14 Auditors, Their Duties And Liabilities

MS.Deepika Prakash

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INTRODUCTION

 

Corporate governance has become the corner stone of corporate law globally. True and fair audits are the core concern for regulators world over. The new Companies Act has made accounts and audits a subject of special interest and has laid down detailed provisions regarding the same. The Act also sets up a National Financial Reporting Authority for setting the standards for the accounting and auditing.

 

AUDIT AND AUDITOR

 

A company carries on its business with the capital provided by the shareholders and other members of the investment community. It is important for them that their investment is safe and that it has been used for the purpose it was intendedto be . The company has to maintain numbers of financial books, accounts and statements for the proper accounting of the income and expenditure. These accounts, books etc must be inspected and verified by an independent person or a firm to give the true picture of internal financial functioning of the company.

 

The Institute of Chartered Accountants of India (ICAI) is a statutory body established under the Chartered Accountants Act, 1949 which regulates the profession of Chartered Accountants in India. ICAI lays down the pre-qualifications, accounting standards, code of ethics as well as education of auditors in India. Only persons who are a member of ICAI with a valid certificate of the institute for auditing may be made an auditor of a company in India. Its “Statement on Objective and Scope of the Audit of Financial Statements”1 lays down the following as the objectives of auditing the financial statements:

 

1.The objectives of an audit of financial statements, prepared within a framework of recognized accounting policies and practices and relevant statutory requirements , if any, is to enable an auditor to express an opinion on such financial statements.

  1. The auditor’s opinion helps determination of true and fair view of the financial position and operating results of an enterprise. The user, however, should not assume that the auditor’ opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise.

 

The main objective of auditing is therefore, is to evaluate the financial statements and confirm that they have been accurately and truly represented in the reports. Auditing which is an independent examination can be done of any entity irrespective of their size or legal form or whether the company is a non- profit making entity or a profit making one.

 

For the purpose of accounting the most important person is an auditor. The recent fall of the Indian company Satyam Computer Services Limited in which the audit and auditing committee was involved, has made the Indian regulator placestringent measures for the appointment as well as duties and liabilities of the auditors of a company. The following is a brief description of how the scam was revealed:-

 

As a lesson learnt, the Companies Act, 2013 Chapter X Secs 139- 148 lays down provisions relating to the appointment, disqualifications as well as duties and liabilities of an auditor. These are discussed as follows:

 

1.  APPOINTMENT OF AUDITORS

 

First auditors- general rules:

 

Auditors are the “gatekeepers of the corporate governance”3They uphold the integrity, authenticity of the financial information of the company.Sec 139 of the Companies Act lays down that an individual or a firm [which includes an LLP u/s 139(4) and 141 (2)]can be appointed as an auditor in a company.

 

The first auditor is to be appointed at a board of meeting within 30 days of the registration of the company. In case the board fails to appoint within the 30 days the auditor then, the board will inform the members and the members shall appoint the auditors in the extra ordinary general meeting of the company.

 

Every appointment will be for five years provided that the company places the matter relating to such appointment for ratification by members at every annual general meeting.

 

Auditor or audit firm so appointed must give in writing consent on such appointment and a certificate from himself or it that the appointment has been made in accordance with the conditions prescribed and that the auditor satisfies the criteria’s provided under the Act (Sec 141 which will be discussed subsequently in the module). A notice of this appointment must be filed with the Registrar within 15 days of the meeting which appoints the auditor.

 

Additional Conditions under Sec 139:

 

Under Sub sec (2) of the appointment provision no listed company or some other companies as notified shall appoint as well as re- appoint:

 

(i) An individual for more than one term of the five consecutive years, or

(ii) An audit firm for more than two terms of five consecutive years

 

Any audit firm which has a common partner with the audit firm whose tenure has just expired with the company may not be appointed as well.The companies are required to comply with these requirements within three years of the implementing of the Act.

 

Rotation of Auditors :

 

Under Sec 139 (3) the members of a company may resolve to rotate in the audit firm appointed, the auditing partner and his team. They may also resolve to get the audit conducted by more than one auditor. The rules regarding the rotation are provided in detail in the Companies Rules

 

Appointment in case of government company under Sec 139 (5) and (7):

 

Under sub sec (7) in case of Government company or company which is owned or controlled by the Central Government/ State Government or both Central and State first auditor shall be appointed by Comptroller and Auditor General of India within sixty days of registration of the company. In case of Comptroller and Auditor General of India does not appoint first auditor within the said sixty days, the Board of directors shall appoint such auditor within next thirty days. In case of failure of Board to appoint first auditor within this period, the members shall appoint such auditor within next sixty days. The first auditor shall hold office until the conclusion of first annual general meeting

 

Under sub sec (5),the auditor of a Government company or a company controlled by the Central Government /State Government / or party by both , the Comptroller and Auditor General of India shall appoint an auditor within a period of one hundred and eighty days from the commencement of financial year to hold office till the annual general meeting has concluded.

