Under Sub- Section (1) of Section 260 read with Section 255 and 476 of the Companies Ordinance, 1984 This order shall dispose of the show cause proceedings initiated against M/s Sarwars, Chartered Accountants through show cause notice dated January 27, 2005 under sub-section (1) of Section 260 read with Section 255 and 476 of the Companies Ordinance, 1984 (the "Ordinance") in respect of Mehr Dastigir Textile Mills Limited (the "Company").
2. The facts leading to this case, briefly stated, are that M/s Sarwars, Chartered Accountants (hereinafter called "the auditors") were appointed as auditors of the Company in its Annual General Meeting held on January 31, 2004 to hold office until the conclusion of next Annual General Meeting. The auditors made their report on the accounts of the Company for the year ended September 30, 2004 (the "accounts") on December 29, 2004.
3. The Enforcement Department examined the accounts of the Company to determine, among other things, whether auditors report pertaining to the aforesaid financial year had been made in conformity with the requirements of Section 255 of the Ordinance, it is otherwise true, contains no such statement which is materially false and there is no omission of material facts about the affairs of the Company. It was observed that the auditors have given matter of emphasis which is reproduced below: 1.1) We have not audited the accounts of the company as at September 30, 2002, therefore we do not express any opinion on para no. (ii) and (d) of the auditors' report dated January 31, 2002 issued by M/s Yousuf Adil Saleem & Co., Chartered Accountants annexed to the Balance Sheet of the company as at September 30, 2002 and consequently the balance of those accounts mentioned in the said para above as at October 01, 2002 remain unconfirmed.
1.2) The company's current profit of Rs. 1,387,809 (after charge of Rs. 4,948,064 as depreciation on revalued assets) does not include the accumulated losses upto September 30, 2002 explanatory reference is made in note 3 and note 22 of the notes to the accounts for the year September 30, 2004. The company's current assets are Rs. 203.044 million as against current liabilities of Rs.
317.544 as at September 30, 2004, the current assets are not sufficient to meet the current obligation. The company has made efforts to increase its operations during the year to meet the foreseeable obligations; in our opinion adequate indicators exist to suggest uncertainty regarding appropriateness of going concern assumption. Despite this fact, the company has prepared its accounts on going concern basis. Consequently the financial statements (and notes thereto) do not disclose the adjustments required to the amount of recorded assets and liabilities and their classification.
Inspite of the matter of emphasis paragraph given above the auditor issued a clean report on the financial statement for the year ended September 30, 2004, as is evident from the opinion paragraph of the said report reproduced below for ready reference: In our opinion and to the best of our information and according to the explanations given to us, the balance sheet, trading, profit and loss account, cash flow statement and statement of changes in equity together with notes forming part thereof, conform with 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 company's affairs as at September 30, 2004 and of the profit/loss, its cash flow and changes in equity for the year then ended.
4. The examination of the accounts, however, revealed the following non-compliances with the International Auditing standards (ISA):
(i) Modification of audit report on unconfirmed opening balances The aforementioned emphasis of matter paragraph contains a reference to Para (ii) of the auditors' report dated January 31, 2002 issued by M/s Yousuf Adil Saleem & Co., Chartered Accountants on the Accounts of the company as at September 30, 2002 which states that the financial statement assertions remained unverified and unsubstantiated and that it was not possible for them to determine the correctness or otherwise of the balances given below and that due to the significance of the matters they express a disclaimer of opinion on the financial statements: {{TABLE}} Rupees in millions S. No. Description Amount 1 Creditors, Advances from customers, Sales tax and Other liabilities 62.920 2 Accrued expenses 5.424 3 Trade debtors 8.016 4 Advances to suppliers, Letters of credit, Receivable from insurance co., Receivable from commercial banks and Others 1.456 5 Stock in trade 7.277 6 Transaction with associated undertaking 6.366 7 Handling and Commission Income 37.475 {{TABLE}} Para 18 of the Auditing Standard (ISA) 500 - Audit Evidence - states that if an auditor is unable to obtain sufficient appropriate audit evidence then he should express a qualified or a disclaimer of opinion, whereas, M/s Sarwars, despite the above stated position, gave a clean report to the shareholders on the financial statements for the year ended September 30, 2004.
