' ASHFAQ AHMED KHAN (DIRECTOR ENFORCEMENT).---This order shall dispose of the show cause proceedings. Initiated against Mr. Saud Ansari (hereinafter called "the auditor") under rule 35 of the Companies (General Provisions and Forms) Rules, 1985 (the "Rules") and subsection (1) of section 260 read with sections 255 and 476 or the Cbmpanies Ordinance, 1984 (the "Ordinance") in respect of M/s Kausar Paints Limited (the "Company").
2. Mr. Saud Ansari is a Fellow Member of the Institute of Chartered Accountants of Pakistan (the "ICAP'). He is conducting his business under the name and style of " Saud Ansari & Co., Chartered Accountants" which is a sole proprietorship. Therefore, Mr. Saud Ansari, FCA himself has been the auditor of the Company since 2000.
3. The facts leading to this case, briefly stated, are that Saud Ansari & Co., Chartered Accountants were appointed as auditors of the Company in its Annual General Meeting held on October 25, 2003 to hold office from conclusion of the said meeting until the conclusion of next Annual General Meeting. The auditor made a report on the accounts of the company for the year ended June 30, 2004 and signed the report on September 15, 2004.
4. The Enforcement Department while examining the accounts and auditors' report of the Company for the year ended June 30, 2004 observed that the Company has not annexed statement of changes in equity in the accounts in contravention of the provisions of para.86 of IAS 1 (Presentation of financial statements),It was also observed that the auditors' report was also not according to Form 35-A prescribed under rule 17-A of the "Rules" as he had failed to give an opinion on the statement of Changes in equity. Further examination of the accounts revealed that the Company had closed down its operations for the last number of years and all its activities such as purchase, production, sales stand suspended due to extreme financial constraints and all its staff had been laid off. Note No, 4 of the accounts also states that PICIC had filed a recovery suit for recovery of dues in the Banking Court, which stands decided against the company. Lease hold land, factory building and plant and machinery had been attached by the court and been auctioned and the auction proceeds were used to settle the borrowing from P.I.C.I.C., U.B.L. And First Allied Bank Modarba. The auditor has not expressed an adverse opinion despite the management's negative assessm ent of the ability of the company to continue its operations and nondisclosure of the management plans to deal with the events and conditions which caused significant doubt about the entity's ability to continue as a going concern. For ease of reference the matter of emphasis paragraph given by the auditor in his report to the members is reproduced as under: "Without intending as a qualification we draw attention to Note No, 4 to the accounts. The Company has suffered losses over the past few years. The manufacturing operations have also been discontinued and the factory has been closed. The Company has also been placed on defaulters desk of the stock exchange. As at June 30, 2004 the Company has accumulated losses amounting to Rs,30,284,646 and its current liabilities exceed its current assets by Rs,4,584,646.
Moreover as stated in Note No, 3 above, factory building and plant and machinery has been auctioned by the court. These factors raised substantial doubts that whether the Company will be able to continue as a going concern, and therefore may be unable to realize its assets and discharge its liabilities in the normal course of business.
' In these accounts the long-term liabilities have not been classified as current liabilities. These accounts do not include any adjustment relating to the recoverability of recorded assets amounts, and discharge of liabilities, should the Company be unable to continue as going concern.
5. The management's assessm ent on the Going Concern issue, as per note 5 of accounts is reproduced as under: "The Company has suffered losses over the past few years. The manufacturing operations have also been discontinued and the factory has been closed. The Company has also been placed on defaulters desk of the stock exchange. As at June 30, 2004 the Company has accumulated losses amounting to Rs,30,284,646 and its current liabilities exceed its current' assets by Rs,4,584,646.
Moreover as stated in Note No, 4 above, factory building and plant and machinery has been auctioned by court. These factors raised substantial doubts that whether the Company will able to Intinue as a going concern, and therefore may be u able to realize its assets and discharge its liabilities in the normal course of business.
' In these accounts the long-term liabilities have not been classified as current liabilities. These accounts do not include any adjustment relating to recoverability of recorded assets amounts, and discharge of liabilities, should the Company be unable to continue as a going concern."
6. Further, the examination of the accounts also revealed that the Company had not followed the following disclosure requirements of various IAS and the Code of Corporate Governance (COCG):
(i) Disclosure of Financial Instruments as per the requirements of paras.56, 66 and 77 of IAS 32 (Financial Instruments: Disclosure and Presentation) has not been made in the accounts.
(ii) Loss per share has not been disclosed in the accounts as per para.47 and para.49 of IAS 33 (Earnings Per Share).
(iv) Pattern of shareholding is not according to the requirement of clause xix (a) of Code of Corporate Governance (the "Code").
(v) The Auditor has not given any remarks on non-submission of statement of compliance with the Code of Corporate Governance by the Company as required by clauses (x 1v) and (xlvi) of the Code.
