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Category: NFRA DIGEST

NFRA Digest

(Editorial Note: Given the increasingly important role played by NFRA in the context of auditing, BCA Journal, will be continuing with reporting on NFRA developments. This new feature titled NFRA DIGEST will cover orders, reports, circulars, notifications, rules, inspection reports, discussion papers, etc. BCAJ seeks to bring to light some of the important changes affecting the profession of audit with a view that members and readers can learn from these developments. The aim is to enable members to improve their audit processes and reduce their audit risk by improving quality and governance frameworks mandated by applicable standards and regulatory expectations. In this context, we are pleased to bring this new feature NFRA Digest to our readers, covering NFRA updates. This is another in a row and will cover the circulars issued by NFRA to date and NFRA orders post-December 2023)

BACKGROUND ABOUT NFRA ORDERS/CIRCULARS:

The National Financial Reporting Authority (“NFRA”) was constituted on 1st October, 2018, by the Government of India under section 132(1) of the Companies Act, 2013 (“the 2013 Act”). Since its inception, the NFRA has issued 67 orders till today highlighting significant deficiencies in the audit process, reporting by the auditors and other matters in relation to the audit of listed entities.

Our previous issues have covered, in detail, the structure of NRFA Orders and Powers of NFRA under Section 132(4)(c) of the 2013 Act with respect to the imposition of monetary penalties and debarment of the member or/and firm, where the professional or other misconduct is proved, key learnings from NFRA orders issued till 31st December, 2023.

In addition to these orders, the NFRA has also issued certain circulars on specific matters based on its findings during the proceedings or on its regular reviews. The NFRA has also issued an order highlighting significant deficiencies in an engagement other than audit engagements.

NFRA CIRCULARS

As per Sub-section 2(b) of section 132 of the Companies Act 2013 read with rule 4(2)(c) of the NFRA Rules 2018, the NFRA is mandated to monitor and enforce compliance with accounting and auditing standards. Further, NFRA is required by sub-section 2(d) of section 132 of the Act read with rule 4(2) of NFRA Rules, to perform such other functions and duties as may be necessary or incidental to the aforesaid functions and duties. NFRA monitors compliance with accounting standards by the companies as part of its review of published financial statements.

Based on these reviews, since inception, the NFRA has issued circulars on three important topics:

Topics Non-accrual of interest on borrowings
Date and Applicability of circular 20th October, 2022

 

Applicability:

 

(a) All Listed companies (b) Unlisted companies specified in Rule 3 of NFRA Rules 2018 (c) Auditors of these companies
Summary of NFRA circular Issue highlighted:

 

•   The company had been classified as Non-Performing Asset (NPA) by the lender banks and was negotiating one-time settlements with the banks. The company had discontinued accrual/recognition of interest expense on these borrowings.

•   The company’s discontinuation of the recognition of accrual of interest while calculating the amortised cost of the borrowings was in violation of Effective Interest Method and Effective Interest Rate (EIR) principles.

•   The Statutory Auditors failed to identify and question the company on this change in accounting treatment and report on non-compliance with Ind AS.

Requirement as per Ind-AS:

 

•   As per para B3.3.1, a financial liability is extinguished only when the borrower is legally released from primary responsibility for the liability (or part of it) either by the process of law or by the creditor.

•   In the present case, the bank had not released the company from the liability of the borrowings as well the interest. The discontinuation of interest expense recognition on financial liability solely based on the Non-accrual of interest on borrowings borrowing company’s expectation of loan/interest waiver/concession without evidence of the legally enforceable contractual documents is non-compliance with Ind-AS.  Hence, the company should have continued the accrual/recognition of interest expenses.

Direction by NFRA:

•   All the companies required to follows Ind-AS and their audit committee are advised not to discontinue the recognition of principal and interest based on management expectation of likely settlement with or without concession from the banks. The auditors are required to ensure strict compliance with this circular.
Topics Accounting policies for Revenue from Contract with Customers and Trade Receivables
Date and Applicability of circular 29th March, 2023

 

Applicability:

 

(a) All Listed companies (b) Unlisted companies specified in Rule 3 of NFRA Rules 2018 (c) Auditors of these companies
Summary of NFRA circular Issue highlighted:

•   Revenue recognition: In many companies, it has been noticed that the significant accounting policies disclosed wrongly state that revenue is recognised and measured at fair value of the consideration received or receivable.

 

•   Trade Receivables: In many companies it has been noticed that their accounting policy, either stating separately or as part of the policy for financial assets including trade receivables, wrongly stating that the trade receivables are initially recognised at fair value.

 

Requirement as per Ind-AS:

 

•   Revenue recognition: As per para 46 of Ind AS 115, Revenue from contracts with customers requires that the entity shall recognise as revenue the amount of transaction price, excluding the estimates of variable consideration that is allocated to that performance obligation. Under Ind AS 115, the application of fair value is relevant only in a limited set of situations like fair value of consideration in form of other than cash.