(ii) Modification of audit report due to disclaimer of opinion on corresponding years financial statements Audit report dated December 31, 2003 on the accounts of the Company for the year ended September 30, 2003 issued by M/s Sarwars, Chartered Accountants included qualifications with reference to the para (ii) and (d) of the audit report issued by M/s Yousuf Adil Saleem & Co., Chartered Accountants on the financial statements of the company for the year ended September 30, 2002 which relate to the following matters: Balances of accounts namely creditors, advances from customers, sales tax and other liabilities, accrued expenses, trade debtors, advances to suppliers, letters of credit, receivable from insurance co., receivable from commercial banks and others, bank balances, stores & spares, stock in trade, transaction with associated undertaking, handling and Commission Income and other liabilities were unconfirmed as at October 01, 2002.
Furthermore, the same report also included qualifications relating to the following matters :
(a) The company's current profit of Rs. 368,076 did not include the accumulated losses amounting to Rs. 268.748 million upto September 30, 2002.
(b) The equity of the company was in negative and current assets are Rs. 116.915 million as against current liabilities of Rs. 219.237 as at September 30, 2004, hence current assets were not sufficient to meet the current obligation. However, in the opinion of the auditor adequate indicators existed to suggest uncertainty regarding appropriateness of going concern assumption.
(c) Non-compliance of IAS - 12, IAS - 16 and IAS - 19.
Therefore based on the audit of the books of accounts of the company and due to the matters given above the opinion paragraph of the audit report on the financial statements for the year ended September 30, 2003 was modified in the following manner: Because of the effects of matters discussed in para 1.1 and 1,2 and (c) above and the significance of the matters we do not express an opinion on the financial statements to the extent and consequences rising there against; The conditions referred to above regarding balance confirmations, non-inclusion of accumulated losses and uncertainty regarding going concern assumption were still prevailing as at September 30, 2004 as is evident from the matter of emphasis given in the auditors' report on the financial statements as at September 30, 2004. However, in sharp contrast to the previous years' audit report the auditor did not modify his opinion expressed on the accounts of the Company for the year ended September 30, 2004 and gave a clean report. This clearly indicated a change in opinion on part of the auditor however, he failed to give substantive reasons for the different opinion in an emphasis of matter paragraph as provided in Para 25 of the ISA 710 - Comparatives - in this regard.
(iii) Modification of audit report on disclaimer of opinion on comparative figures Auditors also failed to modify their opinion in audit report on the financial statements for the year ended September 30, 2004 with respect to their observations expressed in audit report on previous year ended September 30, 2003. A disclaimer of opinion was expressed on last year financial statements for year ended September 30, 2003 on issues of unconfirmed opening balances, non-inclusion of accumulated losses in current year's profits and the uncertainty regarding the going concern assumption. These matters, as on the date of the said audit report issued on financial statements of the company for year ended September 30, 2004, were still unresolved. Accordingly, the observations on prior year figures, which were included in the financial statements for the year ended September 30, 2004, as an integral part thereof, were required to be discussed in the current years audit report on said the financial statements in accordance with Para 12 of the ISA 710 - Comparatives - which requires that when auditor's report on the prior period, as previously issued include a qualified opinion, disclaimer of opinion, or adverse opinion and matter giving rise to modification is unresolved, but does not results in a modification of auditor's report regarding the current period figures, the auditor's report should be modified regarding the corresponding figures.
(iv) Modification of audit report on misstatement in accounts Disclosure in Note 4.3 and 4.4 regarding confirmation of loan liability indicate that the banks have not confirmed the liability as per new arrangement under circular 29 of State Bank of Pakistan but the management has accounted for the benefits accruing due to the said circular thus understating the loan liability by Rs. 47.592 million. Moreover it has not provided markup to the tune of Rs. 47.580 million thereby overstating the profits of the company by the same amount. There is an apparent misstatement in the financial statements, however, the auditors' report does not draw attention of the member to same by way of either a matter of emphasis paragraph or a qualification.
