Facts of the Case

The National Financial Reporting Authority (NFRA) initiated proceedings against M/s S. Prakash Aggarwal & Co., the statutory auditor of Vikas WSP Limited (VWL) for the Financial Year 2019-20.

The proceedings originated from information received from the Securities and Exchange Board of India (SEBI), which reported that Vikas WSP Limited had failed to recognize the entire interest expense on borrowings classified as Non-Performing Assets (NPAs) by lending banks. This resulted in an overstatement of the company’s profits in its financial statements for FY 2019-20.

NFRA examined the audit records and found that the audit firm had failed to comply with various provisions of the Companies Act, 2013, Standards on Auditing (SAs), and Standards on Quality Control (SQC-1). The financial statements contained material misstatements due to partial recognition of interest costs on bank borrowings.

The Engagement Partner, CA Som Prakash Aggarwal, had earlier been proceeded against and penalized separately. Subsequently, NFRA issued a Show Cause Notice to the audit firm itself for professional misconduct arising from deficiencies in the audit engagement and failures in quality control systems.

Issues Involved

  1. Whether the audit firm failed to disclose material facts and material misstatements in the financial statements of Vikas WSP Limited.
  2. Whether the audit firm failed to exercise due diligence and professional skepticism while conducting the statutory audit.
  3. Whether the audit firm failed to obtain sufficient appropriate audit evidence before expressing an unmodified audit opinion.
  4. Whether the audit firm violated Standards on Auditing and Standards on Quality Control by failing to maintain and implement adequate quality control systems.
  5. Whether the audit firm could avoid liability by contending that only the Engagement Partner was responsible for audit deficiencies.
  6. Whether separate proceedings against the audit firm constituted double jeopardy after proceedings against the Engagement Partner.

 

Petitioner’s Arguments (Audit Firm)

The audit firm raised the following contentions:

1. Engagement Partner Alone Responsible

The firm argued that under SA 220 and SQC-1, responsibility for audit engagement performance and audit quality rests with the Engagement Partner and therefore any non-compliance with auditing standards should be attributed only to the Engagement Partner.

2. Adequate Quality Control Policy Existed

The firm contended that it had formulated an SQC-1 policy commensurate with the size and nature of its operations and therefore no misconduct could be attributed to the firm.

3. No Provision for Holding Audit Firm Guilty

The firm argued that professional misconduct must be interpreted strictly under the Chartered Accountants Act, 1949 and that non-compliance with auditing standards alone could not constitute professional misconduct by the audit firm.

4. Double Jeopardy

The firm submitted that the Engagement Partner had already been penalized for the same audit engagement and any action against the firm would amount to double punishment for the same alleged misconduct.

 

Respondent’s Arguments (NFRA)

NFRA rejected the firm’s submissions and contended that:

1. Audit Firm Bears Independent Responsibility

The audit firm was appointed as statutory auditor under Section 139 of the Companies Act, 2013 and therefore remained responsible for compliance with auditing standards and statutory obligations.

2. Quality Control Requires Implementation

Merely formulating a quality control policy is insufficient. The firm must ensure effective implementation and monitoring of quality control systems so that audit engagements comply with professional standards.

3. Responsibility Cannot Be Shifted

The audit firm cannot escape accountability by shifting responsibility to the Engagement Partner because audit reports are issued on behalf of the firm.

4. Separate Liability of Firm and Partner

The relationship between the audit firm and Engagement Partner does not prevent independent liability of the firm. Proceedings against the firm do not amount to double jeopardy.

 

Court Order / Findings

NFRA held that the charges against the audit firm stood proved.

The Authority found several serious audit deficiencies, including:

Material Misstatement in Financial Statements

The company failed to recognize full interest costs on NPA borrowings, resulting in overstatement of profits.

Failure to Obtain Sufficient Audit Evidence

The audit file lacked adequate documentation regarding:

  • Verification of interest costs.
  • Interest certificates from banks.
  • Balance confirmations.
  • Trial balance records.
  • Assessment of accounting treatment adopted by the company.

Defective Audit Documentation

NFRA observed significant deficiencies in audit working papers and audit documentation.

Deficiencies in Management Representation Letter

The Management Representation Letter contained inconsistencies, incomplete information, incorrect references and did not comply with auditing standards.

Failure to Maintain Audit File

The firm failed to properly preserve and maintain audit documentation and engagement records.

Absence of Engagement Quality Control Review (EQCR)

No EQCR was appointed despite requirements under SA 220.

Lack of Governance Communications

The audit file contained no documentation evidencing communication with Those Charged With Governance (TCWG) regarding audit planning, accounting practices and audit findings.

Failure to Exercise Professional Skepticism

The audit firm failed to demonstrate professional skepticism, due diligence and appropriate professional judgment while conducting the audit.

NFRA concluded that the audit firm had failed to implement effective quality control systems and had committed professional misconduct.

 

Important Clarification

NFRA clarified that:

  • An audit firm cannot avoid responsibility merely because an Engagement Partner conducted the audit.
  • The audit firm remains accountable for establishing, implementing and monitoring quality control systems.
  • Compliance with auditing standards is a statutory obligation under the Companies Act, 2013.
  • Professional misconduct may be established where an audit firm fails to ensure compliance with auditing standards and quality control requirements.
  • Proceedings against an audit firm and proceedings against an individual Engagement Partner are separate and distinct.

 

Sections / Provisions Involved

Companies Act, 2013

  • Section 132(4)
  • Section 132(4)(c)
  • Section 139
  • Section 143(9)

National Financial Reporting Authority Rules, 2018

  • Rule 3(1)(a)
  • Rule 11(6)

Chartered Accountants Act, 1949

Part I of Second Schedule

  • Clause 5 – Failure to disclose material facts.
  • Clause 6 – Failure to report material misstatements.
  • Clause 7 – Failure to exercise due diligence or gross negligence.
  • Clause 8 – Failure to obtain sufficient information for expression of opinion.
  • Clause 9 – Failure to invite attention to material departures from accepted audit procedures.

Standards on Auditing (SAs)

  • SA 200
  • SA 220
  • SA 230
  • SA 260 (Revised)
  • SA 315
  • SA 580
  • SA 620
  • SA 700 (Revised)

Standards on Quality Control

  • SQC 1


emphasizes accountability of audit firms for failures in statutory audits of public interest entities.

Link to download the order - https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2024/04/202404261550519674.pdf

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