KSCAA X Taxmann's NFRA Audit Quality

PREFACE

Auditing and Accounting Standards & NFRA

In an era where financial transparency and accountability hold the keys to the integrity of capital markets, the role of auditing standards cannot be overstated. India, with its rapidly evolving economic landscape, has been at the forefront of adopting and enforcing stringent auditing practices to safeguard the interests of its stakeholders. This book is an exploration of the intricate fabric of Auditing Standards in India, with a special focus on the pivotal role played by the National Financial Reporting Authority (NFRA) in ensuring adherence to these standards.

The journey of auditing in India has been marked by continuous evolution, aimed at enhancing the quality and reliability of financial reporting. The establishment of the NFRA, as an independent oversight body, marked a significant milestone in this journey, embodying the nation’s commitment to uphold the highest standards of financial auditing and reporting. It is in this context that the orders of the NFRA, particularly concerning non-compliance with auditing standards, become a subject of paramount importance.

Through this book, we delve into the depths of auditing standards in India, unraveling their development, implementation, and the critical role they play in the financial ecosystem. The focus, however, narrows down to the orders issued by the NFRA on non-compliance. These orders are not merely punitive measures but are reflective of a broader commitment to enforce compliance, ensure accountability, and foster a culture of transparency within the Indian corporate sector.

Each chapter of this book is designed to guide the reader through the various facets of auditing standards in India, with comprehensive analyses of NFRA’s orders. These analyses do not just recount the instances of non-compliance but also offer insights into the underlying principles of auditing standards, the challenges of enforcement, and the implications for auditors, firms, and the wider economy.

NFRA Audit Quality

This book aims to serve as a valuable resource for auditors, regulatory bodies, corporate entities, academicians, students of finance and accounting. It is intended to provoke thought, encourage adherence to auditing standards and inspire a new wave of research and discussion on enhancing audit quality and financial reporting in India.

As the author, my journey in compiling this work has been one of the profound learning and discovery. It is my hope that this book not only enlightens but also empowers its readers to contribute positively to the ongoing discourse on auditing standards and financial integrity in India.

With this book, let us embark on a journey of understanding, scrutiny, and advocacy for a future where financial reporting is synonymous with trust, integrity, and excellence.

Mohan R. Lavi Bengaluru

ABOUT THE AUTHOR

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tant in 1989. He has over 27 years of experience across a variety of industries having worked in and software companies. Mohan has over 8 years of experience in practice. At present, he is a Partner with M/s K P Rao & Co., Chartered reporting (Ind AS, AS & ESG) practices of the AS, Key Audit Matters and the Sarbanes Oxley Act. His articles appear frequently in the Hindu Business Line, Deccan Herald and the Bombay Chartered Accountants Journal. He is also a

reached at mohan.lavi@gmail.com

4 CHAPTER

Background:

Financial Quality Review Reports

NFRA has issued four Financial Quality Review Reports. A summary of these reports is presented below:

Sl No. Date Company

1 23/02/2023 PSP Projects Limited

2 20/07/2022 ISGEC Heavy Engineering Limited

3 14/02/2022 Prabhu Steel Industries Limited

4 28/09/2021 Kudremukh Iron Ore Company Limited

Kudremukh Iron Ore Company Limited (KIOCL)

(a) KIOCL’s accounting policy for Foreign Exchange (Fx) Forward Contracts is erroneous and it is in non-compliance with the classification and measurement requirements of Ind AS 109, Financial Instruments (Ind AS 109). KIOCL has informed NFRA that Fx Forward Contracts are accounted upon realisation, accordingly no unrealized Gain/Loss is accounted as on 31st March 2020, and 31st March 2019. The outstanding amount of Fx Forward Contracts was ` 8,382.03 Lakh and as ` 4,834.55 Lakh as of March 31, 2020 & March 31, 2019, respectively. KIOCL does not apply Hedge Accounting for these contracts. Fx Forward Contracts meet the definition of Derivative (Refer Appendix A to Ind AS 109) FRQR Report on the Annual Report of KIOCL Limited, FY 2019-20 Page 6 of 48 and therefore, fall within the scope of recognition and measurement requirements of Ind AS 109. These financial instruments have to be classified as Fair Value through Profit or Loss (FVTPL) and outstanding Fx Forward Contracts, if any, shall be measured at fair value and unrealised gain or loss recognised in the Statement of Profit and Loss with corresponding balances recognised as financial asset or financial liability in the Balance Sheet. Therefore, KIOCL should take actions

to rectify the erroneous accounting policy applied to Fx Forward Contracts in the financial years 2019-20 and 2018-19 and, also consider the requirements of paragraphs 41 and 42 of Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors for rectification of errors. The action taken in this regard should be reported to NFRA.

