NFRA Flags Audit Lapses and Independence Breaches in Big Four Firm

1. Introduction

The National Financial Reporting Authority, in exercise of its powers under Section 132 of the Companies Act, 2013, issues an inspection report on Big Four audit firms. As part of its inspection cycle, NFRA carried out a detailed audit quality inspection of a leading “Big Four”audit firm in India. The objective of such inspections is not merely to identify deficiencies, but to evaluate the effectiveness of the firm’s quality control framework and its adherence to auditing and accounting standards, while also suggesting areas for improvement.

This inspection assumes significance given the scale, complexity, and public interest associated with audits conducted by large network firms, thereby making audit quality a matter of systemic importance. Let us understand the inspection report with the analysis given below.

2. An Overview of the Inspection Report

The inspection covered both firm-level quality control systems and selected audit engagements. NFRA reviewed the remedial actions taken by the firm in response to earlier inspection findings and assessed critical components of its system of quality management, including independence policies, human resource practices, consultation mechanisms, and monitoring processes.

At the engagement level, NFRA examined a sample of five audit engagements relating to financial statements for the year ended 31st March 2024. The review focused on key audit areas such as revenue and loans and advances, along with certain engagement-specific high-risk areas like investments, going concern, and related party transactions. The inspection process involved a combination of onsite visits, virtual walkthroughs of audit files, and detailed interactions with engagement teams and firm leadership. NFRA clarified that such inspections are not exhaustive in nature but are intended to highlight significant deficiencies and areas requiring improvement.

3. Non-compliances and Deficiencies Identified in the Inspection Report

The inspection brought out several deficiencies across both firm-level controls and engagement-level audit procedures. These observations highlight gaps in compliance with auditing standards, accounting standards, and internal quality control mechanisms, indicating areas which require significant strengthening. Some of these non-compliances and deficiencies are discussed below:

1. Independence Violations – Delays were observed in identifying breaches of independence involving partners holding prohibited financial interests in audit clients. The partners were found to be holding the securities of a company not only while accepting the engagement, but also post acceptance of the engagement. This indicates non-compliance with the independence requirement under SQC-1 and weaknesses in monitoring systems.
2. Human Resource Lapses – A serious deficiency was noted where an individual with a fake professional qualification (Chartered Accountant) was employed and deployed on audit engagements, reflecting inadequate verification procedures.
3. Deficiencies in the Audit of Investments – Certain investments were initially classified as held for sale but later reclassified as non-current assets because the required conditions for held for sale were not met. However, on reclassification, the prescribed measurement requirements were not properly applied, and the recoverable value was determined without adequate basis or supporting documentation. Thus, non-compliance with Ind AS 105, Non-current assets held for sale and discontinued operations and Ind AS 36, Impairment of Assets was observed due to improper classification of assets as held for sale and inadequate impairment assessment, with insufficient audit evidence and a lack of robust documentation.
4. Inadequate Procedures for Loans and Advances – The audit firm failed to obtain sufficient appropriate audit evidence to support management’s assertion that loans given to related parties were at arm’s length, leading to non-compliance with SA 550, Related Parties.
5. Going Concern Assessment Failures – There were significant indicators casting doubt on the entity’s going concern, including sustained losses and negative net worth. Although a support letter was obtained from the holding company, the holding company itself was facing serious investigations and project setbacks, which could impact its ability to provide support. However, these factors were neither adequately evaluated nor disclosed in the financial statements. Despite the presence of significant risk indicators, auditors did not adequately evaluate or disclose material uncertainties, resulting in non-compliance with SA 570, Going Concern.
6. Improper Related Party Disclosures – Related party financing transactions were disclosed on a net basis as “finance provided during the year (net of repayments)” instead of separately showing loans advanced and repayments received. This resulted in improper netting of distinct transactions, thereby not providing adequate transparency of related party transactions.
7. Audit Documentation Deficiencies – An audit working paper was modified multiple times after the audit report had already been signed. Although these changes were stated to be for corrections and formatting, the nature and extent of the edits were not properly documented, leading to non-compliance with audit documentation requirements.
8. Internal Control Weaknesses – Key controls over expenses and payments lacked proper documentation to evidence segregation of duties, as the same individuals were involved in preparation, approval, and authorisation. Although approvals by department heads were claimed, no supporting evidence was available, resulting in a control deficiency and indicating that the control was not operating effectively.

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