Summary & Checklist for CAs to avoid NFRA penalty proceedings

“Stay compliant and avoid NFRA penalty proceedings with this summary and checklist for Chartered Accountants. Learn from the case of M/s ASRMP & Co., Chartered Accountants, covering issues like audit engagement independence, tampering of audit files, lapses in audit procedures, and more. Enhance your audit checklist to prevent the highlighted issues and ensure adherence to regulatory requirements.”

Summary & Checklist for Chartered Accountants (CAs) to avoid NFRA penalty proceedings with reference to the matter of M/s ASRMP & Co., Chartered Accountants

FACTS OF THE CASE

1. SEBI shared an investigation with NFRA in April 2022 regarding the diversion of funds worth Rs 3,535 crores from seven subsidiary companies of Coffee Day Enterprises Limited (CDEL) to Mysore Amalgamated Coffee Estate Limited (MACEL).

2. NFRA initiated investigations into the professional conduct of the statutory auditors of CDEL for the FY 2018-19 under Section 132(4) of the Companies Act 2013.

3. NFRA found that the auditors failed to meet the requirements of the Standards on Auditing and the Companies Act 2013, and demonstrated a serious lack of competence.

4. The auditors failed to evaluate their potential conflict of interest and maintain their independence from CDGL.

5. They made an attempt to deceive NFRA by tampering with the audit file.

6. They failed to exercise professional judgment and skepticism during the audit of fraudulent transactions with MACEL.

7. They failed to report fraudulent loans given to MACEL and diversion of funds to a related party.

8. The auditors failed to perform appropriate audit procedures resulting in misstatements in the financial statements of CDEL.

9. NFRA found the Firm and its partners who performed the audit guilty of professional misconduct and imposed monetary penalties and sanctions.

10. The firm was debarred for two years, and the individual auditors were debarred for five years from being appointed as auditors or undertaking any audit of financial statements or internal audit of the functions and activities of any company or body corporate.

KEY TAKEAWAYS FROM THE ABOVE ORDER

1) Acceptance of audit engagement disregarding Independence requirements

Summary of the issue : As per audit findings, CA A. S. Sundaresha has three audit firms, including M/s Sundaresh & Co, M/s Sundaresha & Associates, and M/s ASRMP & Co, which operate from the same office. The audit firms’ relationships with the Coffee Day Group, combined with their interdependence and lack of independence, indicate self-interest and familiarity threats. Furthermore, M/s ASRMP & Co accepted the audit engagement of CDGL from FY 2018-19 despite a serious conflict of interest. Finally, the audit firms failed to take appropriate measures to reduce the self-interest and familiarity threats, such as obtaining independence confirmations from all engagement team members and conducting an evaluation of independence during the acceptance of the audit engagement of CDGL.

Audit Checklist (1) : Prior to accepting an audit engagement, it is imperative to ensure that appropriate measures have been taken to ensure independence is upheld in accordance with regulatory requirements.

2) Tampering of Audit File and related lapses – SA 230, Audit Documentation

Summary of the issue : The audit file can only be modified after the assembly period to clarify any existing audit documentation arising from comments received during monitoring inspections. The auditor must document the specific reason for the modification, when and by whom it was made and reviewed. The audit file is required to include records of the timing of audit procedures, which the auditors failed to maintain. The audit of CDGL was performed jointly by partners of M/s ASRMP & Co. and M/s Sundaresha & Associates, but to hide this fact, both were named as external reviewers in the audit plan available in the tampered Audit File. The auditor must prepare audit documentation on a timely basis and assemble the audit documentation in an Audit File, completing the administrative process of assembling the final Audit File on a timely basis after the date of the auditor’s report. Alteration, backdating of work papers/reviews, substitution or addition of the new work papers, and placing blank audit papers so as to perform audit procedures (commonly referred to as Audit File Tampering) subsequent to the issuance of the audit report or the assembly of the final Audit File by the auditors are not accepted.

Audit Checklist (2) : The adherence to SQC-1 is mandatory in ensuring timely completion of assembling audit files within 60 days. Any modifications made to the master audit file after the date of completion must be accompanied by proper documentation outlining the specific reasons, date, and personnel responsible for the changes, in addition to a review. It is necessary to maintain records of the timing of audit procedures, even if the auditors failed to maintain them.

3) Lapses in audit relating to fraudulent transactions of Rs 3,769.61 crores with MACEL.

Summary of the issue : The auditors failed to detect the fraudulent diversion of funds by CDGL to MACEL, a promoter-owned entity, without any justification or approval.

The auditors did not exercise professional skepticism or obtain sufficient appropriate audit evidence while doing the audit of related party transactions.

There is a separate Standard on Auditing (SA 240) prescribing the auditor’s responsibilities relating to fraud in an audit of financial statements besides the auditor’s statutory duty to report fraud to the Central Government under section 143(12) of the Act and CARO 2016.

The auditors failed to determine whether the significant related party transactions of unusually high amounts were authorized and approved by the Board of Directors in terms of section 188 of the Act.

The reporting of only the highest debit and credit balance with MACEL instead of the gross transaction amount was not in conformity with Ind AS 24, leading to misstatement in Related Party Disclosure of Rs. 6,958.91 crores.

Audit Checklist (3) : It is crucial to accord specific attention to related party transactions and adhere to the prescribed disclosure requirements as stipulated in the Indian Accounting Standards (IND AS). This will enable us to effectively identify and evaluate any potential risks and ensure that the financial statements provide a true and fair view of the organization’s financial position.

