Facts of the Case

CA M. Vaman Karnath, Partner of M/s Karnath & Karnath Associates, acted as the Engagement Partner for the statutory audit of ten branches of Dewan Housing Finance Corporation Limited (DHFL) for the Financial Year 2017-18.

NFRA initiated an Audit Quality Review in relation to DHFL following reports concerning large-scale financial irregularities and alleged fraud. During the review of the statutory audit conducted by Chaturvedi & Shah, NFRA observed that several branch auditors had issued Independent Branch Auditors’ Reports for DHFL branches.

Investigation revealed that the appointment of branch auditors had not been approved by the shareholders of DHFL in the Annual General Meeting as required under the Companies Act, 2013. Despite the absence of a valid statutory appointment, CA M. Vaman Karnath accepted the engagement as Branch Statutory Auditor and issued Independent Branch Auditors’ Reports for ten branches of DHFL.

NFRA further examined the audit work performed and found several deficiencies in compliance with the Standards on Auditing, audit documentation requirements, audit planning, risk assessment procedures, materiality assessment and audit evidence gathering procedures.

Accordingly, a Show Cause Notice was issued alleging professional misconduct under the Companies Act, 2013 and the Chartered Accountants Act, 1949.

 

Issues Involved

  1. Whether the Engagement Partner accepted the branch audit assignment without verifying compliance with the statutory requirements governing appointment of auditors.
  2. Whether the appointment as Branch Statutory Auditor was legally valid under the Companies Act, 2013.
  3. Whether the auditor complied with the applicable Standards on Auditing while conducting the branch audits.
  4. Whether adequate audit documentation and audit evidence existed to support the audit opinion issued.
  5. Whether the conduct of the auditor amounted to professional misconduct under the Chartered Accountants Act, 1949 and Section 132(4) of the Companies Act, 2013.

 

Petitioner’s / NFRA’s Contentions

NFRA contended that:

  • The appointment of branch auditors was never approved by the shareholders of DHFL as required under Section 139 read with Section 143(8) of the Companies Act, 2013.
  • The Engagement Partner accepted an invalid appointment and issued Independent Branch Auditors’ Reports despite the absence of lawful authorization.
  • The auditor failed to exercise due diligence required under the Chartered Accountants Act, 1949.
  • The auditor violated SA 200 and SA 210 by failing to properly establish and document the terms, objectives and scope of the audit engagement.
  • The audit file lacked adequate documentation required under SA 230.
  • There was no evidence of proper audit planning, risk assessment, determination of materiality, sampling procedures, analytical procedures, assessment of internal controls or obtaining sufficient audit evidence.
  • The unmodified audit opinion was unsupported by adequate audit evidence and was therefore contrary to SA 700.
  • The cumulative failures constituted professional misconduct warranting action under Section 132(4) of the Companies Act, 2013.

 

Respondent’s Arguments

CA M. Vaman Karnath submitted that:

  • There was no reason to believe that the appointment had not been made in accordance with the Companies Act.
  • Reliance was placed on the Central Statutory Auditor and the company regarding compliance with appointment requirements.
  • The engagement was as Branch Auditor and not as auditor of the company.
  • The scope of work had been specified through instructions received from the Central Statutory Auditor.
  • Audit procedures were conducted in accordance with those instructions.
  • No separate engagement letter was considered necessary.
  • Materiality and audit planning were matters handled by the Central Statutory Auditor.
  • Information supplied by the company was considered reliable.
  • Certain deficiencies observed in loan files had already been communicated to the Central Statutory Auditor.

 

Court / NFRA Findings

NFRA held that:

Invalid Appointment

The appointment of the branch auditor was not approved by the shareholders of DHFL as mandated by law. The auditor failed to ascertain whether the requirements of Section 139 of the Companies Act, 2013 had been complied with before accepting the engagement.

Violation of SA 210 and SA 200

No valid engagement letter satisfying the requirements of SA 210 was found. The auditor failed to adequately understand and document the objective and scope of the engagement and lacked professional skepticism.

Violation of SA 230

The audit file did not contain sufficient documentation demonstrating:

  • Nature, timing and extent of audit procedures.
  • Audit evidence obtained.
  • Conclusions reached.
  • Review and supervision of audit work.
  • Risk assessment procedures.
  • Audit planning documentation.

Violation of SA 700

The auditor issued an unmodified opinion despite noting deficiencies in loan documentation and without documenting evaluation of the impact of such deficiencies on the audit opinion.

Other Standards Violated

NFRA found non-compliance with:

  • SA 300 – Planning an Audit of Financial Statements.
  • SA 315 – Identifying and Assessing Risks of Material Misstatement.
  • SA 320 – Materiality in Planning and Performing an Audit.
  • SA 330 – Auditor’s Responses to Assessed Risks.
  • SA 450 – Evaluation of Misstatements Identified During the Audit.
  • SA 500 – Audit Evidence.
  • SA 510 – Initial Audit Engagements and Opening Balances.
  • SA 520 – Analytical Procedures.
  • SA 530 – Audit Sampling.
  • SA 580 – Written Representations.

Professional Misconduct Established

NFRA concluded that the Engagement Partner:

  • Failed to exercise due diligence regarding appointment.
  • Was grossly negligent in professional duties.
  • Failed to obtain sufficient information necessary for expressing an audit opinion.
  • Failed to draw attention to departures from accepted audit procedures.

Accordingly, professional misconduct stood established under the Chartered Accountants Act, 1949 and Section 132(4) of the Companies Act, 2013.

 

Important Clarifications

  • Acceptance of an audit engagement without verifying statutory compliance regarding appointment constitutes professional misconduct.
  • Reliance on management or another auditor does not absolve an auditor from independent verification obligations.
  • Audit documentation is fundamental evidence of audit performance and cannot be substituted by oral explanations.
  • Branch auditors are independently responsible for complying with applicable Standards on Auditing.
  • An unmodified audit opinion must be supported by sufficient and appropriate audit evidence.

 

Court Order / Final Decision

NFRA held CA M. Vaman Karnath guilty of professional misconduct.

The Authority imposed:

  1. Monetary Penalty of ₹1,00,000 (One Lakh Rupees).
  2. Debarment for One Year from:
    • Being appointed as an auditor;
    • Being appointed as an internal auditor; or
    • Undertaking any audit relating to financial statements or internal audit of any company or body corporate.

The order was directed to become effective after 30 days from the date of issuance.

 

Sections Involved

Companies Act, 2013

  • Section 132
  • Section 132(4)
  • Section 139
  • Section 140
  • Section 143(8)
  • Section 143(10)

Chartered Accountants Act, 1949

  • Section 22
  • Clause (9), Part I, First Schedule
  • Clause (7), Part I, Second Schedule
  • Clause (8), Part I, Second Schedule
  • Clause (9), Part I, Second Schedule

Standards on Auditing

  • SA 200
  • SA 210
  • SA 230
  • SA 300
  • SA 315
  • SA 320
  • SA 330
  • SA 450
  • SA 500
  • SA 510
  • SA 520
  • SA 530
  • SA 580
  • SA 700

 

Link to download the order - https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2023/09/20230930762115071.pdf

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