Appointment of Auditors

10.1 Section 139(1) provides that the shareholders at the ‘Annual General Meeting’ (AGM) shall appoint an auditor of a company, for a consecutive period of five years, and that his appointment shall be ratified every year at the AGM. The first proviso to the said sub-section requires the company to place the matter relating to such appointment, for ratification by the members in each AGM. During the consultation, clarity was sought for cases where the shareholders choose not to ratify the auditor’s appointment as per Section 139 (1). A clarification was also sought for cases where the auditor was unwilling to continue at any stage before the completion of his five-year term; whether this would be treated as a casual vacancy.

10.2 The Committee felt that the objective of Section 139(1) is to ensure independence of auditors and any decision taken by the shareholders not to ratify any appointment during the period of five-years would be akin to removal of the auditor and provisions of Section 140(1) should come into play. Explanation to Rule 3 of Companies (Audit and Auditors) Rules, 2014, provides for such a situation and requires that the Board shall appoint another individual or firm as the auditor (s) after following the procedure laid down in this behalf under the Act. There is an inconsistency due to the two provisions, wherein removal would require a special resolution and approval of the Central Government while removal through non-ratification would need a resolution. The Committee felt that it would be advisable to omit the provisions with respect to ratification, as it defeats the objective of giving five year term to the auditors. This would also remove the inconsistency in the Act.

10.3 The Committee felt that if the auditor was unwilling to continue at any stage before completion of his five-year term, it should be treated as a case of resignation, and the provisions of Section 139(8) for the filling up such casual vacancy arising due to resignation should apply. This may be made explicit in the section itself.

Rotation of auditors

10.4 Section 139 (2) provides for the rotation of auditors, and requires such rotation after five consecutive years, in case of individual, and ten consecutive years, in case of a firm. The third proviso to Section 139 (1) requires for the compliance of the provisions of rotation within three years from the commencement of the Act. Rule 6(2) of the Companies (Audit and Auditors) Rules, 2014, provides that the period for which the auditor has held office prior to the commencement of this Act shall be taken into account for the calculation of the period of five, or ten years, as the case may be. It was suggested to the Committee, that the earlier tenure held by the auditor should not be considered for the purposes of determining the cutoff point for rotation of auditors.

10.5 There was strong representation from some of the affected auditors to either omit the provisions or increase the transition period to five years in view of implementation of Indian Accounting Standards. It was pointed out that the new requirements have been largely accepted by the auditors. The Committee noted that the three years’ transitional period provided to companies was reasonable and required no modification. Further, the intention of the legislation had been accurately translated in the Rules, and for this purpose, a transitional time period of three years had already been given. Hence, the Committee felt that there was no need for any change. However, the Committee, felt that Rule 6 ought to provide clarity that the three years’ transition period would be counted from AGM to AGM, and not from the commencement of the Act.

10.6 It was also suggested to the Committee that private companies ought to be exempted from the provisions governing the rotation of auditors. The Committee noted that only large private companies with a paid up capital of Rupees Twenty Crore or more were required to follow this provision. The threshold has been prescribed keeping in view the importance of such a provision for the purposes of good corporate governance and larger public interest. The Committee, therefore, decided against increasing this threshold to reduce the coverage of private companies.

Disqualification of Auditors

10.7 Section 141 (3) (d) of the Act, inter alia, provides that a person shall not be eligible for appointment as an auditor of a company, if he, or his relative, or partner, holds any security, or gives a guarantee, or is indebted to the company for specified amounts, etc. Suggestions received by the Committee expressed difficulty in the application of these provisions, as an auditor did not have any control over the financial decisions of his relatives who were not financially dependent on the auditor, like brother, married sister, or married daughter. It was suggested that, for the purposes of Section 141(3)(d), the term “relative” be restricted only to financially dependent relatives.