(vi) Note 17.2 states that the corresponding figures of the previous year have been rearranged wherever necessary, to facilitate comparison. But para.40 of IAS-1 (Presentation of Financial statements) does not allow such a general statement.
7. In view of the above circumstances, the Enforcement Department felt concerned about the quality of the audit conducted by the auditor and the audit report made by him on the account of the company for the year ended June 30, 2004. This appeared to be a case where the auditor has failed to report on the statement of changes in equity and has not given an adverse opinion in spite of the fact that the management has given a negative opinion on the going concern issue.
Moreover, the auditor failed to report deficiencies relating to disclosure requirements as mentioned in para.6 of this order.
8. Consequently, a notice dated January 18, 2005 was issued to Mr. Saud Ansari pointing out clearly their responsibilities under the Ordinance and Auditing Standards and prima facie towards misleading and inaccurate statements made by him in his report on the Accounts of the Company. He was called upon to show cause as to why action may not be taken against him for contraventions of the mandatory provisions of law. No response was received to the show-cause notice. Therefore, in order to provide an opportunity of personal hearing, the case was fixed on February 22, 2005.
9. In the written submissions which were made at the time of the hearing and verbal arguments, Mr. Saud Ansari, FCA admitted the defaults. He admitted carelessness on his part while making report in terms of section 255 of the Ordinance. He also assured that these defaults would not be repeated in future. The submissions made by him can be summarized as follows:
(i) The audit report was on the prescribed format orm 35A, omission of any sentence is unintentional and due to typographical error.
(ii) He submitted that the Company is on the defaulters desk of Karachi Stock Exchange and its shares are not being traded in the Karachi Stock Exchange, therefore he did not give any remarks on the non- issuance of statement of changes in equity, non-disclosure of information as per the requirements of IAS 32 (Financial Instruments: Disclosure and presentation) and IAS 33 (Earning per share) and non-submission of statement of compliance with the code of corporate governance, by the Company. It was the understanding that the company being on the defaulters desk of KSE, does not come under the preview of the provisions of law, applicable to the listed-companies.
(iii) As regards the going concern issue he stated that the Auditing Standard 23 (now ISA 570)
(Going Concern) prescribed two courses of action for the going concern problem, i,e, (a) Going concern assumption appropriate but material uncertainty exists and (b) Going concern assumption inappropriate. In the case of the first condition, if adequate disclosure is made in the financial statements, the auditor should express an unqualified opinion but modify the auditors report by adding an emphasis of matter paragraph. However, in extreme cases, the auditor may consider it appropriate to express a disclaimer of opinion (para.33 of ISA 23). However, if in the auditors' judgment, the entity will not be able to continue as a going concern, the auditor should express an adverse opinion if financial statements have been prepared on the going concern basis (para.35 of ISA 23). Therefore, according to him, adverse opinion is required to be given only when the disclosure regarding the going concern problem is not given in the accounts and the situation involves material uncertainties that are significant to the financial statements or the auditor in his judgment opines that the situation has gone farther than the realm of uncertainty, and the entity will not be able to continue as. a going concern. In light of ISA 23, he in the professional judgment concluded that the Company is not going to be liquidated in the near future, as all the bank borrowings have been settled, the directors provided financial assistance to pay off the liabilities and their support is available in future. The company has closed its operations for many years, and is still a going concern, and has survived litigation in the banking court and auction of its assets.
"Management plans to deal with these events and conditions" are required to be disclosed, if the going concern assumption is appropriate and material uncertainty exists, and an emphasis of matter is included in the audit report. Since due to his judgment he concluded that the going concern assumption appropriate but material uncertainty exists he concluded an emphasis of matter paragraph in the report. The omission of management's plans to deal with the situation is only unintentional.
(iv) There is no change in the comparative figures as compared to the financial statements for the year ended June 30, 2003 and is in line with the practice of the listed-companies.
10. He, however, admitted the lapses in the audit report and disclosers in the financial statements and submitted that they are purely unintentional and have not been made to mislead or hide material facts. He drawing attention on the size of the balance sheet and financial position of the Company, requested for a lenient view and requested to condone the lapses by assuring that he will be more careful in future.
11. I have heard Mr. Saud Ansari and have also gone through the submissions and the relevant provisions of law and relevant auditing standards and I am of the view that the arguments given by the auditor are not convincing. Pa ra.86 of IAS 1 (Presentation of financial statements) states that a complete set of financial statements includes statement of changes in equity as one, of its components. The auditor's argument that the Company being on the defaulters desk of KSE, does not come under the preview of the provisions of law, applicable to the listed-companies does not carry any weight as the company though on defaulters counter is still a listed company and as per subsection (3) of section 234 of the Ordinance, is required to follow the requirements of IAS while preparing the financial statements. The Company being a listed entity was required to comply with the aforesaid provision of law and the auditor was required to report thereon and issue an audit report as per the format given in Form 35-A which -required an opinion on the statement of changes in equity.