Casual Vacancy under Sec 139 (8):

  • When a casual vacancy arises in acompany which is not a Government company if;
  • the vacancy is due to resignation of the auditor then new appointment shall be filed by the board of directors within 30 days
  • the vacancy is due to resignation then the new appointment shall be approved by the company at a general meeting convened within three months of the recommendations of the Board and the auditor shall hold the office till the conclusion of the next annual general meeting.
  • When a casual vacancy arises in a Government company, the new appointment has to bemade by the Comptroller and Auditor General of India within 30 days. In case he does not fill the vacancy within the said period then the Board of directors shall fill the vacancy within the next 30 days.

 

Re- appointment of retiring auditor [ Sec 140 (4) ]

 

Subject to sub sec (1), a retiring auditor may be re appointed4 at an annual general meeting, if:

 

 

Re- appointment when no auditor is selected [Sec 139 ( 10) ]

 

Under sub sec (10), where at any annual general meeting, no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the company.

 

Appointments in case of audit committee [ Sec 139 (11) ]

 

Under sub sec (11), where a company is required to constitute an Audit Committee under section 177,all appointments, including the filling of a casual vacancy of an auditor under this sectionshall be made after taking into account the recommendations of such committee.

 

2. REMOVAL OF AUDITOR [ Sec 140 ]

 

Auditor appointed under the above sec can be removed under Sec 140 of the companies Act. It is as follows:

An auditor may be removed before the expiry of his time period only by a special resolution of the company. This is to be obtained after the approval of the Central Government in the prescribed manner. Before he is removed he has to be given a reasonable opportunity of being heard.

 

In the situation where auditor has resigned from the company, he shall file within a period of 30 days from the date of resignation the following statement depending whether the company is a Government company or any other form of company:

 

In case of a Government company:

  • A statement in prescribed form with the company and registrar
  • A statement with the Comptroller and Auditor General of India indicating the reasons and other facts as may be relevant with regards to his resignation.

 

In case of a company other than Government Company:

 

Submit a statement in the prescribed manner with the company and the registrar.The Act provides for a penalty of Rs 50,000 in case the auditor does not comply with the above procedure.

 

Special notice

 

Sec 140 provides for the procedure in which when a retiring auditor is being re-appointed or when a retiring auditor must not be appointed if he has completed 5 consecutive tenures ,or 10 as the case may be. A special notice is required to be given on this behalf ( to re appoint or not ) before a resolution at an annual general meeting. Once the notice is received for a resolution the company is to send a copy of the same to the retiring auditor. The retiring auditor under the section makes a written representation to the company which is to be notified to the members of the company. This has to be send by the company so as to:

 

a. State the fact of the representation having been made; and

 

b. Send a copy of the representation to every member of the company to whom notice of the meeting is sent, whether before or after the receipt of the representationby the company.

 

In case the copy of the representation is receivedtoo late or not send in the first place, then the auditor will have the right to present orally or read at the meeting itself. A copy of the representation has to be filed with the registrar as well.

 

Eligibility to be appointed auditor

 

Under sec 141 (1) of the Act, a person or a firm whose partners are chartered accountants may be appointed as auditors of a company in India. An LLP which is registered may also be appointed auditor provided only the partners who are chartered accountants shall be authorized to sign on behalf of the firm.

 

Disqualifications under Sec 141 (3):

 

Following persons shall not be eligible for appointment as an auditor of a company:

 

(a) A body corporate other than a limited liability partnership;

 

(b)  An officer or employee of the company;

 

(c) A person who is a partner or who is in the employment of an officer of employee of the company;

 

(d) A person who or his relative or partner (i) is holding any security of or interest in, or (ii) is indebted to, or (iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its subsidiary, or its holding or its associate company or a subsidiary of such holding company;

 

(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;

 

(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) any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

 

The services under this section 144 are:

 

(a) accounting and book keeping services;

 

(b) Internal audit;

 

(c) Design and implementation of any financial information system;

 

(d) Actuarial services;

 

(e) Investment advisory services;

 

(f) Investment banking services;

 

(g) Rendering of outsources financial services;

 

 

(h) Management services; and

 

(i) Any other kind of services as may be prescribed.

 

It is clear that the above restrictions will prohibit an auditor from rendering certain prescribed non audit services to the company and its holding or subsidiary company in India. It is further submitted that though the Act lays down the services which are prohibited yet it does not define some of them like“investment advisory services” and “management services”. As there are no clear meaning assigned to them, they may be subjected to varying interpretations.