(b) NFRA observes that the accounting policy stated in respect of a material element of financial statement i.e., Revenue (with corresponding impact on related assets such as Trade Receivables, Inventories etc.) is erroneously stated in its statement of significant accounting policies. Based on KIOCL’s response, it is clear that the actual recognition and measurement principles actually applied for accounting of Revenue are different from what is stated in the audited financial statements in many important aspects of recognition and measurement of revenue which has impact on the amount of and timing of revenue recognition by the Company. This kind of erroneous disclosure of accounting policy raises questions over the reliability and accuracy of the financial statements of the Company. Therefore, KIOCL is advised to undertake comprehensive review of the accounting principles actually followed for the financial year 2019-20 vis-a-vis the requirements of applicable Ind ASs and revise and restate its financial statements for the financial year after complying with the provisions of section 131 of the Companies Act, 2013 and Ind AS 8. In respect of Impairment of Financial Assets KIOCL has assumed that the Trade Receivables (Financial Assets) have negligible credit risk as those are backed by Bank’s Letters of Credit and historically there have been no credit losses. Hence, no impairment loss allowance is measured and recognized under Ind AS 109. This assumption of KIOCL is inappropriate and against the concept of Expected Credit Loss (ECL) underpinning the impairment loss recognition and measurement prescription of Ind AS 109. Secondly, KIOCL has reported substantial amount (` 3,514.03 lakh) of its total trade receivables as unsecured. Therefore, KIOCL should have assessed the credit risk in a holistic manner including consideration of forecast future conditions and not just relied on historical loss experience. It should be noted that the paragraph B 5.5.35 of Ind AS 109, which permits use of practical expedient to apply provision matrix based on past due period, which approach is reportedly applied by KIOCL, requires

adjustment of historical loss factors for changes in the current and future forecast conditions. KIOCL has also not complied with credit risk exposure disclosure of paragraph 35N of Ind AS 107 which requires disclosure of gross carrying amounts based on provision matrix used by the entity. Accordingly, KIOCL is advised to reassess its impairment loss allowance for the financial year 2019-20 on entire amount of outstanding Trade Receivables (` 12,266.77 lakh) keeping in mind the underlying concept and principles of ECL approach of Ind AS 109.

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c) In Note 24.20 of financial statements KIOCL has disclosed that the Company had intended to restart BFU Operation during the year 2019-20, however due to un-economic price of Pig Iron, Blast Furnace Unit (BFU) could not be operated during the year. The recoverable amount in each class of assets in BFU and other Units are more than the carrying amount. Hence, there is no impairment loss to be recognized during the year. FRQR Report on the Annual Report of KIOCL Limited, FY 2019-20 Page 7 of 48 NFRA observes that adequate evidence, such as valuation reports, if any, has not been provided by the KIOCL in respect of application of the requirements of Indian Accounting Standard (Ind AS) 36, Impairment of Assets (Ind AS 36). Also, there is no evidence that impairment loss computations were considered/ reviewed/presented to Audit Committee and the Board of Directors (BoD) of the Company. Therefore, NFRA concludes that KIOCL has not complied with the requirement of Paragraphs 9 & 132 of Ind AS 36 and have not disclosed the information required to be presented for users of the financial statements to take decisions.

(d) NFRA observes that KIOCL had investments in liquid mutual funds

in the financial year 2019-2020. KIOCL has disclosed these as investments classified and measured at Amortised Cost as per Ind AS 109. However, these financial instruments shall have to be classified and measured as FVTPL as these financial assets do not meet the cash flows characteristics conditions in paragraphs 4.1.2( b ) and 4.1.2A( b ) of Ind AS 109 for classification and subsequent measurement at Amortised Cost or Fair Value through Other Comprehensive Income. Therefore, KIOCL’s classification and measurements of investments in liquid mutual funds as of March 31, 2019 is incorrect and against the prescriptions of Ind

AS 109 and this incorrect classification and measurement in the previous financial year will also have an impact on the gain/ loss recognised during the financial year 2019-20. Therefore, is it advised to re-examine the classification and measurement of financial instruments in the form of investment in liquid mutual funds and ensure compliance with the requirements of Ind AS 109. Errors/omissions, if any, found should be corrected in accordance with paragraphs 41 and 42 of Ind AS 8 and the same should be informed to NFRA.

(e) KIOCL has stated that the fair value measurement technique applied for investment in liquid mutual funds meets the criteria for classification under Level 1 Fair value Measurement Hierarchy as per paragraphs 76–80 of Indian Accounting Standard (Ind AS) 113, Fair Value Measurement (Ind AS 13). However, these investments have not been disclosed under Level 1 as of March 31, 2019. Therefore, KIOCL is advised to correct the error in disclosures relating to fair value hierarchy.

