CORPORATE LAW

UNIT-III

3.3 Auditing Concept

Bedapriya Lahiri
Assistant Professor
DME Law School
 Readings and References

• Taxmann, Companies Act 2013, Dr. G.K. Kapoor and

Dr. Sanjay Dhamija, Chapter 19 (2019 Edition)
• Avtar Singh, Company Law, Eastern Book Company,
Chapter 12, (2018 Edition).

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 Internal Audit
• Section 138 read with Rule 13 of the Companies
(Accounts) Rules, 2014 requires the following class
of companies to mandatorily appoint an internal
auditor or a firm of internal auditors:
(a) every listed company;
(b) every unlisted public company having –
a. paid up share capital of rupees fifty crores
or more during the preceding financial
year; or
b. turnover of rupees two hundred crores or
more during the preceding financial year;
or 3
 Internal Audit

c. outstanding loans or borrowings from banks or

public financial institutions exceeding rupees one
hundred crore or more at any point of time during the
preceding financial year; or
d. outstanding deposits of rupees twenty five crores
or more at any point of time during the preceding
financial year.
(c) every private company having –
a. turnover of rupees two hundred crores or more
during the preceding financial year; or
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 Internal Audit

b. outstanding loans or borrowings from banks or

public financial institutions exceeding rupees one
hundred crore or more at any point of time during the
preceding financial year.
• It is not compulsory that the internal audit shall be
conducted by an outside firm; it may be conducted
by the employees of the company as well.
• The internal audit shall be conducted by a chartered
accountant or a cost accountant or any other
professional as may be prescribed.
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 Objective of Audit
• A company carries on business with capital provided
by persons who are not in control of the use of the
money supplied by them.
• They would, therefore, like to see that their
investments are safe, are being used for intended
purpose(s) and the annual accounts of the company
present a true and fair view of the state of affairs
• of the company.
• For this purpose, the accounts of the company must
be checked and audited by a duly qualified and
independent person who is neither employed in the
company nor is in any way indebted or otherwise
obliged to the company. 6
 Objective of Audit

• Originally, the audit function was primarily a public

function. Its objective was to detect fraud and error.
• The objectives of an audit are:—
1. The detection of fraud
2. The detection of technical errors
3. The detection of errors of principle.
• With the passage of time and the growth of
enterprises to the size that made significantly
improved internal system of control economical, a
detailed audit of transactions became impractical and
the objectives of the audit function changed
significantly. 7
 Qualifications to be Appointed as 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”. 8
 Qualifications to be Appointed as an Auditor

• Section 2(17) defines a chartered accountant as a

chartered accountant who holds a valid certificate of
practice under sub-section (1) of section 6 of the
Chartered Accountants Act, 1949.
• Section 141(2) of the Act states that if a firm
(including a limited liability partnership) 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.
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 Who Cannot be Appointed as Auditors

• The following entities or persons have been

disqualified under section 141(3) of the Act from
being appointed as an auditor of a company—
(a) a body corporate other than a limited liability
partnership registered under the Limited Liability
Partnership Act, 2008;
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the
employment, of an officer or employee of the
company;
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 Who Cannot be Appointed as Auditors

• A person who, or his relative or partner—

(i) is holding any security of or interest in the company
or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company.
(ii) is indebted to the company, or its subsidiary, or its
holding or associate company or a subsidiary of such
holding company, in excess of such amount as may
be prescribed; or
(iii) has given a guarantee or provided any security in
connection with the indebtedness of any third person to
the company, or its subsidiary, or its holding or associate
company or a subsidiary 11
 Who Cannot be Appointed as Auditors

(e) a person or a firm who, whether directly or

indirectly, has business relationship with the
company, or its subsidiary, or its holding or associate
company or subsidiary of such holding company or
associate company of such nature as may be
prescribed;
(f) a person whose relative is a director or is in the
employment of the company as a director or key
managerial personnel;

