This article has been written by Subhadeepa Sen, a law student from the School of Law, CHRIST (Deemed to be University), Bangalore. This article discusses the qualifications, disqualifications, and the process of appointment of auditors in a company.
It has been published by Rachit Garg.
Table of Contents
Introduction
Section 141 of the Companies Act, 2013 deals with the auditor of a company. More specifically, it talks about the eligibility, the qualifications required and the disqualifications of an auditor. For any company, the auditor plays a role of immense importance. The auditor acts as the assessor of the financial records of the company and makes sure that the accuracy, reliability and genuineness of the records and transactions of the company are in place. The primary responsibility laid upon the shoulders of an auditor is to see to it that transparency and accountability are not compromised. The auditor’s report stands as a hallmark for stakeholders, such as investors, creditors and regulators, that the company’s functioning is free from fraud or error. They play the key role of protecting the goodwill of the company and providing assurance to the stakeholders. Their role is a direct reflection of the effectiveness of a company’s risk management process. The Companies Act 2013, has laid down detailed provisions dealing with the aspects of appointment, removal, resignation, remuneration, powers and duties of an auditor. This article aims to discuss in detail the aspects involving eligibility, the qualifications to become an auditor and disqualifications for the same.
Who is qualified to be an auditor in a company as per Section 141 of Companies Act, 2013
Section 141(1) states that the primary qualification for an individual to be appointed as an auditor of a company is that the said individual must be a chartered accountant in practice. Section 2(1)(b) of the Chartered Accountants Act, 1949 states that a person who is a member of the Institute of Chartered Accountants of India shall be a Chartered Accountant (“CA”). In general terms, a Chartered Accountant refers to an accounting professional who is affiliated to a special professional body. The first such accounting professional body was formed in Scotland in 1854. Most countries have their own professional accounting bodies or institutions. India has the Institute of Chartered Accountants of India (ICAI), which is the national professional accounting body. It was established in the year 1949 vide the Chartered Accountancy Act, 1949. Chartered Accountants are professionals with expertise in matters of taxation, filing tax returns, auditing financial statements, reviewing and presenting financial statements and providing financial advice. In the case of Institute of Chartered Financial Analysts of India v. Council for the Institute of Chartered Accountants of India, (2007) 12 SCC 210, Justice Markandey Katju while discussing the scope of practice that can be delved into by Chartered Accountants, stated that the work of a CA cannot be limited to only auditing, it extends to other functions such as financial advisory services. He further held that a Chartered Accountant could perform auditing functions for one company and at the same time act as the financial advisor to another. Such functions would not create any conflict of interest since an auditor functions as the watchdog for the shareholders, whereas a role of a financial advisor is to advise the management. However, the CA should not be performing both functions in the same organisation.
The provision uses the term “in practice”. This is required to be understood in the context of the Chartered Accountancy Act, 1949. Section 2(2) of the Act provides that the term “to be in practice” means that the member, either in an individual capacity or in partnership, engages himself in the practice of accountancy in consideration of remuneration. The provision lays down the different functions that a Chartered Accountant may engage with, which would fall under the purview of being “in practice”. It provides that the Chartered Accountant is eligible to offer services involving audit, verification of accounts, books, financial statements and records. They can prepare, verify, and certify various financial accounting statements and hold themselves as an accountant to the public at large.
Rendering professional services in terms of accounting and providing aid and assistance in various matters about the procedure of accounting is also a statutory function of Chartered Accountants. They can act as experts in recording financial data, presenting financial data and certifying financial facts and data.
Section 2(2)(iv) puts forth that a Chartered Accountant shall also be deemed to be in practice if he is engaged in any of the functions provided under Appendix 2 of the Act and Regulation 191 of Chartered Accountants Regulations 1988. Appendix 2 sets out that a Chartered Accountant can act as a liquidator, executor, trustee, administrator, arbitrator, receiver, adviser or representative for costing, taxation or financial matters. He is also eligible to take up appointments under the Central or the State Government or Judiciary or any other legal/secretarial appointment. However, this must be undertaken in his professional capacity and not in his personal capacity or capacity as an employee. Additionally, these functions would not be deemed to fall under the purview of practice if they render such services in the capacity of a full-time employee.