(v) Modification of audit report on going concern issue In the auditors' judgment, as stated in the emphasis of matter paragraph reproduced above at sub-paragraph 1.2 of paragraph 3 , adequate indicators exist to suggest uncertainty regarding appropriateness of going concern assumption. Para 35 of the Auditing Standard 570 - Going concern - states that if in 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 are prepared on a going concern basis, however, M/s Sarwars have failed to do so.
5. In view of the above, Enforcement Department was concerned about quality of the audit conducted by the auditors and the audit report issued by them on the accounts of the Company.
Consequently, a notice dated January 27, 2005 was issued to M/s Sarwars, Chartered Accountants, a sole proprietorship. After repeated adjournments and extension in time the response in writing to the show cause notice was finally submitted to the Commission by him vide his letter dated March 08, 2005. In order to provide an opportunity of personal hearing, the case was fixed to be heard on June 10, 2005. However, a request for adjournment was received due to which the hearing was adjourned and held on July 07, 2005. On the date of hearing, Mr. Rashid Sarwar, FCA appeared before me to argue the case. The submissions made by him are discussed as under:
(i) Modification of audit report on unconfirmed opening balances Mr. Rashid Sarwar, FCA, in his reply has contended that the audit report dated December 31, 2004 was issued after studying para 7 and 9 of ISA 500 with special reference to para 8 of the said ISA and therefore, his report is in accordance with para 18 of ISA 500 .
It would be pertinent here to reproduce para 7 and 9 of ISA 500 these read as: Para 7 - ISA 500 Sufficiency is the measure of the quantity of audit evidence. Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for, or detecting misstatements in, the classes of transactions, account balances, and disclosures and related assertions. The quantity of audit evidence needed is affected by the risk of misstatement (the greater the risk, the more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the quality, the less may be required). Accordingly, the sufficiency and appropriateness of audit evidence are interrelated. However, merely obtaining more audit evidence may not compensate for its poor quality.
Para 9 - ISA 500 The reliability of audit evidence is influenced by its source and by its nature and is dependent on the individual circumstances under which it is obtained. Generalizations about the reliability of various kinds of audit evidence can be made; however, such generalizations are subject to important exceptions. Even when audit evidence is obtained from sources external to the entity, circumstances may exist that could affect the reliability of the information obtained. For example, audit evidence obtained from an independent external source may not be reliable if the source is not knowledgeable. While recognizing that exceptions may exist, the following generalizations about the reliability of audit evidence may be useful: Audit evidence is more reliable when it is obtained from independent sources outside the entity. Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective. Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the application of a control). Audit evidence is more reliable when it exists in documentary form, whether paper, electronic, or other medium (for example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of the matters discussed). Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles.
On perusal of these paragraphs, it is clear that these are not relevant to the issues raised in the notice since it related to the unconfirmed closing balance of the year 2002 due to which the previous auditor had given a disclaimer of opinion and based on the same, the audit report on the accounts of the company for the year ended September 30, 2003 was also issued with a disclaimer of opinion By M/s Sarwars.
At the time of the hearing Mr. Rashid Sarwar, FCA extended the same arguments, however, when questioned with the specific reference of Para 18 of the ISA 500 - Audit Evidence - he was unable to provide a satisfactory reply and admitted his default in compliance with the requirements of said provision in ISA 500.
(ii) Modification of audit report due to disclaimer of opinion on corresponding years financial statements It has been contended that the modification, qualification and emphasis of matter paragraph contained in auditors' report on the accounts of the company for the year ended September 30 2004 are identical to those contained in the audit report on the accounts of the company for the year ended September 30, 2003. The audit report on the accounts for year ended September 30, 2003 stands accepted, whereas, the report year ended September 30 2004 has been objected to.
