' Under section 260(1) and section 492 read with section 476 of the Companies Ordinance, 1984.
' ALI AZEEM IKRAM, DIRECTOR ENFORCEMENT.---This order shall dispose of the show-cause proceeding initiated against Messrs Mahboob Sheikh & Co., Chartered Accountants (Auditor), a sole proprietorship managed by Mr. Mahboob Ahmed Sheikh, through show-cause notice dated July 05, 2007 under sections 260 and 492 read with section 476 of the Companies Ordinance, 1984 (the "Ordinance") in respect of Hakkim Textile Mills Limited (the "Company").
2. The facts leading to this case, briefly stated, are that the Auditor audited accounts of the Company for the year ended June 30, 2006 (Accounts). The examination of the Accounts revealed that the Auditor has qualified his report as due to non availability of record he was unable to:-- * physically verify the assets; and * verify debtors, creditors, advances, deposits and prepayments, accrued expenses and gratuity which were all written off during the period ' The Auditor also drew member's attention towards going concern inability of the Company.
3. The Enforcement Department examined the Accounts of the Company to determine, among other things, whether the Auditor's report pertaining to the aforesaid financial year has been made in conformity with the requirements of section 255 of the Ordinance. A detailed scrutiny of the Accounts in the light of the provisions of the Ordinance, International Accounting Standards (IASs) and International Standards on Auditing (ISAs) revealed following irregularities:--
(i) Limitation on Scope:-- The Auditor could not verify almost 98.9% of the total assets due to non-availability of record. Para 38 of ISA 700 (The Auditors' Report on Financial Statements) provides that a disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the Auditor has not been able to obtain sufficient appropriate audit evidence and accordingly is unable to express an opinion on the financial statements. However, despite the material and pervasive effect of said limitation on scope, the Auditor issued a qualified report to the members.
(ii) Corresponding Figures:-- The corresponding figures given in the Accounts under review were unaudited. Para 18 of ISA-710 (Comparatives) requires that when the prior period financial statements are not audited, the incoming auditor should state in the auditor's report that the corresponding figures are unaudited.
However, the Auditor failed to disclose this fact in his report.
(iii) Going Concern Assumption:-- In Auditor's opinion the Company was not going concern yet the Accounts of the Company were prepared on going concern basis. The Auditor drew member attention towards going concern inability while Para 35 of ISA 570 (Going concern) requires that if in the auditor's judgment, the entity will not be able to continue as a going concern, the auditor should express an adverse opinion if the financial statements have been prepared on a going concern basis.
(iv) Other non-Compliances:-- The Auditors report was also silent about the irregularities stated below:-
(a) The Company suffered loss during the period under review; however, the Auditor used the word "profit" in opinion paragraph of his report.
(b) Accounting policies for exchange gain & loss and deferred cost were contrary to requirements of the 4th Schedule of the Ordinance.
(c) Accounting policy for deferred taxation was not in compliance with the requirements of IAS-12 (Income Taxes).
(d) The. Company was not charging depreciation on its fixed assets since 2000. Which is contrary to the requirements of IAS-16 (Property, Plant & Equipment).
(e) The treatment of revaluation surplus was contrary to the requirements of section 235 of the Ordinance read with S.R.O 45(1)2003.
(f) Following disclosures were not made in accordance with the requirements of IAS:-- * Timing of instalments of long-term loans was not disclosed as required by Para. 60 of IAS-32 (Financial Instruments: Disclosure and presentation). * Date of authorization for issue of Accounts and from whom such authorization been made was not disclosed as required by Para. 17 of IAS-10 (Events after Balance Sheet Date). * Loss per share was not disclosed as per Paras. 69 & 70 of IAS-33(Earning per Share). * Disclosure regarding corresponding figures was not in line with Para. 38 of IAS-1 (Presentation of Financial Statements).
(g) As per record available in the office the appointment of the Auditor was made on October 31, 2006 while the Auditors report of the Company was signed on September 30, 2006. The aforesaid amounted to misstatement in the Auditors report.
4. In view of the above, the Enforcement Department felt concerned' about the quality of the audit conducted by the Auditor and the audit report made on the Accounts of the B Company.
