Account, Audit & Auditors under Companies Act, 2013
After a review of relevant provisions of accounts, audit and auditors' obligations and liabilities, one is forced to say "Cheer up Auditors! The 2013 Act doesn't make it a punishable offence to reject company audit assignment".
The Companies Act, 2013 ("the 2013 Act") enacted by Parliament and assented to by the President shall come into force on such date as the Central Govt. may appoint by notification in the Official Gazette. When it comes into force the 2013 Act shall repeal the Companies Act, 1956 ("the 1956 Act"). The 2013 Act makes a number of changes and departures from the provisions of the 1956 Act which are examined in succeeding paras.
CASH FLOW STATEMENT MADE MANDATORY EXCEPT FOR SMALL COMPANIES, OPCs AND DORMANT COMPANIES
1. According to section 2(40)(iii) of the 2013 Act, Cash flow statement shall form part of the financial statements for all companies except for One Person Companies, Small Companies and Dormant Companies. There was no requirement for the preparation and presentation of cash flow statement in the 1956 Act. The Accounting Standards notified under the Companies Act,1956 made cash flow statement mandatory except for small companies. Section 143(2) of the 2013 Act requires the auditor's report to the members of the company shall state whether in his opinion the financial statements give a true and fair view of the state of the companies affairs as at the end of its financial year and profit and loss and cash flow for the year. The 1956 Act did not require the auditor to opine on cash flow for the year.
STATEMENT OF CHANGES IN EQUITY MADE MANDATORY IF APPLICABLE
2. According to section 2(40)(iv) of the 2013 Act, the financial statements shall also include a statement of changes in equity if applicable. There was no such requirement in the 1956 Act
FINANCIAL YEAR SHALL BE 1ST APRIL TO 31ST MARCH SUBJECT TO EXCEPTIONAL CASES
3. The 1956 Act did not require companies to align their financial years for Companies Act purposes with previous year under the Income-tax Act, 1961 i.e. 1st April to 31st March. The definition of "financial year" in section 2(41) of the 2013 Act requires companies to adopt 1St April to 31st March as financial year except in certain circumstances. A company or a body corporate existing as at the commencement of the 2013 Act shall within 2 years from such commencement align its financial year as above.
The ingredients of the definition in section 2(41) are as under:
The expression "financial year" is defined with reference to companies and bodies corporate
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"financial year" means the period ending on the 31st day of March every year, i.e. 1st April to 31st March
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A company or a body corporate existing as at the commencement of the 2013 Act shall within 2 years from such commencement align its financial year as above.
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Exception carved out for first financial year where company incorporated on or after the 1st January of a financial year
Where a company or body corporate has been incorporated on or after the 1st day of January of a year, the (first) financial year is the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate laid before it in its annual general meeting is made up.
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In other words, if a company is incorporated on 31-12-20XX, its first financial year shall be the period from 31-12-20XX to 31-3-20X1.
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If a company is incorporated on 1-1- 20X1, its first financial year will be 1-1-20X1 to 31-3-20X2.
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Exception carved out for holding company or subsidiary of a foreign company
On an application made by a company or body corporate, which is a holding company or a subsidiary of a company incorporated outside India and is required to follow a different financial year for consolidation of its accounts outside India, the Tribunal may, if it is satisfied that the circumstances so warrant, allow any period as its financial year, whether that period is a year or more or less than a year.
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CONSOLIDATED FINANCIAL STATEMENTS MADE MANDATORY
4. Where a company has one or more subsidiaries, it shall:
prepare a consolidated financial statement of the company and all the subsidiaries in the same form and manner as that of its own; and
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lay the consolidated financial statement also before the annual general meeting of the company along with the laying of its financial statement.
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The term "subsidiary" for above purposes shall include associate company and joint venture.
The consolidated financial statements shall be in addition to its own (standalone) financial statements(balance sheet, P&L account, cash flow statement and SOCIE if applicable together with notes to accounts).
The following requirements are also relevant:
The company shall also attach along with its financial statement, a separate statement containing the salient features of the financial statement of its subsidiary or subsidiaries in such form as may be prescribed.
