Council of Institute of Chartered Accountants of India, Referring Authority Vs. S. Srinivasa Iyer - Court Judgment

1. The Chartered Accountant in this reference that has been made under the Chartered Accountants Act, 38 of 1949. is Sreenivasa Iyer. He had audited the balance sheet of the United Bank of Travancore Ltd., for 1949, 1950 and 1951. The Act governing the Bank's annual statement for the first year was the Travancore Companies Act, 9 of 1114, and the balance sheet for the two succeeding years were prepared according to the Indian Banking Companies Act, No. 10 of 1949, that had become then operative in the then Travancore-Cochin State. Also the Chartered Accountants Act was extended in 1951 to part B States.

2. The circumstances leading to the reference can be shortly stated. In the audited balance sheets for the years 1949 and 1950 the share capital of the company appear as under:--

31st December 1949.

31st December 1950.

No. of shares.

Amount

No. of Shares.

Amount

2,00,000

20,00.000

Authorised

30,000

3,00.000

1,60,000

15,00,000

Issued

30,000

3,00.000

93,599

9,35,990

Subscribed

17,403

1,74,030

88,289

5,29,734

Called & Paid up

17,403

1,74,1130

18,859

Calls in arrears

65,174

5,310

10,675

Forfeited..

The aforesaid extract would show that whereas en December 31, 1949 the subscribed shares were 93,593, of which 5310 have been forfeited the position on December 31, 1950 was that the Bank's shares were only 17,403. It is conceded that the balance sheet for the year 1950 contains no explanation of how this change in the capital was brought and how the difference of Rs. 4,12,694/-in the Bank's subscribed capital was adjusted in the account books. The balance sheet of 1950, however, shows the following endorsement by the chartered accountant (hereafter referred to as the accountant:

'The exercise of the power conferred by Section 53(1)(e) of the Travancore Act IX of 1114, on 13th July 1950 has only been intimated to the Registrar and does not appear to have been filed with him. The transaction of the bank which has come to my notice have been within the powers of the bank.'

3. The endorsement only refers to the legal provision under which the reduction in the number of subscribed shares had been brought about, but does not mention what happened to the total paid up capital of Rs. 4,12,694/-. It appears that the Directors early in 1950 had forfeited for nonpayment of further calls the above number of shares excluding 5310 shares already forfeited in 1949. Then in July 1950 the share-holders at the ordinary general meeting are stated to have passed a resolution cancelling the forfeited shares, which purports to have been done under Section 53 (1) (b) of the Travancore Act. Sometime after the cancellation the accountant was asked by the Bank's Managing Director as to the procedure, which should be adopted so far as the paid up amounts on the can-celled shares were concerned and after consulting Messrs. Fraser and Ross, Chartered Accountants, Madras, he had advised as follows:

'As seen from the above in view of the company not proposing to issue the forfeited shares I can see no objection to the proposal of your Directors to transfer the money so received on forfeited shares to any special reserve or utilising it to write down capital expenditure'.

4. It is stated that there is nothing in the Balance sheet of 1950 to show that this paid up capital of Rs. 4,12,694 was treated as reserve for the Bank's bad debts find the omission to so state the deduction is due to the new form concerning the balance sheet in the Banking Act wherein the reserve for bad debts need not be shown. The position under the earlier Travancore Act was different and the relevant entry for the temporary overdrafts and cash credits in the balance sheet for 1949 shows their total to be Rs. 6,44,527-8-8.

The entry in the balance sheet for 1950 about loans other than bad debts for which provision to the satisfaction of the auditor has been made discloses the amount to be Rs. 5,03,861-15-11, and it is clear that the improvement if any was due to the capital profits having been used for the purpose, This then was the situation and it was not a very satisfactory financial position.

5. But to continue with the narration of facts, the Registrar of the Joint Stock Companies, made a complaint to the Council of the Institute of Chartered Accountants of India that the reduction of capital should have been effected only with the sanction of the special resolution of the company and confirmed by an order of the Court in accordance with Section 59 of the Travancore Companies Act corresponding to Section 55 of the then Indian Companies Act. The Registrar therefore complained that the advice by the accountant to the bank in his letter of September 12, 1950 that this reduction of capital can be done without leave of court and his certification of the balance sheet as being in conformity with law amounts to misconduct under items (o) and (p) of the Schedule attached to the Chartered Accountants Act.

