Facts of the Case

The National Financial Reporting Authority (NFRA), exercising powers under Section 132(4) of the Companies Act, 2013, initiated disciplinary proceedings against CA Hemant Khator, Engagement Partner of M/s GSV & Co., statutory auditor of Women Next Lingeries Limited (WNLL) for Financial Year 2016-17.

WNLL was engaged in the manufacture and trading of lingerie, intimate wear and select exclusive wear. During FY 2016-17, the company reported inventory of ₹20.60 crore, trade receivables of ₹14.93 crore, trade payables of ₹3.78 crore, and profit before tax of ₹1.44 crore.

NFRA received information from the Registrar of Companies (ROC), Mumbai indicating that WNLL’s books of account had been falsified and revenue manipulated. Upon investigation, NFRA examined the audit conducted by the Engagement Partner and identified several serious audit deficiencies and violations of auditing standards.

The investigation concluded that the auditor failed to obtain sufficient and appropriate audit evidence, failed to verify inventory, failed to identify related party transactions, failed to obtain external confirmations for trade receivables and trade payables, failed to identify and communicate matters to Those Charged With Governance (TCWG), failed to plan and document the audit appropriately, and failed to report non-compliance with laws and regulations.

 

Issues Involved

  1. Whether the auditor failed to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory.
  2. Whether the auditor failed to identify related parties and related party transactions.
  3. Whether the auditor failed to obtain external confirmations for trade receivables and trade payables.
  4. Whether the auditor failed to plan and document the audit in accordance with Standards on Auditing.
  5. Whether the auditor failed to identify and communicate matters to Those Charged With Governance (TCWG).
  6. Whether the auditor failed to report non-compliance with applicable laws and regulations.
  7. Whether the auditor failed to determine materiality and performance materiality.
  8. Whether the auditor failed to document sampling methodology for substantive testing.
  9. Whether the auditor failed to appoint an Engagement Quality Control Reviewer (EQCR).
  10. Whether such failures constituted professional misconduct under the Chartered Accountants Act, 1949.

 

Petitioner’s Arguments (CA Hemant Khator)

The auditor submitted various explanations in response to the Show Cause Notice, including:

  • Physical stock verification was conducted by the management at regular intervals and management representations were obtained.
  • Audit procedures were carried out based on information provided by management.
  • No related party transactions were identified during the audit period based on management representations and previous audit records.
  • External confirmations from debtors and creditors could not be obtained due to management-imposed limitations.
  • Communication regarding irregularities was verbally made to management.
  • The defaults relating to statutory dues were not considered material enough to qualify the audit report.
  • A team of four persons performed the audit work and therefore a separate EQCR was not considered necessary.

 

Respondent’s Arguments (NFRA)

NFRA contended that:

  • The auditor failed to obtain sufficient appropriate audit evidence regarding inventory amounting to ₹20.60 crore.
  • No alternative audit procedures were documented when physical verification of inventory was not attended.
  • The auditor failed to identify M/s Shiv Apparel as a related party and failed to report related party transactions.
  • No external confirmations were obtained from debtors and creditors despite balances aggregating approximately ₹18.71 crore.
  • Audit planning and understanding of the entity’s environment were inadequately documented.
  • Communication with TCWG was neither documented nor evidenced.
  • Materiality and performance materiality were not determined as required by auditing standards.
  • Sampling methodology and substantive testing procedures were not documented.
  • Mandatory EQCR requirements applicable to a listed entity were not complied with.
  • These failures demonstrated gross negligence and lack of professional skepticism.

 

Court Order / Findings

NFRA held that the auditor committed serious professional misconduct and violated multiple Standards on Auditing.

The Authority found that:

Inventory Verification Failure

The auditor failed to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory, contrary to SA 501 and SA 500.

Related Party Transactions

The auditor failed to identify related parties and related party transactions despite available information indicating the existence of such relationships.

External Confirmations

The auditor failed to obtain confirmations from debtors and creditors and also failed to perform adequate alternative audit procedures as required by SA 505.

Audit Planning Deficiencies

The auditor did not adequately plan the audit and failed to document understanding of the entity and its environment as required under SA 300 and SA 315.

Failure to Communicate with TCWG

The auditor failed to identify matters requiring communication to Those Charged With Governance and failed to maintain evidence of such communication as required under SA 260.

Non-Compliance with Laws and Regulations

The auditor failed to appropriately consider and report statutory defaults and legal non-compliances under SA 250.

Materiality and Documentation Failures

The auditor failed to determine materiality and performance materiality and failed to document substantive testing and sampling procedures.

EQCR Non-Compliance

The auditor failed to appoint an Engagement Quality Control Reviewer despite statutory requirements applicable to the audit engagement.

NFRA concluded that these failures amounted to professional misconduct under the Chartered Accountants Act, 1949.

 

Important Clarifications

Mere Management Representation Is Not Audit Evidence

Management representations cannot substitute sufficient and appropriate audit evidence where verification procedures are required.

External Confirmations Are Critical Audit Procedures

Where confirmations are not received, auditors must perform and document alternative procedures.

Documentation Is Mandatory

Audit work performed without adequate documentation cannot be relied upon as evidence of compliance with auditing standards.

Professional Skepticism Is Essential

Auditors are required to exercise professional skepticism throughout the audit engagement and cannot rely solely on management assertions.

Related Party Identification Is an Auditor’s Independent Responsibility

Reliance solely on management disclosures is insufficient where available evidence indicates related party relationships.

EQCR Requirement Must Be Complied With

For applicable engagements, appointment of an Engagement Quality Control Reviewer is mandatory and cannot be dispensed with without justification.

 

Sections Involved

Companies Act, 2013

  • Section 132(4)
  • Section 132(4)(c)

Chartered Accountants Act, 1949

  • Section 22
  • Clause 7 of Part I of the Second Schedule
  • Clause 8 of Part I of the Second Schedule

Standards on Auditing (SAs)

  • SA 200 – Overall Objectives of the Independent Auditor
  • SA 230 – Audit Documentation
  • SA 250 – Consideration of Laws and Regulations
  • SA 260 – Communication with Those Charged With Governance
  • 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 500 – Audit Evidence
  • SA 501 – Audit Evidence – Specific Considerations for Selected Items
  • SA 505 – External Confirmations
  • SA 550 – Related Parties
  • SA 220 – Quality Control for an Audit of Financial Statements

 

Final Order / Penalty

NFRA imposed the following sanctions on CA Hemant Khator:

  1. Monetary Penalty of ₹2,00,000 (Rupees Two Lakhs).
  2. Debarment for Two Years from:
    • Being appointed as an auditor, or
    • Undertaking any audit of financial statements or internal audit functions of any company or body corporate.

Link to download the order -https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2023/04/2023042993.pdf

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.