Consequently, a notice under section 260 and section 492 read with section 476 of the Ordinance dated July 05, 2007 (SCN) was issued to the Auditor. Reply to the SCN was received from the Auditor, vide letter dated July 19, 2007, stating that in paragraph (a) of the Auditor's report he has stated his inability to verify anything due to non-availability of any record, hence, the report in fact showed a disclaimer of opinion and not a qualified opinion. He argued that as he has expressed a disclaimer of opinion, therefore he was not responsible for any discrepancy in financial statements of the Company. He further contended that the discrepancies mentioned in the SCN did not jeopardize the interest of any user of financial statements as the Company has closed down its business since. 1999 and the management of the Company intends to liquidate it. Regarding the appointment issue it was informed that the appointment was made on October 31, 2005. A copy of Form 29 was also submitted as evidence.
5. Being not satisfied with the representation made by the Auditor the case was fixed for hearing on August. 1, 2007 which was adjourned on the request of the Auditor. The matter was finally heard on August 16, 2007. On the date of hearing, Mr. Mahboob Ahmad Sheikh appeared before the undersigned and reiterated his earlier stance. Subsequent to the hearing the Auditor submitted a written representation vide letter dated August 24, 2007 which contained following submissions:--
(i) The objection is that the language used in Auditors Report =is not exactly the same as of International Auditing Standards. We have stated in our report to the members that:-
(a) Due to non-availability of record we
(b) were not able w verify the assets of the company.
(c) Sufficient record was not available to verify the writes off of debtors, creditors, advances deposits and prepayments, accrued expenses and gratuity
(d) The Company has no sufficient funds for the payment of loan resdheduled by the bank. The Company is not operating for the last seven years therefore is riot a going concern.
(ii) It was reported in the Auditors report that the Accounts otherwise give true and fair position of the results of the company and there was nothing in the Accounts other than the facts stated above.
(iii) All the three points mentioned above certainly show that the Auditor could not verify any amount appearing in the Accounts. A' man of ordinary prudence, having a little knowledge of accountancy, will certainly get the impression that it is a disclaimer.
(iv) In terms of section 260 of the Ordinance the auditor is only liable if he fails to bring out the material facts about the affairs of the company and such default is wilful. In the instant report the default is not wilful as we have discussed all the material items in the report.
(v) The interest of any shareholders was not jeoparadized. There is no trading in the shares of the Company. Over 80% shares are held by the Directors and their Associates.
6. I have thoroughly considered the submissions of the Auditor; however, I do not find myself convinced with the arguments presented before me. In terms of section 255 of the Ordinance the Auditor was required to report, among other things, whether or not the Accounts of the Company conform to the approved accounting standards, give the information as required by the Ordinance and give a true and fair view of the Company's state of affairs. The Auditor was also required to follow the applicable auditing standards. However, the Auditor has not only failed to report the non-compliances with the IAS's and the Ordinance, as referred above, but has also failed to make his report in accordance with the ISAs. The Auditor's plea that he has issued a disclaimer of opinion on the. Accounts is groundless and without any merit. The disclaimer of opinion means that an Auditor does not express an opinion on the financial statements due to the significance of his observations. However, in the instant case, though the material and pervasive effect of limitation on scope as reported in Para (a) of the Auditor's report required a disclaimer of opinion, the Auditor expressed a qualified opinion. For ease of reference the relevant paragraphs of the Auditor's report are quoted below:-- Quote
(a) in our opinion, due to non-availability of record we are not able to physically verify the assets of the company. We also draw attention to note # 20 where the company writes off its debtors, creditors, advances, deposits and prepayments and accrued expenses, gratuity whereas the record available are not sufficient for audit purpose to verify this action.
(b) in our opinion:
(c) the balance-sheet and profits and loss account together with the notes thereon have been drawn up in conformity with the Companies Ordinance, 1984, and are in agreement with the books of account and are further in accordance with accounting policies consistently applied.
