PPT | Key NFRA Observations in its Audit Quality Review (AQR) Reports

Audit Quality Review (AQRs)

by NFRA Key observations made in their Audit quality review reports .

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This Presentation is based on findings as per NFRA Report. This is neither an independent view nor the opinion of the speaker. Similarly No Opinion is expressed for or against any Audit Firm/NFRA.

Introduction (1) The Central Government may, by notification, constitute a National Financial Reporting Authority to provide for matters relating to accounting and auditing standards under this Act. (2) Notwithstanding anything contained in any other law for the time being in force, the National Financial Reporting Authority shall— Section 139(2)(b) of Companies Act, 2013

(a) make recommendations to the Central Government on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or class of companies or their auditors, as the case may be; (b) monitor and enforce the compliance with accounting standards and auditing standards in such manner as may be prescribed; (c) oversee the quality of service of the professions associated with ensuring compliance with such standards, and suggest measures required for improvement in quality of service and such other related matters as may be prescribed; and (d) perform such other functions relating to clauses (a), (b) and (c) as may be prescribed.

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Introduction

For the purpose of monitoring and enforcing compliance with auditing standards under the Act by a company or a body corporate governed under rule 3, the Authority may-

Rule 8 of the NFRA Rules, 2018

a) Review working papers (including audit plan and other documents) and communications related to the audit; b) Evaluate the sufficiency of the quality control system of the auditor and the manner of documentation of the system by the auditor; and c) Perform such other testing of the audit, supervisory, and quality control procedures of the auditor as may be considered necessary or appropriate

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Process The observations made in the Audit Quality Review Report(AQRR) are restricted to some significant deficiencies noted in the Engagement; they do not cover all the deficiencies that may have occurred in the performance of the Engagement by the Audit Firm.

NFRA commences an Audit Quality Review (AQR) of the statutory audit of any company and arrives at Prima Facie Conclusions (PFC), which are detailed in the PFC Report. The response of the Audit Firm to the PFC Reports is duly considered and Draft Audit Quality Review Report (DAQRR) is issued. Again the responses are considered and the final Audit quality review report is issued.

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AQRR Flow

• Prima Facie Conclusions (PFC) Response from the Firm

Response from the Firm • Draft Audit Quality Review Report(AQRR)

• Final Audit Quality Review Report(AQRR)

AQRR is not an Overall rating tool of any audit firm .

Key Observations from NFRA

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Non - Compliance with Independence Requirements as per NFRA

Independence of Mind

The state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism

Independence in appearance

The avoidance of facts and circumstances that are so significant a reasonable and informed third party, having knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity or professional skepticism had been compromised.”

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Compliance with Independence Requirements Section 144(8) of Companies Act, 2013 - Auditor not to render certain services.

An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company), company or its holding company or subsidiary company, namely:(a) accounting and book keeping services; (b) internal audit; (c) design and implementation of any financial information system; (d) actuarial services; (e) investment advisory services; (f) investment banking services; (g) rendering of outsourced financial services; (h) management services; (i) any other kind of services as may be prescribed: Provided that an auditor or audit firm who or which has been performing any non-audit services on or before the commencement of this Act shall comply with the provisions of this section before the closure of the first financial year after the date of such commencement.

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Compliance with Independence Requirements – provision of management services leading to self review threat.

Concept of Management Services given Wider Canvas by NFRA.

Admittedly, the term “Management Services” has not been defined in the Companies Act, 2013. In such situations, the settled principles of statutory construction require that the words used in the statute must be understood in their normal or dictionary sense and be given their literal and direct meaning.

“Management Service” are any service/activity which puts auditor in the shoes of company’s management or places auditor in a decision-making role akin to company’s management. In other words, “Management Service” are understood to mean “Services that essentially constitute Management Responsibilities” also providing any kind of support (inclusive of analysis, research, advice etc.) that is required by the management for the performance of those actions/functions.

E.g.: Ind AS Implementation Services provided by the way of advice on conversion of Consolidated Financial Statements, leading to Self Review Threat.(Source NFRA AQRR Report)

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Threat to Independence Requirements- provision of review of IND AS services.

