An Introduction to Auditors: Roles, Responsibilities, and Qualifications

By Sahil Kumar 21 Minutes Read

Introduction

A company operates using capital provided by its shareholders and other investors, who rely on the assurance that their investment is secure and used for its intended purpose. To ensure proper accounting of income and expenditure, the company must maintain various financial books, accounts, and statements.

These records must be inspected and verified by an independent individual or firm to present an accurate picture of the company’s internal financial operations.

The Institute of Chartered Accountants of India (ICAI) is a statutory body established under the Chartered Accountants Act, 1949, responsible for regulating the profession of Chartered Accountants in India. The ICAI sets the pre-qualifications, accounting standards, code of ethics, and educational requirements for auditors in the country.

Only individuals who are members of the ICAI with a valid certificate are eligible to be appointed as auditors of companies in India. The ICAI’s “Statement on Objective and Scope of the Audit of Financial Statements^[1]” outlines the primary objectives of auditing financial statements as follows:

1. The objective of an audit of financial statements, prepared within a framework of recognized accounting policies and practices and relevant statutory requirements, if any, is to enable an auditor to express an opinion on such financial statements.

2. The auditor’s opinion helps determine a true and fair view of the financial position and operating results of an enterprise. The user, however, should not assume that the auditor’ opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise.

The primary objective of auditing is to evaluate the financial statements and verify that they have been accurately and truthfully presented in the reports. Auditing, being an independent examination, can be conducted on any entity, regardless of its size, legal form, or whether it is a profit-making or non-profit organization.

Appointment of Auditors

• Section 139^[2] stipulates that either an individual or a firm can be appointed as an auditor for a company. The first auditor must be appointed by the board of directors within 30 days of the company’s registration. If the board fails to do so within this timeframe, it must notify the members, who will then appoint the auditor at an extraordinary general meeting.
• The auditor’s appointment is for a term of five- years, subject to ratification by the members at each annual general meeting. The appointed auditor or audit firm must provide written consent to the appointment and a certificate confirming that the appointment meets the prescribed conditions and that the auditor satisfies the criteria set out in the Act.
• Notice of the appointment must be filed with the Registrar within 15 days of the meeting at which the auditor was appointed.
• Under Subsection (2) of the appointment provisions, no listed company, nor certain other notified companies, may appoint or reappoint:

I. An individual as auditor for more than one term of five consecutive years.

II. An audit firm for more than two terms of five consecutive years.

• Furthermore, an audit firm that shares a common partner with the outgoing audit firm whose tenure has just ended may not be appointed. Companies must comply with these requirements within three years of the Act’s implementation.

Eligibility of an Auditor

• Under Section 141(1) of the Companies Act, 2013, an individual or a firm with partners who are chartered accountants is eligible to be appointed as an auditor for a company in India. This ensures that the auditing process is conducted by professionals with the necessary qualifications and expertise.
• Additionally, a Limited Liability Partnership (LLP) can also be appointed as an auditor, provided that only those partners who are chartered accountants have the authority to sign on behalf of the LLP. This stipulation ensures that the responsibility for auditing remains with qualified professionals, maintaining the integrity and accuracy of financial reporting.
  

Powers and Duties of an Auditor

The duties of an auditor under Section 143 of the Companies Act, 2013, are as follows:

1.  Right to Access

An auditor has the right to access all books of account and vouchers of the company, whether kept at the registered office or elsewhere. This right includes requesting information from company officers necessary for performing audit duties. In cases of specific matters, the auditor may seek information on proper security for loans, transactions by book entries, sales of assets at a loss, loans and advances recorded as deposits, personal expenses charged to revenue accounts, and cases where shares were allotted for cash.

In the case of Deputy Secretary to The Government of India, Ministry Of Finance Informant v. S.N Das Gupta^[3], It was held that an auditor must ensure not only the arithmetical accuracy of accounts but also their substantial accuracy, necessitating the request for additional information when needed.

2. Report on Financial Statements

The auditor is responsible for preparing a report on the financial statements, which is required to be presented at the company’s general meeting. This report must adhere to accounting and auditing standards and must be submitted at the end of the financial year. The report should state:

• Whether all necessary information and explanations have been obtained and, if not, detail the missing information and its effect.
• Whether proper books of account have been kept and adequate returns received from branches not visited.
• Whether the report on any branch office audited by someone other than the company’s auditor has been received and considered.
• Whether the balance sheet and profit and loss account agree with the books of account and returns.
• Whether the financial statements comply with accounting standards. Observations or comments on financial transactions with adverse effects on the company.
• Whether any director is disqualified under Section 164(2)^[4].Any qualifications, reservations, or adverse remarks related to accounts.
• Whether the company has adequate internal financial controls and their effectiveness. Any other prescribed matters.

