Audit regulator the National Financial Reporting Authority (NFRA) has found several deficiencies in the statutory audit conducted by SRBC & Co LLP, a member of EY (Ernst & Young), of Infrastructure Leasing & Financial Services (IL&FS) for FY17-18. According to the audit quality review report (AQRR), the audit quality of the firm is seriously compromised, and SRBC & Co had no justification for giving a true and fair view on the financial statements of IL&FS.
In its 390-page AQRR, NFRA says, "The audit quality is seriously compromised due to the large-scale non-compliance with professional standards and regulatory and legal requirements, and the inappropriate reporting made by the audit firm (SRBC & Co). These lapses prevented the investors, creditors and stakeholders from knowing on time the true and fair picture of the state of affairs of IL&FS."
"If SRBC & Co had been vigilant, shown professional scepticism, sufficiently challenged management assumptions and claims and strictly complied with its audit responsibilities, such lapses by IL&FS perhaps could have been detected much earlier and the tens of thousands of crore of losses and haircuts that the banks, creditors, and investors were ultimately saddled with would have been averted," NFRA says.
According to the AQQR, SRBC & Co formed an opinion on the financial statements of IL&FS and issued its audit report without obtaining reasonable assurance about whether the financial statements as a whole were free from material mis-statement, whether due to fraud or error, and, thereby, failed to meet the requirements of Standards on Auditing 700 (SA 700).
Para 15 of SA 200 requires that the auditor plan and perform an audit with 'professional scepticism', recognising that circumstances may cause the financial statements to be materially mis-stated.
"The AQRR identifies instances such as impairment of investments, evergreening of loans, approval of related party transactions, recording of revenue, violation of capital and leverage ratios, and numerous other instances given in this AQRR where the audit firm failed to exercise professional scepticism and failed to challenge the management assumptions and claims in key areas of financial reporting. It is needless to emphasise the importance of maintaining professional scepticism throughout the planning and performance of the audit," NFRA says.
Further, it says, as detailed in the AQRR, the audit documentation, which is an essential requirement maintained by the audit firm, such as those relating to investment policy, impairment testing of investments, and use of materiality, failed to provide a clear record of the professional judgements made and significant decisions taken.
On 25 September 2019, the Union government asked NFRA to review the statutory audit done by SRBC & Co of IL&FS for FY17-18. The IL&FS group comprises around 250 subsidiaries, including listed and unlisted associates and joint ventures as of 31 March 2018, engaged in the infrastructure sector.
As per books of accounts, IL&FS group's revenues were around Rs17,672 crore, and it had total assets of Rs115,814 crore and total external liabilities of Rs106,543 crore. It reported a net loss of Rs1,886 crore (consolidated) and a profit of Rs584 crore (stand-alone) for FY18.
NFRA has earlier completed the audit quality review (AQR) of IL&FS' two subsidiaries—IL&FS Financial Services Ltd for FY17-18 (joint audit by Deloitte Haskins and Sells LLP and BSR and Associates LLP) and IL&FS Transportation Networks Ltd (audit by SRBC & Co) for the same financial year, on a reference from the government.
In its preliminary submissions, SRBC & Co had contended that NFRA has no jurisdiction on audits for FY17-18 and the review relates to a period when the NFRA was not in existence and the provisions of section 132 of the Companies Act, 2013 had not been notified.
The audit regulator says NFRA is just a new forum introduced to look into compliance with the law as it stood on the date of audit. This change of forum to NFRA is only procedural and does affect any party's substantial rights, including the auditor. Hence, NFRA is well within its powers to make this AQRR, it added.
According to the AQRR by NFRA, there was a violation of the norms on the auditor's independence. NFRA observed that the initial appointment of SRBC & Co and continuation of the same firm as statutory auditor of IL&FS was violative of the norms of independence. "This is because its network Ernst & Young Global Ltd/EY) provided prohibited services to the IL&FS group and also had a business relationship with the IL&FS group," NFRA says.
The AQRR also found lapses in the audit of investment, loans and advances by SRBC & Co. "The total value of investments shown in the standalone financial statements of IL&FS as of 31 March 2018 amounts to Rs12,320 crore, which is almost 50% of its balance sheet size. The audit firm failed to properly verify these investments in almost 80% of the cases. The deficiencies are observed in the areas of use of valuation experts, fair valuation, and impairment loss evaluation. Also, there are certain investments (Rs1,637 crore) for which no evidence of verification is available in the audit documentation. There is no evidence that the audit firm has ensured that the management had tested each investment individually for impairment."
IL&FS had disbursed loans amounting to Rs8,124 crore to about 26 related parties during FY17-18. The AQRR observes, "The audit firm failed in designing and performing sufficient and appropriate audit procedures to mitigate the risks, including risks of management override of internal controls, associated with the sanction of these loans, and disbursement of loans by the Company.
"The audit firm ignored potential cases of evergreening and rollover of loans and failed to understand its implications on the financial statements of the Company."
According to the AQRR, there were lapses in the audit of revenue from operations. It says, "Around 93% of the total revenues, Rs1,899 crore in the standalone financial statements, of IL&FS was from related parties. However, the transactions were made in violation of section 177 of the Companies Act, 2013. The audit firm failed to perform enough tests of details to verify the occurrence of revenue, completeness of revenue transactions, and the accuracy of the revenue recorded. The audit firm failed to evaluate the management assertion that related party transactions were conducted on terms equivalent to those prevailing in an arm's length transaction."