NCLAT Backs NFRA Order, Says Statutory Audit Is Not a Mere Ceremonial Exercise

In a significant judgment reinforcing the responsibilities of statutory auditors, the National Company Law Appellate Tribunal (NCLAT) has upheld disciplinary action taken by the National Financial Reporting Authority (NFRA) against a chartered accountant and his audit firm, observing that a statutory audit is far more than a ceremonial exercise and must be conducted with due professional scepticism, adequate audit evidence and strict adherence to auditing standards.

The appellate tribunal dismissed the appeals filed by CA Som Prakash Aggarwal, the Engagement Partner, and M/s S. Prakash Aggarwal & Co., the statutory auditors of Vikas WSP Ltd. (VWL) for the financial year 2019-20, thereby affirming NFRA's findings of professional misconduct and the disciplinary measures imposed on both the individual auditor and the audit firm.

Tribunal Reiterates Auditor's Independent Responsibility

While delivering its judgment, the NCLAT emphasised that statutory auditors perform an independent public interest function and cannot merely rely on explanations or representations provided by a company's management.

The Tribunal observed that statutory audits are intended to provide independent assurance to shareholders, lenders, investors and other stakeholders, and therefore require auditors to obtain sufficient appropriate audit evidence before expressing an audit opinion. It further stressed that professional scepticism is a mandatory requirement under the Standards on Auditing (SAs) and cannot be substituted by management assurances or expectations of future settlements.

Background of the Case

The matter arose from NFRA's examination of the statutory audit of Vikas WSP Ltd., a company listed on both the BSE and NSE. The regulator found deficiencies in the audit relating to the company's financial statements for FY 2019-20, particularly concerning the non-recognition of substantial interest liabilities on bank borrowings and the issuance of an unmodified audit opinion despite material accounting issues.

According to NFRA, the auditors failed to adequately verify the accounting treatment adopted by the company and did not maintain sufficient audit documentation demonstrating independent verification of management's assumptions. The regulator concluded that the audit work did not comply with the applicable Standards on Auditing and Indian Accounting Standards (Ind AS).

NCLAT Supports NFRA's Findings

After examining the records, NCLAT concurred with NFRA's findings and held that the auditors had violated the applicable auditing standards and provisions governing professional conduct.

The Tribunal observed that an auditor is expected to independently evaluate accounting treatments, obtain corroborative evidence wherever necessary, and appropriately modify the audit report if material misstatements remain unresolved. Merely relying on management representations or anticipated one-time settlement (OTS) proposals with lenders cannot justify the issuance of an unmodified audit opinion.

Importance of Audit Documentation and Professional Scepticism

The judgment also highlights the critical importance of maintaining proper audit documentation. NCLAT noted that the audit file should clearly demonstrate the procedures performed, evidence obtained, professional judgments exercised and conclusions reached during the audit.

The Tribunal reiterated that compliance with the Standards on Auditing (SAs) is mandatory and that quality audit documentation plays a vital role in establishing whether an audit has been conducted in accordance with professional standards.

Responsibility of Audit Firms

Apart from the Engagement Partner, the Tribunal also upheld NFRA's action against the audit firm, observing that audit firms have an independent responsibility to establish and maintain effective systems of quality control in accordance with SA 220 and related professional standards.

The judgment states that audit firms cannot evade responsibility for deficiencies in their quality control systems, and both the engagement partner and the audit firm may be held accountable where professional misconduct is established.

Significant Message for the Profession

The ruling is expected to serve as an important precedent for the auditing profession by reinforcing that statutory audits are a critical safeguard for investors, creditors and the public. It reiterates that auditors must exercise independent judgment, maintain professional scepticism, gather sufficient audit evidence and comply with the prescribed auditing standards before certifying financial statements.

The judgment also strengthens NFRA's role as the regulator responsible for maintaining audit quality and professional accountability in public interest entities.

Key Takeaways

• NCLAT upheld NFRA's disciplinary action against CA Som Prakash Aggarwal and M/s S. Prakash Aggarwal & Co.
• The Tribunal reaffirmed that statutory audits are not mere formalities and require independent professional judgment.
• Auditors cannot rely solely on management representations or anticipated settlements without sufficient corroborative evidence.
• Compliance with the Standards on Auditing, robust audit documentation and professional scepticism remains mandatory.
• The ruling reinforces the accountability of both engagement partners and audit firms for maintaining audit quality. CA Sansaar