Companies Act, 2013: Analysis relating to Audit & Accounts

Relating to Audit and Auditors Chapter-X [Companies (Audit and Auditors) Rules, 2014]

Manner and procedure of selection of auditors

Every company shall, at first AGM, appoint an auditor who shall hold office from the conclusion of that meeting till the conclusion of every sixth AGM and thereafter till the conclusion of every sixth meeting and the manner and procedure of selection of auditors by the members of the company at such meeting shall be such as may be prescribed [Section 139(1)].

Where a company has constituted an audit committee (AC), the AC shall recommend the name of the auditor to the Board, which shall then consider and recommend the appointment to the members. If the board is not satisfied with the recommendation, it may send back the recommendation for re-consideration with their reasons. If the AC does not agree to reconsider its recommendation, the Board shall submit to the members its own recommendation for consideration of members and shall explain the reasons for not accepting the recommendation of the audit committee in the Board’s report.

In other cases, the Board shall consider and recommend auditor to members in the AGM for appointment.

The AC /Board shall take into consideration, the qualifications and experience of the proposed auditor and also consider the completed and pending proceedings against the auditor before the ICAI or any competent authority or Court of law [Rule 3].

No significant differences in this regard between the draft and final rules.

Rotation of Auditors

Mandatory rotation of auditors in every 5 years and of audit firm in every 10 years in case of listed companies and prescribed class of companies. A cooling off period of 5 years has been stipulated [Section 139(2)].

The prescribed class of companies, required to rotate their auditor, shall mean the following classes of companies excluding one person companies and small companies:-

- Unlisted Public Company with paid-up share capital           => INR 10 Crore

- Private Limited Company with paid-up share capital         => INR 20 Crore

- All Companies having public borrowings or public deposits => INR 50 Crore [Rule 5].

The class of companies in the draft rules was prescribed as all companies excluding one-person companies and small companies.

Manner in which the companies to rotate their auditors on the expiry of term

The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors in pursuance of sub-section (2) [Section 139(4)].

For the purpose of the rotation of auditors:

(i) The period for which it has been holding office as auditor prior to the commencement of the Act shall be taken into account in calculating the period of 5/10 consecutive years, as the case may be. Illustration explaining rotation has been added in the final rules.

(ii) Consecutive years shall mean all the preceding financial years for which the firm/inpidual has been the auditor until there has been a break by five years or more.

(iii) The incoming auditor shall not be eligible if such auditor is associated with the outgoing auditor under the same network of audit firms or is operating or functioning, hitherto or in future, under the same brand name, trade name or common control.

(iv) For the purpose of rotation of auditors, break in term for a continuous period of 5 years would only be considered as fulfilling the requirement of eligibility.

(v) If a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years.

(vi) Where a company has appointed joint auditors, the company shall follow the rotation of auditors in such a manner that all of the joint auditors do not complete their term in the same year [Rule 6].

Illustrations have been included in the final rules explaining the calculations of the balance period of service on account of retrospective application of rotation requirement.

Explanation for the meaning of the word ‘consecutive years’ have also been included in the final rules.

The final rules have categorically stated that if a partner of the rotating firm retires from the said firm and join another firm; such other firm shall also be ineligible to be appointed for next 5 years.

Removal of the auditor before expiry of his term

The auditor 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 [Section 140(1)].

The application, for removal of auditor, shall be made to the Central Government within 30 days of the resolution passed by the Board.

The company shall hold the general meeting within 60 days of receipt of approval of the Central Government for passing the special resolution. [Rule 7].

The draft rules prescribed that the application should be made to the Central Government within 30 days from the date on which the special resolution was passed in general meeting.

Disqualifications of auditor

The following persons shall not be eligible for appointment as an auditor of a company, namely:—

(g) Person/ partner in a firm who holds appointment as an auditor in more than 20 companies [Section 141(3)(g)].

No clarifications made in the final/draft rules regarding this ceiling limit of 20 companies up to which a persons or partner can conduct audit.

No clarifications made in the final/draft rules regarding this ceiling limit of 20 companies.

Disqualifications of auditor

The following persons shall not be eligible for appointment as an auditor:—

(d) a person who, or his relative or partner is holding any security of or interest or is indebted or has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, for such amount as may be prescribed [Section 141(3)(d)].

The monetary ceiling for securities and guarantee has been prescribed at INR 1 Lakh while that for indebtness has been prescribed at INR 5 Lakhs.

Further in the event of acquiring any security or interest by a relative, above the threshold prescribed, the corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of such acquisition or interest [Rule 10].

The monetary ceiling for indebtness has been increased from INR 1 Lakh under draft rules to INR 5 Lakhs in final rules.

Also the draft rule was silent on the action to be taken in the event of acquiring any security or interest by a relative above the threshold prescribed.

Disqualifications of auditor

The following persons shall not be eligible for appointment as an:—

(e) Person/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 [Section 141(3)(e)]

The term “business relationship” shall construe any transaction entered into for a commercial purpose. except:-

(i) commercial transactions which are in the nature of professional services permitted to be rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and the rules or the regulations made under those Acts;

(ii) commercial transactions which are in the ordinary course of business of the company at arm’s length price - like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other similar businesses. [Rule 10].

Only the first exception relating to services prescribed under the Chartered Accountants Act, 1949 was prescribed in the draft rules.

Exception as regard to commercial transactions, which are in the ordinary course of business of the company at arm’s length price, was not prescribed.

New Matters for Audit Report

The audit report shall also state auditor’s comments on such other matters as may be prescribed [Section 143(3)(i)].

The Auditor’s report shall also include their views and comments on the following matters:

(a) Whether the company has disclosed the effect, if any, of pending litigations on its financial position in its financial statement;

(b) Whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts;

(c) Whether there has been delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company [Rule 11].