The matter was referred to a Committee of the Council of the Institute which consisted of four members, and the President with two other members opined that the accountant's conduct was not proper and he had thereby committed what are covered by items (o) as well as (p) of the schedule. The dissenting opinion of the Vice-President was in favour of the accountant, but when the matter came to be considered by the Council of the Institute at its first meeting in March 1955, the conclusions were against him. Those conclusions read as follows.

'The respondent failed to report that there was a reduction of capital with a corresponding reduction in the loans and advances on the assets side and that his report on the balance sheet that it was drawn up in conformity with the law, was not correct as it contravened Section 59 of the Travancore Companies Act and Form 'F' prescribed under the Act. He also failed to report on the non-disclosure of the forfeiture and cancellation of shares and the creation of a reserve for bad debts of an amount equivalent to the amount paid on forfeited shares, thus offending against clauses (o) and (p) of the schedule to the Chartered Accountants Act.'

6. It is obvious that the accountant has been found guilty of two acts. One is his failure to report the reduction of capital with the corresponding reduction in the loans and advances, and the other is the failure to report about the creation of the reserve for bad debts of an amount equivalent to the amount paid on the forfeited shares. Dealing with the first, his advocate has referred us to several books on audits and in particular a passage in the Principles of Auditing by F. R. M. de Paula, O. B. E., F. C. A., at p. 193 which reads thus:

'Shares may be forfeited for non-payment of calls, if express power to this effect is contained in the Articles. In cases where shares are forfeited in this way. an auditor must see that the Articles give the directors this power, and, further, that the provisions of the Article have been carried out as regards giving the defaulting share-holder proper notices. The minute of the directors forfeiting the shares must be inspected, and it must be seen that the correct entries have been made in the financial books to record this transaction, and that the Share Ledger has been adjusted accordingly. The amount called up upon the shares forfeited must be debited to Share Capital Account and credited to a Forfeited Shares Account; and the debit balances upon the Call Accounts, which represent the calls due upon these shares but unpaid, should be written off to the debit of the Forfeited Shares Account; the latter account will then show a credit balance equalling and representing the amount paid up upon the shares forfeited.

If these shares are re-issued at a discount, which can be done provided the discount does not exceed the amount already paid upon the shares by the old shareholder, any such discount should be debited to the Forfeited Shares Account, and if thereafter, this account shows a credit balance, this represents the final profit upon the forfeiture, which profit should be transferred to general reserve, or used to write down preliminary expenses or fixed assets. But there is nothing in the Companies Act to prevent this profit being credited, to Profit and Loss Account, subject of course, to any restrictions provided in the Articles of the particular company. If, at the date of the Balance Sheet, the shares have not been re-issued, the auditor should see that the credit balance upon the Forfeited Shares Account is shown as a separate item in the Balance Sheet, being described as 'amounts paid up upon shares forfeited.' (7) He has urged that the Bank's articles of association had authorised such forfeitures of shares, which power the Directors had exercised without any complaint, that the effect of the forfeiture was to forfeit all the rights of the then holders of the shares and to reduce pro tanto the issued capital of the company, and that after the shares had been forfeited there was no legal bar to their being cancelled at the general meeting of the shareholders. That apart there is no materials on record to suggest that the forfeiture was done with the knowledge of the accountant, or that he advised the Directors to get a resolution cancelling them passed at the general meeting of the shareholders. Moreover two opinions can be honestly held about the cancellation of forfeited shares being effected in exercise of powers under Section 53 (1) (e) of the Travancore Companies Act, 9 of 1114, as the divergence of views among the members of the committee suggest, and an auditor may reasonably believe any statement made to him about the cancellation being proper. Therefore we feel that the accountant should be given the benefit of doubt and not punished for the remarks he had made in the end of the balance sheet of 1950.