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 Who Cannot be Appointed as Auditors
(g) 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 at the date of such appointment or reappointment
holding appointment as auditor of more than twenty
companies;
(h) 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;
(i) 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. 13
 Disqualifications of an Auditor

• Under Section 140(5) of the Act the Tribunal may by

order remove an auditor if it is satisfied that the
auditor of a company has acted in a fraudulent
manner or has abetted or colluded in any fraud by or
in relation to the company or its directors or officers.
• An auditor against whom a final order has been
passed by the Tribunal shall not be eligible for
appointment as an auditor of any company for a
period of five years from the date of passing of the
order [Proviso to Section 140(5)].
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 Disqualifications of an Auditor

• In case of professional or other misconduct, the

National Financial Reporting Authority (NFRA) has
the power to debar the member or the firm form being
appointed as an auditor or internal auditor of
undertaking any audit in respect of financial
statements or internal audit of the functions and
activities of any company or body corporate or
performing any valuation as provided under section
247.
• The debarment would be for a minimum period of
six months but may extend to ten years. [Section
132(4)(c)(B) 15
 Ceiling on Audit

• According to sub-clause (g) of Section 141(3) a

person cannot be auditor of more than twenty
companies at a time.
• For the purpose of counting twenty companies as
aforesaid, only public companies and private
companies having paid up capital of rupees one
hundred crore or more are to be considered.
• One person companies, dormant companies, small
companies and private companies having paid up
capital of less than rupees one hundred crore are
excluded for this purpose.
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 Appointment of First Auditors
• 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 or auditors so appointed shall hold office
until 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 a
case the first auditors are appointed by the members
in an extraordinary general meeting within ninety
days. 17
 Appointment of Subsequent Auditors
• Section 139(1) provides that “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”.
• 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. 18
 Tenure of Appointment

• 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 by section 96, should the office
of the auditor fall vacant by the date general meeting
ought to have been held.
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 Tenure of Appointment

• Unlike the case of directors, the answer seems to be

in the negative— the auditor is expected to continue
in office till the annual general meeting is actually
held and concluded.
• Thus, if an annual general meeting is 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
[Section139(10)].
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 Compulsory Rotation of Auditors
• Section 139(2) of the Act provides for compulsory
rotation of the auditors for the listed companies and
certain class or classes of companies.
• The companies that are required to compulsorily
rotate their auditors include all unlisted public
companies having paid up capital of rupee ten crore
or more and all private limited companies with paid
up share capital of rupees fifty crores or more.
• Under Section 139(2) a listed company or a class of
company prescribed shall not appoint an individual as
auditor for more than one term of five consecutive
years whereas an audit firm shall not be appointed for
more than two terms of five consecutive years 21
 Compulsory Rotation of Auditors
• Cooling off Period: An individual auditor or audit
firm that has completed the prescribed tenure of five
or ten consecutive years respectively shall have a
cooling off period of five years during which it shall
not be eligible for reappointment as auditor in the
same company. [proviso to Section 139(2)].
• The Act has prescribed a compulsory break of five
year before the auditor or the firm becomes eligible
for reappointment as auditor in the same company.
• The cooling off requirement even applies to an audit
firm that which has one or more common partners
with the audit firm that is being rotated. 22
 Re-appointment of Retiring Auditor
• In accordance with the provisions of section 139(9) of the
Act, a retiring auditor may be re-appointed at an annual
general meeting if -
1. he is not disqualified for reappointment.
2. he has not given the company notice in writing of his
unwillingness to be reappointed.
3. a special resolution has not been passed at that meeting
appointing somebody else instead of him or providing
expressly that he shall not be reappointed.
• The reappointment will not be automatic. It may also be
noted that non-reappointment of the retiring auditor in the
AGM is not removal of the auditor as contemplated in
section 140(1) of the Act. It is simple retirement. 23
 Rights of Retiring Auditor [S. 140 (4)]