Under the final rules, the auditor is required to comment only provisions in respect to material foreseeable losses for which provision was required to be made.

The draft rule didn’t use the word material in this respect.

Reporting of Frauds by auditor

If an 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)].

(1) The provisions regarding reporting of fraud by auditor shall also extend to such branch auditor to the extent it relates to the concerned branch.

(2) In case the auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company

(i) auditor shall forward his report to the Board/ AC, as the case may be, immediately, seeking their reply/observations within 45 days;

(ii) on receipt of such reply/observations the auditor shall forward his report and the reply /observations along with his comments to the Central Government (CG) within 15  days of receipt of such reply/observations;

(iii) in case the auditor fails to get any reply/observations from the Board /Audit Committee within 45 days, he shall forward his report to CG along with a note in this regard.

(3) The provision of this rule shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148 and section 204 respectively. [Rule 13].

The draft rules required the auditors to report to the Central Government on only those offences involving fraud which is likely to materially affect the company.

Such reporting was to be made within 30 days of his knowledge or information with a copy to Audit Committee/ Board.

Materiality was determined based on the frequency of such fraud or the amount involved, in case it exceeded 5% of net profit or 2% of turnover.

The provision of these rules was not applicable to a cost auditor and a secretarial auditor.

Liability to devolve on concerned partners only

Where, in case of audit of a company, it is proved that the partner(s) of the firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil or criminal, for such act shall be of the partner(s) concerned and of the firm jointly and severally [Section 147(5)].

In case of criminal liability of any audit firm, the liability other than fine shall devolve only on the concerned partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud [Rule 9].

There was no such provision in the draft rule.

Relating to Accounts Chapter-IX [Companies (Accounts) Rules, 2014]

Consolidation of Accounts

The Central Government may provide for the consolidation of accounts of companies in such manner as may be prescribed [Section 129(3)].

The final rules provides that for a company covered under Section 129(3) [i.e. which is having either subsidiary or associate or JV] but which is not required to prepare consolidated financial statements (CFS) under the Accounting Standards (i.e. it is not having subsidiary but have either associate or JV), it shall be sufficient if the company complies with disclosure provisions on CFS provided in Schedule III of the Act [Rule 6].

There was no such exemption in draft rules and hence under the draft rules read with Section 129(3), a company was required to prepare CFS in case it was having subsidiary or associate or joint venture.

Board Report-SFS

There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors [Section 134(3)].

The Board Report shall be prepared based on the stand alone financial statements and the report must contain a separate section on the performance and financial position of each of the subsidiaries, associates and JV included in the CFS [Rule 8].

No differences in this regard between the draft and final rules.

Board Report-Content

The Board Report shall include the conservation of energy, technology absorption, foreign exchange earnings and outgo, in such manner as may be prescribed [Section 134(3) (m)].

The report of the Board shall contain the following details:

(A) Conservation of energy- Steps taken / impact on conservation of energy, for utilising alternate sources of energy and capital investment on energy conservation equipment.

(B) Technology absorption- Efforts made towards technology absorption and benefits derived as a result of the efforts. In case of imported technology, details of technology imported etc.

(C) Foreign exchange earnings and Outgo-In terms of actual inflows and outflows during the year [Rule 8].

No differences in this regard between the draft and final rules.

Board Report-Annual Evaluation

The Board Report shall, in case of a listed company and every other public company having such paid-up share capital as may be prescribed, include a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and inpidual directors [Section 134(3)(p)].

The paid up share capital has been prescribed at INR 25 crore or more, calculated at the end of the preceding financial year. [Rule 8].

No differences in this regard between the draft and final rules.

Board Report-Other Matters

The Board Report shall include such other matters as may be prescribed [Section 134(3)(q)].

The Board Report shall also, inter alia, include:

(i) financial summary/highlights;

(ii) change in the nature of the business;

(iii) details of directors or KMP who were appointed or have resigned during the year;

(iv) names of companies which have become or ceased to be its Subsidiaries, JVs or associate companies during the year along with reasons therefor;

(v) details relating to Deposits covered under Chapter V of the Act;

(vi) details of significant and material orders passed by the regulators/courts/tribunals impacting the going concern status and company’s operations in future

(vii) details in respect of adequacy of internal financial controls with reference to the Financial Statements.

[Rule 8(5)].

The draft rule didn’t require the Board Report to comment on the adequacy of internal financial controls with reference to the Financial Statements.

It may be further noted that Section 134(5) of the Act requires the directors of only listed company to state in the Directors’ Responsibility Statement that they had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively.

Internal Audit-Mandatory

Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor to conduct internal audit of the functions and activities of the company [Section 138(1)].

The following class of companies shall be required to appoint internal auditor:-

(a) every listed company

(b) every unlisted public company having

- Paid-up share capital => INR 50 Crore, or

- Turnover => INR 200 Crore, or

- Outstanding Loans or Borrowing => INR 100 Crore, or

- Outstanding Deposit=> INR 25 Crore

(c) every private company having

- Turnover => INR 200 Crore, or

- Outstanding Loans or Borrowing => INR 100 Crore [Rule 13].

There has been change in the threshold prescribed for Internal Audit. The draft rules specified the following criteria:-

(a) every listed company

(b) every public company having paid-up share capital => INR 10 Crore;

(c) every other public company which has any outstanding loans or borrowings from banks or public financial institutions exceeding INR 25 crore or which has accepted deposits of INR 25 crore or more.

Internal Audit-scope and periodicity

The Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board [Section 138(2)].

The Audit Committee or the Board shall, in consultation with the Internal Auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal audit [Rule 9.15(2)].

There are no differences in this regard between the draft and final rules.