•   Trade Receivables: As per para 5.1.3 of Ind AS 109, the financial assets in the form of trade receivables, shall be initially measured at their transaction price unless those contain a significant financing component determined in accordance with Ind AS 115.

 

Direction by NFRA:

•   The illustrative examples of correct accounting policies with respect to revenue recognition and trade receivables are mentioned in the circular.

•   All the listed companies and other entities falling with the domain of NFRA which are required to follow Ind-AS are hereby advised to comply with Ind AS 115 and Ind AS 109, as discussed above. The auditors of these companies are required to ensure strict compliance, in the performance of their audits, with the provision of the Ind ASs as brought out above.
Topics Fraud Reporting- Statutory Auditors’ responsibilities
Date and Applicability of circular 26th June, 2023

 

Applicability:

 

(a) Auditors of entities regulated by NFRA
Summary of NFRA circular Issue highlighted:

 

•    NFRA has noticed that auditors are not fulfilling their statutory responsibilities relating to reporting fraud as mandated under the Companies Act 2013 read with relevant rules and applicable Standards on Auditing (SAs).

 

•    The Hon’ble Supreme Court of India in a recent judgement has held that the consequence of section 140(5) will be applicable also to those auditors who resign from their audit engagements without reporting fraud/suspected fraud.

 

Requirement under different provisions:

 

•    Section 143(12) of CA 2013 and related rules lays down certain reporting responsibilities on the auditor in relation to fraud. Rule 13 of the Companies (Audit and Auditors) Rules 2014, prescribes detailed steps that need to be followed by auditors in relation to reporting of fraud.

 

•    SA 240- The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements elaborately deals with the auditors’ responsibilities relating to fraud in an audit of financial statements. The guidance in SA 240 also details the communication to the management, TCWG and Regulatory & Enforcement authorities regarding reporting of fraud/suspected fraud.

 

Direction by NFRA:

 

•    The Statutory Auditors is duty bound to submit Form ADT-4 to the Central Government u/s 143(12) even in cases where the Statutory Auditors is not the first person to identify the fraud/suspected fraud.

•    Resignations does not absolve the Auditor of his responsibilities to report suspected fraud or fraud as mandated by law.

NFRA ORDERS:

A) On Statutory Audit Engagements: The observations summarised below relates to the orders issued by NFRA during the period from 01st January, 2024 to 30th April, 2024. Further, the issues covered in this publication represent additional/new observations other than those covered in the previous issues.

1. Despite of giving multiple communications by NFRA to submit the audit files through speed-post, e-mail communications and letters, EP did not respond. (Order No. 002/2024 dated 5th January, 2024)

2. Failure to evaluate the management’s assessment of the entity’s ability to continue as a Going concern despite the presence of significant indicators like defaults in repayment of Cash credit facilities and term loans, uncertainties relating to recoverability of trade receivables, continuing and increasing losses, negative operating cash flows, long delay in completion of many projects etc. (Order No. 003/2024 dated
08th January, 2024)

3. Failure to obtain sufficient appropriate audit evidence relating to revenue recognition and failure to evaluate the risk of fraud in revenue recognition. (Order No. 003/2024 dated 08th January, 2024)

4. Failure to perform physical verification or any alternate audit procedures to determine the existence and condition of inventory and also to modify his audit opinion with respect to inventory. (Order No. 003/2024 dated 08th January, 2024)

5. Failure to determine Materiality for the financial as a whole while establishing the audit strategy and to determine performance materiality for the purpose of assessing the risk of material misstatements and determining the timing, nature and extent of further audit procedures. (Order No. 003/2024 dated
08th January, 2024)

6. Failure to communicate in writing significant deficiencies in internal control with TCWG and with management on a timely basis. (Order No. 003/2024 dated 08th January, 2024)

7. Recognition of interest cost on borrowing rate at a rate lower than loan agreement for FY 2014–15 & 2015-16, disclosing balance interest liability as a contingent liability and non-recognition of interest at all for FY 2016–17 due to ongoing negotiations for restructuring of NPA accounts resulting into understatement of losses. (Order No. 005/2024 dated 22nd February, 2024)

8. Failure to obtain sufficient appropriate audit evidence for the verification of revenue. (Order No. 005/2024 dated 22nd February, 2024)

9. False reporting in CARO with respect to loans given to related parties. (Order No. 005/2024 dated 22nd February, 2024)

10. Violation of the Responsibilities as Joint Auditor. (Order No. 008/2024 dated 12th April, 2024)

11. Indulged in self-review by preparing material information for the financial statements of the Company, which subsequently became the subject matter of audit opinion, and this violated the Code of Ethics and Standards on Auditing. (Order No. 008/2024 dated 12th April, 2024)

12. Failure to analyse the contradictory evidence. (Order No. 008/2024 dated 12th April, 2024)

13. Failure to obtain sufficient appropriate audit evidence regarding the reasonability of estimate of Expected Credit Loss (ECL) on Financial Assets. (Order No. 008/2024 dated 12th April, 2024)

14. Acceptance of Audit Engagement before receipt of NOC from predecessor auditor (Order No. 012/2024 dated 26th April, 2024)

15. Not obtaining sufficient appropriate audit evidence of significant matters (fraud reported by previous auditors as the reason for resignation) reported by the previous auditor before acceptance of engagement and also during the course of audit and reporting.

