NFRA finds significant deficiency in the verification of related party transactions and arm’s length price by PWCA LLP
Section 132 of the Companies Act, 2023 inter alia, mandates NFRA, to monitor compliance with Auditing and Accounting Standards, to oversee the quality of service of the professions associated with ensuring compliance with such standards, and to suggest measures required for improvement in the quality of their services. The relevant provisions of NFRA Rules prescribe the procedures in this regard, which include evaluation of the sufficiency of the quality control system of Auditors and the manner of documentation of their work. Under this mandate, NFRA initiated audit quality inspections in April 2024.
Recently, NFRA test checked of audit engagements performed by M/s Price Waterhouse Chartered Accountants LLP (PWCA hereinafter), and M/s Price Waterhouse & Co Chartered Accountants LLP (PW& Co CA) during the financial year 2023.
These audit firms were selected using the parameters of size, composition and nature of the audit firms, the number of audit engagements completed in the year under review: complexity and diversity of preparer’s financial statements audited by the firms and other risk indicators.
The scope of the inspection was to review of the remedial measures and improvements made in response to the previous inspection observations for firm-wide quality controls to evaluate the Audit Firm’s adherence to SQC 1, Code of Ethics and the applicable laws and rules. Secondly, review of individual Audit Engagement Files- A sample of three (3) individual audit engagement files pertaining to the annual statutory audit of financial statements for the year ending 31.03.2023 was selected. Three significant audit areas identified in respect of each audit engagement were, internal financial control over financial reporting pertaining to revenue, related party transactions and impairment of nonfinancial assets, due to their inherent higher risk of material misstatement.
As stated by the NFRA, M/s PWCA and M/s PW & Co CA are Limited Liability Partnership firms with offices at 10 locations in India. They are members of Price Waterhouse & Affiliates’ (PW&A), a domestic network of eleven CA firms, which is registered with the Institute of Chartered Accountants of India (ICAI), all operating from common offices. PW&A Network firms are all members of the international network of PricewaterhouseCoopers International Limited. As on 31.03.2023, PWCA had 93 partners, and 2572 staff members and PW & Co CA had 92 partners and 279 staff members. The PW&A network firms had a total of 212 partners as on 31.03.2023. 10. As on 31.03.2023, PWCA audited 141 PIEs and PW & Co CA audited 30 PIEs as covered under Rule 3 of NFRA Rules, 2018.
As per NFRA Inspection report, in two engagement files selected for review in the current inspection cycle, a significant deficiency in the verification of related party transactions and arm’s length price testing have been observed. The lack of sufficient documentation and the limited scope of testing raise questions about the quality and reliability of the audit conclusions.
It was observed that in case of the audit of a Company, the conclusion of the Audit Firm that the Related Party Transactions (RPTs) were at arm’s length was not supported by sufficient documentary evidence in the Audit Work Papers (AWP). The AWP documents that invoice price of the related parties was compared with the unrelated ones and differences were noted; that these differences were due to competitive market and strategic discount; and that the pricing was vetted by an independent CA on a yearly basis. However, the specific goods/services received/given for which such comparison has been made is not documented. Further, the arm’s length testing done by the Engagement Team was limited only to the pricing and did not cover other qualitative aspects viz., terms and conditions, guarantee, provision for doubtful debts, expenses for bad debts etc. as required by Para 18 of Ind AS 24. Further, Rule 15(1) of the Companies (Meetings of Board and its Powers) Rules, 2014 requires that the agenda of the Board meeting at which the resolution is proposed to be moved for entering into any contract or arrangement with a related party shall inter alia disclose the manner of determining the pricing and other commercial terms.
The NFRA has given a finding that in case of the second auditee, the Financial Statements disclosed that Company had only one Related Party. Regarding arm’s length testing of Related Party Transactions, the AWP only stated that the arm’s length testing of Related Party Transactions will be verified during the Statutory Audit. However, no sufficient evidence is seen in the AWP of how the ET had tested that the RPTs were undertaken at arm’s length. The Audit Committee meeting minutes documented in the Audit File notes that the margins for the RPTs with the sole Related Party of Company were same as per similar other orders received from the sole Related Party and that from other non-related party clients. It was documented by the Audit Firm that they would be considering the same while verifying the RPTs during the year during their statutory audit. However, there is no sufficient documentation in the Audit File that the Audit Firm verified that these RPTs were at arm’s length by comparing the same with orders/contracts from unrelated parties. The Audit Committee Meeting minutes only show what the Audit Committee noted and not what procedures the Audit Firm performed in verifying the arm’s length pricing of these RPTs. Therefore, the NFRA reached the conclusion that the Audit Firm failed to ensure Arm’s Length Testing of RPTs and appropriate Comparison, Qualitative Analysis and documentation.
The said Audit Firms provided a written response to the Inspection Report, stating that they are considering how to further enhance audit file documentations including recording details of audit procedure performed etc.
Download NFRA Inspection Report Click Here >>
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