A company carries on huge businesses based on the capital which has been provided by someone else who are not in the day to day management of the company. They would, therefore, would like to see that their investments are safe, are being used for intended purposes and the annual accounts of the company present a true and impartial account of the state of affairs of the company. To enable this, the accounts of the company must be inspected and reviewed in a timely manner by an independent individual who is not employed in the company or is in any way indebted or otherwise obliged to the company. An audit can thus be called as the detection of fraud, technical errors and errors of principle[i].
The auditor is often in a position to discover frauds. Where, during the course of his audit, he comes across circumstances which arouse his suspicion, he should decide whether a fraud, in fact, does exist, and if so, whether it would be sufficiently material to affect his opinion on the accounts he is auditing. If, after the auditor has completed his audit, a fraud is discovered pertaining to that period, it does not necessarily mean that the auditor has been negligent or that he has not performed his duties competently. Merely because the audit report has been signed doesn’t signify that there is no fraud has been committed. The auditor to the best of his knowledge must perform the task at hand and take due diligence while conducting the same. If he has conducted his audit by applying due care and skill in consonance with the professional standards expected, the auditor would not be held responsible for not having discovered that fraud.
The main objective of auditing today is the evaluation of financial statements to see whether they truly and fairly represent the actual financial position. Detection of frauds and errors is only an incidental objective. The auditor recognises that any fraud, if sufficiently material, may affect his opinion as to whether the accounts show a true and fair view and he takes this into account in conducting an audit[ii].
Who can be an Auditor?
Section 141(1) of the Act prescribes the qualifications and disqualifications for being appointed as a company auditor. An auditor of a company possessing the qualifications prescribed in section 141 of the Act is generally known as the statutory auditor of the company as he derives his duties, power and authority from the statute i.e. The Companies Act.
According to section 141(1) “a person shall be eligible for appointment as auditor of a company only if he is a chartered accountant”. Section 2(17) defines a chartered accountant as “a chartered accountant who holds a valid certificate of practice under sub-section (1) of section Chartered Accountants Act, 1949”. It is further provided that a firm, including a limited liability partnership, whereof majority of the partner’s practise in India are qualified for appointment as auditor, may be appointed by the firm to be the auditor.
Under the Chartered Accountants Act, 1949, only a chartered accountant holding a certificate of practice can be engaged in the public practice of accountancy. However the Chartered Accountants Act, 1949 also permits the chartered accountants to enter into partnership with other professionals. Thus, Section 141(2) of Companies Act states that if a firm is appointed as an auditor, only those partners who are chartered accountants are authorized to sign on behalf of the firm. Thus, it is only a practising chartered accountant who can be appointed as an auditor of a company. Further, such a chartered accountant is also subject to the requirements of ethical conduct as contained in the Chartered Accountants Act[iii].
Disqualifications of an Auditor
The following entities or persons have been disqualified under section 141(3) of the Act from being appointed as an auditor of a company. The disqualifications as aforesaid are largely to ensure the independence of the auditors and for avoiding any conflict of interest while performing his duties as an auditor because of any pecuniary interest in the company whose accounts are being audited.
- “A body corporate other than a limited liability partnership registered under the Limited Liability Partnership Act, 2008;
- A person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction;
- A person who, directly or indirectly, renders any service referred to in section 144 to the company or its holding company or its subsidiary company.[iv]”
Where the Chartered Accountant is employed whole-time, he is an employee of the company. In Dharangdhara Chemical Works v. State of Saurashtra[v], the court held that Chartered Accountant who is in whole-time employment of the company cannot be appointed as its auditor.
Appointment of an Auditor
The provisions with regard to the appointment of an auditor can be divided into three categories:
The first auditors can be validly appointed only by a resolution or Board of directors or that of the company in the general meeting. Section 139(6) lays down that the first auditor or auditors of a company shall be appointed by the Board of directors within thirty days of the date of registration of the Company. The auditor so appointed shall hold office until the exercise its power, till the conclusion of the first annual general meeting. If the Board of directors fails to exercise its power, it shall inform the members of the company. In such cases, the first auditors are appointed by the members in an extraordinary general meeting within ninety days.
Sometimes, the first auditors of a company are named in the Articles of Association. However, such appointment of auditors cannot be held valid since the Act grants it no recognition. In case of a Government company or a company owned or controlled by the Central Government, State Government or in part, the first auditors shall be appointed by the Comptroller and Auditor-General of India within sixty days from the date of registration of the company. If the CAG fails to exercise his power, the Board is authorized to appoint the first auditors within the next thirty days. In case of a failure by the Board, the members must be informed who shall appoint the first auditor in an extraordinary general meeting within sixty days.[vi]
Every company shall, at the first annual general meeting, appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting[vii]. The matter relating to such appointment shall be placed for ratification by members at every annual general meeting. The subsequent auditor or auditors are appointed by the members in annual general meeting by passing an ordinary resolution.
