Unit- 1: Company Auditor

By –RadhikaVisiting Faculty

J H B W C

IntroductionAs compared to the Sole proprietorship or

partnership, the Company form of organization differs in one important respect & it is that the business like sole proprietorship or a partnership firm is managed by the owners.

Whereas in case of a company the ownership of the company and the management vest in different persons.

The share holders who are the owners of the company have no right to take part in the management of business.

Cont.To ensure the money invested by the share holders

are managed properly , it is made compulsory under the Companies Act , for the Companies to get their a/c audited every year.

The Audit is compulsory for…Most of the Audits undertaken by professional

auditors are company audits.Therefore the Auditor has to get himself acquainted

with various provisions of the Companies Act, relating to his qualification, disqualification, appointment and removal.

Qualification According to the provision in Section 226 of the

Companies Act, According to the provision of Chartered Accountants Act,

1949, a person, who is a member of the “Institute of Chartered Accountants of India” qualified and can be appointed as an Auditor of the Company.

Any firm whose all partners are qualified and practicing Chartered Accountants and those who possess the above mentioned eligibility such firm can practice in the name of the firm.

A person holding a certificate under “Restricted Auditor’s Certificate” (Part B State) Rules, 1956 is also qualified to act as auditor of a Company.

Cont.The Central Govt. is empowered to cancel the validity of such

certificates. The central Govt. has formulated the Certified Auditor’s Rules 1961.

Appointment and Re-appointment of auditor

according to section-224 of the Companies Act:1. First Appointment :

The board of directors appoints the first auditor of the company within one month of the registration of the company, which continues till the end of the first annual general meeting of the company.

If the board of directors does not appoint the first auditor of the company in this way, the first auditor of the company is appointed in the annual general meeting of the company.

Cont.2. Appointment every year :

Every year, Company appoints the auditor in the annual general meeting by share holders. The auditor appointed this way holds office till the completion of next annual general meeting.

The auditor has to be intimated about his appointment within seven days after the resolution about the appointment has been passed in the annual general meeting.

Cont.

And after getting this information the auditor has to inform the registrar of companies in writing in a prescribed form whether he has accepted or refused the appointment within thirty days. This provision is also applicable in the case of reappointment of an auditor according to the Companies Act.

Cont.3. Re-appointment :

Only the auditor who has been appointed by the company should be reappointed in the annual general meeting. Of course, reappointment is not done under following circumstances :

(1)If auditor is not qualified for reappointment.(2)If a resolution has been passed to appoint another

person instead of him or resolution has been passed that the same auditor should not be reappointed.

(3)If auditor has given a notice in writing to the company about his unwillingness for his own reappointment.

Cont.

(4) If the notice about the resolution of other auditor’s appointment instead of the current auditor has been received by the company but because of death, insanity, inability or disqualification of such person, the resolution cannot be proceeded with.

Cont.

4. Appointment by the Central Government :

When the appointment or re-appointment of an auditor is not possible at annual general meeting of the company, the Central Government appoints the auditor. In this case, the company has to inform the Central Government within the seven days of completion of annual general meeting of the company that the auditor is not appointed or re- appointed.

Cont.5. Appointment of an auditor of Government

Company or Corporation :In the Corporation, government

companies which are established by the laws of State Government or Central Government in which the government has the right for more than 50%, the appointment of an auditor of such companies is done by the Central Government on the advice of the Comptroller and Auditor General of India.e.g. LIC, General Insurance Corporation..

The current CAG of India is Shashi Kant Sharma, who was appointed on 23 May 2013.

Cont.

6. Appointment by a Special Resolution :

According to the amendment in Companies Act of 1974, a new section-224 (1) (A) is included. As informed in it, the auditor can be appointed or reappointed by the special resolution passed in the annual general meeting of the company in the following circumstances :

(1) The company whose 25% or more of subscribed capital is held by public financial institution, the Central Government or the State Government;

Cont.(2) The company whose 25% or more of Capital is held

by such financial or any other institution established under the State Act and 51% of subscribed capital is held by the State Government;

(3) The company whose 25% or more subscribed capital is held by nationalized bank or general insurance company.

If the auditor has been appointed without passing any special resolution by the company, it will be considered that the auditor has not been appointed at all and later, the Central Government will get the right of appointing the auditor.

Cont.

7. Appointment to fill the casual vacancy :If there is any casual vacancy of an

auditor because of death, insanity, insolvency, the board of directors can appoint another auditor, but if the current auditor has resigned and there is any vacancy, the board of directors cannot appoint any other auditor. General meeting possesses the right to fill the casual vacancy that is caused by the resignation of an auditor. Auditor appointed for such casual vacancy will held the office till the completion of next annual general meeting.