In NRFA’s View, the below points are considered as Management Services Discussion with Management on accounting policy options available under Ind AS and their implications, including providing insight on Ind AS Provide Ind AS technical materials and guidance of a general nature Advise to Management in understanding available accounting options under Ind AS.

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Threat to Independence Requirements- provision of review of IND AS services.

In NRFA’s View, the below points are considered as Management Services

Advise, review and provide observations on technical accounting memoranda prepared by Management and proposed accounting policies under Ind AS prepared by the management Advise, review and provide observations on the results of calculations of the specific adjustments needed to convert Local GAAP to Ind AS prepared by Management Advise and comment on the skeleton lnd AS financial statements and disclosures Prepared by Management”.

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Going Concern – Key points to consider. However SAAE not available in Audit Files.

Some Indication that may cast Doubt in the Going Concern Assumption

Conforming the Going Concern Assumption • Auditor is to obtain Sufficient and Appropriate Audit Evidence(SAAE) regarding the Going Concern assumption and conclude on the appropriateness of managements use of Going Concern.

• Long Term Borrowings • Negative Cash Flow • Adverse Ratios

• Events or Conditions exist that can be assessed as material uncertainty on the Going Concern Assumption of the of the Entity, SAAE is to be obtained for the same.

• Lowering of Credit Rating have not been validated with reference to the management Explanations.

• Loss of key manpower • --the list is only indicative

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Going Concern Lack of adequate evidence and documentation as per NFRA

Cash Flow

Credit Rating

GC Memo

•Absence of projected Cash Flow for next 12 Months form the date of Financial Statements and no Linkage to any of the Work papers but attached as a file in Going Concern Memo. No detailed notes and evaluation by the audit firm .

•No Copy of Credit rating agency report is available in the file. Implication of such rating not assessed and analyzed .

•Signed a day before the Audit report is Signed.(What is the Extent of Work Done remains a key question ) •No Linkage between GC Memo and Notes to Accounts.

•Very General Remarks in the GC Memo; no specific reference to Management Memo.no pointed discussions on key GC considerations on finance related aspects .

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Going Concern Lack of adequate evidence and documentation as per NFRA

Others

• Failure to test the source of Cash generation and company’s ability to meet Future liabilities • Final Assessment of GC Memo and conclusion not documented in Work papers.

• Failure to Report material facts.

• Documents in WP files contradicts the Audit Team’s conclusions.

• No objective evidence available for making statements regarding settlement of subordinated Debt.

• Lack of Objective Evaluation of Going Concern and no evidence of any discussions and independent corroboration of the management statements .

• Futuristic Statements on projects or Contracts not supported by evidence and hence full reliance placed on management representation without independent verification .

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Evaluation of Risk of Material Misstatements (ROMM) Key Observations by NFRA Team Planning events neither discussed the Fraud Risks nor Fraud considerations memo and also failed to analyze frauds and how eventually they are addressed in the audit process .

No Robustness noted in Team Planning event documentation on Revenue Recognition.

Presumption of fraud risk in revenue not discussed and addressed in the team planning event.

Management Override of controls and its implications and the response of the audit firm not documented and evidenced .

Response to Fraud Risk identified and response by the way of Audit Steps not documented.

Failed to discuss components of entity’s Financial Statements which are susceptible due to fraud and the response of the audit firm not documented.

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Investments Key Observations by NFRA

Ind AS Non Compliance

Management Related

Others

•According to Ind AS Investment in Associate has to be tested for impairment indicators and the same was not tested and no evidence available in Audit Files.

•EOM of Associate Company reproduced and no separate assessment has been done by the firm as required under AS. Hence no adequate work done and assessed at the holding company level.

•Complete reliance on management representation regarding carrying value of investments in Associate.

•Estimates given in Legal opinion not verified.

•No Independent Evaluation of Management Experts work used as Audit Evidence.

•No Independent Evaluation of Managements Review and approval Process and testing of data on the ICFR related to investments.

•Lack of Professional Skepticism and display of Professional Judgment in evaluating the investments in Associate and Company has not computed recoverable amount and the same has not been addressed by the Audit Firm.

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Reversal of Expected Credit Loss Key Observations by NFRA No evidence of Expected Credit Loss(ECL) Models having been independently verified by Audit team.