(d) the expenditure incurred during the year was for the purpose of the company's business; and
(e) the business conducted, investments made and , expenditure incurred during the year were in accordance with the objects of the company;
(f) in our opinion, and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof conform with the approved accounting standards as applicable in Pakistan, and, give the information required by the Companies - Ordinance, 1984, in the manner so required and respectively give a true and fair view of the state of the company's affairs as at June 30, 2006 and of the profit, its cash flows and changes in equity for the year then ended, subject to our observation, mentioned thereto,
(g) we draw attention that the company has no sufficient funds for the payment of the loan rescheduled by the bank. The company is not operating for the last seven years, therefore it is not a going concern. The value of assets shown in the balance sheet is lower than the realizable value of these assets.
(h) in our opinion no Zakat is deductible at source, under the Zakat and Ushr Ordinance, 1980.
Unquote
7. The format of an audit report as provided in the ISAs is such that the opinion paragraph concludes the effect of all qualifications arising due to limitations on scope, going concern uncertainty or disagreement with the management on accounting policies etc. Thus the Auditors' liability is not merely to state qualifications in the report, but the severity or otherwise of their impact should have been appropriately and clearly expressed in the opinion paragraph. In the present case, the Auditor has not only failed to report all irregularities but by issuing a qualified opinion the auditor has also diluted the material and pervasive effect of the issues reported by him.
Furthermore, the Auditor's statement that his report gives an impression of a disclaimer is not sustainable as the law requires the auditor to form an opinion on the financial statements based on the audit. Such opinion should be expressed in clear and explicit terms and the auditor should not leave it to the shareholders to infer. In this connection, I refer to the case of---London and General Bank Ltd. (1895) 2 Ch 166 wherein it was observed by the court that 'A person whose duty is to convey information to others, does not discharge that duty by simply giving them, so much information as is calculated to induce them, or some of them, to ask for more. ...The duty of an auditor is to convey information, not to arouse inquiry and although an auditor might infer from an unusual statement that something was seriously wrong, it by no means follows that ordinary people would have their suspicions aroused by a similar statement.... '
8. Now I come to the issue of wilfulness. I do not concur with the Auditor's statement that the default was not wilful. In this connection, I find it quite relevant to refer to the order of the Appellate Bench of the Commission in the case of Shaikh Jalaluddin, FCA v. Commissioner (Enforcement). Which was upheld by the Honorable Sindh High Court in an appeal filed by the auditor in that case. n the said order the auditor who was penalized argued that his default was not wilful although he had failed to comply with the provisions of the law and applicable auditing standards. The Appellate Bench while holding that his default was indeed wilful observed that "In the case of City Equitable Fire Insurance Co. Ltd. Re, 1925 Ch 407. It was held that a default. In case of breach of duty, will be considered 'wilful' even if it arises out of being recklessly careless, even though there may not be knowledge or intent. Simply put, if the Appellant admits to know the auditing standards and claims to have followed them when in reality, as proven above he has not, then keeping in view his status as a professional and his duty as a fiduciary he should be held to be wilfully in default." In the instant case the Auditor admits to be acquainted with the ISAs and in his report he claims to have followed them. However. While making report on the Accounts of the Company he has not followed the ISAs. Thus the Auditor is held to be wilfully in default.
9. It is clear from the preceding paragraphs that the Auditor has signed the audit report otherwise than in conformity with the requirements of section 255 of the Ordinance and has made himself liable for punishment under section 260(1) of the Ordinance.
10. For the forgoing, I impose a fine of Rs,25,000 (Rupees twenty five thousand only) on Messrs.
Mahboob Sheikh & Co., Chartered Accountants, tinder section 260(1) of the Ordinance instead of imposing a maximum penalty of Rs,100,000 (Rupees E one hundred thousand). However, since the evidence provided by the Auditor confirming his appointment on October 31, 2005 has been found satisfactory; therefore, no penalty is imposed under section 492 of the Ordinance.
11. The Auditor is hereby directed to deposit the fine of Rs,25,000 (Rupees twenty five thousand only) in the Bank Account of Securities and Exchange Commission of Pakistan maintained with Habib Bank Limited within 30 days of the date of this Order and furnish receipted bank voucher to the Securities and Exchange Commission of Pakistan.