Regulation 191 of Chartered Accountants Regulations 1988 provides for the acceptance of part-time employment of Chartered Accountants in practice.
Section 2(2) further provides that a member of the Institute who is a salaried employee of a chartered accountant or a firm of chartered accountants will be deemed to be ‘in practice’.
Chartered Accountants/ members of the Institute are of two kinds – Associate Members and Fellows, as provided under Section 5 of the Chartered Accountant Act. However, the Companies Act does not specify whether the person appointed as an auditor must be an Associate or must be a Fellow.
Section 141(2) provides that a firm, including a limited liability partnership firm, can be appointed as an auditor; however, only the partners who are Chartered Accountants shall be eligible to sign on behalf of the firm while functioning as the auditor of the company.
Who is disqualified from being an Auditor
Section 141(3) of the Companies Act, 2013 talks about persons or entities that are disqualified from becoming an Auditor. Rule 10 of the Companies (Audit and Auditors) Rules 2014 also provides conditions for disqualification.
The first condition stipulated is that a body corporate cannot be appointed as an auditor. Now it is to be understood what a corporate body would mean in this context. Section 2(11) of the Companies Act, 2013 lays down the definition of the term “body corporate”. It provides that all companies, whether incorporated within India or outside, except the Co-operative Society, will fall under the purview of the body corporate. Section 141 puts a bar on body corporates from being appointed as an auditor. The reason behind this is that in a company, there doesn’t exist the concept of unlimited liability. The work done by an auditor is of extreme importance and can have high stake repercussions. However, a company’s directors cannot be made personally liable if any such issue arises. On the other hand, in the case of firms and even limited liability partnership firms, this risk is not present. In firms, at least one partner has unlimited liability. Therefore, accountability is also higher. Owing to these reasons, firms, including limited liability partnership firms, are appointed as auditors, whereas body corporates are barred.
The second restriction is upon the appointment of an officer or employee of the company. The term officer has been defined under Section 2(59) of the Companies Act; it includes directors, managers, key managerial personnel, or anyone under whose instruction the Board of Directors is accustomed to act. An employee may be understood as a person employed by the company and who draws a salary from the company. It must be understood that the task undertaken by an auditor requires utmost independence and application of fairness in practice. However, being an officer or an employee of a company brings in a possibility of partiality and bias in the actions of the said persons. Bias can prove to be disastrous when it comes to audit reports since it is the audit report that acts as a hallmark of reliability for all stakeholders.
In furtherance of the same reason, a partner or anyone who is an employee of the above-mentioned persons, i.e., an officer or employee of the company, would not be appointed as an auditor. Since these persons share a relationship with the persons mentioned under 141(3)(b), their actions cannot be deemed to be impartial and can suffer from influence. Therefore, they cannot be appointed as an auditor for the company.
Clause ‘d’ to Section 141 (3) provides a list of categories that are restricted from being appointed as an auditor. It puts forth,
A partner or any of his relatives or partners holding any form of security or interest in the organisation or any of its subsidiaries or holding or associate or subsidiary of any of its holding companies shall not be appointed as an auditor. Being a shareholder, a person would naturally be interested in holding out the company as profit-making so that the returns are greater. Therefore, there exists a possibility of such a person projecting a report that has inflated profits. Even though there is no situation of direct influence, however, there still remains a possibility of conflict of interest. Thereby such a risk is ruled out by the Companies Act 2013 by barring such persons from being appointed.
Rule 10 of the Company (Audit and Auditors) Rules, 2014) provides a proviso to this provision. It provides that only the relative of an auditor is permitted to hold securities not exceeding one lakh rupees in face value. In case such a person acquires securities above the prescribed limit, the auditor shall have to take corrective measures within 60 days of such acquisition.