• right to receive notice of the resolution

• right to make a written representation to the company
and request its notification to members of the company.
• right to get his representation circulated among the
members. (The fact that the representation has been
received must be mentioned in any notice of the
resolution given to members). In such a case a copy of
the representation shall be filed with the Registrar.
• right to get his representation read out at the meeting, if
it has not been sent to the members because of delay in
receiving or default on the part of the company.
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 Removal and Resignation of an Auditor

• Proviso to Section 139(2) establishes a right of the

company to remove an auditor and right of the
auditor to resign from such office of the company.
• However in order to make the removal of
independent and conscientious auditors difficult, the
Act has laid down specific procedure in this regard.
• Likewise obligation has been casted on the resigning
auditor to clearly state the reasons thereof.
• The procedure contains many safeguards to ensure
the independence of auditors.

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 Rights of Retiring Auditor [S. 140 (4)]

• An auditor may be removed, at any time before the

expiry of his term by passing a special resolution of
the company after obtaining the prior approval of the
Central Government and giving the auditor a
reasonable opportunity of being heard [Section
140(1)].
• If an auditor resigns from his office before the expiry
of his term, he needs to file a statement with the
Registrar within thirty days of the date of resignation
[Section 140(2)].
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 Removal by the Tribunal

• In certain circumstances the Tribunal may direct the

company to remove the auditors.
• If the Tribunal is satisfied that the auditor of a
company has acted in a fraudulent manner or has
abetted or colluded in any fraud by or in relation to
the company or its directors or officers, it may direct
the company to change its auditors.
• The tribunal may take such an action either suo motu
or on an application made to it by the Central
Government or by any person concerned [Section
140(5)].
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 Remuneration of Auditors
• As per Section 142(1) of the Act the remuneration of
the auditor is fixed by the general meeting or in a
manner as may be determined in the general meeting.
• Notice that, it is not necessary that the amount of
remuneration be specified by the company in its
general meeting. It would be enough if the manner in
which the remuneration is to be fixed is laid down in
the general meeting.
• It is also not essential that the remuneration be fixed
in the same general meeting in which the auditor is
appointed. The Board of Directors may fix
remuneration of the first auditors appointed by it. 28
 Rights of the Company Auditor

• Right to access to books and Account etc.: As per

section 143(1), every auditor of company has a right
of access at all times to the books, accounts and
vouchers of the company, wherever kept.
• 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. Similarly, the term
‘books’ includes the financial, statutory, and
statistical books.
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 Right to obtain information or Explanation
• Section 143(1) also entitles the auditor of a company
“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”.
• The auditor has a right to specifically enquire about
the following matters:
(a) 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 interests of the
company or its members; 30
 Right to obtain information or Explanation
(b) whether transactions of the company which are
represented merely by book entries are prejudicial to
the interests of the company;
(c) 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 have been sold at a
price less than that at which they were purchased by
the company;
(d) whether loans and advances made by the company
have been shown as deposits;
(e) whether personal expenses have been charged to
revenue account; 31
 Rights of the Company Auditor

• Right with Respect to Branch Accounts: Section

143(8) provides that the accounts of the branch
office, if any, of the company are required to be
audited either by the company’s auditor or by any
other person qualified for appointment as an auditor
of the company under this Act and appointed as such
under section 139.
• Right to Sign the Report: Only the person appointed
as an auditor has the right to sign the auditor’s report
or sign or certify any other document of the company
[Section 145].
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 Rights of the Company Auditor

• Right to Receive Notices: Section 146 provides that

all notices of and other communications relating to
any general meeting of a company, which any
member of the company is entitled to have sent to
him, shall also be forwarded to the auditor of the
company.
• Right to attend General Meeting: Under section
146 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.
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 Duties of Company Auditor
• Duty to Make Report under S 143: Sub-sections (2)
and (3) of section 143 provide that 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
statements which are required by or under this Act to be
laid before the company in general meeting also that the
report shall confirm the position, envisaged in the under-
mentioned manner in which the requirements are to be
met.
• Sub-section (2) specifically requires that the auditor
should report whether to the best of his information and
knowledge the said accounts and financial statements
give a true and fair view of the state of company’s affairs
at the end of financial year and the profit and loss and34
 Compliance with Auditing Standards