The audit report on the accounts for the September 30 2004 was issued after consulting para 18 of the relevant ISA which states that the auditor should express a qualified opinion or a disclaimer of opinion, the audit report dated December 29, 2004 contained a qualified/disclaimer of opinion. ISA 700 in paras 28, 29 and 30 lays down the format of an unqualified report, types of modifications and matters that effect auditor's opinion and circumstances an auditor's report is modified by adding emphasis of matter paragraph respectively. Furthermore, Institute of Chartered Accountants has prescribed the format for audit report in accordance with the requirements of the Companies Ordinance, 1984. The audit report dated December 29, 2004 expresses the opinion on the truth and fairness of the financial statements after satisfying itself and bringing on record the observation of auditors in manner and the extent specified in the audit report, thus audit report is not inappropriate and contains modification and qualification already accepted in earlier years. In no way the said audit report can be called as unqualified and inappropriate.
On careful consideration of the contentions it appears that the arguments put forward by the auditors' is that they have issued a qualified report and the contention raised in notice regarding issuance of a clean report is unjust. In this regard the report issued by the auditors' needs to be examined in the light of ISA 700. The said ISA in para 5 provides the following basic elements of an audit report: i. Title ii. Addressee iii. Opening or introductory paragraph iv. Scope paragraph v. Opinion paragraph vi. Date of report vii. Auditor's address viii. Auditor's signatures The opinion paragraph further has two elements one being the reference to the financial reporting framework used to prepare the financial statements and the second being the all important expression of opinion on the financial statements. Para 30 of the same ISA states that the auditors' report can be modified by adding an emphasis of matter paragraph to highlight a matter affecting the financial statements. However, it is stated that the addition of an emphasis of matter paragraph does not effect the auditors' opinion. As regards qualified, disclaimer and adverse opinions para 37, and illustrations in para 44 and 46 of ISA 700 require that the words "except for", "do not express an opinion", and "do not give true and fair view" respectively should be used in the opinion paragraph. It is very clear from the perusal of audit report issued on December 29, 2004 on the accounts of the company for the year ended September 30, 2004 that it has not been modified to give a qualified opinion or disclaimer of opinion, although an emphasis of matter paragraph has been added but as clearly stated in ISA 700 and discussed above an emphasis of matter paragraph does not effect the auditors' opinion.
At the time of hearing the auditor once again argued that the report has been duly modified, however, when his attention was drawn to afore-referred paragraphs of ISA 700 and the same were read out to him he admitted that he accepted his default in modifying the opinion paragraph of his report.
(iii) Modification of audit report on disclaimer of opinion on comparative figures The auditors have taken the plea that the audit report dated December 29, 2004 was drawn up after carefully analyzing para 6(a), (b), 7, 10, 12(a), 17 and 20(a) & (b) of ISA 710 and accordingly the audit report addressed an adverse, qualified opinion by inserting a emphasis of matter paragraph disclaiming the previous auditors report on the accounts for the year ended September 30, 2002 and stating that balances as at October 01, 2002 remained unconfirmed.
The argument put forward by the auditors lacks merit because the comparative figures with reference to accounts in question are balances as at September 30, 2003 on which the auditor himself had given a disclaimer of opinion in his audit report on the financial statements then ended. It is apparent from bare reading of the audit report that the auditors have neither qualified his report on the current years figures based on the previous years qualification nor has he modified his report regarding the corresponding figures as required by the para 12 ISA 710. When this was pointed out to Mr. Rashid Sarwar, FCA during the hearing, he admitted his default.
(iv) Modification of audit report on misstatement in accounts It has been contended that notes to the accounts form an integral part of the balance sheet and cannot be read in isolation of the audit report and comments on the balance sheet. Note 4.3 has been read in isolation, note 7.4 is an integral part of Note 4.3 which states that the mark-up amounting to Rs. 47.580 Million has not been provided by company in mutual agreement of Muslim Commercial Bank. If the same had been provided it would have increased the accumulated losses and decreased the current year profit. The contention that notes to the accounts referred to in the notice related to the audit report of the year 2002 dated January 31, 2003, and as these accounts were not audited by him, thus no comments are called for on the issue was also raised.
