Companies Act - 2013: Rotation of Auditors

With the implementation of Companies Act, 2013 the Ministry of Corporate Affairs has notified the provisions relating to rotation of auditors/audit firm w.e.f. 01st April, 2014.

Changing nearly six decades old regulations of audit of companies,  the new Companies Act makes it mandatory for certain class of companies to appoint auditors for limited tenure after the implementation of majority of provisions of Companies Act, 2013 coming into force w.e.f. 01st April, 2014.

Statutory Provisions related to rotation of Auditors/Audit Firm

Chapter X of Companies Act, 2013 containing the 10 sections from Section 139 to Section 148 covers the provisions related to Audit & Auditors. The Ministry of Corporate Affairs has also notified ‘The Companies (Audit and Auditors) Rules, 2014’ w.e.f. 01st April, 2014.

According to Sub-Section 2 of Section 139 of Act:

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 inpidual as auditor for more than one term of five consecutive years;

and

(b) an audit firm* as auditor for more than two terms of five consecutive years

* the firm shall include the Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008 (Explanation to Section 139 of the Act).

So, if an inpidual as proprietor is appointed as auditor, its appointment period will be 5 consecutive years, while if audit firm (eg. partnership firm or LLP) is appointed, its appointment period will be 10 consecutive years (2 terms of five consecutive years).

The word ‘year’ has not been defined in Companies Act, 2013 nor the Rules provide any clarification of term ’year’. The general interpretation suggests a time period of 12 months from the date of original appointment.

Classes of companies covered in Rotation Scheme

According to Rule 5 of The Companies (Audit and Auditors) Rules, 2014, for the purposes of sub-section (2) of section 139, the class of companies shall mean the following classes of companies excluding one person companies and small companies:-

(a) all unlisted public companies having paid up share capital of rupees 10 crore or more;

(b) all private limited companies having paid up share capital of rupees 20 crore or more;

(c) all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees 50 crores or more.

One person company and small company shall have the meaning assigned in Section 2(62) & 2(85), respectively of the Act.

The 3rd proviso to Section 139(2) provides the transition period of 3 years to the companies existing on or before the commencement of this Act to comply with the requirements of these provisions within three years from the date of commencement of this Act.

Restrictions on re-appointment of Auditors and mandatory rotation of Auditors/Audit Firm

Restriction on re-appointment of auditors and mandatory rotation of auditors/audit firms has now been provided in this Act, which was not earlier provided in The Companies Act, 1956. According to 1st proviso to Section 139(2) of Act:

(i) an inpidual auditor who has completed his original term of 5 consecutive years shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term;

(ii) an audit firm which has completed its original two terms of 5 consecutive years, shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term

The above implication gives the cooling period of 5 years to auditors after the tenure of their original term of appointment of 5 year/10 years, before being eligible for re-appointment. 

For the purpose of this clause a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation (Explanation II of Rule 6 of Companies (Audit and Auditors) Rules, 2014).

A further category of restriction on re-appointment is provided in 2nd  proviso to Section 139(2) of Act which provides that as 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 five years.

The implication of this proviso that if ABC & Co. is auditor of M/S XYZ Ltd. and the balance sheet of M/S XYZ Ltd. is being signed by Mr. A who is also a partner in other firm PQR & Co.If the original tenure of appointment of ABC & Co. is expiring on 20th August, 2020. The CA firm PQR & Co. can’t take the appointment of auditor of M/S XYZ Ltd. for the period of five years starting from 21st August, 2020 and upto 20th August, 2025.

In the above example, PQR & Co. can take the advantage of being appointed as auditor on a date starting after the expiry of financial year 2020-2021. In simple words, PQR & Co. is being eligible for appointment of auditor of M/S XYZ Ltd. after the start of new financial year from the expiry of original tenure of ABC & Co., as the proviso mentions only of one preceding financial year.

Illustration explaining rotation in case of Inpidual Auditor

The following illustration tries to explain the total tenure of appointment in case of Inpidual Auditor being appointed before the commencement of provisions of Section 139(2) of the Act.

Illustration explaining rotation in case of Audit firm

The following illustration tries to explain the total tenure of appointment in case of Audit firm being appointed before the commencement of provisions of Section 139(2) of the Act.

Note:

(1) Inpidual auditor shall include other inpiduals or firms whose name or trade mark or brand is used by such inpidual, if any.

(2) Audit Firm shall include other firms whose name or trade mark or brand is used by the firm or any of its partners.

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

Position of Joint Auditors

According to sub-rule 4 of Rule 6 of The Companies (Audit and Auditors) Rules, 2014 - where a company has appointed two or more inpiduals or firms or a combination thereof as joint auditors, the company may follow the rotation of auditors in such a manner that both or all of the joint auditors, as the case may be, do not complete their term in the same year.

Manner of rotation of auditor by the companies

Rule 6 of The Companies (Audit and Auditors) Rules, 2014 prescribes the following manner of rotation of auditors by the companies:

(1) The Audit Committee shall recommend to the Board, the name of an inpidual auditor or of an audit firm who may replace the incumbent auditor on expiry of the term of such incumbent.

(2) Where a company is required to constitute an Audit Committee, the Board shall consider the recommendation of such committee, and in other cases, the Board shall itself consider the matter of rotation of auditors and make its recommendation for appointment of the next auditor by the members in annual general meeting.

(3) For the purpose of the rotation of auditors-

(i) in case of an auditor (whether an inpidual or audit firm), the period for which the inpidual or the firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be;

(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms.

Explanation I - For the purposes of these rules the term “same network” includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control.

Explanation II - For the purpose of rotation of auditors,-

(a) a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation;

(b) 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.

Rotation not yet over: still Internal Rotation (sub-section 3 of Section 139)

Besides the above rotation, the members of the company may also resolve to provide that -

(a) 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; or

(b) the audit shall be conducted by more than one auditor.

Freedom of Step-out still provided [4th proviso to Section 139(2)]

Nothing contained in Section 139(2) of Act shall prejudice the right of the company to remove an auditor or the right of the auditor to resign from such office of the company.

Conclusion

Making it mandatory for audit firms to rotate is one of the measures of improving the independence, objectivity and professional skepticism of auditors.

The rotation of auditors had been now mandatory not just for listed companies but for all companies, including private companies covered in class of companies mentioned in Rule 5 of Companies (Audit and Auditors) Rules, 2014.

A press release from The Institute of Chartered Accountants of India (ICAI) quotes its President, CA. K Raghu as saying: “Rotation of Auditors which has not been accepted across the world is now only restricted to certain class of companies leaving close to 90% of the companies outside the scope of rotation. This will benefit small and medium practitioners (which means auditors) and corporate”. 

Reference to Act means Companies Act, 2013 unless stated otherwise.

Views are personal and may not be relied as an opinion on any statutory act, section or rule.

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