Companies Act

This article has been written by Naveen Talawar, a law student at Karnataka State Law University’s law school. The article discusses Section 177 of the Companies Act, 2013 in detail.

This article has been published by Sneha Mahawar.​​ 

Introduction

A transparent accountability system is nourished by good corporate governance. Following several corporate scandals, including those involving Sahara, Satyam, and Enron, both in India and internationally, corporate governance became increasingly important to boost the nation’s financial situation by gaining the trust of investors. As a means of ensuring the accuracy of financial statements, the role of the audit committee is essential. The board of the company delegated this authority by establishing various committees to handle work that requires more expertise, focus, and technical decisions because it is difficult for the board to take every decision with due diligence and to give it the required time and effort. As a result, the board establishes the audit committee, whose goal is to make sure that a company provides accurate, sufficient, and credible information to investors as well as to third parties who conduct independent studies that assess the performance of the company. Section 177 of the Companies Act, 2013 provides for the constitution of an audit committee, which has been discussed in detail in this article.

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What is an audit committee

The audit committee is a fundamental element of the corporate governance system in public companies. It aims to boost public confidence in the reliability of the company’s internal control procedures, financial reporting, and announcements. Its main responsibilities are disclosure and financial reporting. It evaluates and records the auditor’s objectivity, effectiveness, and performance. It also examines the financial statement and the audit report.

Chapter XII (Sections 173–195) of the Companies Act, 2013 contains the provisions governing Board of Director meetings and the powers of the board, and Section 177 of the Companies Act, 2013 specifically mentions the audit committee. Every listed company, as well as the other specified classes of companies, must have an audit committee of the board, in accordance with Section 177 of the Companies Act, 2013, read with Rule 6 of the Companies (Meetings of the Board and its Powers) Rules, 2014.

In addition to those provided in the Companies Act, listed companies are also subject to the requirements of Regulation 18 of the SEBI (Listing Obligations and Disclosure Requirements) Rules 2015 relating to the audit committee.

Section 177 of the Companies Act, 2013

The following classes of companies and every listed company are required to have an audit committee of the board, in accordance with Section 177 of the Act and Rule 6 of the Companies (Meetings of the Board and Powers) Rules, 2014: 

  1. All public companies having a minimum paid-up capital of ten crore rupees.
  2. All public companies with turnover of at least one hundred crore rupees. 
  3. All public companies with aggregate outstanding loans, borrowings, debentures, or deposits exceeding fifty crore rupees. 

The paid-up share capital, turnover, outstanding loans, borrowings, debentures, or deposits as appropriate as they existed on the date of the most recent audited financial statements shall be taken into consideration for the purpose of this rule.

Composition of the audit committee

In accordance with the Companies Act

Section 177(2) of the Companies Act of 2013 states that the audit committee must have a minimum of three directors, with independent directors constituting a majority. The chairperson and the majority of the members of the audit committee shall be capable of reading and understanding financial statements.

In accordance with Regulation 18 of the SEBI (LODR) regulations, 2015

The audit committee must have at least three directors. Independent directors must make up at least two-thirds of the audit committee. If the listed entity has outstanding SR equity shares, only independent directors may serve on the audit committee. The audit committee must consist of members who are all financially literate and at least one who has expertise in accounting or a related area of financial management. The chairperson of the audit committee shall be an independent director. The secretary of the audit committee shall be the company secretary.

Reconstitution of the audit committee

Section 177(3) of the Companies Act, 2013 provides that every audit committee of a company that existed immediately before the enactment of the Companies Act must be reconstituted within a year of the Act’s implementation.

Functions of the audit committee

According to Section 177(4) of the Companies Act, 2013, every audit committee must operate in accordance with the written terms of reference set forth by the board, which must include:-

  1. The recommendation for the appointment, remuneration, and terms of appointment of the company’s auditors.
  2. Examine and monitor the auditor’s independence and performance, as well as the efficiency of the auditing process.
  3. Examination of the audit report and the financial statements; 
  4. Approval or any subsequent modification of the company’s transactions with related parties.
  5. Examination of inter-corporate investments and loans. 
  6. Valuation of the company’s undertakings or assets, as necessary.
  7. Valuation of the internal financial controls and risk management systems.
  8. Monitoring the end use of funds raised through open offers and related matters.