B) On Other Engagements:

Date of order 3rd January, 2024
Nature of Engagement Reports u/s 80 JJAA of the Income Tax Act, 1961
Observations by NFRA

In the order, NFRA highlighted following significant deficiencies in the Form 10DA issued u/s 80JJAA of the Income-tax Act, 1961:

a. Failure to verify reorganization of business with various parties

 

b.   Failure to exclude employees whose contribution was paid by the Government

c.   Lapses in reporting additional employees

d.   Failure to verify payment of additional employee cost by account payee cheque/draft/electronic means

e.   Failure to verify the salary limit of ₹25,000 per month for new employees

Based on the above, NFRA concluded that the
concerned CA has failed to exercise due diligence in the conduct of professional duties and has also failed to obtain sufficient information which is necessary for the expression of an opinion, or its exceptions are sufficiently material to negate the expression of an opinion.

Key Takeaways

The implementation of these circulars issued by NFRA on various matters will be reviewed for scrutiny by them in subsequent inspections of the entities or audit firms. Therefore, it is imperative that the audit firms should create adequate documentation in respect of their audit procedures and diligence applied to ensure compliance of the same either by an entity or themselves.

The NFRA’s recent action on certification engagement of listed entities carried out by CA firms is also one of its kind. The CAs in practice and specially engaged by listed entities for statutory audit or other engagements should exercise a greater degree of professional scepticism.

“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.” Warren Buffett

NFRA DIGEST

BACKGROUND ABOUT NFRA ORDERS

The National Financial Reporting Authority (“NFRA”) was constituted on 1st October, 2018 by the Government of India under section 132(1) of the Companies Act, 2013 (“the 2013 Act”). The NFRA had issued its first order on 22nd July, 2020 and since then has issued 58 orders till December 31, 2023.

As mentioned in our March 2024 issue (Page 67), these orders are issued generally when irregularities are noticed by some regulators e.g. Serious Fraud Investigation Officer (SFIO), Securities Exchange Board of India (SEBI), Director General of Income Tax (Investigation), Central Economic Intelligence Bureau (CEIB), Ministry of Finance, Media Reports, Ministry of Corporate Affairs (MCA) regarding irregularities observed by FRRB except in case of DHFL matter wherein NFRA has initiated the investigation on Suo Moto. Orders are normally concluded with debarment and imposition of penalty.

Our previous issue also covered, in detail, the structure of NRFA Orders and Powers of NFRA under Section 132(4)(c) of the 2013 Act with respect to imposition of monetary penalties and debarment of the member or / and firm, where the professional or other misconduct is proved

KEY LEARNINGS FROM NFRA ORDERS

The Statutory Auditors, including the Engagement Partners (‘EPs’ hereafter) and the Engagement Team that conduct the Audit are bound by the duties and responsibilities prescribed in the 2013 Act, the rules made thereunder, the Standards on Auditing (‘SAs’ hereafter), including the Standards on Quality Control (‘SQC’ hereafter) and the Code of Ethics. Violation of any of these constitutes professional or other misconduct and is punishable with penalty prescribed under section 132(4)(c) of the 2013 Act.

These NFRA orders have highlighted observations / lapses on the part of Statutory Auditors in relation to compliance with SAs and other applicable regulatory requirements.

For the purpose of better understanding and learning perspective of the reader, the observations/lapses in these orders are classified into following key themes of accounting and auditing:

1. Independence requirements

2. Engagement Quality Control Reviewer (EQCR)

3. Audit Evidence and Documentation

4. Performing Risk Assessment and Audit Execution

5. Audit Reporting

6. Related Party (RP) Relationship, Transactions and Disclosures

7. Going Concern (GC) assessment

8. Auditing of Accounting Issues

9. Non-compliance with laws and regulations

10. Presentations and Disclosures

11. Professional Misconducts

Major observations / lapses in each of the above-mentioned themes are as follows:

Sr. No. Themes Observations/Lapses
1. Independence requirements

●    Engagement Partner (EP) accepted the audit engagement despite owning the shares of the auditee Company through a Company which was wholly-owned by him and his family members and thereby violating applicable laws and Standard relating to conflict of interest and independence. (Order No- 65/2023)

