Under Section 260(1) read with Section 255 and 476 of the Companies Ordinance, 1984 This order shall dispose of the proceedings initiated through show cause notice No. EMD/233/214/2002 dated September 3, 2004 (SCN) against M/s. Mansha Mohsin Dossani Khan & Co., Chartered Accountants under Section 260(1) read with Section 255 and 476 of the Companies Ordinance, 1984 (Ordinance).
2. In order to fully appreciate the issue in hand, it is necessary to have a glance into the relevant background facts of the case. Examination of the annual audited accounts of Ashfaq Textile Mills Limited (Company) for the year ended June 30, 2003 (accounts) revealed that M/s. Mansha Mohsin Dossani Khan & Co., (Auditor) has audited the accounts and has issued an unqualified report. However, scrutiny of the accounts revealed certain non-compliances with the provisions of the Ordinance, 4th Schedule and International Accounting Standards (IASs) as summarized below: I. Treatment of revaluation surplus: The policy for treatment of revaluation surplus was contrary to the provisions of Section 235 of the Ordinance read with S.R.O. 45(I)/2003 dated January 13, 2003 and IAS-16 (Property, Plant & Equipment). The Company failed to transfer incremental depreciation from surplus on revaluation of fixed assets account to accumulated profit/loss account through statement of changes in equity.
II. Accounting policies: The accounting policies for deferred taxation and stores & spares were not found in accordance with IAS-12 (Income Taxes) and IAS-2 (Inventories) respectively.
III. Disclosures requirements of IAS and 4th Schedule: The Company has not followed the disclosure requirements of IAS and 4th Schedule in respect of following: i. Disclosure of staff retirement benefits was not in accordance with Para 120 of IAS-19 (Employee Benefits). ii. Disclosure of liabilities against assets subject to finance lease was not in line with Para 23 of IAS- 17 (Leases). iii. Major components of tax expense and relationship between tax expense and accounting profit was not disclosed as per Para 79 and 81 of IAS-12 (Income Taxes). iv. Reasons for departure from IAS-16 (Property, Plant & Equipment) and IAS-19 (Employee Benefits) were not disclosed as per requirement of Para 13 of IAS-1 (Presentation of Financial Statements). v. Disclosure regarding exchange differences arising on foreign currency transactions was not made as per Para 42(a) of IAS-21 (The Effects of Changes in Foreign Exchange Rates). vi. Accounting policy relating to provisions was not given as required by Para 97 of IAS-1 (Presentation of Financial Statements). vii. Disclosure of re-arrangement of corresponding figures was contrary to requirements of Para 40 of IAS-1 (Presentation of Financial Statements). viii. Disclosures regarding revalued amounts of fixed assets were not in line with Para 2(c) of Part II of 4th Schedule and Para 64 of IAS 16 (Property, Plant & Equipment). ix. Distinction of freehold and leasehold land was not made as required by Para 2 of Part II of 4th Schedule. x. Non-disclosure of plant capacity as per Para 2(vii) of Part I of 4th Schedule.
3. For the foregoing, the Enforcement Department was of the view that the Auditor should have reported the said irregularities through modification of opinion. Consequently, a SCN was issued to the Auditor on September 03, 2004. The Auditor filed an appeal in the Lahore High Court, Rawalpindi Bench (Court), against the said SCN which was dismissed on January 31, 2005. The Auditor, therefore, was asked to submit written explanation and also appear before Director (Enforcement) on February 16, 2005. Mr. Khan Muhammad, FCA, submitted a written representation to the SCN and appeared before the Director (Enforcement) on the said date to argue the case. The Director (Enforcement) based on written representation and admission of default by the Auditor during the proceedings of the hearing passed an Order on February 18, 2005 and imposed a penalty of Rs.
20,000/- on Mr. Khan Muhammad who assumed the sole responsibility for the audit of the accounts. Mr. Khan Muhammad, however, being not satisfied with the Order of Director (Enforcement) filed an appeal in the Court. The Court in its Order dated August 01, 2007 remanded back the aforesaid Order declaring it to be defective for failing to specify the precise factual defaults of the Auditor and directing the Commission to pass a fresh Order based on the record after grant of hearing.