No Assessment made by the audit firm regarding the computation of the deemed cost of investment.

No SAAE for Reversal of ECL by the way of notes, analysis and justification.

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Reversal of Expected Credit Loss Key Observations by NFRA Documents not available in Audit file • • •

Reassessment of Business plans Reduction in Credit Risk– evidence supporting the same Evidence of increased Cash Flows

Evidence for Credit impairment observable; Increase in credit risk ignored • • •

Conversion of Loan to Zero % Conversion of loan to equity Increase in cost of projects

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Other observations Key Observations by NFRA Other observations •

De-recognition of Loans

•

Reversal of ECL

•

Accounting of deemed equity not backed by SAAE

No Qualitative or Quantitative disclosures given as per applicable accounting standards

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Provision of Interest Free Loans to Joint Ventures and Subsidiaries Management Expert

•

Management Expert’s Opinion of JV’s received and filed one day before signing of the Audit Report.

Extent of work done not available.

Independent Evaluation •

No Independent Evaluation of reasonableness and relevance of assumptions of Management expert.

Approval of Loan

•

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No Sufficient testing over granting of loan found in the Working Papers, including detailed assessment of ability to repay the loan.

Conclusion

•

Basis of forming conclusion and opinion was to be documented as well and the same is not evident.

Financial Guarantees Key Observations by NFRA Letter of Comfort not treated as Financial Guarantees but disclosed in the Statements being challenged by NFRA.

Financial

Concept of Substance over form in documentation not followed consistently.

Letter of Comfort for SPV’s which were not performing well were not available in Audit Files as also Detailed work not available.

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De-Recognition of Borrowings Key Observations by NFRA Bank Confirmations not available to evidence the appropriateness of the De-Recognition of borrowings.

No Deed of Assignment of loan found in Work Papers.

Principles of Accounting standard not followed.

Appropriateness of De-Recognition challenged.

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Evaluation of Engagement Quality Control(EQC) Review Key Observations by NFRA No Evidence of discussion of critical matters between Engagement Partner(EP) and Engagement Quality Control Review(EQCR) Partner.

No comments or inputs of EQCR Partner noted in Team Planning event.

Ticking a Yes/No Checklist and signing on Work Papers not sufficient evidence to prove that EQCR has done an objective review and evaluation of significant judgments made by EP.

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Evaluation of Communication With Those Charged With Governance(TCWG) Key Observations by NFRA Opinion on Going Concern formed based on meeting with TCWG alone and same not supported by appropriate records including Cash Flow Projections.

No evidence of significant matters including Audit Plan have been communicated to TCWG in a timely manner.

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CARO Related Matters Key Observations by NFRA Evidence of stock statements available in files and no Physical verification Work papers are available.

No evidence on the checking of Internal Controls related to: • •

Inventory Cut – off procedure.

No evidence of reconciliation with both book records and Physical Verification.

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Litigations Related Key Observations by NFRA

EOM given instead of Qualification of Report • EOM Given in lieu of a Qualification regarding investment in a company.

• Shares shown as Current Investments when a portion of same has been sold by the lender in market and matter should have been Qualified instead of being shown as EOM as there is ownership issue.

• Recoverability of Trade Receivable is a matter of professional Judgment to be backed by SAAE and in case there is a disagreement, it should be Qualified in Audit Report and not to be reported as an EOM. • No Legal opinion/ Detailed Analysis available in file for EOM on matter concerning an arbitration before CCI.

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Litigations Related Key Observations by NFRA

Observations related to other Documents and Evidences.

• Auditor should have evidence in file on why a Qualification was not necessary in a matter which is litigated.

• No Confirmations from trustees for shares held in De-mat format.

• Summary of important documents like Contract Notes witch customers - Claim documents, Arbitration award, appeal filed and minutes of meeting with claim department not available in Working Paper Files of Engagement Team(ET)

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Evaluation of Internal Control over Financial Reporting(ICFR) Key Observations by NFRA

• List of questions used for evaluating ICFR for purchases, sales etc. by the way of checklist with column for answers as Yes/No/NA.