A partner or any of his relatives or partners who is a debtor for an amount exceeding 5 lakhs (as provided under Rule 10 of the Companies (Audit and Auditors) Rules, 2014) to the company or to any of its holding/associate/subsidiary of the holding companies is barred from appointment. It is presumed that a person who is indebted to a company is in a position where he can be influenced by the management of the company and, thus, it is likely that bias might creep into the preparation of audit reports which will have a detrimental effect on the stakeholders of the company.
A partner or any of his relatives or partners who is a guarantor or has provided security exceeding 1 Lakh rupees (as provided under Rule 10 of the Companies (Audit and Auditors) Rules, 2014) for a third party is also barred from being appointed as an auditor. The reasons for the same are similar to that in the case of a partner or his relatives or his partner being indebted to the company. Therefore, it is in the interest of the stakeholders that such a person should be barred from being appointed.
Now it is required to be understood who all shall come under the provision of ‘relative’ in the context of this Section. A reference may be drawn to Section 2(77) of the Companies Act, which provides the definition of the term ‘relative’. A literal interpretation of the provision would imply that the members of a HUF alongside step-father/mother/brother/sister/son would fall under the purview of relatives under this provision.
Section 141(3)(e) provides that if the company or any of its subsidiary companies has business relationships with any persons or firms, then such person or firm shall not be eligible to be appointed as an auditor. As per Rule 10 (4) of the Companies (Audit and Auditors) Rules, 2014 the term ‘business relationship’ would mean any kind of commercial relationship. However, there are two exceptions to this which are as follows:
- Professional Services rendered by auditors or auditor firms under the Companies Act, 2013 or Chartered Accountants Act, 1949, even though of commercial nature, would not amount to a business relationship.
- Transactions which are in the ordinary course of business, even though of commercial nature, would be exempted from this category.
This bar is again provided to eliminate any kind of bias in the auditing of the company.
The next bar is upon an individual whose relative is working as a director or KMP of the company.
Clause (g) sets out two kinds of persons who cannot be appointed as an auditor.
The first kind is persons who are in full-time employment in any other place. This provision correlates with Section 2(2)(i) of the Chartered Accountants Act, 1949. Under the Chartered Accountants Act, a person who is holding full-time employment will not be considered a Chartered Accountant, and as clearly set out in Section 141(1) a person cannot be appointed as an auditor unless he is a Chartered Accountant in practice.
The second restriction is upon a person or partner of a firm that is acting as an auditor for more than 20 companies at the same time. This bar is set so as to prevent auditors from engaging an excessive number of clients so that they are able to provide adequate attention to each client since an audit is a highly important matter.
Section 141(3)(h) prevents a person from being appointed as an auditor of a company if he has been convicted by a Court for an offence that involves fraud less than 10 years ago. Section 17 of the Indian Contract Act, 1872 defines the term ‘fraud’. Under the said section, the element of fraud includes acts such as deliberate misstatement of facts, active concealment of fact, making a promise without the intention of performing it, any other deceptive act or any act which is specifically declared as fraudulent by the law in force.
Section 141(3)(i) sets out that if a person has rendered any service mentioned under Section 144 of the Companies Act, 2013 to the company/its subsidiary or holding, such person shall not be appointed as an auditor. Section 144 provides a list of non-audit services that an auditor is not allowed to render to a company whether directly or indirectly. It can be either accounting service; or internal audit; or actuarial services; or investment advisory services; or investment banking services; rendering outsourced financial services etc. If any auditor engages himself in any of these services, he shall be barred from being appointed as an auditor.
Judicial Perspective
Sanjay Sreesha v. Serious Fraud Investigation Office (2022) – The Karnataka High Court, in this instant case, discussed the eligibility criteria of auditors of a company. It reiterated that being a Chartered Accountant is a sine qua non for being appointed as an auditor. Additionally, they held that if the Chartered Accountant is a partner of the firm that has been appointed as the auditor of a company, he shall be eligible to sign the audit reports on behalf of the firm. While discussing the extent of liability, the Court laid down that the firm and the partner would be considered equally liable, and the partner cannot escape scrutiny by pushing the entire liability on the shoulders of the firm. This once again clarifies the reason why firms are allowed to be appointed as auditors. However, body corporates are not.