4. In compliance with the direction of the Court the matter was heard by the undersigned on August 30, 2007. Mr. Khan Muhammad, on our advice, also submitted a written reply before the hearing date. On the date of hearing, Mr. Aftab Hameed, FCA (Counsel) appeared to argue the case as an authorized representative of Mr. Khan Muhammad. Mr. Khan Muhammad also attended the hearing. During the course of hearing all issues were discussed in detail with the Auditor and his Counsel. The Auditor and his Counsel offered almost similar arguments as were earlier submitted in the written representation. The contentions raised by them are summarized in Paragraphs below: 4.1) Treatment of revaluation surplus contrary to Section 235 of the Ordinance and IAS-16: The Company adopted policy of realization of revaluation surplus at time of disposal in line with Section 235(2) of the Ordinance. The Company's policy of realizing whole amount of surplus on disposal of assets was also in line with Para 39 of the IAS-16 (Property, Plant & Equipment). The proviso added by the Companies (Amendment) Ordinance 2002, for treatment of incremental depreciation was not mandatory and the amount involved was not material, therefore, the Company continued its previous accounting policy. Moreover, SRO # 45 dated 13-01-2003 was not followed by the Company due to some ambiguity. The language of the law i.e. Section 235 of the Ordinance is very much clear in its letter and spirit, therefore, SRO cannot supersede the law.
Accordingly, there was no reason to modify our audit report on this issue.
4.2) Accounting Policies 4.2.1) Accounting policy for deferred taxation: The Company falls in the ambit of presumptive tax regime therefore deferred tax accounting does not apply to the Company.
4.2.2) Policy regarding stores and spares: Policy regarding stores & spares was appropriate as the same were always purchased for consumption. Further, determination of Net Realizable Value (NRV) was impracticable.
Subsequently, the Company changed its policy to bring it in line with lAS-2 (Inventories) and observed no financial impact.
4.3) Disclosure Requirements of IAS and 4th Schedule 4.3.1) Disclosure of staff retirement benefits: A qualified actuary was not involved, as permitted by Para 57 of IAS-19 (Employee Benefits), because in the opinion of management, the carrying amount of liability recognized at the balance sheet date was more than approximate amount required to settle the liability and the Auditor was agreed with the management view point. This valuation was based on estimates, averages and approximation made by the Company which is also allowed by Para 51 of said IAS. Keeping in view the assumptions made by the management and after due satisfaction a clean audit report was issued.
4.3.2) Liabilities against assets subject to finance lease: The relevant disclosure was made in note 7 to the accounts.
4.3.3) Major components of tax expense and relationship between tax expense and accounting profit: Tax expense of the Company comprises only current tax which was disclosed in note 28 to the accounts.
4.3.4) Disclosure regarding exchange differences arising on foreign currency transactions: As disclosed in note 2.14 to the accounts that the exchange differences are adjusted in the period of realization and the Company has no other exchange differences except differences arising on sales, therefore the amount of exchange difference of Rs.179,515/- being immaterial was not disclosed separately.
4.3.5) Accounting policy relating to provision: The accounting policy relating to provisions has been duly given in note 2.4 to the accounts.
4.3.6) Disclosure of re-arrangement of corresponding figures: Disclosure was given due to general practice to ensure and facilitate the users that the corresponding figures are quite comparable. The standard does not strictly prohibit such disclosure. There being no material rearrangement/regrouping of figures of the corresponding period no specific disclosure was required.
4.3.7) Disclosure of revalued amount of fixed assets: Disclosures in this respect have been given in note 4 and 13 to the accounts. The disclosure of basis of revaluation and effective date of revaluation was made in the period in which revaluation was carried out.
4.3.8) Distinction of freehold and leasehold land: The Company has no leasehold land therefore no such distinction was necessary.
4.3.9) Non-disclosure of plant capacity: Normal capacity of the plant was not disclosed however proper reason for non-disclosure was given. Under the law disclosure of plant capacity is only required where it is determinable.