Auditor’s Remuneration :If the auditor has been appointed by the

board of directors, his remuneration too will be decided by the board of directors. If the auditor has been appointed by the annual general meeting, his remuneration will be decided by the annual general meeting itself. If auditor has been appointed by the Central Government, the Central Government will decide his remuneration too. In short, one who appoints will decide the remuneration too but the remuneration is paid by the company.

Cont.

The amount given to the auditor as reimbursement of expenses is included in the remuneration of the auditor. According to the provisions of Companies Act, remuneration paid to the auditor should be shown separately and it is to be shown in the profit and loss account of the company.

Removal of an Auditor1. On the Expiry of his term:

The First Auditor appointed by BoD Holds office till the conclusion of the next AGM The Company Can remove such auditor at a general

meeting And can appoint any other person But notice for the nomination of such person must have

been given to the members of the co. before 14 days of meeting

If there is no re-appointment of retiring Auditor.

Cont.2. Before the expiry of his Term:

The Auditor appointed by BoD can be removed by the share holders in the general meeting and another person nominated to be appointed in his place for which a special notice has to be given to the members 14 days before the meeting. The approval of central Govt. is not required.

In other circumstances the auditor can be removed by the co. but the approval of Central Govt. must be obtained.

Rights of an Auditor1. Access to Books and Accounts:

Books, a/c and vouchers weather kept at any placeExamine vouchers and books of a/c and all supported

documentsAll time free to examine the documentsAccording to the Law Auditor has right to access to the

books and all documents but he may not get help from the Court.

2. Right to Obtain Information and Explanation: such information and explanation he may think necessary for the performance of his duties as an auditor.

Cont.3. Right to Attend General Meeting:

Entitled to receive all notice of GM like any other memberNot compulsory to attend all meetingBut adverse comment of his report then he should remain

present

4. Right to be Heard at the Meeting: right to make clarification on any point regarding accounts

that he has examined he is not bounded to give reply to any que. Raised in the

meeting except the Chairman Asks.

Cont.5. Right to visit Branches:6. Right to receive Remuneration:

He has the right to receive remuneration. Provided he has completed his work.

According Dicksee…7. Right to receive notice of Removal:

When any share holders desires to propose any other person as an Auditor he has to give the Special notice to the Co. so do the Auditor as he has the right to receive and also has the right to make representation in writing in his defense against such notice.

He also has the right to compel the co. to send his reply to all member and to have it read at GM

Cont.8. Right to be Indemnified:

The Co. can indemnify any officer or auditor against any liability incurred by him in defending any proceedings whether civil or criminal.

He can also recover the amount if the grant givent by the court and judgment given in his favor.

9. Right to get expert Advice: He has right to get legal or technical advice But the opinion must be free from the dependence.

10 . Auditor’s Lien:

If the auditor has worked as an accountant, he gets special right (lien) on books of accounts but if he has worked just as an auditor, he does not get any special right on books of accounts.

Sometimes a problem arises of auditor’s lien because there is no clearification in Company Law.

Duties of An Auditor

A. Duties of an auditor according to Companies Act.B. Duties of an auditor according to judicial decision.C. Professional Ethics. (Code of Conduct)

A. Auditors duties according to Companies Act :

1. To present Audit report:

It is the preliminary duty of an auditor that he should present the report before shareholders after verification of accounts of the company.

The auditor has to address his report to only the shareholders and present it to them.

Only in special audit, auditor has to give his report addressing the Central Government.

It is not auditor’s duty to send audit report to each and every shareholder. Once he submits such a report to the company secretary, his duty is considered to be fulfilled.

Cont.2. Certification to be given for statutory report :

The company has to hold a statutory meeting within six months after registration of the company in which statutory report is to be presented. The auditor has to give a certificate for the following matters in this statutory report.

(1) Number and types of shares issued by the company.(2) Total amount of cash received by the company for allocated

shares.(3) Statement of receipts – payments of cash till that date.

Cont.3. When the prospectus is issued:

The company who has been running business and when it issues the prospectus, the information and detail of profit-loss account of the last five years, amount of dividend distributed every year during the last five years and the auditor’s report for assets and liabilities of the company should be included in the prospectus.

Cont.

4.Assist the special auditor/inspector :

To verify company’s accounts and management, Central Government appoints special auditor. At that time, it is auditor’s duty to offer necessary and possible help to such auditor-inspector.

B. Duties of an auditor according to judicial decision:1. To be acquainted with the Articles: The Auditor should make him self acquainted with the AoA

of the Company.

2. To exercise reasonable care-skill : According to the statement of the Justice Lipse in the judicial

decision of Kingston Cotton mills case, auditor should exercise reasonable care and skill while doing his duty. Of course, what is reasonable care-skill can be decided on the basis of particular circumstances of respective case.