N.E Merchant and Anr. v. State (1967) – In this case, the Court laid down the importance of appointing Chartered Accountants as auditors. The Court puts forth that the duties undertaken by an auditor require him to apply expert knowledge and cannot be cowed down by the management of the company since he has the responsibility to project the correct financial position of the company. He is required to carry out his duties as an auditor without fear or favour and audit the accounts of the company. The Court stated that a Chartered Accountant is well equipped to handle such affairs and he plays a vital role in relation to the financial aspects of the business of a company. The Court referred to a passage from a pamphlet issued by the Institute of Chartered Accountants of India, which set out that not only is a Chartered Accountant an expert in terms of technical qualifications but also in possession of qualities like high objectivity, independence of thought and integrity.
Amar Nath Malhetra v. M.C.S. Limited (1992) – The Court, in this case, while discussing the qualifications and disqualifications of an auditor, emphasised the need to maintain the independence of auditors. The Court laid down that an auditor needs to act as a watchdog for the protection of the shareholders and is required to examine the accounts with a view to give the shareholders a true and fair picture of the same. The auditor owes a duty towards all the beneficiaries of the company. Therefore, the aspect of their independence while appointing them is of utmost importance.
Union of India v. Mr. Mukesh Maneklal Choksi & Anr (2019) – In this case, the family members of the auditor were holding shares of the company, which is in violation of the prohibition laid down in Section 141(3)(d). Despite this, the auditor went on to issue an auditor certificate without even examining the books of record. This was a case of gross irregularity and fraudulent action on the part of the auditor. It was held that such an action could not be condoned. The auditor’s primary duty is towards the best interests of the company and the stakeholders of the company. The auditor must act independently and not be biassed in his approach.
How does the appointment of an auditor take place – Section 139 of Companies Act, 2013
An auditor is appointed under Section 139 and Rule 3 of the Companies (Audit and Auditor’s) Rules, 2014. In accordance with the said provisions, an auditor is appointed by the Audit Committee of a company. This audit committee consists of at least 3 directors, and the others shall be decided by the board of directors on a time-to-time basis. It is prescribed that a minimum of 2/3rd of the audit committee members should not consist of whole-time or managing directors. The chairperson of the Audit Committee should possess the ability to understand financial statements. Individuals possessing knowledge in aspects of finance and accounting, who are not a part of the company, should be included in the Audit Committee. The primary function of this committee is to supervise the preparation, presentation and reporting of the company’s financial statements. The reports approved by the committee require the signatures of its members, and the members would be held accountable for any kind of misstatement or fraudulent reporting. The committee works in coordination with the Statutory Auditors of the company. The Audit Committee makes a recommendation to the Board of Directors. Before making such a recommendation, the Audit Committee is required to consider a number of factors, including the qualifications, the experience and the pending proceedings against the candidate. Such qualifications should be in line with the requirements set out under Section 141 of the Companies Act. Additionally, they should also verify that there exists no ground for which the person so recommended may be disqualified under the Act. Upon receiving the recommendation, the Board of Directors has a choice to either accept the recommendation or reject it. In case the Board accepts the recommendation, it shall put it forth before the members in the Annual General Meeting. In case the BOD rejects, it shall send the name back to the Audit Committee, which shall then either recommend back the same person, which shall signify that they are not willing to change their suggestions; in such a case, the Board of Directors shall have to suggest a name by themselves and propose it in the Annual General Meeting, citing the reasons as to their disagreement with the Audit Committee or the other scenario might be that the Audit Committee send in the name of another person, in case this name is approved by the Board of Directors, it shall be proposed before the other members at the Annual General Meeting and in case it does not approve the name then the same cycle will repeat.
