Key Observations
from NFRA Order against Engagement Partner for Professional Misconduct
Key
Observations from NFRA Order against Engagement Partner for Professional Misconduct
Contents 1. Non-Compliance of AS 11 on outstanding liability arising out of foreign currency loan. 5-6 2. Inaccurate accounting approach for leased assets 7 3. Non-compliance with the presentation of Financial Statements 7-8
In an order issued by National Financial Reporting Authority (NFRA), a member of the Institute of Chartered Accountants of India (ICAI) has alleged for collective lack of due diligence and gross negligence in the audit resulting in professional misconduct. A detailed analysis of the non-compliances, replies of Engagement Partner (EP), and conclusion of NFRA on such replies and non-compliances has been discussed below:
Non-Compliance of AS 11 on outstanding liability arising out of foreign currency loan.
The company has an outstanding foreign currency loan on the balance sheet date. As per standard practice, any such foreign currency monetary items existing on the balance sheet date should be translated at the closing rate and the exchange difference arising out of such translation should be transferred to the statement of profit & loss. However, the management of the company did not follow this procedure and instead carried the loan at the existing book value.
The above practice by the company was not reported by the auditor and hence NFRA through its Show Cause Notice (SCN) charged the EP for not reporting the non-compliance by the company as per AS 11,” The effects of changes in foreign exchange rates”.
The engagement partner in his reply to SCN has contended the following arguments:
ABased on professional judgment, he believes that the impact of the non-consideration of foreign currency loans was not material and hence did not require any disclosure. He further stated that valuing the foreign currency loan at the closing exchange rate would have resulted in an increased liability for the company and could have potentially misled the stakeholders.
The forex loan was non-performing and the suit was already filed by the lender. Also, the Board had expected a favourable outcome at a much lower amount.
CThe EP has also given the reference of AS 11 and pointed out that the standard allows certain circumstances when the closing rate may not be applied.
B5. Key Observations from NFRA Order against Engagement Partner for Professional Misconduct
However, NFRA after observing and analyzing the replies of EP, provided the following facts:
AThe provision of AS 11 states that the company shall at each balance sheet date report the foreign currency monetary items using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date.
Though the accounting impact is below the benchmark considered for materiality however the audit file submitted by EP does not include any working paper evidencing the determination and application of materiality. Also, the impact of foreign loan translation would have increased the loss of the company by 7-8%, which is material.
CBThe fact that the suit has been filed by creditors for recovery, does not imply that the company should not make appropriate disclosure of its liabilities and not translate the foreign currency liability at closing rate on balance sheet date.
There was no analysis in the audit file showing the existence of exceptional circumstances justifying the non-application of the closing rate as per para 11(a) of AS 11.
D6. Key Observations from NFRA Order against Engagement Partner for Professional Misconduct
Inaccurate accounting approach for leased assets
It was observed that the company presented the assets given on the finance lease under the schedule of tangible assets, thus, violating the provisions under para 26 of AS 19 “Leases” which suggests that the lessor should recognize the assets given on the finance lease as receivables in its balance sheet at an amount equal to the net investment in the lease.
For this misrepresentation of the finance lease, NFRA charged the EP for non-reporting of improper accounting of assets given on the finance lease.
The EP in his reply to SCN has contended that the terms of the lease have been broken/infringed, rendering the lease agreement to be null and void. Hence they cannot be treated as lease transactions leading to the consequent non-applicability of AS 19. Therefore, the relevant assets deserve classification under the appropriate head of fixed assets schedule which reflects the true and firmness of the asset in a more transparent perspective.
NFRA after observing and analyzing the replies of the auditor stated that the explanation given by the engagement partner cannot be accepted as assets given under finance lease have to be presented by the lessor as receivables as per para 26 of AS 19. Presenting the unpaid finance lease receivables as fixed assets is misleading and erroneous because the definition, recognition, measurement and disclosure requirements of fixed assets and lease receivables are completely different.
NFRA identified the following non-compliances with the format of Division I of Schedule III to the Companies Act, 2013:
The adjustments, additions, deductions in the gross block and depreciation for the previous year were not mentioned in the depreciation schedule.
7. Key Observations from NFRA Order against Engagement Partner for Professional Misconduct Non-compliance with the presentation of Financial Statements
A
There was no disclosure pertaining to the break-up of trade receivables into outstanding balances of more than 6 months and less than 6 months.
B
The EP in his reply to SCN has contended the following arguments:
AThe entire balance of trade receivables was outstanding for more than 6 months being brought forward balances from previous years and the omission of disclosure for the same does not mislead the users.
The EP explained that it is an old age practice to give the depreciation schedule and has attached financial statements of some companies to substantiate his explanation.
The EP in his reply to SCN has contended the following arguments:The EP in his reply to SCN has contended the following arguments:
ABIt is possible that the balances of two reporting years can be the same with different compositions, therefore the disclosure of break up of trade receivables in accordance with the note 6P of “General Instructions for Preparation of Balance Sheet” is useful for the users of financial statements.
Schedule III clearly states that the corresponding amount for the previous reporting period needs to be given for all items in the financial statements including notes. The wrong practice doesn’t become legitimate just because it is being followed by other companies and not being reported by other auditors.
Considering the proven professional misconduct and keeping in mind the nature of violations, principles of proportionality NFRA, in the exercise of powers under Section 132(4)(c) of the Companies Act, 2013, hereby order imposition of a monetary penalty of Rupees One Lakh upon the Engagement Partner.
B8. Key Observations from NFRA Order against Engagement Partner for Professional Misconduct
Income-tax Department Income-tax Appellate Tribunal Indian Institute of Banking & Finance National Institute of Securities MarketsAn Education Initiative of SEBI
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