 

3. POWERS AND DUTIES OF AUDITORS

 

Duties of an auditor have been stated under Sec 143 of the Companies Act which are illustrated as under:-

 

 

Let us discuss them in detail :

 

1. Right to access

 

Under this Act every auditor of a company shall have a right of access at all times to the books of account and vouchers of the company, whether they are kept at the registered office or any other place. He is under this provision entitled to ask the same from the officers of the company all the information that he considers necessary for the performance of his duties as auditors. The Sec 143 (1) (a) to (f) lays down the list of matters on which the auditor may seek information.

 

These rights are also available to an auditor of a holding company:

 

a) Proper security for loan and advances,

 

b) Transaction by book entries

 

c) Sale of assets in securities in loss

 

d) Loan and advances made shown as deposits,

 

e) Personal expenses charged to revenue account

 

f) Case received for share allotted for cash

 

2 Make a report on financial statements

 

It is the duty of the auditor to make a report on every financial statement which was required by the Companies Act to be laid before the company in a general meeting. This report is to be in accordance to the accounting and auditing standards required under the Act. This report has to be placed before the members of the company at the end of the financial year. The report shall state5:

 

a) whether he has sought and obtained all the necessary information and explanations which to the best of his knowledge and belief forhis audit and if not, the details thereof and the effect of such information on the financial statements;

 

(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;

 

(c) whether the report on the accounts of any branch office of the company audited under sub-section (8) by a person other than the company’s auditor has been sent to him under the proviso to that sub-section and the manner in which he has dealt with it in preparing his report;

 

(d) whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;

 

(e) whether, in his opinion, the financial statements comply with the accounting standards;

 

(f) the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;

 

(g) whether any director is disqualified from being appointed as a director under sub-section (2) of section 164;

 

(h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;

 

(i) whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls;

 

(j) such other matters as may be prescribed.

 

In case the report does not mention all the necessary information that is required to be stated, then the auditor needs to state all reason for the same.

 

Audit report to be submitted to government company

 

In the case of a Government company, the auditor as appointed under Sec 139, has to prepare the accounts in the manner directed by the Comptroller and Auditor General (CAG) of India to whom this report has to be submitted .The report shall include the directions if any, given by the CAG, the action taken as well as its impact on the accounts and the financial statement of the company.

 

After the report has been submitted to the CAG, within 60 days has a right to:

 

a) Conduct a supplementary audit, and

 

b) Comment upon or supplement such audit report. This comment/ report has to send to by the company to every person entitled to copies of audited financial statements under Sec 136 , sub section (1) as well as be placed before the annual general meeting.

 

Prepare branch report

 

Where a company has a branch office, the accounts of that office shall be audited either by the company’s auditor, or by any other person qualified for appointment as an auditor of the company, where the branch office is situated in a country outside India, the accounts of the branch office shall 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 that country.6

 

The branch auditor shall also prepare a report on the accounts of the branch examined by him. This report is to be sent to the auditor of the company who shall deal with it in his report in such manner as he considers necessary.

 

Comply with accounting standards

 

One of the major duties of the auditor is to conduct audit and prepare the report as per the accounting standards recognized by law. The Central Government notifies these standards after consultation with the National Financial Reporting Authority created under the Companies Act.

 

Report fraud

 

A critical duty under this section that has been assigned to the auditor is that whenever during his appointment, he has reasons to believe that an offence involving fraud is being committed against the company by its officers or employees, he has to immediately report the matter to the Central Government within such time and in such manner as prescribed.

 

Sub section (13) further elaborates on this duty by adding that no duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reasons of his reporting the fraud if it is done by him in good faith.

 

Duty to sign audit report

 

The auditor has to sign the auditor’s report or sign or certify any other document of the company in accordance with the provisions of sub section (2) of section 141. All the observations, qualifications as well as comments of the auditor on the financial transactions or matters which have adverse effect on the functioning of the company and which have been mentioned by the auditor in his report have to be read before the company in general meeting and will be open to inspection by any member of the company.

 

Right to attend meetings

 

The auditor under sec 146 has to be forwarded all notices regarding the general meeting of the company. He, unless exempted by the company itself, has to himself or through his authorized representative (who must be a qualified auditor as well) must attend the general meetings and have the right to be heard at such meetings.

 

LIABILITIES OF AN AUDITOR

 

Auditorsappointed in a company are liable under two broadheads:

  • Civil liabilities
  • Criminal liabilities

 

CIVIL LIABILITIES- Under the civil liabilities of a company auditor, following two actions can be taken against him within the common law principles (i) negligence, (ii) misfeasance.