Sometimes, in certain cases, an audit committee has to be constituted under Section 177 of the Act and all appointments of auditors shall be made based upon the recommendation of the Audit Committee[viii].To give effect to the requirements of Section 139(11), the Companies (Audit and Auditors) Rules 2014 lay down the manner and procedure of selection and appointment of auditors[ix].
The Audit Committee recommends the name of the auditor to the Board. If the Board agrees with the recommendations of the Audit Committee, it shall further recommend the name proposed to the members to be appointed in the annual general meeting. Within fifteen days of the meeting in which the auditor is appointed, the company shall inform the auditor concerned and also file a notice of such appointment with the Registrar[x].
Filling of casual vacancy:
If there arises a situation whereby there is a casual vacancy, the Board of Directors are mandated to fill the same within 30 days. However, this is subject to the limitation that where the vacancy has arisen due to resignation, it can be filled only by company in general meeting which is convened within 3 months of recommendations of Board.
Tenure of Auditor
Section 139(1) provides that an auditor is appointed from the conclusion of one annual general meeting until the conclusion of the sixth annual general meeting. The meeting wherein such appointment has been made shall be counted as the first meeting. But, if the annual general meeting is not held within the period prescribed, the office of the auditor fall vacant by the date general meeting sought to have been held.
The auditor is expected to continue in office till the annual general meeting is actually held thus, if adjourned, his tenure will extend till the conclusion of the adjourned meeting. Similarly if at an annual general meeting no auditor is appointed or reappointed, the existing auditor shall continue to be the auditor of the company[xi].
Independence of Auditor
Auditor not to render certain services. This has been done to ensure that the auditor’s independence and objectivity is not compromised because of the fees earned by him by rendering other services to the company for which he is acting as an auditor. To achieve this objective Section 141(3) and Section 144 has to read simultaneously to prohibit the auditor to render certain prescribed services and maintain the independence of the office.
These persons cannot be appointed as auditors;
- A currently employed officer or employee of the company;
- A person who has been a partner or is currently employed as a partner, or who is in the employment of the company as an officer or employee;
- A person who, or his relative or partner-
- is having any interest or security in the company or its subsidiary or its holding or its associate company or;
- is indebted in excess to the company or its subsidiary or its holding or its associate company or;
- has given a guarantee or security in connection with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company;
- Any person or a firm which has a business relationship with the company, or its subsidiary, or its holding or associate company either directly or indirectly;
- A person whose relative is a director or is employed as a key managerial personnel in the company;
- A person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is already an auditor of more than twenty companies on the date of appointment;
Further he cannot render any service directly or indirectly, to the company or its holding company or subsidiary company. These include accounting and book keeping services, internal audit; design and implementation of any financial information system; actuarial services; investment advisory services; investment banking services; rendering of outsourced financial services; management services; and any other kind of services as may be prescribed.
Status of an Auditor
The status of an auditor has been subject to a number of judicial interpretations. Broadly, the auditor has been seen through the lens of an agent and an officer of the company.
Auditor as an Agent:
An auditor acts as an agent of the shareholders. He is expected to safeguard their interests. In Spackman v. Evans[xii], Cranworth LJ, held that the auditors may be agents of the shareholders, so far as relates to the audit of the accounts. For the purposes of the audit, the auditors will bind the shareholders. Further the shareholders, would not be deemed to be precluded from objecting to any actions of the directors or others merely on the ground that the auditors were aware of such actions. Thus, although an auditor is an agent of the shareholders and according to the law of agency ‘the knowledge of the agent is the knowledge of the principal’, the shareholders are not bound for any information which the auditor might have acquired during the course of audit if he had not communicated it to the shareholders.
Auditor as an Officer:
In London and General Bank[xiii]case, an auditor was held to be an officer of the Company. Lindley LJ, held that an auditor is an officer of the company as he is appointed by the company and his position is described in the section as that of an officer of the company. He is not a servant of the directors. On the contrary, he is appointed by the company to check the directors and for some purposes and to some extent, it seems to me quite impossible to say that he is not an officer of the company.
In Kingston Cotton Mill Co. Ltd[xiv], it was decided that the auditors are officers of the company.
In India, in Connell v. Himalaya Bank Ltd[xv], it was held that auditors, if appointed at a general meeting of the company and if also paid by the company, were officers of the company.