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The Central government shall prescribe the manner of consolidation of accounts of companies by way of rules.
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The provisions of this Act applicable to the preparation, adoption and audit of financial statements of a holding company shall, mutatis mutandis, apply to consolidated financial statements also.
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The auditor of a holding company shall also have the right of access to the records of all its subsidiaries insofar as it relates to the consolidation of its financial statement with that of its subsidiaries.[Section 143(1)]. Section 143(1) seems to imply that auditor of holding company shall also be auditor of consolidated financial statements.
5. APPOINTMENT OF AUDITORS BY NON-GOVT. COS AT AGM FOR 5 YEAR TERM SUBJECT TO RATIFICATION AT EVERY AGM
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 manner and procedure of selection of auditors by the members of the company at such meeting shall be such as may be prescribed.
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"Firm" for the purposes of Chapter X dealing with "Audit and Auditors" shall include LLP incorporated under the LLP Act, 2008.
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The auditor so appointed shall hold office from the conclusion of that meeting till the conclusion of its sixth AGM and thereafter till the conclusion of every sixth meeting.
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The company shall place the matter relating to such appointment for ratification by members at every AGM.
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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.[Section 139(10)]
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One wonders what is the rationale for appointing the auditor for a 5-year term and placing it for annual ratification at every AGM? Especially when the 2013 Act contains a provision like section 139(10)?
TIME-BOUND APPOINTMENT OF FIRST AUDITORS BY NON-GOVT . CO.S
6. Section 139(6) of the 2013 Act provides that the first auditor shall be appointed by the Board of Directors within 30 days from the date of registration of the company. The 2013 Act provides for time-bound appointment of first auditors of a company by providing that in the case of failure of the Board to appoint such auditor, it shall inform the members of the company, who shall within 90 days at an extraordinary general meeting appoint such auditor. This wasn't the case under the 1956 Act.
TIME-BOUND FILLING OF CASUAL VACANCY IN OFFICE OF AUDITOR WITHIN 30 DAYS IN CASE OF NON-GOVT. CO.S
7. Section 139(7) provides as under:
Casual vacancy be filled by the Board of Directors within 30 days.
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But if such vacancy is due to resignation of auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the approval of the Board and he shall hold office until the conclusion of the next AGM[Section 139(7)].
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Thus, filling of casual vacancy made time-bound by the 2013 Act which was not the case with the 1956 Act.
TIME-BOUND APPOINTMENTS OF AUDITORS BY CAG IN CASE OF GOVT. CO.S
8. Provisions for appointment of auditors as per Table below:
Situations
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Provisions regarding appointment of auditors
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Annual appointment /reappointment
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Appointment of first auditor
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Filling up casual vacancy in the office of an auditor
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Note:
The above provisions apply if company is owned or controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments.
MANDATORY ROTATION OF AUDITORS FOR LISTED COMPANIES AND OTHER PRESCRIBED CLASS/CLASSES OF COMPANIES
9. Mandatory rotation of auditors means law stipulates a limit of number of years during which an individual auditor/audit firm may be the auditor of a company and after which auditor must be compulsorily changed. The cooling off period is the minimum gap between expiry of maximum tenure and appointing the auditor again which is stipulated by law.
The following provisions may be noted:
No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or re-appoint—(a) an individual as auditor for more than one term of 5 consecutive years; and (b) an audit firm (including LLP) as auditor for more than two terms of 5 consecutive years :
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Every company, existing on or before the commencement of this Act which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within three years from the date of commencement of this Act.
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The above provisions shall not prejudice the right of the company to remove an auditor or the right of the auditor to resign from such office of the company. [Section 139(2)]
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The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors. [Section 139(4)]
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The provisions regarding the cooling off period are as under:
An individual auditor who has completed his term as per (a) above shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of his term.
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An audit firm (including LLP) which has completed its term under (b) above, shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.
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The provisions of mandatory rotation of auditors and cooling off period cannot be circumvented by appointing partner/sister concern of the audit firm whose tenure is over. On the date of appointment no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of 5 years.