Work done and WP Related

• No Documentation of work done pertaining to risks associated with business, operations and company strategy to minimize such risks

• Work Paper Contains only TB, Bank Guarantee copies, Statement of Contract Receipts. There is no documentation of Audit Procedures performed and conclusions reached.

• IT Processes relevant to flow of transactions not identified by the audit firm for testing operating effectiveness of IT Controls

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Evaluation of Internal Control over Financial Reporting(ICFR) Key Observations by NFRA

• No Evidence in file for RCM’s, Walk-through’s and control testing.

Evidence

• No Evidence for impairment testing for investment in associate available in file.

• No Evidence of having obtained any legal opinion on certain tax matters which were under litigation.

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Evaluation of Internal Control over Financial Reporting(ICFR) Key Observations by NFRA

EOM

Others

• EOM was provided on matters where external confirmations were not obtained on receivables, loans, Bank Borrowings since the matters were sub judice.

• Investments made in an associate were not written down to Nil value despite lenders invoking the pledged shares of the concerned company. No SAAE for considering the same as investment as also no evidence of the matter having been raised with TCWG.

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Revenue Recognition Key Observations by NFRA Revenue Recognition Work Papers had TB’s, Bank Statements, Salary Sheets and Sub Contract expenses and no conclusion regarding appropriateness and accuracy of revenue recognition.

No Record of independent Engineer Report, Verification of Contract, Sub Contract agreements, independent Engineer Report, Determination of POC of Respective projects and Cost Sheets.

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Regulatory Related Key Observations by NFRA Regulators report not considered and serious lapses noted in such communicated with TCWG and followed up in Audit Process.

Report were not

Such Serious Lapses have not been factored in assessment of ROMM. Critical agreements like shareholder and options agreement not part of Audit Files and no evidence regarding checking and verification by Auditors.

Loans given were not secured and no registration of charges was created was not properly evidenced and sample selection not adequate.

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Regulatory Related Key Observations by NFRA Charges pending verified.

for registration for more than one year for loans and same were not

Subsequent events like decline in Share Price of company have not been factored in audit procedures and no further analysis was done.

Similarly regulatory action including SCN for cancellation of registration not appropriately factored in Audit Procedures and ignored.

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The Mandated Do’s (Indicative List)

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• Evaluate Non-Audit services closely and ensure that independence is not impaired.

• Definition of Management Services to be broad based. Conflicting situations should be avoided.

• Audit Committee pre-approval together with detailed noting's to be kept in Audit files.

• Closely monitor any possible Self Review Threat.

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• On Going Concern related matters prepare detailed Work papers. Evaluating the Key Assumptions of the management and challenge the same with an independent view. Ideally the same shall also be cleared by Those Charged with Governance.

• Projected Cash Flow Statement and other forward looking assumptions should be backed by strong Audit evidence like orders, Board ratified Plans, Etc. • Team Planning meeting should have detailed agenda including carry forward points from Previous year/ Presumptive fraud risk related to Revenue/ Significant components of Balance Sheet/ Preliminary analytical review Analysis and related Audit Procedures.

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• Team Planning events should be done on an ongoing basis to factor new developments.

• Independent Assessment of Management experts work and legal experts opinion should be appropriately documents.

• ECL models Should be analyzed and assumptions of the management should be challenged.

• If any reversal of ECL provisions should be viewed with as a Potential Fraud Risk.

• Loans to Related Parties including terms and conditions should be evaluated with respect to repayment capabilities, Fairness of the terms and conditions etc.

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• Complex transactions like de-recognition of Borrowings should be supported with updated confirmations and if necessary a robust legal opinion regarding Non-Recourse before causing necessary accounting entries.

• In respect of CARO requirements detailed Working Paper’s with samples selected and tested and Appropriate conclusions should be documented, similarly in respect of ICFR, Key controls should be tested and analyzed whether the controls are effective or not and then conclusions drawn.

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• Linkage to be established between

Planning Document

Audit Conclusion Summary

Work Papers

Communic ation with TCWG

• Subsequent event to be properly documented as Adjusting and Non Adjusting Event and appropriately dealt with in the Audit Report.

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Definitions to be Monitored Carefully EMPHASIS OF MATTER

QUALIFIED OPINION

A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.

The auditor shall express a qualified opinion when: (a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or (b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

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Questions & Answers

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