12. The argument of the auditor that the accounts of the company have been prepared on going concern assumption is not based on true facts and need some discussion in light of the relevant legal provisions. Circular No,11 of 2002 dated November 11, 2002 issued by ICAP provides guidance to the auditors on the reporting on going concern assumption. The said circular clearly states the following indicators, which suggest material uncertainty regarding the appropriate ness of the going concern assumption: ' Negative capital and reserve, ' Current liabilities in excess of current assets, Default in repayment of debt instalments, ' The directors in the director's report have failed to report or to mention any strategy to overcome the liquidity problems being faced by the Company and the company's plan to manage the repayment of debts and recover losses.
' I have noted that the management itself has given a negative assessment of going concern in the note 5 of the accounts and did not mention any strategy to overcome the liquidity problem and the plans for the recovery of huge losses. Moreover, the director's report is silent on the going concern issue and does not discuss the future prospects of the Company. The Company has accumulated losses to the tune of Rs,30,284,646 and its current liabilities have exceeded its current assets by Rs,4,584,646. The manufacturing operations of the Company have been discontinued; the factory has been closed for number of years and all the staff has been laid off. The Company has also been placed on the defaulters desk of the stock exchange. Note No 4 of the accounts states that PICIC had filed a recovery suit for the recovery of dues in the Banking Court, which stands decided against the Company. Lease hold land, factory building and plant and machinery had been attached by the Court and been auctioned and the auction proceeds were used to settle the borrowing from P.I.C.I.C., U.B.L. And First Allied Bank Modarba. It was also noticed that even winding up proceedings have been initiated against the Company but the auditor was not aware of this fact.
13. During the course of hearing Mr. Saud Ansari was asked as to whether he had followed the requirements of Auditing Standard, ISA-570 (Going Concern) to form a judgment on the appropriateness of the going concern assumption but he could not give an appropriate response.
At this point, it is necessary to look at the requirements of Auditing Standard, ISA- 570, which provides comprehensive guidelines with regard to indications of possible going concern issue and procedures to be performed to adequately address it. Its para.2 requires that when planning and performing audit procedures and in evaluating results thereof, the auditor should consider the appropriateness of the going concern assumption underlying the preparation of the financial statements. Moreover, the Standard also provides a list to exemplify the possible indications of risk regarding going concern that could be considered by the auditors. These are: Financial Indications ' Net liability or net current liability position.
' Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment.
Or excessive reliance on short-term borrowings to finance long-term assets.
' Indications of withdrawal of financial support by debtors and other creditors.
' Adverse key financial ratios.
' Substantial operating losses.
' Arrears or discontinuance of dividends. Inability to pay creditors on due dates.
' Difficulty in complying with the terms ( I loan agreements.
' Change from credit to cash-on-delivery transitions with suppliers.
' Inability to obtain financing for essential new :-:duct development or other essential investments.
Operating Indications ' Loss of key management without replacement.
' Loss of a major market, franchise, licence, or principal supplier.
' Labour difficulties or shortages of important supplies. Other Indications ' Non-compliance with capital or others tutory requirements.
' Pending legal proceedings against the entity that may, if successful, result in claims that are unlikely to be satisfied.
' Changes in legislation or government policy expected to adversely affect the entity.
' Para.12 of the Standard requires that the auditor should remain alert for evidence of events or conditions, which may cast significant doubt on the entity's ability to continue as a going concern throughout the audit. If such events or conditions are identified, the auditor should, in addition to performing the procedures in paragraph 26, consider whether they affect the auditor's assessm ents of components of audit risk. Para.26 of the Standard requires that when events and conditions are identified which may cause significant doubt on the entity's ability to continue as a going concern, the auditor should:
(a) Review management's plans for future actions based on the going concern assessme nt;
(b) Gather sufficient appropriate audit evidence to confirm or dispel whether or not a material uncertainty exists through carrying out procedures considered necessary, including considering the effect of any plans of management and other mitigating factors; and
(c) Seek written representations from the management regarding the plans for future actions.
' Procedures that are relevant in this connection have also been identified and are as follows: - Analyzing and discussing cash flow, profit and other relevant forecasts with management. - Analyzing and discussing the entity's latest available interim financial statements. - Reviewing the terms of debentures and loan agreements and determine whether any have been breached. - Reading minutes of the meetings of shareholders, the Board of Directors, and important committees for reference to financing difficulties. - Inquiring of the entity's lawyer regarding the existence of litigation and claims and reasonableness of management's assessments of their outcome and the estimate of their financial implications. - Confirm the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds. - Consider the entity plans to deal with unfilled customer orders. - Reviewing events after period end to identify those that either mitigate or otherwise effect the entity's ability to continue as a going concern.
