improper Acceptance of Audit Engagement

The Engagement Partner accepted the assignment without first communicating with the previous auditor and without allowing reasonable time for a response.

2. Inappropriate Emphasis of Matter

The auditors issued an Emphasis of Matter paragraph where the circumstances warranted modification of the audit opinion. The audit report effectively endorsed the company’s position regarding the fraud reporting issue.

3. Failure to Evaluate Going Concern Adequately

The auditors failed to obtain sufficient and appropriate audit evidence to conclude that there was no material uncertainty regarding the company’s ability to continue as a going concern.

4. Deficiencies in ECL Assessment

The auditors did not perform adequate audit procedures to verify the reasonableness of the Expected Credit Loss provision relating to the loan portfolio.

5. Failure in Fraud Risk Assessment

The auditors failed to appropriately assess and respond to fraud risks despite knowledge of the previous auditor’s fraud reporting under Section 143(12).

6. Lack of Professional Skepticism

NFRA observed gross negligence, inadequate professional skepticism, insufficient due diligence, and failure to adequately challenge management assertions.

NFRA concluded that the deficiencies were so significant that the audit opinion became unreliable and material misstatements remained unreported.

 

Final Order

NFRA held M/s Shridhar & Associates and CA Ajay Vastani guilty of professional misconduct.

Penalties Imposed

On M/s Shridhar & Associates

  • Monetary Penalty: ₹2 Crore

On CA Ajay Vastani

  • Monetary Penalty: ₹50 Lakh
  • Debarment for 5 Years from:
    • Being appointed as a statutory auditor;
    • Being appointed as an internal auditor; and
    • Undertaking any audit relating to financial statements or internal audit of any company or body corporate.

 

Important Clarification

This order highlights that a successor auditor cannot merely rely upon management explanations when a previous auditor has reported suspected fraud and resigned from the engagement.

The decision reiterates that:

  • Professional skepticism is a fundamental audit requirement.
  • Fraud indicators require enhanced audit procedures.
  • An Emphasis of Matter cannot be used as a substitute for a modified audit opinion where circumstances warrant qualification or other modification.
  • Auditors must independently evaluate fraud risks, going concern assumptions, loan impairments, and management assertions.
  • Failure to comply with Standards on Auditing may attract disciplinary action and monetary penalties under Section 132(4) of the Companies Act, 2013.

 

Sections Involved

  • Section 132(4), Companies Act, 2013
  • Section 143(12), Companies Act, 2013
  • Section 139, Companies Act, 2013
  • National Financial Reporting Authority Rules, 2018
  • Standards on Auditing (SAs)
  • ICAI Code of Ethics


Link to download the order - https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2024/05/2024051797901178.pdf

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