ENABLING PROVISION FOR VOLUNTARY ROTATION OF AUDITORS AND ROTATION OF AUDIT PARTNERS
10. Rotation of audit firm is not to be confused with rotation of audit partner/team. The former is mandatory. The latter is optional. Section 139(3) of the 2013 Act provides that subject to the provisions of this Act, members of a company may resolve to provide that in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members. Thus, company to which mandatory rotation of auditors does not apply, company may in general meeting resolve to rotate auditors.
REMOVAL OF AUDITOR BEFORE EXPIRY OF TERM
11. The following provisions in this regard may be noted:
The auditor appointed under section 139 may be removed from his office before the expiry of his term only by a special resolution of the company after obtaining the previous approval of the Central Government in that behalf in the prescribed manner.
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Before taking any action(i.e. removal before expiry of term), the auditor concerned shall be given a reasonable opportunity of being heard.[Section 140(1)]
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The 1956 Act only required ordinary resolution for removal of auditors. Also the 1956 Act had an elaborate procedure for removal of auditors in section 225 which has been replaced by simple rule of natural justice that was the essence of section 225.
TRIBUNAL MAY DIRECT THE COMPANY TO CHANGE ITS AUDITORS
12. Section 140(5) of the 2013 Act contains provisions regarding Tribunal's powers to direct company's change of auditors which are as under:
The Tribunal, may, by order, direct the company to change its auditors, if it is satisfied that the auditor of a company has:
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acted in a fraudulent manner or
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abetted or colluded in any fraud by, or in relation to, the company or its directors or officers.
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The Tribunal may so direct either suo motu or on an application made to it by the Central Government or by any person concerned.
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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 15 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.
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Such auditor (who has been removed by Tribunal as above) shall also be liable for action under section 447. Such auditor shall be disqualified from being appointed as auditor for 5 years from the date of passing the order.
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In case of a firm, the liability shall be of the firm of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by or in relation to the company or its directors or officers.
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RESOLUTION AT AGM APPOINTING AS AUDITOR A PERSON OTHER THAN A RETIRING AUDITOR [SECTION 140(4)]
13. The procedure to be followed is as under:
Special notice [See section 115] shall be required for a resolution at an annual general meeting for appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed except where the retiring auditor has completed a consecutive tenure of 5 years/10 years [See section 139(2)]. [Section 140(4)(i)]. Section 115 requires that the special notice has to be given to the company by such number of members holding not less than 1% of the total voting power or holding shares on which such aggregate sum not exceeding Rs. 5,00,000 as may be prescribed has been paid-up.
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On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor. [Section 140(4)(ii)]
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Where such special notice is given and the retiring auditor makes written representations not exceeding a reasonable length to the company and request their notification to the members of the company, the company shall, unless the representations received are too late for it to do so—(a) in any notice of the resolution given to the members, state the fact that representations have been made; and (b) send a copy of the representations to every members of the company to whom notice of meeting is sent, whether before or after the receipt of the representation by the company. [Section 140(4)(iii)]. The 1956 Act imposed a limitation of 1000 words on the length of the outgoing auditor's written representations. The 2013 Act omits this limit.
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If a copy of representation is not sent to members as aforesaid because they are received too late or because of company's default the auditor may require that the representation be read out at the meeting. This right is without prejudice to his right to be heard at the meeting.
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If a copy of the representation is not sent as aforesaid, a copy of it shall be filed with the ROC.