• Section 141(9) requires the auditor to comply with

the auditing standards as may be prescribed for the
performance of the audit. For this purpose the Central
Government may prescribe auditing standards as
recommended by the Institute of Chartered
Accountants in consultation with the National
Financial Reporting Authority.
• Till such auditing standards are notified, the standards
already specified by the ICAI shall be followed
[Section 141(10) and proviso].
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 Duty to Report Fraud

• Section 143(12) of the Act imposes a duty on the

auditor 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.
• 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.
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 Duty to Report Fraud

• On receipt of reply from the Board or the audit

committee, the auditor is required to forward his
report, reply or observations of the Board or the audit
committee and his comments upon such reply or
observations to the Central Government within
fifteen days of receipt of such reply or observations.
• If the auditor fails to comply with section 143(12), he
shall be punishable with fine which shall be not less
than rupees one lakh but may extend to rupees
twenty-five lakh.
37
 Duty to attend General Meeting
• Under section 146 the auditor has a duty to attend the
general meeting either by himself or through his
authorized representative unless exempted by the
company.
• The authorized representative shall be person who is
qualified to be an auditor.
• Scope of duties of an auditor - The statutory duties
of the auditor cannot be limited in any way either by
the Articles or by the directors or members but a
company may extend them by passing a resolution at
the general meeting or making a provision in the
articles [Newton v. Birmingham Small Arms Co.
38
Ltd. (1875)].
 Duty to Make Statement in Prospectus
• Under sub-clause (iii) of section 26(1)(b) an auditor is
required to make a report to be included in the prospectus of
a company. Such a report should be made out on—
(a) the profits and losses of the business of the company for
each of the five financial years immediately preceding the
issue; and
(b) assets and liabilities of its business on the last date to
which the accounts of the business were made up (not more
than one hundred and eighty days before the issue of the
prospectus).
• In case of a new company for which five years since
incorporation has not lapsed, the report on the profit and
losses should cover the period from the date 39of
incorporation
 Penalty for Contravention
• Any contravention with the provisions from sections 139
to 146 makes the company liable to fine which shall not
be less than rupees twenty-five thousand but which may
extend to rupees five lakh.
• Every officer in default is punishable with fine between
rupees ten thousand and rupee one lakhs or imprisonment
extending up to one year or both [Section 147(1)].
• Any contravention by the auditor of section 139
(appointment), section 143 (power and duties), section
144 (prohibited services) or section 145 (signing of audit
report) shall be punishable with fine of rupees twenty-five
thousand to rupees five lakhs or four times the
remuneration of auditor, whichever is less [Section
40
147(2)].
 Audit Committee
• Section 177(1) of the Act requires every listed
company and such other class or classes of companies
as may be prescribed to constitute an Audit
Committee as a committee of the Board of Directors.
• This Committee shall consist of such number of
directors as its members, as may be determined by the
Board. However, the number shall not be less than
three out of which majority shall be independent
directors.
• Proviso to section 177(1) requires that the majority of
the members of the Audit Committee including the
chairperson shall have the ability to read and
understand the financial statements. 41
 Functions of Audit Committee

The audit Committee is to take care of the following:

(i)the recommendation for appointment,
remuneration and terms of appointment of auditors of
the company;
(ii) measures to review and monitor the auditor’s
independence and performance and effectiveness of
audit process;
(iii) examination of the financial statement and the
auditors’ report thereon;
(iv) approval or any subsequent modification of
transactions of the company with related parties; 42
 Functions of Audit Committee

(v) scrutiny of inter-corporate loans and investments;

(vi) valuation of undertakings or assets of the
company, wherever it is necessary;
(vii) process for evaluation of internal financial
controls and risk management systems;
(viii) monitoring the end use of funds raised through
public offers and related matters.

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THANK YOU!

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