●    EP, proprietorship firm, had provided audit and non-audit services to 29 entities belonging to the concerned Group including its promoters. The audit firm of EP’s daughter had provided audits as well as non-audit services to 27 entities of the concerned Group. Further, her firm was actively participating in making presentations etc. on behalf of EP’s firm and a partner of her firm as partner of EP’s firm in the Audit Committee meetings of the company. All these audit firms operate from the same address. (Order No. 23/14/2022)

●    The firm was found to have either directly or indirectly provided prohibited services to the auditee or its holding company. (Order No. 20012/1/2020)
2. Engagement Quality Control Reviewer (EQCR)

●    No evidence in the file regarding the work performed by the EQCR partner. Further, having a checklist in file with response “Yes” and “No” is not sufficient audit procedures by EQCR partner. Para 25 of SA 220 that stipulates to document the reason and basis for conclusion. (Order No. 64/2023)

●    Failure to have formal appointment of EQCR Partner even though the Company was listed. (Order No. 20012/2/20222)

●    Acceptance of appointment as EQC reviewer without experience and authority i.e. 2 years’ experience professional was assigned as EQCR to review the work of 32 years’ experience EP which demonstrated that EQCR was without adequate experience and authority as reviewer. (Order No. 30/2023)

●    Non-availability of EQCR in the firm as the firm was proprietary. NFRA considered his firm to be ineligible to carry out statutory audits of listed companies in absence of EQCR. (Order No. 023/2023)

●    EQCR also failed to: (Order No. 20012/1/2020)

–      review selected working papers related to significant judgements,

–      perform objective evaluation of the significant judgements made by engagement team

–      document his work properly and separately from the work of the audit team, to independently analyse and question the engagement team regarding the issues arising out of RBI inspections and directors etc.

–      prepare proper documentation related to discussion between the EQCR team and EP.
3. Audit Evidence and Documentation ●    No evidence as to who performed the work, who reviewed it and the date and extent of such review. (Order No. 62/2023)

●    Failure to document discussion of significant matters with Those Charged With Governance (TCWG). (Order No. 62/2023)

●    Failure to document allocation and division of work between joint auditors. (Order No. 20012/2/20222)

●    No communication with TCWG regarding responsibilities of auditors, overview of planned scope of work etc. (Order No. 023/2023)

●    No evidence at all of work performed on Internal Financial Control over financial reporting. (021/2023)

●    Not seeking external confirmations for balances of debtors and creditors. (Order no. 23/05/2021)

●    Misconduct in relation to the role of engagement partner due to non-availability of evidence of EP’s review in file, designating other partner as EP in audit file instead of signing partner, no evidence of EQCR performed. (Order No. 20012/1/2020)

●    Non-availability of engagement letter in the audit file. (Order No. 023/2023)

●    Lack of documentation with regard to recoverability assessment of security deposits given several years back. (Order No. 58/2023)

●    Failure to prepare documentation regarding Auditor’s responsibilities relating to fraud in an Audit of Financial Statements (“FS). (Order no. 62/2023)
4. Performing Risk Assessment and Audit Execution ●    Failure to perform Analytical Procedures in spite of substantial decrease in key financial parameters like revenue, PBT etc. (Order No. 62/2023)

●    Failure to conduct branch audit, reliance by EP on the work of illegally appointed branch statutory auditors. (Order No. 63/2023)

●    Failed to identify the deficiencies in internal control relating to the appraisal and sanction of loans. (Order No. 63/2023)

●    Lapses in fulfilling auditor’s responsibilities relating to fraud even though the auditor was aware about FIR due to fraud against managerial personal of the auditee company. (Order No. 30/2023)

●    Failure to perform audit work for physical verification and valuation of PPE due to miscommunication between joint auditors. (Order No. 20012/2/2022)

●    Non-assessment of risk of material misstatement in balance of Trade Receivables even though the previous auditor had issued a qualified opinion. (Order No. 29/2023)
●    Failure to question the accounting policies related to trade receivables, improper disclosure, non-disclosure of credit risk profile of trade receivables and also to obtain external confirmation of outstanding trade receivables. (Order No. 21/2023)

●    Failure to perform risk assessment, determine materiality, analytical procedures, communicate with TCWG, reporting on fraud etc. (Order No. 21/2023)

●    Failure to report fraudulent loan transactions, fraudulent understatement of loan and evergreening of loans through structured circulation of funds.  (Order No. 23/14/2022)

●    Failed to understand the nature of business and comprehend that a company which was a shell company used by promoters for financial manoeuvres and there was no operation in the company since its incorporation. (Order No. 23/14/2022/05)

●    Failed to understand the rational for interest free loan given to a group company without business rationale. (Order No. 23/14/2022/05)