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If the rights to make representations are being abused by the auditor, the company or any aggrieved person may apply to the Tribunal. If the Tribunal is satisfied that the auditor is abusing his rights, the company need not circulate or read out such representations. [Second Proviso to section 140(4)]
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RESIGNATION OF AUDITOR - AUDITOR'S DUTIES
14. Where auditor resigns from the company, his duties are as under:
The auditor who has resigned from the company shall file within 30 days of resignation a statement in the prescribed form with the company as well as with the ROC indicating reasons and other facts as may be relevant with regard to his resignation. [Section 140(2)]
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In case of companies referred to in sub-section (5) of section 139 [companies owned and controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments] the auditor shall also file such statement with the Comptroller and Auditor General of India, indicating the reasons and other facts as may be relevant with regard to his resignation. [Section 140(2)]
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If auditor does not file such statement as above, he shall be punishable with a fine not less than Rs. 50,000 but which may extend to Rs. 5,00,000. [Section 140(3)]
SERVICES WHICH AUDITOR SHOULD NOT PROVIDE TO THE AUDITEE COMPANY
15. Section 144 of the 2013 Act provides that an auditor appointed under this Act shall not directly or indirectly provide any of the following "other services" (i.e. services other than statutory audit under the 2013Act) to auditee-company or its holding company or subsidiary company
(a)
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accounting and book keeping services;
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(b)
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internal audit;
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(c)
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design and implementation of any financial information system;
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(d)
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actuarial services;
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(e)
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investment advisory services;
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(f)
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investment banking services;
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(g)
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rendering of outsourced financial services;
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(h)
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management services; and
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(i)
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any other kind of services as may be prescribed.
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Services other than the above may be provided by the auditor to the company only if the services are approved by the Board of Directors or the audit committee, as the case may be.
An auditor or audit firm who or which has been performing any non-audit services on or before the commencement of this section shall comply with this section before the closure of the first financial year after the date of such commencement.
The term "directly or indirectly" shall include rendering of services by the auditor:
(a)
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in case of auditor being an individual, either through himself or through his relative or any other person associated with such individual or through any other entity, whatsoever, in which such individual has significant influence or control, or whose name or trade mark or brand is used by such individual.
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(b)
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in case of auditor being a firm (including LLP incorporated under the LLP Act, 2008), either through itself or through his parent, subsidiary or associate entity, whatsoever, in which the firm or any partner of the firm has significant influence or control, or whose name or trade mark or brand is used by the firm or any of its partners.
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DISQUALIFICATIONS OF AUDITORS
16. The 2013 Act introduces the following new disqualifications for auditors:
a person or a firm who 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.
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a person whose relative is a director or in the employment of the company as a key managerial personnel.
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a person who has been convicted by a Court of an offence involving fraud and a period of 10 years has not elapsed from the date of such conviction.
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any person whose subsidiaries or associate companies or any other form of entity, engaged in consulting and specialized services (See section 144)- Section 141(3).
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The 2013 Act also modifies existing disqualifications in the 1956 Act.
AUDITOR OBLIGED TO COMPLY WITH THE AUDITING STANDARDS
17. The 2013 Act accords statutory recognition to auditing standards also. The 1956 Act recognized only accounting standards. Section 143(9) of the 2013 Act provides that every auditor shall comply with the auditing standards. The Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by ICAI, in consultation with and after examination of recommendations made by the NFRA. [Section 143(10)] Until any auditing standards are notified, any standard or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards. [Section 143(10)]
REQUIREMENT OF HIGHLIGHTING CERTAIN COMMENTS IN AUDIT REPORT IN THICK TYPE OR ITALICS OMITTED
18. Clause (e) of section 227(3)(e) of the 1956 Act required the auditor's report to state in thick type or italics observations or comments of the auditor which have any adverse effect on the functioning of the company. Clause (e) was badly drafted. Section 143(3)(f) omits requirement to highlight comments in thick type or italics. Besides the drafting of clause(e) gave the impression of widening the scope of audit beyond financial matters. Section 143(3)(f) redrafts the requirement to provide that auditor's report shall state the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company.
Section 143(i) of the 2013 Act requires the auditor's report to state whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls.
