Negligence – Failure to disclose a material fact
Arjuna (A) – Hey Bhagwan, last so many occasions you have been telling me the instances of negligence of a chartered accountant. Surely, it is a misconduct.
Shrikrishna (S) – Yes. That is clause (7) of Part I of Second Schedule. But remember that it covers not only gross negligence, but also the lack of due diligence.
A – I understood. But I am now tired of listening to the stories of negligence. Tell me something else today.
S – Actually, although this is one of the most serious misconduct, this clause rarely operates alone. Quite often, alongwith this clause 7, one or both of the other two items are invoked.
A – What are they?
S – First is clause (5); and then (8). These are invoked simultaneously although the net result is clause (7).
A – Tell me one by one. Don’t confuse me by explaining all of them together.
S – OK. Let us start with clause (5). It says that if the auditor is aware of a material fact which is not disclosed in a financial statement; but disclosure of it is necessary, then it is a misconduct. In short, it is a failure in performing his duty.
A – But the primary duty of disclosure is that of Management. Our Council specifically makes us write such a remark in our audit report.
S – Agreed. But that does not absolve the Auditor of his duty to comment on such deficiencies. That is the very job of an auditor. Otherwise, on what basis can you say that the accounts give true and fair view?
A – But you know, many times, clients do not tell us the full facts. Or they pressurise us not to mention certain things.
S – If you start accepting such requests from the management, then you are not fit to be an auditor. Moreover, it is also your duty to ask for information.
A – We do ask; but often, we do not insist on it. And if we report certain things, we feel the client would be in deep trouble.
S – That is a mistake. Heavens are not going to fall if you report certain discrepancies.
A – I can tell you, in many companies, fixed assets register is never maintained properly. In fact, it is not maintained at all!
S – Yet, you write a standard remark in CARO report.
A – Yes. But tell me of some other instances.
S – I must have told you of a case of an auditor of an educational trust. A very prominent educational institution had schools and colleges at multiple locations. Highly placed people were on its governing body.
A – Then what happened?
S – It had opened many bank accounts required from time to time. Sometimes, accounts were opened for temporary purpose of receiving some grants; or for particular projects which were then completed.
A – Yes. It is quite normal.
S – One junior professional was their auditor. They told him that out of some 16 bank accounts, statement of 5 accounts were not available despite follow-up with respective banks.
A – That is a common difficulty. Accounts must have been inoperative.
S – They told him that there were hardly any transactions except perhaps a few internal transfers. He believed them and did not put any remark.
A – We also avoid putting any qualification in such cases. We feel shy of doing so!
S – That’s the trouble. In the subsequent year, there was some other auditor. He found the bank statements and noticed that there was an impact of about Rs. 30,000/-. Remember, the total collection of that Trust was more than Rs. 8 crore!
A – Oh. Then the impact was negligible!
S – Subsequent year’s auditor adjusted it in the Trust Fund in the next year and again did not put any remark. The adjustment was shown in the balance sheet without any explanation.
A – Actually, for educational trusts, there is no revenue impact. Who complained in this case?
S – Surprisingly, the Income Tax department complained! This again was not revealed in scrutiny assessment; but while processing the application for renewal of section 80 G certificate, the Director of Income Tax noticed it!
A – But why is the tax department bothered about such trivial things?
S – That’s your fate! Many times, even big blunders go unnoticed; and a small thing proves fatal. I also told you long back that whether any person’s interests are adversely affected or not is not material. Council wants to ensure that its member performed his duty diligently!
A – That is all right; but why small people are victimised? So in this case, what happened?
S – Unfortunately, auditors for both the years were held guilty of professional misconduct.
A – Oh my God! The first auditor should have mentioned the fact that bank statements were not made available. He should have stated a disclaimer to that effect.
S – Yes. Thus, it is a failure to disclose a material fact. Its impact on quantum may not be material; but in principle, it is a lapse when statements of 5 out of 16 banks accounts are not available.
A – Had he taken Management Representation Letter?
S – Yes, he had obtained MRL. But his ‘stars’ were unfavourable.
A – How then, are other clauses attracted?
S – Clause (8) talks about failure to obtain sufficient information which is necessary for expression of an opinion. The negligence or lack of due diligence is the resultant failure. One has to take care of all these clauses.
A – Yes. We often consider only ‘gross negligence’ as a misconduct.
S – Important point is when a punishment is awarded; it may be for each such clause. Thus, if one’s membership is suspended, it may be one or two months for each of these clauses!
A – Then I should be more vigilant and should write the report without any such psychological inhibitions. Without fear or favour!
S – For small lapse, consequences may be too harsh!
A – God, only you can save the audit profession!