10.8 The Committee deliberated on the suggestion and noted that the definition of the term ‘relative’ had been significantly changed and the coverage reduced to only eight relatives. It was also noted that restricting the coverage to ‘financially dependent relatives’ in the Indian context would impair the principle of ensuring independence of the auditor. It was deliberated whether the difficulties expressed would be addressed if the thresholds with respect to holding securities, or giving loans etc. under Section 141(3)(d)(i) & (ii), read with Rule 10(2) & (3), are linked to a certain percentage (say two percent) of the total share capital of a company. The Committee, however, felt that revision in the thresholds would not adequately address the difficulties and instead, for the purpose of section 141(3)(d), the term relative should be suitably modified.

10.9 Section 141 (3) (i) provides that any person whose subsidiary, or associate company, or any other form of entity is engaged on the date of appointment, in the services prohibited under Section 144, shall be disqualified from being appointed as an auditor. It was suggested during the public consultation that the language of Section 141(3) (i) was such that a firm which was engaged in any of the activities mentioned in Section 144 anywhere in the world, and was rendering any such service to companies other than the auditee company, could not be appointed as an auditor of a company in India, even if such services were rendered to an entity which was totally unconnected with the auditee company. It was requested to provide clarification that the restriction under Section 141(3)(i) would apply, only if the services were rendered to the company that proposed to appoint the auditor. The Committee noted that any relaxation to section 141(3)(i) read with Section 144 would compromise independence of auditors. However, clarity needs to be provided by suitably amending the clause.

Powers and duties of auditors and auditing standards

10.10 The first proviso to Section 143 (1) of the Act provides that the auditor of a holding company shall also have the right to access the books of accounts of subsidiary companies, in connection to the consolidation of accounts. In view of this, it was suggested that the auditor of the holding company should also have the right of access to accounts and records of a joint venture/ associate company, also in connection with the consolidation of accounts of such entities with the holding company. The Committee recommended a change in the first proviso to Section 143 (1) to provide that the auditor of a holding company to have a right of access to the accounts and records of the associate company and joint venture company, whose accounts are required to be consolidated.

10.11 Section 143 (3) (i) requires the auditor to state in his report whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. This has to be read with Section 134 (5) (e) on the Directors’ Responsibility Statement which also defines internal financial controls, and Rule 8(5)(viii) of Companies (Accounts) Rules, 2014. Rule 10A of the Company (Audit and Auditors) Rules, 2014, makes the requirement under Section 143(3)(i) optional for FY 14-15 and is mandatory from FY 15-16 onwards. It has been expressed that auditing internal financial control systems by auditors would be an onerous responsibility. It was also expressed that their responsibility should be limited to the auditing of the systems with respect to financial statements only, and that this cannot be compared with responsibility of directors which is wider and can be discharged as they have other resources like internal auditors, etc. who can be used for this purpose. In this regard, the Committee recommended that the reporting obligations of auditors should be with reference to the financial statements.

10.12 It was brought before the Committee that a combined reading of the requirements of Section 129(3), 129(4) as well as Sections 143(2) and 143(3) of the Companies Act, 2013, suggests that the Act prescribes the same reporting requirements for the auditors for both the standalone and consolidated financial statements. The application of the auditor’s specific reporting requirements under Section 143(3) of the Act for consolidated financial statements may result in practical issues around implementation, particularly in relation to foreign subsidiaries/JVs/associates of Indian Companies to which the Act would not apply and accordingly these provisions shall not be applicable to them. Specific reporting requirements under Section 143(3) of the Act such as “whether proper books of accounts as required by law are being kept”; “consideration of the report of branch auditors”; “disqualification of directors under Section 164(2)”; “any other matter that may be prescribed such as the current report on CARO” may not be practicable for the audit of the consolidated financial statements. In the case of Indian subsidiary, associate and joint venture companies, such reporting requirements would also be covered by the auditor’s report on the financial statements of those Indian entities. Further, the requirement to report on internal financial controls is quite exhaustive and application of the same to the consolidated financial statements would significantly enlarge the scope of audit of consolidated financial statements. In view of this, the Committee felt that it would be sufficient if the auditor expressed a true and fair opinion on the consolidated financial statements and reported on the relevant and significant matters concerning subsidiaries/associates requiring attention of shareholders rather than the entire reporting requirements of Section 143(3) of the Act. The Committee suggested that ICAI may issue a guidance note, consistent with international practices.