(f) NFRA observes that the KIOCL has done reversal of Inventories (Manganese ore) during the year as mentioned in negative figure in note 24.13 Rs. 0.94 lakh FY 2019-20 (Rs. 21.31 lakh FY 201819). In this respect disclosure requirement of Paragraph 36(g) of Indian Accounting Standard (Ind AS) 2, Inventories (Ind AS 2) states that:

“36 The financial statements shall disclose:

(g) the circumstances or events that led to the reversal of a write-down of inventories in accordance with paragraph 34”. NFRA observes that KIOCL has not complied with Paragraph 36(g) of Ind AS 2.

(g) In Note 24.6 of Financial Statements, KIOCL has made certain disclosure regarding Plant, Property & Equipment (PPE) w.r.t. Land in Kudremukh wherein mining operation was suspended w.e.f. 01/01/2006. NFRA observes that the objective behind the disclosure is unclear. Also, there is no disclosure of the impact of this on the financial statements of the Company. Also, there is no disclosure about whether KIOCL has considered the impairment of PPE as per Ind AS 36. NFRA has examined the response of KIOCL and observes that in the absence of any quantitative information about the carrying amount, fair value of the land, recoverable value or impairment loss, if any, the financial impact of the above

on the financial FRQR Report on the Annual Report of KIOCL Limited, FY 2019-20 Page 8 of 48 statements of the KIOCL is not ascertainable. The disclosure is ambiguous and appears to obscure relevant and material information. The information included in Note 24.6 does not help users in making economic decisions. Further KIOCL has not provided any valuation done by the management to support the contention that there is no significant change in estimate and no impairment loss is expected. Paragraph 9 of Indian Accounting Standard (Ind AS) 36, Impairment of Assets (Ind AS 36) states that: “An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.” NFRA concludes that KIOCL has not adhered to the requirement of Paragraph 9 of Ind AS 36 and have not disclosed the information required to be disclosed.

(h) NFRA observes that KIOCL has not complied with the disclosure requirements as per Indian Accounting Standard (Ind AS) 37, Provisions, Contingent Liabilities and Contingent Assets (Ind AS 37).

(i) NFRA observes that KIOCL has made critical error in disclosing the amounts of lease liabilities as part of liquidity risk disclosures required under Indian Accounting Standard (Ind AS) 107, Financial Instruments: Disclosures (Ind AS 107). Instead of disclosing the contractual amounts of lease payables, KIOCL has erroneously disclosed present value of lease payments of Rs. 12,381.42 lakh instead of gross amount of Rs. 28,686.18 lakh.

(j) The Company has not disclosed the Direct Tax paid (Net of Refund) of 1090.08 lakh, in the Statement of Cash Flows, the same has been clubbed under the head Increase/(Decrease) in trade and other payable while calculating cash flow from operating activities. Therefore, the Company has not complied with Paragraph 35 of Indian Accounting Standard (Ind AS) 7, Statement of Cash Flows (Ind AS 7).

(k) In the Statement of Changes in Equity (SOCIE), the Company has not complied with requirement of Paragraphs 10 & 79(b) of Indian Accounting Standard (Ind AS) 1, Presentation of Financial Statements (Ind AS 1) along with presentation requirement of

Division II of Schedule III to the Companies Act, 2013, and has not presented the Equity Share Capital and Other Equity separately. Further a description of the nature and purpose of each reserve within equity is not disclosed in the Notes as required by para 79(b) of Ind AS 1.

(l) NFRA observes that KIOCL has not complied with the disclosure requirement of Paragraph 36(e) of Ind AS 2 Inventories w.r.t. disclosure of write down of Finished Goods due to valuation of Finished Goods at Net Realisable Value (NRV).

(m) NFRA has observed numerous other errors in disclosures in the Notes to Financial Statements which are not relevant or useful to the users of financial statements and have potential to obscure the material information in the financial statements.

(n) In view of the major errors and omissions in the financial statements indicating non-compliances with the certain fundamental aspects of Ind AS principles and requirements, coupled with numerous disclosure errors, it is recommended that KIOCL prepares and publishes revised financial statements including restatements, wherever required as per Ind AS 8 and section 131 of the CA, 2013.