Further, subject to the conditions outlined in Rule 6A of the Companies (Meetings of Board and its Powers) Rules of 2014, the audit committee may also grant omnibus approval for related party transactions to be included in the proposals of the company. If the audit committee does not approve a transaction that is not covered by Section 188, it must still make recommendations to the board.

The transaction which involves an amount of up to Rs. 1 crore has been made by a director of the company without the approval of the audit committee and is not approved by the audit committee within three months of the transaction date may be voidable at the discretion of the audit committee. However, if the transaction involves a related party of any director or is authorized by another director, the concerned director has to indemnify the company against any loss incurred as a result of the transaction. However, a transaction between a holding company and its wholly-owned subsidiary company other than that of the transaction referred to in Section 188 is exempted from the provisions of this clause.

Powers of the audit committee

In accordance with the Companies Act, 2013

Sections 177(5) and 177(6) of the Companies Act, 2013 provide for the following powers of the audit committee:

  1. The audit committee, before the financial statements are presented to the board, has the power to ask the auditors for their opinions on internal control mechanisms, the scope of the audit, including their observations, and a review of the financial statements.
  2. The audit committee may also speak with the management of the company, external and internal auditors, and auditors regarding any pertinent issues.
  3. The audit committee has the power to look into any matter related to the matters listed in its terms of reference or those that the board has referred to, and the committee for this purpose may seek professional advice from external sources.
  4. To have complete access to the information contained in the records of the company.

In accordance with SEBI (LODR) Regulations, 2015

According to the SEBI (LODR) Regulations of 2015, the audit committee shall have the following powers:

  1. Investigate any activity that falls within its terms of reference.
  2. Inquire about information from any employee.
  3. Obtain legal or other professional advice.
  4. If necessary, it will secure the attendance of outsiders with relevant expertise.

Disclosure in the board’s report

According to Section 177(8), the board’s report under Section 134(3) must disclose the composition of an audit committee, and if the board did not accept any audit committee recommendation, the reasons for doing so must be disclosed in such a report.

Constitution of a vigil mechanism

Every listed company and the companies are required to create a vigil mechanism for their directors and employees to report any reasonable concerns or grievances, in accordance with subsections (9) and (10) of Section 177 of the Companies Act, 2013, and Rule 7 of the Companies (Meetings of Board and its Powers) Rules, 2014.  These companies include those that accept public deposits and those that have borrowed money from banks and other public financial institutions exceeding Rs. 50 Crores.

In case of other companies

In the case of other companies, the board of directors must designate a director to serve on the audit committee for the purpose of a vigil mechanism for other directors and employees to express their concerns. The companies that are required to have an audit committee are responsible for overseeing the vigil mechanism through the audit committee. If any of the committee members have a conflict of interest in a particular situation, they are required to recuse themselves so that the other committee members can handle the situation.

Safeguards to employees and director

The vigil mechanism provides reasonable safeguards against the victimisation of the directors, employees, or anyone else using the mechanism. It also provides direct access to the chairperson of the audit committee or the director nominated to serve in the role of the audit committee, as applicable, in appropriate or exceptional cases. 

Action against the frivolous complaint

A director or employee may be subject to reprimand if they repeatedly file frivolous complaints, and the audit committee or the director designated to serve in that capacity may also take appropriate action.

Non-compliance with the provisions of the audit committee

The company shall be fined between Rs. 1 lakh and Rs. 5 lakhs and any company officer in default shall be punished with imprisonment for up to one year and a fine between Rs. 25,000 and Rs. 1 lakh, or both.

Conclusion

The audit committee is set up to regularly review processes and procedures to guarantee the effectiveness (success) of internal control systems, ensuring that the reporting of financial results is accurate and professional at all times. As a result, the audit committee’s function is to act as a channel for accurate and open financial reporting. Therefore, the penal provisions in the Companies Act of 2013 are now stricter and more severe for both companies and officers who are in default. A thorough examination of an organisation’s operations and the maintenance of internal control systems can aid in the detection and prevention of various types of fraud and other accounting irregularities.

Strong auditing systems can aid in reducing a variety of risks that can arise in an organisation, such as information risk, fraud risk, asset misappropriation risk, and risk management on operations. A company cannot produce accurate financial reports for internal or external purposes without a proper audit system. As a result, the audit committee is important to the company.

References

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