●    Misconduct in evaluation of Risk of Material Misstatements – not considering certain serious RBI non-compliance while doing risk assessment. (Order No. 20012/1/2020)
5. Audit Reporting ●    Issuing qualified opinions on SFS and CFS with 11 and 15 qualifications respectively despite the fact that the nature and effect of qualifications were material and pervasive to the FS instead of issuing Adverse Opinion or Disclaimer of Opinion. (Order No. 65/2023)

●    Issuing a qualified opinion instead of adverse opinion for non-consolidation of the subsidiary. The assets & liabilities of the subsidiary constituted 19.20% and 28.96% respectively of the assets and liabilities of Parent. (Order No. 62/2023)

●    Audit report not modified with respect to reporting on Unilateral extinguishment of trade payables and non-compliance with valuation of finished goods inventory. Included only as KAM without communicating these matters to TCWG. (Order No. 59/2023)

●    Misuse of Emphasis of Matters for issuing a modified audit opinion. The auditor reported various matters under EOM para which by its nature requires modification in auditor’s report due to non-availability of sufficient appropriate audit evidence. (Order No. 27/2023)

●    False reporting by auditor in independent auditor’s report – this mainly includes non-inclusion of cash flow in FS and annual report uploaded on BSE, wrongly reporting the company as NBFC in CARO report though the Company was into the business of media and content syndication and not an NBFC, missing disclosures regarding SBN in FS but auditor’s report states that it is included in FS. Lapses in audit conclusion since none of the above transactions were modified by the auditor in its audit opinion. (Order No. 23/30/2021)

●    Non-consideration of observations of Internal audit reports wherein it was reported that management had not carried out any physical verification of PPE whereas the auditor in its report stated that it was carried out by management. (Order No. 29/2023)
6. Related Party (RP) Relationship, Transactions and Disclosures ●    Lapses in understanding the nature of RP relationship and transactions, failure in testing the completeness of RPs and transactions, failure in evaluating management override of controls, failure in verifying arm’s length basis of RP transactions and failure to report these in CARO 2016. (Order No. 63/2023)

●    Failure to report non-disclosure of RP Loans on gross basis (Order No. 62/2023)

●    Failure to report outstanding balance of capital advances to a wholly owned subsidiary under RP disclosure. (Order No. 021/2023)

●    Failure to identify RP and RP transactions even through 100% sales were made to RP. (Order No. 23/30/2021/2)

●    Charged with failure to exercise professional skepticism while performing audit of fraudulent transactions with its subsidiary. (Order no. 23/14/2022)

●    Charged with recording of certain repayment cheques received from subsidiary to reduce the loan at year end without encashing these cheques. Further, the subsidiary’s bank account does not have sufficient balance to clear the cheques. (Order No. 23/14/2022)

●    Failure to exercise professional judgement while performing the audit of RP transactions and balances, various items of cheques received but not realised and cheques issued but not cleared (as there were no sufficient bank balances available). This indicates the intention to suppress true balances of borrowings from RPs and present a sound financial position. Further, external party payments were done using NEFT or RTGS whereas the cheques were used only for RP transactions indicating additional factor of fraud. (Order no. 23/14/2022)

●    Failure to identify suspected fraudulent diversion of funds given as land advances to RPs which was outstanding at the beginning of the financial year and completely recovered during the year without purchasing any land. Release of huge amounts to RPs on the pretext of land advances, title disputes of land for which money is advanced and return of advances on the flimsy explanation of non-suitability of land, were required to be evaluated by auditors with professional scepticism. (Order no. 23/14/2022)

●    Failed to understand the rational for interest free loan given during the year which in turn was given to the personal account of the promoter and his relatives. (Order No.23/14/2022/05)
●    Failure to detect fraudulent diversion of funds through various RPs in the form of loans and advances. (Order No. 28/2023)

●    Failure to exercise professional skepticism during verification of advance to subsidiary wherein the amount of advance granted was significantly higher as compared to the actual transactions. (Order No. 23/14/2022)

●    Charged with failure to exercise due diligence with respect to capital advances given to one group entity and the lapses include no board approval in place u/s 188 for such advances. (Order No.23/14/2022)
7. Going Concern (GC) assessment ●    Non-assessment of GC or lapses relating to GC basis of accounting in spite of current period and accumulated losses, negative net worth, negative working capital, defaults in repayment of borrowings, discontinuation of many divisions etc. (Order no. 63/2023, 20012/2/20222, 23/14/2022/05, 20012/1/2020)
8. Auditing of Accounting Issues ●    Consolidated financial statements (“CFS”) materially misstated due to non-consolidation of the subsidiary in CFS considering the investment is temporary in nature, relying blindly on the opinion of experts. (Order No. 63/2023)

●    Lapses in evaluation of unilaterally writing back of substantial liabilities and subsequent recognition of the amounts involved as gains. (Order No. 59/2023)

●    Failure in evaluation and attendance at physical verification of inventories and to report on incorrect accounting policy for valuation of inventories. (Order No. 59/2023)