' At the time of hearing the auditor was inquired about the compliance of the aforesaid requirements of the standard but he failed to provide a satisfactory response nor made any submissions.
14. The auditor's argument that in his judgment the going concern assumption was appropriate but material uncertainty exists, made him to include an emphasis of matter paragraph in the report is unfounded due to the fact that he himself has stated in the submissions provided that "Management plans to deal with these events and conditions" are required to be disclosed, if the going concern assumption is appropriate and material uncertainty exists. He has also admitted that there is an omission of the management plans in the management assessment of going concern. In this respect, the guidance contained in para.32 of the Auditing Standard 570 (Going Concern) is reproduced below: "If the use of the going concern assumption is appropriate but a material uncertainty exists, the auditor should consider whether the financial statements:
(a) adequately describe the principle events or conditions that give rise to the significant doubt on the entity's ability to continue in operation and management's plans to deal with these events or conditions.
(b) clearly state that there is material uncertainty related to the events or conditions which may cast significant doubt on the entity's ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business. "
' The deficiency of the aforesaid disclosures by the management makes it clear that the use of going concern assumption in was inappropriate.
15. The entity's continuance as a going concern for the period exceeding one year is assumed in the preparation of financial statements. In this case the Company was no more a going concern on the date of signing of the audit report. There were several indicators, which have already been discussed in the preceding paragraphs that could have confirmed the inappropriateness of going concern assumption. In the circumstances, it was the duty of the auditors to give an adverse opinion on the going concern assumption and bring this fact and violation of International Accounting Standards to the knowledge of the shareholders in his report. In my view the auditor has failed to give an adverse opinion on the going concern issue in the report to the shareholders.
There were significant indications that the going concern assumption was unfounded. The auditor, thus, has failed to take reasonable level of care while performing his duties.
16. As regards the auditors' argument that there is no change in the comparative figures as compared to the financial statements for the year ended June 30, 2003 is not satisfactory as Note 17.2 of the accounts under review states that the corresponding figures of the previous year have been re-arranged wherever necessary, to facilitate comparison.
17. Before deciding this case, I deem it necessary to make some observations on the role of auditors of a company. The auditors being the ultimate watchdog of the shareholders interest are required to give a report on the accounts and books of account after conducting the audit in accordance with the prescribed procedures and requirements of the Ordinance, International Accounting and Auditing Standards. The shareholders are the ultimate entity to whom the auditors are responsible and they must keep this fact in mind while auditing the books of accounts and reporting thereon.
18. The duties and responsibilities of an auditor appointed by the shareholders under section 252 of the Ordinance can best be understood if we look at the place of an auditor in the scheme of the company law. The capital required for the business of a Company is contributed by its shareholders who may not necessarily be the persons managing the company. In the case of a listed-company, the general public also contributes towards the equity of the Company. Such persons do not have any direct control over the company except that they elect directors for a period of three years and entrust the affairs of the company to them in the hope that they will manage the Company to their benefits. The shareholders are, therefore, the stakeholders and the ultimate beneficiaries. Practically, however, the shareholders have no control over the way their company is managed by the Directors appointed by them. It is, therefore, necessary that there must be some arrangement in place whereby the shareholders who are the real beneficiaries must get some independent view as to how the Directors have managed the affairs of the Company.
The law, therefore, recognizing this situation, has provided that the shareholders should appoint an auditor who shall be responsible to audit the accounts and books of account and make out a report to them at the end of each year. This is the only safeguard provided by law to the shareholders to ensure that the business is carried on by the Directors in accordance with sound business principles and prudent commercial practices and no money of the Company is wasted or misappropriated.' The law, therefore, make the auditors responsible in case they fail to make out a report in accordance with the legal requirements. It is, therefore, extremely important for the auditors to be vigilant and perform their duties and obligation with due care while auditing the accounts and books of accounts.
19. In view of the forgoing, the lapses and non-compliances on the part of the Auditors cannot be taken lightly. Considering the admission of default by the Auditors and circumstances of the case as discussed above, I am of the view that Mr. Saud Ansari, FCA has signed the audit report otherwise than in conformity with the requirements of section 255 of the Ordinance and rule 17-A of Rules and has made himself liable for punishment under subsection (1) of section 260 of the Ordinance and Rule 35 of the Rules. Accordingly, I impose a fine of Rs,20,000 (Rupees twenty thousand only) on Mr. Saud Ansari, FCA.
20. Mr. Saud Ansari, FCA is directed to deposit the fine of Rs,20,000 (Rupees twenty thousand only) in the Bank Account of Securities and Exchange Commission of Pakistan maintained with Habib Bank Limited or Demand Draft drawn in favour of SECP within 30 days of the date of this order and to furnish a receipt/Bank voucher to the Securities and Exchange Commission of Pakistan.