If the report lacks the necessary information, the auditor must explain the reasons for this omission.

An auditor is not responsible for ensuring that their report is delivered to or received by the shareholders. Once the auditor has signed the report and the Balance Sheet and submitted them to the company’s Secretary, their duty is considered fulfilled.^[5]

3. Audit Report for Government Companies

For a Government company, the auditor must prepare the accounts as directed by the Comptroller and Auditor General (CAG) of India. The report should include any directions from the CAG, the actions taken, and their impact on the accounts and financial statements. The CAG has the right to conduct a supplementary audit and comment on or supplement the audit report within 60 days. These comments must be sent to the company and presented at the annual general meeting.

4. Branch Report Preparation

When a company has a branch office, the branch accounts must be audited either by the company’s auditor or by another qualified person. If the branch is located outside India, the audit can be performed by an accountant or other qualified auditor according to local laws. The branch auditor must prepare a report, which should be sent to the company’s auditor, who will incorporate it into their report as necessary.

5. Compliance with Accounting Standards

Auditors must conduct audits and prepare reports in accordance with the accounting standards prescribed by law. The Central Government notifies these standards after consulting with the National Financial Reporting Authority. The auditor is not an insurer; his responsibility is limited to exercising reasonable care and skill in his duties.^[6]

6. Reporting Fraud

If an auditor suspects that fraud is being committed against the company by its officers or employees, they must report this to the Central Government in the prescribed manner and time frame. An auditor will not be considered in breach of duty for reporting fraud if done in good faith.

7. Duty to Sign Audit Report

The auditor must sign the audit report and certify any other company documents as required by Section 141(2). All observations, qualifications, and comments on financial matters affecting the company must be read at the general meeting and be available for inspection by any member of the company.

8. Right to Attend Meetings

Under Section 146^[7], the auditor must receive all notices of general meetings. Unless exempted, the auditor or their authorized representative (a qualified auditor) must attend these meetings and has the right to be heard.

Disqualification of an Auditor

Section 141(3)^[8] mentions the criteria for the Disqualification of An Auditor. The following individuals and entities are not eligible for appointment as an auditor of a company:

a) A body corporate, other than a Limited Liability Partnership (LLP).

b) An officer or employee of the company.

c) A person who is a partner or is employed by an officer or employee of the company.

d) A person who, or whose relative or partner:

• Holds any security or interest in the company, its subsidiary, holding, or associate company, or in a subsidiary of such a holding company.
• Is indebted to the company, its subsidiary, holding, or associate company, or a subsidiary of such a holding company.
• Has given a guarantee or provided security in connection with the indebtedness of any third party to the company, its subsidiary, holding, or associate company, or a subsidiary of such a holding company.

e) A person or firm that has, whether directly or indirectly, a business relationship with the company, its subsidiary, holding, or associate company, or a subsidiary of such holding company, of a nature prescribed by regulations.

f) A person whose relative is a director or is employed by the company as a director or key managerial personnel.

g) A person who is in full-time employment elsewhere or a person or partner of a firm holding an appointment as auditor if such person or partner, at the time of appointment or reappointment, is already the auditor of more than twenty companies.

h) A person who has been convicted by a court for an offence involving fraud, provided that ten years have not elapsed since the date of such conviction.

i) Any person whose subsidiary or associate company or any other form of entity, is engaged in consulting and specialized services as described in Section 144, as of the date of appointment.

Removal of an Auditor

An auditor appointed under Section 139 can be removed under Section 140^[9]. The removal of an auditor before the end of their term requires a special resolution passed by the company, which must be obtained after securing approval from the Central Government in the prescribed manner. Before removal, the auditor must be given a reasonable opportunity to be heard.

If an auditor resigns from the company, they must file a statement within 30 days of their resignation. The requirements vary depending on whether the company is a Government company or another type of company:

1. For a Government Company:

• Submit a statement in the prescribed form with the company and the registrar.
• Submit a statement to the Comptroller and Auditor General of India, indicating the reasons and other relevant facts regarding the resignation.

In the case of Union of India and Another v. Deloitte Haskins and Sells LLP & Another^[10] the Supreme Court clarified that an auditor’s resignation after submitting an application under Section 140(5) of the Act does not automatically halt the proceedings initiated under the Section.^[11]

2. For Other Companies:

• Submit a statement in the prescribed form with the company and the registrar.