10.13 Section 143(5) provides that in case of a Government company, the ‘Comptroller and Auditor General’ (C&AG) shall appoint the auditor and direct such auditor on the manner in which the accounts are required to be audited and thereupon the auditor so appointed shall submit a copy of the audit report to the C&AG which, among other things, include the directions, if any, issued by the C&AG, the action taken thereon and its impact on the accounts and financial statement of the company. It was suggested that since the directions issued by C&AG involved voluminous data/information, this ought to be allowed to be filed separately as annexures with the C&AG and need not be made part of a public documents such as an auditor’s report. C&AG was consulted in this matter and it was noted that the directions issued does not entail voluminous information. The Committee, therefore, recommended that no change is required.

Reporting of Fraud by auditor u/s 143(12)

10.14 Section 143 (12) provides that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. After due consideration, the Committee concluded that the words “is being committed” appearing in the sub-section should be retained, as auditors were responsible for reporting not only frauds that had been committed and had been acted upon by the company, but also frauds that were continuing, but were either not known, or had not been acted upon. The Committee also noted that the Form ADT-4, which specified the manner of reporting fraud, should be modified to allow an auditor to explain his comments.

Protection to the Auditor

10.15 Suggestion was made during the consultative process that protection should be given to auditors for liabilities arising on account of reporting on fraud u/s 143 (12). The Committee noted that Section 143 (13) already provided for adequate protection.

Auditor not to render certain services

10.16 Section 144 prohibits rendering of certain non-audit services directly or indirectly to the auditee company or its holding company or subsidiary company. Clarity was sought on the term ‘management services’ used in Section 144(h). It was also suggested that restrictions under Section 144(h) and (i) should apply to listed companies and public interest entities only. A view was also given that such services could be allowed subject to certain percentage of audit fees being received by the auditor. In this regard, ICAI had undertaken an exercise to list out such management services. The Committee felt that the nature of the suggestions and issues being raised are broadly aimed at opening a window for the auditor to have a relationship other than that of an auditor and auditee, and thus may impinge on the independence of the auditor. It, therefore, recommended no change in the provision, or for providing any exemption to any class of companies. However, it was recommended that ICAI, after consulting the Ministry of Corporate Affairs, should come up with a guidance note for auditors.

Punishment for contravention

10.17 Section 147(5) provides that where an audit is conducted by an audit firm, and it is proved that the partner or partners of the audit firm have acted in a fraudulent manner or abetted or colluded in any fraud, the liability, whether civil or criminal for such act shall be of the partner or partners concerned of the audit firm and of the firm jointly and severally. Rule 9 of the Companies (Audit and Auditors) Rules, 2014, provides that in case of criminal liability of any audit firm, the liability other than fine shall devolve only on the concerned partners, who acted in a fraudulent manner or abetted or colluded in any fraud. The Committee recommended that the provisions of Rule 9 should be introduced in the Act.

10.18 With regard to the liability of ‘any other persons’ in Section 147(3)(ii), the section on ‘Penalties’ in the report has dealt with this issue in detail (Paragraph 28.17 and 28.18 of Part I of the report).

Audit of items of cost in respect of certain companies

10.19 Attention of the Committee was drawn to the definition of the term ‘cost accountant’ appearing in Section 2(28) of the Act. It was suggested that this covered only a cost accountant in employment, and not a cost accountant in practice. It was pointed out that as the term cost accountant in practice has also been used, the same might also be defined. The Committee recommended for change in the existing definition to allow for a cost accountant in practice too.

10.20 It was pointed out that there is no provision under Section 148 to ensure/check whether a company required to maintain cost records is complying with relevant provisions or not. The disclosures under CARO 2015, it was pointed out, is from the auditor. It was suggested that a disclosure in this regard may be provided in the Board’s report. The Committee suggested that Section 134(3) may provide for such disclosure of compliance.

10.21 A suggestion was also made to correct the name of the Institute of Cost Accountants of India, which was appearing as the ‘Institute of Cost and Works Accountants of India’ in Section 148. The Committee recommended that the change in the name of ICAI in the Act may be made.