DUTIES OF AUDITOR/CWA/CS TO REPORT TO CENTRAL GOVERNMENT WHERE FRAUD IS COMMITTED OR BEING COMMITTED ON THE COMPANY
19. If an auditor of a company, in the course of the performance of his duties as auditor, 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, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed.[Section 143(12)] No duty to which an auditor of a company may be subject to (e.g. duty of confidentiality under the CA Act, 1949) shall be regarded as having been contravened by reason of his reporting the matter as above if it is done in good faith. [Section 143(13)] Section 143(12) casts a duty on "auditor of a company" and not on a branch auditor. So if a branch auditor reports any fraud by officers/employees to Central Government, he will not get the protection under section 143(13) even if such reporting is in good faith. Section 143(14) provides that the provisions of section 143(12)/(13) shall mutatis mutandis apply to a—
(a)
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the Cost Accountant in practice conducting cost audit under section 148; or
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(b)
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the Company Secretary in practice conducting Secretarial Audit under section 204;
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If any auditor, cost accountant or Company Secretary in practice do not report fraud committed or being committed as above, he shall be punishable with fine which shall not be less than Rs. 1,00,000 but which may extend to Rs. 25,00,000. [Section 143(15)]
AUDITOR'S DUTY TO ATTEND GENERAL MEETING
20. Section 146 of the 2013 Act provides that the auditor shall attend any general meeting
(i)
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by himself or
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(ii)
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through his authorised representative who is qualified to be an auditor.
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Such attendance is compulsory unless otherwise exempted by the company.
The 1956 Act gave the auditor a right to attend general meetings but didn't make such attendance obligatory.
AUDITOR'S LIABILITIES
21. Section 147 of the 2013 Act brings about a sea change in auditor's criminal liability for contravention of the provisions relating to contents of audit report (section 143 of the 2013 Act), not to render prohibited non-audit services (section 144 of the 2013 Act) and signing of audit report (section 145 of the 2013 Act) as under :
While section 233 of the 1956 Act only imposed on the auditor a paltry penalty of fine upto Rs. 10,000, section 147 of the 2013 Act provides for minimum fine of Rs. 25,000 and maximum fine of Rs. 5,00,000. If contravention is wilful or knowingly with intent to deceive the company or its shareholders or creditors or tax authorities, section147 of the 2013 Act provides for imprisonment of the auditor upto one year and with increased fine-minimum Rs. 1,00,000 and maximum Rs. 25,00,000.
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Further, section 147 of the 2013 Act requires the convicted auditor to refund remuneration to the company and to pay for damages to the company, statutory bodies or authorities or to any other persons for loss arising out of incorrect or misleading statements of particulars made in his audit report. These provisions were not there in the 1956 Act.
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Section 147 of the 2013 Act also introduces the following new provisions which were not there in the 1956 Act :
Under section 147 of the 2013 Act the Central Government shall, by notification, specify any statutory body or authority or an officer for ensuring prompt payment of damages to the company or the persons specified above. Such body, authority or officer shall after payment of damages to such company or persons file a report with Central Government in respect of making such damages in such manner as may be specified in the said notification.
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Under section 147 of the 2013 Act where the auditor of a company is an audit firm and it is proved that the audit partner or partners has or have :
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acted in a fraudulent manner or
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abetted or colluded in any fraud by or in relation to or by the company or its directors or officers,
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the liability, whether civil or criminal, as provided in the Act or any other law for the time being in force, for such an Act would be of the audit partner or partners concerned as well as of the firm jointly and severally.
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It is the liability towards third parties stipulated by section 147(3) which is the cause for alarm. If the audited financial statements are used for a purpose which they are not intended and fit to serve, it would not be in the fitness of things to make the auditor liable in damages. Section 147(3) jettisons the above time-tested judicially evolved norms which limits auditor's liability to third parties. This section makes the auditor liable for financial loss of every potential investor and every creditor who seeks to rely on them even though general financial statements are prepared basically in discharge of accountability to existing shareholders. Courts have devised principles to limit the liability of auditors towards third parties so that auditors are not, to borrow the words of Justice Cardozo, "exposed to liability in an indeterminate amount for an indeterminate time to an indeterminate class". Section 147(3), by making the auditors liable to any and every third party who suffers a loss without regard to whether it was legitimate to use the audited financial statements for the purpose for which the third party used, seeks to expose the auditors "to liability in an indeterminate amount for an indeterminate time to an indeterminate class".
CONCLUSION
22. The only thing one can say after reviewing the provisions of the 2013 Act regarding auditors' liabilities and obligations is "Cheer up Auditors! The 2013 Act doesn't make it a punishable offence to reject company audit assignment".
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CA SANJAY DEWAN
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