8. The failure to state Rs. 4,12,694 having been treated as reserved for the bad debts in our opinion is more serious. It is clear that the Bank's Director consulted the accountant and he in his turn had asked the advice of Fraser & Boss, Chartered Accountants, Madras. It is equally clear that the adjustments, if really the amount had been adjusted at all, had been at the advice of the accountant and because of the omission to state the adjustment the position had become misleading. We would here emphasise, as has been already done by Rajamannar, C. J., in Registrar of Companies v. P, M. Hegde. AIR 1954 Mad 1080 at p. 1084, on what is the duty of the auditor who takes the responsibility of auditing bank's annual balance sheet. There the learned Chief Justice quoted with approval and we also do here -- the following passage from Dickee's Auditing, 17th Edn. P. 97 :

'We cannot sufficiently emphasise the importance of auditors realising their responsibilities not only to the company but to the public. Such responsibilities are all the greater in the case of banks. 'In dealing with bank accounts' and all other accounts of a similar nature the auditor must never forget that his responsibilities are not confined to safeguarding the interests of the proprietors. His report carries greater weight with the public. It is not, of course, suggested that he guarantees the safety of the customers' deposits; but lie would reasonably be blamed if, after he had signed without remark the usual auditor's report on an apparently sound balance sheet, the bank were afterwards discovered to be insolvent.'

9. Any doubt concerning the wisdom of the rule may well be dispelled if one were to remember that the bank in the case before us has gone into liquidation and the losses suffered by innocent depositors have yet to be estimated. That apart under Section 30 (3) (b) of the Banking Companies Act, 10 of 1949, the accountant is under the duty of stating whether or not the transactions have been within the powers of the company. That has not been done. The certificate by the accountant on the profit and loss account sheet of 1950 evidently has been made with a view to discharge the aforesaid statutory liability; but it is inaccurate in two respects.

The certificate is firstly silent as to the cancelled shares being partly paid and what were the amounts of such paid-up capital. It is further silent about the paid-up capital on the advice of the accountant being treated as special reserve and liable to be set off towards capital expenditure over losses. The third omission is that the accountant has not stated the aforesaid paid amount being treated as reserve for bad debts to be within the power of the Bank. Because of the three omissions we feel that item (o) of the schedule to the Act covers the auditors conduct and that the financial statement has become misleading.

10. The Counsel for the accountant has argued that because of Section 29 of the Banking Act and the form in it about the balance sheet for the banks, it was no longer necessary to state the bank's reserve for bad debts and his client cannot be held guilty of having omitted to state something whose disclosures were necessary. We think the argument confuses the liability of the banks under Section 29 with the responsibility of the accountant under Section 30 (3) (b) of the Act. After all persons functioning as auditors are under obligation to the general public as well; for their reports are generally treated as certificates of the banks being in sound financial position. It is clear that the bank in the case before us was in financial difficulties and very soon went into liquidation. The accountant was consulted and having obtained advice had forwarded it to the Managing Director.

In these circumstances he ought to have stated that in his opinion the paid up capital of the forfeited shares that had been later cancelled was properly used as special reserve for bad debts. The concealment does make the financial statement misleading because the bank had a large amount of bad debts in the particular year and was not in a position to effect such bad debts except by utilising the capital profits got from the cancelled shares.

11. Relying on State of West Bengal v. Brindaban Chandra, AIR 1957 Cal 44 at p. 53 the Counsel for the accountant has then argued that his client cannot be found guilty of any misconduct as he was acting honestly, and that he cannot be guilty of negligence because such a charge has never been framed against him. We do not think, having regard to the correspondence which passed between the accountant and the Bank's Managing Director that the omission to state what he had advised would be regarded as reasonable conduct. Nor do we see how an honest person would hesitate to state what he had assured himself to be the correct position. Therefore the conduct of the accountant before us cannot be held to be either reasonable or honest.

12. The next argument is that, the accountant was not charged with what he has been found guilty by the Institute. Having gone through the record we do not think the conclusion the Institute had reached can be said to have taken the accountant by surprise. In such proceedings the Institute cannot be expected to adhere to the procedure usually followed in courts of law. Of course the principles of natural justice must be observed; but in the case before us we do not find the findings by the Institute vitiated by failure to observe standards of fairplay. We therefore find the accountant guilty of conduct which is covered by item (o) of the schedule to the Chartered Accountants Act.

13. Coming to the question of sentence itis clear that the act was committed within a fewmonths of the extension of the Chartered Accountants Act to Part B States and it may be thatthe accountant had not fully appreciated the consequences which should follow the failure. Wealso feel that the proceedings against him havebeen kept pending for a long time and any sentenceexcept that of reprimand would be unjust. HisCounsel has also apologised for his client's acts.In these circumstances we severely warn the accountant, which he should keep in mind and intimatethat any similar conduct in his part in futurewould entail grave consequences. The referenceis accordingly decided.