The Act imposes a penalty of ₹50,000 if the auditor fails to comply with these procedures.^[12]

Liabilities of an Auditor

Auditors appointed to a company hold significant responsibilities, and their actions (or inactions) can lead to liabilities under two primary categories: civil and criminal.

1. Civil Liabilities

• Liability for Negligence: Auditors must perform their duties with reasonable care and diligence, acting as agents for shareholders and investors. If an auditor’s negligence results in a financial loss to the company, they may be liable to compensate for the loss. In ICAI v. S.K. Jain^[13], the court found the auditor guilty of gross negligence for certifying statements without proper verification from the company’s books. The case of Price Waterhouse And Co. Now Known as Price Waterhouse And Co. Bangalore Llp And Others v. Securities And Exchange Board Of India^[14] reinforces that auditors must perform their duties with reasonable skill and care, but they are not obligated to operate under suspicion unless there are valid grounds for such suspicion.
•  Liability for Misfeasance: Misfeasance involves a breach of duty or trust, where the auditor either performs their duties wrongfully or fails to perform them properly, causing financial harm to the company. Such actions can result in liability for the auditor under common law principles.

2. Criminal Liabilities

• Penalty for Non-compliance: Under Section 147, if provisions related to auditor appointments and reporting are violated, the company faces a fine between ₹25,000 and ₹5,00,000. An auditor who knowingly contravenes these provisions with intent to deceive may face imprisonment up to one year and a fine ranging from ₹1,00,000 to ₹25,00,000. Additionally, the auditor must refund their remuneration and pay damages for any losses resulting from incorrect or misleading statements.
• Penalty for Failure to Report Fraud: According to Section 143^[15], auditors are required to report any fraud they believe is being committed by the company’s officers or employees. Failure to report such fraud, as stipulated in subsection (15), can result in a fine between ₹1,00,000 and ₹25,00,000. In the case of Registrar Of Companies, Bombay Complainant v. P.M Hegde^[16], The court determined that auditors are required to exercise reasonable care and diligence. Although they are not expected to uncover all frauds, failing to make inquiries when suspicion arises can result in liability for negligence.

• Liability for Fraud: Under Section 140(5)^[17], the Company Law Tribunal can direct a company to replace its auditor if it is found that the auditor has acted fraudulently or colluded in fraud. The tribunal can also disqualify the auditor from being appointed for any company for five years. The auditor may also face further actions under Section 447^[18].
• Action under Section 447: If found guilty of fraud, an auditor faces imprisonment between six months and ten years, and fines not less than the amount of the fraud, extending up to three times the amount involved.
•  Class Action: Section 245 allows 100 or more members or 10% of deposit holders to file a class action suit against auditors for improper or misleading statements in audit reports or fraudulent conduct. This action can be taken against both the audit firm (if applicable) and the individual partners involved. These liabilities underscore the importance of auditors’ roles in ensuring accurate and honest financial reporting and maintaining the integrity of financial statements.

Conclusion

Auditors are fundamental to corporate governance, serving as a crucial pillar in ensuring transparency and accountability. Their core responsibility is to examine whether the financial statements and accounting records of a business accurately and fairly represent its financial position. The audit report must be both authentic and precise, reflecting the true state of affairs. This module elaborates on the processes involved in auditor appointment, including their qualifications, disqualifications, and tenure, as well as their powers, duties, and liabilities as outlined by the law. With the enactment of the new Companies Act, there has been a significant enhancement in the reporting responsibilities of auditors. This development is aimed at bolstering the protection of shareholders and other investors by ensuring more rigorous and comprehensive oversight.

^[1] http://www.icai.org/new_post.html?post_id=450

^[2] Companies Act, 2013, Act No. 18 of 2013, s. 139.

^[3] 1955 SCC ONLINE CAL 209.

^[4] Companies Act, 2013, s. 164(2).

^[5] Re Allen, Craig & Co. (London) Ltd., [1934] Ch 1.

^[6] Re Kingston Cotton Mills Co (No 2), [1896] 2 Ch 279 (CA).

^[7] Companies Act, 2013, s. 146.

^[8] Companies Act, 2013, s. 141(3).

^[9] Companies Act, 2013, s. 140.

^[10]  (2020) 10 SCC 373

^[11] 2023 SCC OnLine SC 557

^[12] Companies Act, 2013, s. 147(1).

^[13] (2011) 9 SCC 732.

^[14] 2019 SCC ONLINE SAT 165.

^[15] Companies Act, 2013, s. 143.

^[16] 1954 SCC ONLINE MAD 168.

^[17] Companies Act, 2013, s. 164(2).

^[18] Id. at s. 477.

Sahil Kumar