However, this position has changed with the Companies (Amendment) Act, 2000 coming into force. The definition of the term “officer” in section 2(30) of the Companies Act, 1956 has not included auditor for any of the provisions of the Act. Even the new act of 2013, the term ‘officer’ given in section 2(59) does not include auditor.
Thus, the first view of the auditor being a agent of the company seems to be compliant with the existing law of the land.
Rights of an Auditor
The Companies Act, 2013 has provided a wide array of rights to the auditor to ensure that he is able to discharge his duties effectively. The rights of an auditor are his statutory rights and cannot be limited or abridged either by the Articles or resolution of the members. The court in Newton v. Birmingham Small Arms Co. held that any provision to the contrary is ultra vires and hence void[xvi].
Right of access to books and account:
Every auditor of company has a right of access at all times to the ‘books’, ‘accounts’ and ‘vouchers’ of the company[xvii]. The term ‘vouchers’ includes all documents, correspondence, agreements, etc., which support any of the transactions or data disclosed in the financial statements, directly or indirectly. The term ‘books’ includes the fiscal and statistical books. The phrase ‘all times’, however, implies only to the normal business hours. In case of a holding company the auditor also is entitled to access to records of all its subsidiaries and associates insofar it relates to the consolidation of its financial statements with that of its subsidiaries and associates[xviii].
Right to obtain Information or Explanation:
The auditor of a company has the right to require from the officers of the company such information and explanations as the auditor may think necessary for the performance of his duties as auditor[xix].In addition, the auditor has a right to specifically enquire about the following matters:
- Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the company or its members;
- whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company;
- where the company not being an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities has been sold at a lower price that what they were purchased by the company;
- whether loans and advances made by the company have been shown as deposits;
- whether personal expenses have been charged to revenue account;
Rights with respect to Branch Accounts:
A ‘branch office[xx]‘ of a company means any establishment or office described by the company as its branch office. Being a part of the company, it also needs to audit. Thus, accounts of the branch office of the company are required to be audited cither by the company’s auditor or by any other person qualified for appointment as an auditor[xxi]. In case the branch office is situated outside India, the accounts of the branch office are required to be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of the country where the branch office is located. Where the accounts of any branch office are audited by a person other than the company’s auditor, the branch auditor shall submit a report to the company’s auditor[xxii].
Right to sign the report:
An auditor has the right to sign the auditor’s report or sign or certify any other document of the company[xxiii]. Correspondingly a firm of limited liability partnership is appointed as the auditor, only those partners that are chartered accountants are authorized to act and sign on behalf of the firm[xxiv]. Thus, if a firm or LLP has partners who are not chartered accountants, they are not authorized to sign the auditor’s report.
Right to receive notices:
All notices and such other communications shared between members regarding the general meeting of a company, shall also be forwarded to the auditor of the company[xxv].
Right to Attend General Meeting:
The auditor has the right to attend any general meeting and be heard, at any general meeting which he attends, on any part of the business which concerns him as auditor[xxvi]. The auditor may make any statement or explanation with regard to the accounts as he may deem fit. The auditor also has right to send his authorized representative to attend the meeting instead of attending the meeting himself personally. Further, it is obligatory that any qualifications, observations or comments on the financial transactions or matters which have any adverse effect on the function of the company mentioned in the auditor’s report be read at the general meeting and also shall be open to inspection by any member of the company[xxvii].
Right to Remuneration:
An auditor is entitled to his remuneration on the completion of his work.
Duties of an Auditor
Every right available to an individual has a corresponding duty. An auditor under the Companies Act is no exception. They have a general duty to oversee that the company’s financial statements are in order and present a true picture of the state of affairs of the company. Apart from this, the Act also prescribes certain mandatory duties within its domain.
Duty to make a Report of Financial Transactions :
It is the duty of the auditor to report to the members of the company on the accounts examined by him and on every financial statement which are laid before the company in general meeting[xxviii]. The auditor should report whether to the best of his information and knowledge the said accounts and financial statements which give a true and fair view of the state of company’s affairs at the end of financial year and the profit and loss and cash flows for the financial year.
Lindley J, in London and General Bank, held that an auditor, is not bound to do more than exercise reasonable care and skill in making enquiries and investigations. He is not an insurer, he does not guarantee that the books do correctly show the true position of the company’s affairs; he does not guarantee that his balance sheet is accurate according to the books of the company, if he did, he would be responsible for an error on his part, even if he were himself deceived due without any want of reasonable care on his part say, by the fraudulent concealment of a book from him.
The report should answer questions on whether, proper books of account as required by law have been kept by the company, whether the balance sheet is drawn according to the reported profits and losses, observations on financial transactions, remarks on maintenance of records etc.