●    Failure to report non-provisioning of land advances given. (Order No. 58/2023)

●    Failure to report on non-provisioning on dues outstanding for more than 3 years. (Order no. 58/2023)

●    Failure to perform Impairment testing under Ind AS 36 for investments in subsidiaries even though these subsidiaries were loss making. (Order No. 20012/2/2022)

●    Failure to report non-recognition of Interest Cost on Borrowings classified as NPAs but was only disclosed in notes to accounts. (Order No. 29/2023)

●    Allowing recognition of deferred tax assets in absence of virtual certainty supported by convincing evidence for sufficient future taxable income. Considering the company was making consistent losses, the assets should not have been recognised. (Order No. 27/2023)

●    Note to the FS states that provision for gratuity funds and leave encashment has been made on ad hoc basis whereas accounting policy states that provision is made based on valuation by independent actuary resulting in contradictory disclosures. (Order No. 27/2023)

●    Failed to report non-provision of Interest Costs on Borrowings from Bank and NBFCs resulting in understatement of loss eight times of reported loss. (Order No. 23/2023)

●    Non-provisioning for trade receivables- Unsecured, Considered Doubtful comprising 22% of total assets. (Order No. 23/2023)

●    Wrong amortization of certain expenses like Preliminary expenses, Listing expenses etc. which do not meet the definition of non-current assets as no future benefit is expected to flow. (Order No. 23/2023)

●    Outstanding foreign currency loan liabilities were carried at transaction date exchange rate and not re-evaluated using closing date exchange rate. (Order No. 20/2023)

●    Inflation of Revenue and Purchase by recording Open position Commodity Market Future Trading on daily basis instead of recording once on settlement date. (Order No. 23/05/2021)

●    Lapses in audit of inappropriate recognition of finance cost which was an extraordinary item since the underlying borrowings were not used for business purpose but shown as ordinary items in FS. (Order No. 23/14/2022)

●    Failure to carry out impairment testing even though there were consistent losses, erosion of net worth and defaults in repayment of loans taken from financial institutions. (Order No. 29/2023)
9. Non- compliance with laws and regulations ●    Not considering flagged significant potential violations in National Housing Board (NHB) inspection reports issued under NHB directions. (Order no. 63/2023)

●    Failure to report full particulars of loan to RP – Section 186(4) of the Companies Act, 2013 (Order No. 62/2023)

●    Non-evaluation of utilisation of IPO proceeds- CARO 2016 even though approx. 44% of IPO proceeds were paid to one of its RP. (Order No. 59/2023)

●    Erroneous Application of Financial Reporting Framework by the Company- the company has erroneously applied the provisions of Companies Act, 2013 while the Companies Act, 1956 was applicable for the reporting period. (Order No. 27/2023)

●    The FS has been prepared under Accounting Standards instead of Indian Accounting Standards resulting in revision of audit report and full FS. (Order No. 20012/1/2022)
10. Presentations and Disclosures ●    Failure to report non-disclosure of Trade Payable covered under the Micro, Small and Medium Enterprises Development Act, 2006 (Schedule III of the Companies Act, 2013) (Order No. 62/2023)

●    Inadequate disclosure in CARO due to failure to report the period of defaults in repayment of loans or
borrowings to banks and FIs and dues to debenture holders. (Order No. 20012/2/2022)

●    Non-evaluation of Income tax orders for demand resulted in non-provision or disclosure in the FS. (Order No. 25/2023)

●    Multiple non-compliance with the format of FS not meeting the requirements of Division I of Schedule III. (Order No. 23/2023)

●    Assets given on lease were wrongly shown under PPE as tangible assets instead of showing as receivable as per Schedule III. (Order no. 20/2023)

●    Misstatement in cash flow statement- increase in short-term borrowing were shown as operating activity instead of financing activity, loans and advances to RPs should be shown as Investing activity but shown under operating activities. (Order No. 23/14/2022)

●    Lapses in evaluation of corporate guarantee and creation of charge – non-disclosure of contingent liability given by the Company for corporate guarantee given in respect of loans taken by family members of promoters from banks and other private companies. Further, these transactions were not disclosed under RP note. (Order No. 23/14/2022)
11. Professional Misconducts ●    Failure to maintain audit file and co-operate with NFRA. The auditor did not respond to NFRA emails seeking audit file and SQC policy despite several extensions of time. (Order No. 27/2023)

●    Charged with tampering of audit files during the period NFRA asked to submit the audit file to the actual date of submission of audit file including creation of new Audit work papers during the said period. (Order No. 23/14/2022, 23/14/2022/05)

(Order No. as mentioned against each observations indicates the respective NFRA orders in which the above lapses have been stated)

KEY TAKEAWAYS FOR FUTURE

The observations/lapses highlighted by the NFRA clearly highlights that the audit quality remains a persistent concern across all the types of companies and the statutory auditors. The CAs in practice and specially engaged in the statutory audit of companies covered by NFRA should consider this as an opportunity and ensure the compliance of the Standard on Auditing (SAs) in the engagements carried out by them. The auditing errors can only be minimised and not totally eliminated but should be reduced to acceptable levels.