ISGEC Heavy Engineering Limited

(a) NFRA observes deficiencies in implementing the provisions of Ind AS 109 Financial Instruments relating to impairment loss allowance (provisioning) for some of the financial assets viz. Trade Receivables and other financial assets. (Para 2.1)

(b) The company did not evaluate impairment loss allowance on ‘Unbilled Revenue 1’ (under Other Current Asset) despite it being a contract asset for which the company was required to evaluate impairment loss in accordance with the requirements of Ind AS 109. (Para 2.2)

(c) The Company did not make the required disclosure for Employee Benefits-Pensions in accordance with Para 135 of Ind AS 193 regarding defined contribution plans. The note provided by the Company lacks clarity on whether the employee benefit of Pension is a defined benefit plan or a defined contribution plan. Such disclosure is important to enable the users of financial

statements to understand the characteristics of the benefit plans, the consequential liabilities of the Company and the risks associated with them. (Para 2.3)

(d) ISGEC has given corporate guarantees to the banks to secure the credit facilities granted by the banks to three of its subsidiaries. These corporate guarantees should have been accounted for as financial guarantees in accordance with Para 4.2.1 of Ind AS 109. But the Company has not done the same, resulting in noncompliance with the requirements of Ind AS 109. (Para 2.4)

(e) ISGEC acquired another overseas company through one of its wholly owned subsidiaries during the year but did not disclose this transaction in the consolidated financial statements of ISGEC in accordance with the requirements 5 of Ind AS 103 Business Combinations. The Company has not made adequate disclosures in this regard. (Para 2.5)

(f) The overseas company so acquired was in distress due to financial difficulties, but ISGEC did not evaluate impairment loss on its investment value in its subsidiary in accordance with Ind AS 109. Though the amount involved is not material, this shows weakness in the internal controls with respect to impairment evaluation by the company. Also, ISGEC has earlier provided a loan to the same wholly owned subsidiary but did not evaluate the increase in credit risk on this loan as per the requirements of Ind AS 109. (Para 2.6)

(g) ISGEC has given loans to two of its foreign subsidiaries namely, ISGEC Investments Pvt. Ltd., Singapore and Eagle Press & Equipment Co. Ltd., Canada but did not disclose the purpose of giving loans to its foreign subsidiaries in its Board Report in accordance with the provisions of section 186 of the Companies Act, 2013.

(Para 2.7) 1.3.2 Key observations categorized as ‘Moderate’ Impact:

(a) NFRA has observed that certain information regarding ‘significant payment terms’ (e.g. when a payment is due) as required 9 by Ind AS 115 Revenue from contracts with customers is not disclosed in the notes to the financial statement of the Company. Also, disclosure regarding ‘obligations for returns, refunds, and other similar obligations’ 10 has not been made by the Company. This disclosure is mandatory as per Ind AS 115. (Para 3.1)

NFRA AUDIT QUALITY

AUTHOR : KARNATAKA STATE CHARTERED ACCOUNTANTS ASSOCIATION , MOHAN R LAVI

PUBLISHER : TAXMANN

DATE OF PUBLICATION : MARCH 2024

EDITION : 2024 Edition

ISBN NO : 9789357784771

NO. OF PAGES : 124

BINDING TYPE : PAPERBACK

DESCRIPTION

Rs. 375 USD 5

This book is a comprehensive exploration of auditing standards in India, focusing on the influence of the National Financial Reporting Authority (NFRA) on these standards. It discusses the decisions of the NFRA, providing a deep understanding of the practical application of auditing standards in the Indian context.

Aimed at practitioners, academicians, and students, the book offers guidance, fosters informed discussions, and encourages adherence to high-quality auditing standards.

The Present Publication is the Latest 2024 Edition, authored by CA. Mohan R Lavi. It is published exclusively by Taxmann for KSCAA. The noteworthy features of the book are as follows:

• [Introduction to NFRA] The book opens with a detailed introduction to the NFRA, explaining its inception, objectives, and the significant impact it has had on enhancing the quality and reliability of financial reporting in India

• [Detailed Analysis] Through meticulous analysis, the book discusses the decisions made by the NFRA, offering insights into how these rulings influence and shape the auditing standards and practices in India

• [Practical Applications] By summarizing NFRA's decisions, the book provides practical insights into the application of auditing standards, aiding auditors, corporations, and students in understanding the nuances of compliance and reporting

• [Regulatory Framework] Readers are guided through the regulatory landscape governing auditing in India, gaining a comprehensive understanding of the legal and professional frame works that dictate auditing practices

• [Global Context] The book also touches upon international auditing standards, providing a comparative analysis that highlights the global relevance and alignment of India's auditing practices

• [Future Outlook] A forward-looking discussion on the future of auditing and the evolving role of regulatory bodies in ensuring financial integrity and transparency is a key focus toward the end of the book

• [Expert Perspectives] Contributions from the author, who is a seasoned professional, enrich the narrative, offering readers a well-rounded perspective on the auditing field ORDER NOW