Under Section 139(1) r/w Rule 4 of the Companies (Audit and Auditors) Rules 2014, the firm/individual so recommended shall provide written consent and a certificate stating that:
i) he is not disqualified from the applicable acts and regulations such as the Companies Act, 2013 and the Chartered Accountants Act 1949 and their rules;
ii) he is eligible for an appointment;
iii) the proposed appointment is as per the terms and within the limits of the Act;
iv) a true and correct list of all proceedings pending against the proposed entity.
After these formalities are duly complied with, the auditor shall be appointed at the Annual General Meeting through an ordinary resolution. The information about such an appointment must be given to the auditor in the form of a letter, and the ROC is required to be intimated within 15 days by filling a Form ADT-1.
Procedure for appointment of First Auditor
Section 139(6) of the Companies Act deals with the appointment of the first auditor. It is prescribed that other than a government company, the first auditor shall be appointed within the first 30 days of registration by the Board of Directors. In case this does not happen, the auditor shall be appointed within 90 days at an extraordinary general meeting after informing the members of the company. The tenure of the first auditor will continue till the conclusion of the first annual general meeting. At the first annual general meeting, an individual or a firm will be appointed as an auditor by an ordinary resolution. The process of appointment such an auditor has been elaborated on above. Such an auditor will hold office for a period of 5 years (till the 6th Annual General Meeting).
Conclusion
The auditor plays an extremely crucial role in maintaining transparency and fairness in the functioning of the company. All the stakeholders of the company are completely dependent upon the report given by the auditor, which acts as a hallmark of the genuineness of the company. The stability and growth of the company are dependent upon this reason being the present and potential shareholders would be willing to invest only if they know that the company is conducting business in a transparent manner. The auditor is required to exercise independent thought and not get influenced by the management of the company. The functions of the auditors are beneficial to the company since it helps them maintain consistency, detect errors in their processing or detect fraud. Thus it is of utmost importance that the independence of the auditors is maintained. If the persons appointed are of such nature that they can be exploited or influenced by the management, then the integrity and transparency of the reports shall not be maintained, which will lead to a loss of trust in the company by the shareholders. The Companies Act 2013 has been instrumental in maintaining the independence of the auditors. The qualifications set out by the act make sure that the person so appointed is a financial expert and is capable of preparing accurate reports of the company’s financial statements. The disqualifications laid down ensure that any person who has the possibility of having a conflict of interest between the interest of the company and personal interest is barred from being appointed. The appointment procedure laid down in the act makes sure that there is no form of bias or favouritism involved and is done keeping in mind the best interest of the company and its stakeholders. Overall, the Companies Act 2013 contains a robust mechanism regarding the qualifications, disqualifications and appointment of the auditor.
Frequently Asked Questions(FAQs)
Who is an auditor, and what is his role?
The auditor is a financial expert who is appointed by a company in order to prepare a report on the financial reports of the company, which is known as the auditor’s report. They make sure that the company’s operations are in conformity with the applicable laws and regulations. Furthermore, they also advise the company on various financial matters.
What are the different types of auditors?
There are primarily two kinds of auditors in a company- the Internal Auditors and the External Auditors. Internal Auditors are the ones who perform internal auditing functions as a part of their employment. The External Auditors, on the other hand, are the ones that are independent third parties who are appointed by the company to perform an audit.
Can the same person be reappointed as an auditor?
An auditor can be reappointed. However, a person cannot be appointed as an auditor for more than one term of 5 consecutive years. And an auditing firm cannot be reappointed for more than two terms of 5 consecutive years.
What is the procedure for the removal of an auditor?
In order to remove an auditor before the end of his term, a special resolution is required to be passed, and prior permission from the Central Government is required to be taken.
References
- https://www.taxmann.com/post/blog/company-auditor-qualifications-disqualification-appointment#:~:text=3.,(1)%20%26%20(2)%5D&text=A%20firm%20whereof%20majority%20of,the%20partner%20in%20individual%20capacity.
- https://e-book.icsi.edu/Actpagedisplay.aspx?PAGENAME=17525#:~:text=Companies%20Act%2C%202013&text=141.,be%20auditor%20of%20a%20company.
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