 

(1) Liability for negligence – An auditor is meant to perform his duties as an agent of the shareholders and other persons who have invested in the company. He is expected to safeguard the interests of his shareholders. He must exercise his reasonable care and diligence in the performance of his duties. If he fails to do so and in consequence the principal suffers any lossthen he may be liable to compensate loss caused to the company resulting from his negligence. In the case of ICAI v. S.K.Jain7 , the Court held the chartered accountant concerned guilty of gross negligence by certifying a statement on the export of leather goods without initially verifying facts from relevant books of the company.

 

(2) Liability for Misfeasance – Misfeasance is a breach of duty or breach of trust. If the auditor does something wrongfully in the performance of his duties or he does not perform his duties properly in the first place resulting in a financial loss to the company, he may be held liable for misfeasance.

 

CRIMINAL LIABILITIES – Thecriminal liabilities of an auditor when he does not perform his duties effectively have been laid down in the Companies Act are as following:

Penalty for non-compliance

 

Under Sec 147 of the Act, if any provisions stated under Sec 139 or 146 are contravened, the company shall be punishable with a fine which shall not be less than Rs 25,000 but which may extend to Rs 5, 00,000.

 

If any auditor has knowingly or willfully contravened such provisions with an intention to deceive the company/shareholders/ creditors/ tax authorities, he shall be punishable with imprisonment for a term which may extend to one year and with a fine not less than Rs 1, 00,000 which can be extended till Rs 25, 00,000.

 

The auditor so convicted has to refund the remuneration received by him to the company as well as pay damages to the company/ bodies/ authorities/ any person for loss arising out of an incorrect or misleading statement made by the auditor in his audit report.

 

Penalty for failure to report a fraud

 

Under Sec 143 it is the duty of the auditor to report any fraud that he has reasons to believe company’s officers or employees are committingagainst the company. Sub section (15) lays down a fine of not less than one lakh which may extend to twenty five lakh rupees if any auditor , cost accountant or company secretary does not comply with the provisions of sub section (12) regarding reporting of fraud to the central government.

 

Liability when auditor has committed a fraud

 

The Company Law Tribunal has been powered under sub sec (5) of Sec 140 to either suo motu or on an application made to it by the Central Government or by any other person concerned if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order; direct the company to change its auditors:

 

The section further provides that if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place. The Act lays down a strict consequence for the auditor after Tribunal has passed its final order. The Act does not allow the auditor whether individual or firm to be eligible to be appointed as an auditor of any company for a period of 5 years from the date of passing of this order. The auditor is further liable for action under Sec 447 as well. This step has been taken under the Act for auditors to understand the importance of their duty of auditing and not to commit fraud

 

4. Action under Section 447

 

A person, who has been found guilty of fraud, shall be punishable with imprisonment which shall be not less than 6 months and which may extend to 10 years. He shall also liable to be fined with an amount which shall not be less than the amount involved in the fraud , but which may extend to three times the amount involved in the fraud.

 

5. Class action

 

Under Sec 245 of the Act, any 100 or more members or deposit holders of the company or 10 % of the total number of members/ deposit holders of the company may file a class action suit to claim damages or compensation or demand any other suitable action against the auditor in the manner prescribed.

 

The action under Sec 245 can be initiated against an auditor for any improper or misleading statement of particulars made in the audit report or for any fraudulent, unlawful or wrongful act or conduct. In such an action liability will be of the audit firm (in case the audit is being conducted by a firm) as well as each partner who was involved in making such improper or misleading particulars in the audit report.

 

CONCLUSION

 

Auditors form one of the pillars of corporate governance. The auditor is responsible for verifying whether the financial statements and books of accounts exhibit a true and fair view of the state of affairs of the business. His audit report has to be authentic and accurate. In this module how the auditor is appointed, his qualifications, disqualifications, tenure as well as powers, duties and liabilities have been discussed as per the provisions under the law. Under the new Companies Act, the reporting responsibilities of the auditor have increased significantly. This step has been taken in order to protect the shareholders and other investors in the company.

 

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References:-

 

1. A. K. Majumdar and Dr G.K.Kappor, Taxmann’s Company Law and Pactice,Taxmann

Publication, 16th Edition (2011).

2. S. Balasubramanian, A Ramaiya Guide to Companies Act, LexisNexis Butterworths Wadhwa Publication, 2013.

3. A Singh, Introduction to Company Law, Eleventh edition, 2014, Eastern Book Company

4. A Singh, Company Law, fifteenth edition, 2011, Eastern Book Company

5. Companies Act 2013 with Rules, Taxmann, 2014

6. Company Law, Mayson, French and Ryan, twenty second edition, 2005-06

7. Securities Law, Hudson, Sweet & Maxwell, 2008

8. International Securities Law Handbook, Best and Solier, third edition, Wolters Kluwer, 2010

9. Bare Act: Companies Act, 2013