The New Delhi Principal Bench of the National Company Law Appellate Tribunal (NCLAT) has clarified that RBI prudential norms stopping banks from recognising interest income on NPA accounts do not wipe out the borrower’s obligation to accrue and recognise interest expense in its own financial statements. Under Ind AS 109, a borrower cannot stop recognising interest merely because the account has turned NPA or because a one-time settlement is under discussion. Interest liability continues until the liability is legally extinguished, modified, discharged, cancelled, or expires.
The Tribunal also laid down that Standards on Auditing are mandatory and not mere guiding principles. An auditor of a listed entity must maintain proper documentation, obtain sufficient appropriate audit evidence, apply professional scepticism, and issue a modified opinion where the financial statements are materially misstated. Failure to do so can amount to professional misconduct under the Chartered Accountants Act and attract action under Section 132(4) of the Companies Act.
The Tribunal further held that an audit firm has independent and primary liability for quality control failures under SQC 1, separate from the engagement partner’s personal liability. The firm cannot escape liability by arguing that only the engagement partner was responsible for audit execution. Proceedings against both the firm and the individual auditor on the same audit are legally maintainable and do not amount to double jeopardy.
The Division Bench comprising Justice Mohammad Faiz Alam Khan (Judicial Member) and Naresh Salecha (Technical Member) found that RBI’s IRACP norms apply to banks as regulated entities and only govern when banks can recognise interest income on NPA accounts. Those norms do not extinguish the borrower’s contractual obligation to account for interest expense in its own books. The Tribunal emphasised that the RBI circular itself required banks to keep a memorandum record of accrued interest on NPA accounts, which showed that the underlying borrower liability continued to exist.
On Ind AS 109, the Tribunal held that borrowings remain financial liabilities measured at amortised cost using the Effective Interest Method unless the liability is legally extinguished, discharged, cancelled, or expires. A mere expectation of one-time settlement or future waiver cannot justify non-recognition of accrued interest. The Tribunal said expected OTS cash flows cannot be substituted for contractual cash flows unless there is a legally concluded modification or extinguishment of the liability.
The Tribunal treated the steep fall in finance cost from Rs. 21.08 crores to Rs. 4.16 crores as a glaring red flag that should have triggered strong professional scepticism. It observed that if interest had been properly accounted for, the company would likely have shown a loss instead of profit, and the understatement of interest of at least about Rs. 16.91 crores represented nearly 88% of the reported profit before tax. The Tribunal also noted that during CIRP, banks filed and the resolution professional admitted large interest claims, reinforcing that the liability had never been waived.
On audit standards, the Tribunal found serious failures in audit documentation, risk assessment, audit evidence, and professional scepticism. It noted that the audit file lacked documentation of the NPA interest issue, challenge to management’s accounting treatment, bank confirmations, revised loan documents, or records of discussions on the alleged OTS. The Tribunal held that audit documentation is not a mere formality and that without documentation there is no verifiable basis for the audit opinion.
The Tribunal also found that the management representation letter relied on by the auditor was unreliable because it was not on letterhead, did not identify the signing authority, and contained an impossible reference to inventory records as on a later date. It said reliance on such a defective document as the basis for accepting a material accounting treatment and still issuing an unmodified opinion reflected a fundamental failure of professional duty.
As to the audit report, the Tribunal held that an unmodified opinion was plainly unsustainable because the alleged misstatement affected finance costs, current liabilities, profit before tax, profit after tax, retained earnings, and net worth. In such circumstances, the auditor ought to have at least considered a modified opinion, whether qualified or adverse, instead of certifying that the financial statements gave a true and fair view.
The Tribunal further held that appointment of an Engagement Quality Control Reviewer was mandatory for the audit of a listed company under SA 220. Since VWL was a listed entity, the engagement partner could not lawfully sign the audit report without completion of EQCR. The absence of EQCR was treated as removal of an important safeguard that could have caught the audit failures.
On the audit firm’s liability, the Tribunal rejected the argument that only the engagement partner could be proceeded against. It held that the firm, as the appointed statutory auditor, had independent and primary responsibility under SQC 1 to establish and ensure implementation of quality control systems. Merely having a policy document was not enough; the firm had to ensure that its personnel complied with professional standards and that audit reports issued by the firm or its engagement partner were appropriate.
The Tribunal also rejected the plea of double jeopardy. It held that proceedings against the engagement partner and the firm arose from separate though overlapping obligations. The firm’s liability was based on systemic and institutional quality control failure, distinct from the engagement partner’s engagement-level lapses, and NFRA was legally permitted to issue a later show cause notice to the firm even though the Tribunal advised NFRA to avoid such delay in future.
Briefly, the appeals arose out of NFRA orders passed against (i) CA Som Prakash Aggarwal, the engagement partner, and (ii) M/s S. Prakash Aggarwal & Co., the audit firm, in relation to the statutory audit of Vikas WSP Ltd. for FY 2019-20. NFRA had earlier held the engagement partner guilty of professional misconduct and imposed a penalty of Rs. 3 lakhs, a three-year debarment from audit assignments, and mandatory training in Standards on Auditing and Ind AS. In a separate later order, NFRA imposed a penalty of Rs. 5 lakhs on the audit firm.
Vikas WSP Ltd. was a listed company on BSE and NSE and therefore a public interest entity required to comply with Indian Accounting Standards. Its borrowings from a consortium of banks had already been classified as NPAs, yet in FY 2019-20 the company recognised only about Rs. 4.16 crores as finance cost as against about Rs. 21.08 crore in the previous year, despite outstanding borrowings of about Rs. 135.65 crores. SEBI flagged this issue to NFRA, alleging that non-recognition of interest on bank borrowings had overstated the company’s profits, which led to the disciplinary proceedings.
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The auditor’s defence was that the company had disclosed in its notes that the lender banks had not charged interest after classifying the account as NPA under RBI prudential norms, and that the company was also negotiating a one-time settlement with lenders. According to the auditor, this justified non-provisioning of interest, and the issue involved a technical interpretation of Ind AS 109 and professional judgment rather than concealment or misconduct.
The audit firm separately argued that NFRA could not again proceed against the firm after having already proceeded against the engagement partner on the same facts. It contended that under SQC 1 its role was only to establish quality control policies, while actual audit execution responsibility rested with the engagement partner, and therefore the firm could not be made liable in the same way as the individual auditor.