The NFRA in collaboration with the Institute of Chartered Accountants of India (ICAI) may also consider publishing sample audit manuals with minimum documentation requirements. For mid-sized firms, this may be especially useful as they could use this document as a reference point for their audit documentation.

“Audit work documentation, if performed in true spirit, leads to ‘thinking audit’ rather than ‘ticking audit’.”

– Dr Ajay Bhushan Pandey – NFRA Chairperson

NFRA Digest

(Editorial Note: Given the increasingly important role played by NFRA in the context of auditing, BCA Journal will be continuing with reporting on NFRA developments. In February 2024, an article was published on the 5 NFRA inspection reports of 2023. This new feature titled NFRA Digest will cover orders, reports, circulars, notifications, rules, inspection reports, discussion papers, etc. BCAJ will cover some of these developments affecting the profession of audit with a view that members and readers can learn from these developments. The aim is to enable members to improve their audit processes and reduce their audit risk by improving quality and governance frameworks mandated by applicable standards and regulatory expectations. In this context, we are pleased to bring this new feature NFRA Digest to our readers, covering NFRA updates. This first few NFRA Digests will carry a condensed coverage of past NFRA publications to bring readers up to speed till December 2023.)

BACKGROUND ABOUT NFRA, ITS POWERS AND DOMAIN

The National Financial Reporting Authority (“NFRA”), constituted on 1st October, 2018 by the Government of India under section 132(1) of the Companies Act, 2013 (“the Act”), is an independent regulator set up to oversee the auditing profession and the Indian Accounting Standards (“Ind AS”) under the Act. Though this section was enacted with the rest of the Act, it was ultimately notified only in 2018, after the PNB scam came to light. NFRA’s functions are laid down by sub-section 2 of section 132 covering:

a. Making recommendations to the Central Government on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or their auditors. Accounting and auditing standards are now to be prescribed by Rules made under the Act by the Central Government, based on the recommendations of the ICAI, in consultation with and after examination of the recommendations of the NFRA;

b. Monitoring and enforcing compliance with accounting and auditing standards in such manner as may be prescribed;

c. Overseeing the quality of service of the professions associated with ensuring compliance with such standards, and suggesting measures required for improvement in the quality of services; and

d. Performing such other functions relating to clauses (a), (b) and (c), as described above, as may be prescribed.

The Central Government has notified the NFRA rules 2018 using its powers under the aforesaid section.

Rule 4 lays down that the NFRA shall protect the public interest and the interest of investors, creditors and others associated with the companies or bodies corporate under NFRA’s purview by establishing high-quality standards of accounting and auditing and exercising effective oversight of accounting functions performed by the companies and bodies corporate and auditing functions performed by auditors.

In addition, sub-section (4) of section 132 vests NFRA with the power to investigate professional misconduct by any auditor of any of these companies. When such misconduct is proved, NFRA is empowered to impose monetary penalties up to 10 times the fees received and also to bar the auditor from being appointed as auditor or internal auditor of any company or body corporate for up to 10 years.

In order to remove any chance of regulatory overlap, the said sub-section very unambiguously provides that where the NFRA has initiated an investigation, no other institute or body shall initiate or continue any proceedings in such matters of misconduct.

Rule 3 specifies what class of companies would fall under the purview of the NFRA. Other rules laydown what procedures should be followed in discharging the functions specified in the Act, 2013, some details about the internal administration of the NFRA, etc.

NFRA’s jurisdiction covers all listed companies, unlisted public companies with either turnover, or share capital or borrowing above certain specified thresholds, all banking, insurance and electricity generation and supply companies, foreign subsidiaries of these entities of certain size, etc.

In addition, the Central Government can make reference to the NFRA, for actions in respect of any other company, or class of companies, in the public interest.

Keeping the above objective in mind, NFRA till31st December, 2023 has issued following:

FRQR REPORTS

The FRQR focuses on the role of preparers, i.e., those responsible for the preparation of financial statements and reports in accordance with the applicable accounting standards. Therefore, the FRQR evaluates how well the Chief Financial Officer, and the rest of the Management, and the Audit Committee, as well as the Board of Directors of the Company, have performed in preparing financial statements that show a true and fair view as required under the Companies Act, and in accordance with the applicable accounting standards.The FRQR concludes with an advisory to the preparers, highlighting the matters that need improvement. In case there are violations of accounting standards and the law that require action to be taken under the law, the matter is reported to the authorities who can take action.