4) Lapses in audit relating to fraudulent understatement of advance to MACEL by Rs 222.50 crores and failure to detect evergreening of loans

 Summary of the issue :  CDGL received four cheques of Rs 65.50 crores in March 2019 from MACEL, which were cleared on 04.04.2019 by evergreening of loans through circulation of funds between MACEL and CDGL.

Auditors overlooked the obvious evergreening of loans of Rs 65.50 crores by the circular transactions on the same day, which was evident from payment column of the same bank statement for the same day.

Similar evergreening through circulation of funds could be observed from bank statement of CDGL with Induslnd Bank as well as Karnataka Bank.

There was no economic substance in these transactions, and funds were being misappropriated, resulting in a material misstatement of the financial statements and fraud.

The Auditors violated section 143(1)(b), 143(12) of the Act, SA 200, SA 240, SA 315, SA 330, and CARO by failing to perform requisite additional auditing procedures and questioning such transactions.

Audit Checklist (4) : It is important to thoroughly examine the approval and use of loan funds, and carefully review the repayment schedule. In cases where new loans are obtained, it is crucial to assess the potential for evergreening of loans and prioritize evaluating the substance over form of transactions.

5) Lapses in audit relating to diversion of Rs 130.55 crores to M/s Classic Coffee Curing Works

Summary of the issue : CDGL shareholders passed a special resolution allowing investment up to Rs. 4,000 crore.

The Audit Committee approved Related Party Transactions (RPT) with seven related parties, but the loan of Rs. 130.55 crore given to CCCW was not covered and thus unauthorized.

The loan was given to Kumar Hegde for purchasing 750 acres of coffee estates, but an advance of Rs. 130.55 crore was given even though only 100 acres had been identified for purchase, indicating diversion of funds.

Kumar Hegde repaid the loan to CCCW in FY 2019-20, which was orchestrated by rotation of CDGL’s own funds via ‘Round tripping of funds’ involving MACEL.

The Auditors were grossly negligent in conducting the audit of Consolidated Financial Statements, and CDGL was involved in evergreening of loans and round tripping of funds with the motive of converting the loan of Rs. 130.55 crore given to CCCW into the loan given to MACEL.

Audit Checklist (5) :Due care must be taken with regards to authorization of the utilization of the loan funds. Articles of association must be checked whether the funds utilized relates to the objects of the business and the due diligence must be exercised with regards to diversion of funds

6) Lapses in audit relating to capital advance given to Dark Forest Furniture Company Private Limited (DFFCPL)-Rs 87.92 crores

Summary of the case : The advance given to DFFCPL was without any agreement and cannot be treated as “Arm’s length” since it was unusual in terms of the size of transactions with DFFCPL.

The auditors did not perform any audit procedure to evaluate whether these transactions were at “Arm’s length” and did not have any working in the Audit File to show the same.

The advance was provided to DFFCPL by violating Section 177 & 188 of the Act and the auditors failed to exercise due diligence while conducting the audit of capital advance.

The auditors violated SA 200, SA 240, SA 315 and SA 330 and did not report the noncompliance of Section 188 and 177 of the Act.

Audit Checklist (6) : It is necessary to verify that related party transactions are conducted at an Arm’s length price and that adequate documentation or substantial audit evidence is obtained to support this verification.

7) Other Issues encountered in the above case :

♦ The Doctrine of Indoor Management is not applicable to auditors and they should obtain a certified copy of the Board resolution approving the Financial Statements and authorizing the Directors to sign the Financial Statements.

♦ The auditors violated SA 700 by not taking into account the large-scale fraudulent transactions of huge amounts and failing to draw attention to the presence of material misstatements in the financial statements of CDGL.

♦ The auditors violated SA 250 by not reporting diversion of funds, structured circulation of money, and round tripping of funds as per PMLA.

♦ The auditors violated SA 260 and SA 265 by not determining TCWG nor communicating with TCWG and not developing an effective audit plan.

♦ The auditors were charged with non-compliance with SA 210, SA 510, and SA 720

Audit Checklist (7) : It is imperative to include adequate disclosures in the audit report and also take into account other relevant information, as per SA 720, while forming an opinion on the financial statements. Special attention should be paid to financial items that show a material difference in substance compared to the previous year.

♦ The paragraph discusses the definition of the Engagement Partner (EP) as per SQC 1 and the responsibility of the EP for the engagement and audit report. It also talks about the violation of SQC 1 as the audit firm appointed more than one EP. The external reviewers mentioned in the audit plan were not covered in the Standards, and their role was not specified in the audit file. The involvement of external reviewers in the audit shows that the audit of CDGL was performed by both the audit firm and Sundaresha & Associates. The lack of clarity in determining the EP led to a perfunctory audit, adversely affecting the audit’s performance. The Audit Firm failed to establish and maintain a system of quality control to comply with professional standards.

Audit Checklist (8) :  To ensure effective engagement management and mitigate the risk of conflicts of interest, the audit team must establish clear definitions of roles and responsibilities, document segregation of duties within the team, and periodically review work performed. The engagement partner must also conduct timely verification of the work and document the findings. In situations where an external reviewer is engaged for a specific audit, it is imperative to ensure that there are no conflicts of interest present.

Audit Checklist to avoid the above stated issues