Cont.3. To verify the truthfulness of transactions :

According to the judicial decision of Registrar of Companies Mumbai V/s. P.M. hedge case, auditor should not check only the accounts from the arithmetical view but he has to inquire into transactions in depth and should verify the truthfulness and authenticity of transactions not only him self that it contains a true and correct picture of the co.’s affairs but to all the members of the companies and so to the third party.

Cont.4. To verify the assets :

In the judgment of London Oil Storage Co. Vs. Sear Hasluck & Co. the judge Shri Alverstone has ruled that, “it was auditor’s duty to verify the existence of all assets shown in the balance sheet. If the auditor fails to do his duty, auditor is liable to submit the loss suffered by the client.

Cont.5. Disclose true economic condition :

In the case of London and General Bank Ltd., the judge Shri Lindle has stated that it was not the auditor’s duty to give advice to the trader but to disclose the true economic condition of the company.

C. Professional Ethics: (Code of Conduct)1. Regarding the acceptance of appointment or re-

appointment:If he is appointed in place of retiring auditor, auditor

should inform the retiring auditor in writing before he accepts the appointment. Moreover, he should accept the appointment or re-appointment after following the provisions of sections 224 and 225 of Companies Act.

2. Regarding the rejection of less fees :Appointment cannot be accepted on lower fees in

place of any other Chartered Accountant.

Cont.3. Regarding signing the report :A person who is the member or a partner of Institute

of Chartered Accountant of India can sign the annual accounts. Any other person should not be allowed to sign on the annual report on his behalf.

4. Regarding not getting work through advertisement :

Through advertisements or circulars auditor’s work cannot be obtained.

Cont.5. Regarding not getting work by giving commission:

He cannot pay commission, brokerage or pay fees out of profit of business to get any work of audit. Of course, there is nothing wrong if he gives the share of profit to the partner of the firm after his retirement or death as per agreement.

Liabilities of an Auditor

1. Civil Liability :(A) Liability arising from negligence(B) Liability arising from misfeasance

2. Criminal liabilities :

3. Auditor’s Liability to the third party :

Liabilities of an AuditorAuditor of a private institute is not appointed under

any Law. He is appointed by an agreement with the client. So, his liabilities are decided on the basis of instructions given by the client. It is advisable for the auditor of private institute to get instructions of the client in writing so that there will be no confusion regarding the work done by him in future.

Company auditing is different from this. He is appointed according to the Indian Companies Act of 1956 and his liabilities are showed in the law.

Cont.1. Civil Liability :(A)Liability arising from negligence:-

As auditor is appointed by the company, it becomes auditor’s duty to protect the interest of the company. Moreover, as auditor represents shareholders, it becomes prime and sacred duty of an auditor to maintain the trust of shareholders. In order to fulfill his duty faithfully auditor should use care – skill.

Of course, it is difficult to define fair care – skill and it is again difficult to define it or measure it. It can be decided on the basis of form, type of the case or Condition.

Cont.If the auditor fails to do his duties, he should be ready

to suffer its results. It means, he should pay for the losses suffered by the client.

Here, it should be remembered that auditor has to pay for the losses of the client only if the loss occurs because of his negligence to his duties. But if the owner has not suffered any losses because of auditor’s negligence or auditor had not been negligent and yet the client had suffered, in that case the auditor is not liable to pay for it. This can be easily understood with the help of following manner.

Cont.

Moreover, if the client has really suffered losses because of the negligence of the auditor, only the company has the right to file a file a suit for the recovery of damages, individual shareholders cannot claim. Of course, if the company is making losses, its liquidator can file such suit.

Loss without negligence

An auditor is not liable for

Negligence without loss

Cont.(B) Liability arising from misfeasance:-

As Auditor is considered liable for negligence, in the same way, he can be found liable for misfeasance also. As the representative of shareholders, auditor should protect the interests of shareholders and for this auditor should take proper care and use his skill and expertise. Even then, if auditor does not follow his duty properly, means if he commits misfeasance, auditor is liable for this. If company has suffered any loss because, of auditor’s misfeasance or breach of trust, auditor should pay the damages.

Cont.

When company becomes insolvent as per the provisions of Company’s Act, court feels that founders of the company, management or officers (including auditor) have misused the money of the Company or kept it in unauthorized manner with them or they have committed misfeasance or breach of trust; in that case the court can order such founders, management or officers to pay for the loss company has suffered because of their breach of trust and misfeasance by holding them liable.

Cont.When auditor gets the idea that a case is going to be

filed against him for negligence, breach of trust or misfeasance, before the case is filed, auditor can make himself free from such liability by sending an application to the court and if the court finds it proper, it can make the auditor free from such responsibility.