Duty to Attend General Meeting:
The auditor has a duty to attend the general meeting either himself or through his authorised representative unless exempted by the company[xxix].The authorised representative shall be person who is qualified to be an auditor[xxx].
Duty to Report Fraud:
The auditor has an obligation to report to the Central Government if in the course of the performance of his duties as auditor, he has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company involving an amount of rupees one crore or more[xxxi]. The auditor first needs to forward his report immediately (not later than two days) to the audit committee or the Board seeking their reply within forty five days. On receipt of reply from the Board of the audit committee, the auditors are required to forward his report, reply or observations to the Central Government within fifteen days.
Duty to make statement in Prospectus:
An auditor is required to make a report which is included in the prospectus of a company. Such a report should be made out on the profits and losses of the business of the company for each of the five financial years immediately preceding the issue; and of the assets and liabilities of the company on the last date to which the accounts of
the business were made up.
Duty to produce documents and evidence:
The auditor is duty bound for reserving and producing all books and paper or relating to the company to an inspector or any person authorised by him in this behalf with the previous approval of the Central Government. Further he is under a duty to give to the inspector all assistance in connection with the investigation which he is reasonably able to give.
Duty to acquaint themselves with their duties:
This duty has primarily gained foothold due the judicial interpretations. The courts have often equated that auditors are bound to acquaint themselves with their duties under the Companies Act[xxxii]. If any additional duty is imposed on them through the Articles of the company, they are obliged to follow them. Ignorance of the Articles and of additional duties imposed by them would not afford any legal justification for not observing them[xxxiii].
The role of an auditor has increasing gaining an important stature in the corporate governance. In the age of increasing number of frauds, an auditor keeps a bird’s eye view of the accounts and finance of the company and ensures that the company is working in the best possible manner. However, this can only be ensured through an independent and autonomous body which is not regulated by the company’s managerial positions.
Frequently Asked Questions:
Who is an Auditor?
An auditor is any individual who has been appointed by the company to assess its financial statements and present a true and fair view of the company affairs. They are usually appointed by the company and must have a Chartered Accounts Degree.
Why is Auditing Necessary in a Company?
The main objective of auditing today is the evaluation of financial statements to see whether they truly and fairly represent the actual financial position. Detection of frauds and errors is only an incidental objective. The auditor if recognises that any fraud has been commit dust report the same to the central government in public interest.
What are the Rights of Auditor?
The Companies Act, 2013 has provided a wide array of rights to the auditor to ensure that he is able to discharge his duties effectively. The auditor of company has a right of access at all times to the ‘books’, ‘accounts’ and ‘vouchers’ of the company. Further he can enquire into the loans, transactions and assets of the company to gauge the company’s financial situation. The auditor shall also be a corresponding ember to any of the general meeting of the company and notices for the same can be sent to him. An auditor is entitled to his remuneration on the completion of his work.
What are Duties of Auditor?
They have a general duty to oversee that the company’s financial statements are in order and present a true picture of the state of affairs of the company. Apart from this, they also have the duty to verify that the statements of account drawn up on the basis of the books of the business, confirm that the management has not exceeded the financial administrative powers vested in it by the Articles of Association, and investigate matters in regard to which his suspicion is aroused.
Edited by Shikhar Shrivastava
Approved & Published – Sakshi Raje
[i] L.R. DICKSEE Auditing
[ii]1978 edition p.4. The ICAI has since issued AAS-4 on Fraud and Error embodying the same thought. The Research Committer of the ICATIN its publication ‘Statement on Auditing Practices had stated”
[iv] COMPANIES ACT
[v]AIR 1957 SC 264
[vii] Sec 139(1)
[ix] Rule 3
[x]Proviso to Section 139(1). The notice to Registrar about appointment of auditor is required to be given in Form ADT-1 of the Companies (Audit and Auditors) Rules, 2014 as amended vide Notification F.No. 1/33/2013-CL V dated 16 February 2018
[xi] Section 139(10)
[xii] 3 H.L. 236
[xiv] |1896]2 Ch. 279
[xvi] Newton v. Birmingham Small Arms Co. 2 Ch. 37
[xvii] SECTION 143(1)
[xviii] PROVISO TO 143(1)
[xix] Section 143(1)
[xx] Section 2(14) of the Act
[xxi] Section 143(8)
[xxii] Rule 12 of the Companies (Audit and Accounts) Rules, 2014
[xxiv] Section 141(20)
[xxv] Section 146
[xxvi] Section 146
[xxvii] Section 145
[xxviii](2) and (5) of section 143
[xxix] Section 140
[xxx] Newton v. Birmingham Small Arms Co. 2 Ch. 378
[xxxi] Section 143(12)
[xxxii]Re Bolivie Exploration Syndicate3 TLR 146