NFRA has issued four such reports so far, and the companies which were reviewed by NFRA include PSP Projects Limited, ISGEC Heavy Engineering Limited, Prabhu Steel Industries Limited and KIOCL Limited.

AQR AND INSPECTION REPORTS

The AQR / Inspection Reports, on the other hand, have the objective of verifying compliance by the Audit Firm with the requirements of Standards on Auditing relevant to the performance of the Engagement. The AQR / Inspection Reports also have the objective of assessing the Quality Control system of the Audit Firm and the extent to which the same has been complied with in the performance of the engagement. NFRA completes his review and publishes the report as mandated by law.

MAJOR OBSERVATIONS BY NFRA IN ITS AQR REPORTS

As stated above, since its inception, NFRA has issued total seven reports which include one Supplementary AQR (“SRQR”). The firms to which such reports are issued include Deloitte Haskins & Sells, LLP, BSR & Associates LLP, Rajendra K Goel&Co. and SRBC & Co LLP.

Major observations include:

• In almost all reports, appointment is considered to be illegal or void due to violation of section 143(3)(e) (subsisting business relationships on the date of appointment) and section 141(3)(i) (provision of non-audit services directly or indirectly) of the Companies Act, 2013.

• Compromise in independence due to non-audit services for substantial fees and absence of Audit Committee approval for such services.

• Violation of SQC-1 and SA 220 by naming two partners as Engagement Partners leading to loss of accountability.

• Not adequately challenging the going concern assumptions.

• Non-determination of the persons comprising those charged with governance (“TCWG”), non-communication of audit matters, independence matters, etc., to TCWG.

• The EQCR, as said to have been carried out, has been shown to have been a complete sham, and has been found to be inadequate or a complete travesty of the EQCR process by appointing the EP himself as its EQCR partner.

• Gross violation of independence requirements due to non-audit services provided technically by a network-firms under the same brand claimed to be different firms but indirectly provided by same network firms.

• Independent Auditor’s Report is misleading due to non-identification of transactions, violative of accounting and auditing standards. The impact is both material and pervasive.

• No satisfactory rebuttal of the presumption of ROMM due to fraud in respect of revenue recognition and management override of controls, ultimately resulting in several violations of applicable provisions of Ind AS and SAs.

• Non-identification and assessment of Risk of Material Misstatements (ROMM) through understanding the entity and its environment, including its internal control. No ROMM procedures performed at the assertion level.

• Non-evaluation of work done by management’s expert.

MAJOR OBSERVATIONS BY NFRA IN ITS INSPECTION REPORTS

NFRA issued Audit Quality Inspection Guidelines in November 2022, which cover the objective, criteria for selection, scope of review, methodology for selection of audit firms and individual audit assignments, the inspection cycle, the inspection reports including its structure and timelines for responses by audit firms. Keeping these guidelines in mind, NFRA has issued five inspection reports from 22nd December to 29th December, 2023. (Refer to BCAJ Articles on Page 21, February 2024, and Page 25 in this issue for summary of major observations.)

ORDERS / DEBARMENTS

Orders are issued generally when irregularities are noticed by some regulators, e.g., Serious Fraud Investigation Officer (SFIO), Securities Exchange Board of India (SEBI), Director General of Income Tax (Investigation), Central Economic Intelligence Bureau (CEIB), Ministry of Finance, Media Reports, Ministry of Corporate Affairs (MCA) regarding irregularities observed by FRRB except in case of DHFL matter wherein NFRA has initiated the investigation on Suo Moto. Orders are normally concluded with debarment, if required and imposition of penalty.

The NFRA orders are generally structured as below:

1. Executive Summary,

2. Introduction & Background,

3. Issue of jurisdiction and procedures,

4. Major lapses in the Audit and Charges in the Show Cause Notice (SCN),

5. Finding on the article of Charges of Professional Misconduct,

6. Penalty & Sanctions.

Section 132(4)(c) of the Act, 2013, provides that NFRA shall, where professional or other misconduct is proved, have the power to make order for:

A. Imposing penalty of (I) not less than one lakh rupee, but which may extend to five times of the fees received, in case of individual and (II) not less than five lakh rupees, but which may extend to ten times of the fees received, in case of firms;

B. Debarring the member or the firm from (I) being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and the activities of any company or body corporate or (II) performing any valuation as provided under section 247, for a minimum period of six months or such higher period not exceeding 10 years as may be determined by NFRA.

Considering the above provision of the Act, 2013, NFRA has debarred the individual or firms and imposed penalties in most of the orders. The debarment period of individual professional ranges from six months to 10 years and firms from two to four years. The financial penalties, in the case of individual professional ranges from ₹1 lakh to ₹25 lakhs, and in the case of firms from ₹10 lakhs to ₹200 lakhs.

The upcoming NFRA Digests will cover NFRA orders, circulars, consultation papers, etc., issued till December 2023, to enable the reader to read not just the chronology but their classification under key themes.