The contention of the auditors needs to be examined in the light of para 30 of ISA 700 which states that: "In certain circumstances an auditors' report may be modified by adding an emphasis of matter paragraph to highlight a matter affecting the financial statements which is included in a note to the financial statements that more extensively discusses the matter."
It is amply clear from the para quoted above that although disclosure are made in the notes to the accounts the auditors is duty bound to at least refer these matters in his report which are affecting the financial statements of the company, however, the auditor has failed to do so.
At the time of hearing Mr. Rashid Sarwar, FCA strongly contested the issue as he was of the opinion that the referred note was not included in the financial statements for the year ended September 30, 2004 and was in fact part of the financial statements for the year ended September 30, 2002.
During the course of the hearing the relevant note No. 4.4 was read out to him from the accounts for the year ended September 30, 2004 and compared with the text as written in the show cause notice. It was clarified that the SCN has a typographical error only wherein note number has been mentioned as 4.3 instead of 4.4. He then accepted that the matter called for modification of the opinion paragraph of the audit report issued by him which he has failed to do.
(v) Modification of audit report on going concern issue The auditors contention in this regard was that the modification and qualification on the going concern issue was adopted consulting para 8 of ISA 570. Despite the fact that the notes to the accounts extensively defined the matter with which the auditors had their reservation, however, these were not satisfied and a qualified/modified/emphasized report was issued.
In this regard it is held that neither the accounts nor the notes attached thereto provide any justification of preparing the accounts on going concern basis. In fact this issue has not been discussed either in the accounts or in the notes appended thereto. According to para 34 of ISA 570 if adequate disclosure is not made in financial statements the auditor should express a qualified or adverse opinion, whereas the audit report in question only contain a modification by way of emphasis of matter paragraph. M/s Sarwars at the time of hearing admitted that he had defaulted in modifying the opinion paragraph of his report on this issue.
6. 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. It has, however, been noticed in several cases that auditors are not performing their statutory duties with due care and in accordance with the legal requirements.
7. 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 was, 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 failed 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.
8. In our socio-economic environment chartered accountants, who act as auditors of listed and other companies enjoy a position great respect. Accounts audited by them and reported upon carry a weight and are relied upon by various authorities and stakeholders. They are also often called upon to issue their certifications on various issues, by different authorities, stakeholders and also by international organizations, as a means to provide due comfort to these authorities, stakeholders and organizations for their intended purposes. Even otherwise, Chartered Accountants are viewed as very respected and noble professionals in our social fabric. For these reasons, it is further more important for the auditors to exercise due diligence in performing their duties and discharging their responsibilities. Their failure in exercising due professional care and diligence also amounts to a breach of trust which the society in general and statue in particular has reposed in them. Careless and casual attitude and not exercising due diligence by the auditors while discharging their responsibilities and issuing their reports may spell disaster for such trust and confidence.
9. Now, reverting to the present case, it is clear from the preceding paragraphs that the auditors failed to perform their professional duties with reasonable degree of care and skill. Moreover, at the time of hearing, Mr. Rashid Sarwar, FCA admitted that he has defaulted on the issues raised in the show cause notice and that the opinion paragraph of the audit report has not been modified to form a qualified or disclaimer of opinion. It is therefore viewed that the auditors have committed a breach of fiduciary duty cast upon them by the shareholders.
10. After careful consideration of the facts, the circumstances of this case and in view of admitted default, I, am of the view that Mr. Rashid Sarwar, FCA, the sole proprietor of the firm has signed the audit report otherwise than in conformity with the requirements of Section 255 of the Ordinance and committed a willful default in terms of Section 260 of the Ordinance and has thus made himself liable for punishment under Sub-section (1) of Section 260 of the Ordinance. Accordingly, I impose a fine of Rs 50,000 (Rupees Fifty thousand only) under Sub- section (1) of Section 260 of the Ordinance on Mr. Rashid Sarwar, FCA.
11. Mr. Rashid Sarwar, FCA is directed to deposit the fine of Rs 50,000 (Rupees Fifty 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.
12. A copy of this Order may also be sent to ICAP for information and necessary action in accordance with the provisions of the Chartered Accountants Ordinance, 1961.