According to the provisions of Companies Act, any company cannot keep the auditor free from liability of negligence, breach of trust or misfeasance by its articles or agreement. If there has been any provision or agreement has been made, as it is against Companies Act, it is considered null and void.

Cont.Yet, in certain circumstances civil or criminal liability

of auditor is created, company can give relief to the auditor under the following conditions :

(1) Judgment should be in favor of the auditor; or(2) Auditor should have been declared innocent; or(3) The court must have given relief the auditor

according to the provisions of Section-633 of Companies Act.

Cont.

If auditor has made any false statements in the prospectus inviting the public to invest in shares or debentures, as an expert, auditor is considered liable for it.

Moreover, if any person has purchased share, debenture on the basis of such false statements and if he has suffered loss, auditor is liable to pay for it. But if auditor withdraws his statements before the issue of prospectus is out, he becomes free from the liability.

Cont.2. Criminal liabilities :

Auditor is an officer of the company and if he breaks the provisions of law; it is known as criminal liability of the auditor. For this, auditor is liable to fine or punishment. Regarding auditor’s criminal liability, various provisions of Companies Act are as follows:

1. According to Section-63 of Companies Act, if a prospectus is issued by the company containing false statement, every person including auditor who authorized the issue of such provisions in section 68 of the Companies Act, to punish him.

Cont.2. Contrary to the provisions of Section-233 of

Companies Act, if any auditor gives report or certifies documents of the company, auditor or any other person who has signed the report or any one who was certified documents does this intentionally, he is liable for fine up to Rs.1000.

3. According to Section-240 of Companies Act, the auditor should help the inspector appointed by the Central Government. If auditor does not help him, he is liable to be punished with imprisonment of six months and or with fine of Rs.2000.

Cont.4. According to Section-242 of Companies Act, the Central

Government take necessary steps on the basis of the report by the inspector and if the suit has been filed against the person related to the company, if the auditor does not help, it is treated similar to contempt of court and the auditor will be held liable to punishment.

5. According to Section-477 of Companies Act, a Private Court can examine the auditor when the company is making loss and the important documents which are with the auditor should be submitted to the court if necessary. If the auditor does not remain present in the court, he can be arrested.

Cont.6. According to Section-478 of Companies Act, the

auditor of the company can be investigated by the High Court on the basis of official liquidator’s application. It’s remark will be made and the auditor should sign on it. In the civil or criminal procedure of an auditor, such entry can be used as an evidence.

7. According to Section-539 of Companies Act, if the auditor makes any false or fraudulent entry in the account books of the company, register or tears, destroys, alters or tampers with it, the auditor is liable for the punishment up to seven years imprisonment and or fine.

3. Auditor’s Liability to the third party :Generally, the auditor is appointed by the

company. So, the relationship between the company and auditor is established according to the agreement. Therefore, auditor is aware of the fact, that if he fails to do his duty, he is liable to pay for the loss suffered by the client; but the question arises here is that, whether other persons of the society connected with the financial interest of the company like creditors, debenture holders etc. can consider the auditor liable for his work or not ?

If any third party takes any decision keeping in mind the accounts certified by the auditor, trusting his report and if the annual accounts prove to be wrong and as there is no reference to the wrong accounts in the report of the auditor, if the third party incurs any loss, can the auditor be considered liable to pay for the losses ?

In binary circumstances, the answers to these questions are into negative because auditor’s appointment, remuneration, removal etc. are not decided by the third party. Generally, an agreement is made between the company and the auditor. Company appoints the auditor. It pays remuneration.

Therefore, auditor is accountable to the company and not the third party. Yet it is not totally true. In certain situations, auditor is liable to even the third party.

1. If the auditor has prepared accounts, registers, reports with negligence and if they are prepared keeping in view certain transactions with the third party and if actions are to be taken on the basis of it by the third party, then the third party can get the compensation for the losses shown by the auditor.

2. If any shareholder decides individually to invest in the company on the basis of certified accounts or auditor’s reports, auditor is not liable to that shareholder individually.

3. If the accountant knows that his accounts will be based for the estimation of taxes and yet if any negligence is showed, the auditor is not liable for it.

It should be remembered that towards the third party, auditor has a moral liability. They will act depending on his reports so, if auditor has made false or misguiding statements and the third party suffers loss, it is auditor’s moral liability.

According to Indian Companies Act, if there is any misguiding statement in the magazine and auditor has given his permission, auditor is liable to pay for the damage suffered by the person who has invested money depending on it.

But it should be remembered that the auditor should be honest. While auditing, he should use fair skill, vigilance and expertise. It is necessary that auditor is honest and gives his report after proper verification of accounts. Auditor has moral liability too. The third party deals with the company thinking that accounts which have been verified by the qualified auditor are correct. In this situation, auditor should take care of the interest of third parties.