4.3.10) Departure from IAS-16 (Property, Plant & Equipment) and IAS-19 (Employee Benefits): As the provisions of IAS-16 (Property, Plant & Equipment) and IAS-19 (Employee Benefits) have been duly complied with therefore, requirements of Para 13 of IAS-1 (Presentation of Financial Statements) were not at all applicable in this case.
5. In addition to the specific reply on the issues raised in the SCN, as stated above, some general objections were also made. It was argued that SCN was devoid of any legal sanction and was issued in transgression of the authority. In this regard, Commission's SRO 183 (1) 2001 dated 20 March, 2001 read with SRO 862 (1) 2000 dated December, 2000 and Section 474 of the Ordinance were referred. It was further contended that the audit was carried out in accordance with all the applicable provisions and requirements of the Ordinance, International Standards on Auditing
(ISAs) and IASs and no default was committed at all as the issues raised in the SCN were not so material to justify a modified opinion. It was further asserted that no admission of any default was ever made before the Commission during previous representation.
6. I have carefully examined the arguments offered by the Auditor and his Counsel and have also studied the record placed before me in detail. I have also got through the relevant provisions of the Ordinance and applicable IASs & ISAs. Regarding some issues I have found the Auditor's response satisfactory; however, I am not convinced with the Auditor's stance in following matters: 6.1. Treatment of revaluation surplus: SRO # 45 dated 13-01-2003 was issued to ensure consistency of Section 235 of the Ordinance with the requirements of IAS-16 (Property, Plant and Equipment) and IAS-12 (Income Taxes). The Commission was competent authority to issue such notification under Section 514 of the Ordinance read with Section 43(c) of the Securities and Exchange Commission of Pakistan Act, 1997. The Companies were therefore required to comply with the said notification.
6.2. Accounting Policy for deferred taxation and stores & spares: Accounting policies should be in line with IASs. Subsequently, the Company has changed its policy for inventories in compliance with IAS-2 which shows the Auditor's claim that the determination of NRV was impracticable is not valid.
6.3. Major components of tax expense and relationship between tax expense and accounting profit: ICAP's opinion 1.3 in volume X of its Selected Opinions has clarified that disclosure of relationship between tax expense and accounting profit should be made in all circumstances.
6.4. Disclosure of re-arrangement of corresponding figures: IAS does not allow such a general disclosure. If there was no material rearrangement / regrouping of corresponding figures, the same should have been disclosed.
6.5. Disclosure of revalued amount of fixed assets: Following disclosure under Para 64 of IAS-16 substituted 4th Schedule were not made. Basis used to revalue the assets The effective date of revaluation The carrying amount of each class of revalued property, plant and equipment that would have been included in the financial statements had the assets been carried at cost less accumulated depreciation. Total amount of reduction or revaluation excluded from or included in book value of assets in every balance sheet subsequent to revaluation.
The Auditor's plea that these disclosures were made at the time of revaluation is not acceptable because the said disclosures are required whenever the items of Property, Plant & Equipment are stated at revalued amounts.
6.6. Non-disclosure of plant capacity: Plant capacity has been disclosed in the subsequent accounts hence the plea that it was difficult to determine plant capacity is not valid.
6.7. Departure from IAS-16 (Property, Plant & Equipment) and IAS-19 (Employee Benefits): As discussed above the Company has not fully complied with the requirements of IAS-16.
7. Besides, the Auditor's objections regarding authority of the SCN are also not legitimate. The jurisdiction to take cognizance of the contravention under Section 260 of the Ordinance has been duly delegated to Director (Enforcement) under S.R.O 161(I)/2004 dated March 17, 2004. Director (Enforcement) was, therefore, competent to take action under Section 260 of the Ordinance.
8. In view of the preceding paragraphs, I do not concur with Auditor's claim that there was no default at all. I, however, agree to the auditors' view that the impact of the said discrepancies on the financial statements was not so material to require the Auditor to modify his opinion. However it is noteworthy to mention that as per the clear guidance available in the International Auditing Standards, in situations that do not affect the audit opinion an auditor is still required to emphasize upon the said discrepancies by means of adding emphasis of matter paragraph to his report. For the foregoing, instead of imposing penalty under Section 260 of the Ordinance, I, hereby warn the Auditor to be careful in future.