THE LEGAL BRIDGE

Judiciary & Law Notes Series

THE COMPANIES ACT, 2013

CHAPTER X

Audit and Auditors

Sections 139–148

For Judicial Service Aspirants & Law Students

RJS • DJS • PCS-J • HJS • UPJS • BJS • MPCJ

Appointment • Rotation • Disqualifications • Fraud Reporting

— Enriched with landmark judgments and illustrative case law —

Chapter X — Audit and Auditors

If the management of a company represents the eyes and hands of the corporate body, the auditor represents the conscience of the shareholders. The auditor's report is the statutory certificate that the financial statements present a true and fair view. Chapter X of the Companies Act, 2013 (Sections 139 to 148) lays down a comprehensive regime governing the appointment, qualifications, rotation, powers, duties, liabilities, and removal of company auditors — along with cost audit.

Post the Satyam Computers scandal, the 2013 Act substantially tightened the audit regime, introducing mandatory rotation, restrictions on non-audit services, statutory duty to report fraud, and heavy penalties — including personal liability under Section 447 for frauds of ₹1 crore or more.

Section 139 — Appointment of Auditors

(1) First Appointment at the First AGM

Every company shall, at the first annual general meeting, appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting 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.

The ratification of the auditor's appointment at every AGM was initially mandatory but was omitted by the Companies (Amendment) Act, 2017 — so once appointed for five years, no annual ratification is required. Written consent of the auditor to such appointment and a certificate from him that the appointment, if made, shall be in accordance with the prescribed conditions, must be obtained before the appointment.

(5) Government Companies

In the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government, or Governments, or partly by the Central Government and partly by one or more State Governments, the Comptroller and Auditor-General of India (CAG) shall, in respect of a financial year, appoint an auditor duly qualified to be appointed as an auditor of companies under this Act, within a period of 180 days from the commencement of the financial year, who shall hold office till the conclusion of the annual general meeting.

(6) First Auditor of a Company

(2) Mandatory Rotation of Auditors

No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or re-appoint:

• An individual as auditor for more than one term of five consecutive years; and
• An audit firm as auditor for more than two terms of five consecutive years.

An individual auditor who has completed his term shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term. An audit firm which has completed its term shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term.

Rule 5 of the Companies (Audit and Auditors) Rules, 2014 prescribes the classes of companies (other than listed companies) to which mandatory rotation applies: unlisted public companies with paid-up share capital of ₹10 crore or more; private companies with paid-up share capital of ₹50 crore or more; and all companies (listed or otherwise) having paid-up share capital below the above thresholds but having public borrowings from financial institutions, banks, or public deposits of ₹50 crore or more.

(9) Casual Vacancy

Any casual vacancy in the office of an auditor shall:

• In the case of a company other than a Government company, be filled by the Board of Directors within 30 days, but if such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within 3 months of the recommendation of the Board and he shall hold the office till the conclusion of the next AGM;
• In the case of a Government company, be filled by the CAG within 30 days. If CAG does not fill the vacancy, the Board shall fill it within the next 30 days.

Section 140 — Removal, Resignation of Auditor

(1) Removal Before Expiry of Term

The auditor appointed under Section 139 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. This twin-lock procedure (CG approval + special resolution) is designed to protect auditor independence — preventing management from terminating an inconvenient auditor mid-term.

Before taking any action, the auditor concerned shall be given a reasonable opportunity of being heard.

(2) Resignation of Auditor

The auditor who has resigned from the company shall file within a period of thirty days from the date of resignation a statement in the prescribed form with the company and the Registrar, and in case of companies referred to in Section 139(5) (Government companies), the auditor shall also file such statement with the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his resignation.

(4) Tribunal's Direction for Change of Auditors (Fraud)

Notwithstanding anything in this section, where the Tribunal is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors. If the application is made by the Central Government and the Tribunal is satisfied, it may within 15 days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place.

Section 141 — Eligibility, Qualifications and Disqualifications

A person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant. A firm, whereof majority of the partners practising in India are qualified for appointment, may be appointed by its firm name to be auditor of a company. Only the partners who are chartered accountants shall be authorised to act and sign on behalf of the firm.

(3) Disqualifications — Persons Not Eligible

1. A body corporate other than a limited liability partnership registered under the Limited Liability Partnership Act, 2008;An officer or employee of the company;A person who is a partner, or who is in the employment, of an officer or employee of the company;A person who, or his relative or partner, (i) is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company (a relative may, however, hold security or interest in the company of face value not exceeding ₹1,00,000); (ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ₹5,00,000; or (iii) 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 ₹1,00,000;A person or a 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;A person whose relative is a director or is in the employment of the company as a director or key managerial personnel;A person who is in full-time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies (the 20-company ceiling; OPC, small, dormant, and private companies with paid-up share capital less than ₹100 crore are excluded from this limit);A person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction;Any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialised services as provided in Section 144.

Section 142 — Remuneration of Auditor

The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may be determined therein: provided that the Board may fix remuneration of the first auditor appointed by it. The remuneration shall, in addition to the fee payable to an auditor, include the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but does not include any remuneration paid to him for any other service rendered by him at the request of the company.

Section 143 — Powers and Duties of Auditors

Powers

Every auditor of a company shall have a right of access at all times to the books of account and vouchers of the company, whether kept at the registered office of the company or at any other place and shall be entitled to require from the officers of the company such information and explanation as he may consider necessary for the performance of his duties as auditor.

Duties — Matters to be Enquired into and Reported on [Section 143(1) and (3)]

The auditor shall inquire into the following matters:

1. Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members;Whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company;Where the company not being an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company;Whether loans and advances made by the company have been shown as deposits;Whether personal expenses have been charged to revenue account;Where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been so received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

The auditor's report must state (under Section 143(3)) whether he has obtained all information and explanations; whether proper books of account have been kept; whether the balance sheet and profit and loss account are in agreement with the books; whether they comply with accounting standards; whether any director is disqualified from being appointed; and whether the company has adequate internal financial controls and the operating effectiveness of such controls.

(12) Duty to Report Fraud

Notwithstanding anything contained in this section, 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.

• For fraud of ₹1 crore or more — report to the Central Government (via the Secretary, Ministry of Corporate Affairs).
• For fraud of less than ₹1 crore — report to the Audit Committee (where constituted) or to the Board.
• Auditor must report within 2 days of becoming aware of the fraud; disclosure also required in the Board's report.
• Failure to comply with Section 143(12) attracts fine of ₹1 lakh to ₹25 lakh.

Section 144 — Auditor Not to Render Certain Services

An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company):

1. Accounting and book-keeping services;Internal audit;Design and implementation of any financial information system;Actuarial services;Investment advisory services;Investment banking services;Rendering of outsourced financial services;Management services;Any other kind of services as may be prescribed.

The purpose of this section is to ensure the auditor's independence by preventing conflict of interest — an auditor cannot be an auditor and a consultant to the same company at the same time.

Section 145 — Auditor to Sign Audit Reports, etc.

The person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other document of the company, in accordance with the provisions of sub-section (2) of section 141, and the qualifications, observations or comments on financial transactions or matters, which have any adverse effect on the functioning of the company, mentioned in the auditor's report shall be read before the company in general meeting and shall be open to inspection by any member of the company.

Section 146 — Auditor to Attend General Meeting

All notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself or through his authorised representative, who shall also be qualified to be an auditor, any general meeting and shall have right to be heard at such meeting on any part of the business which concerns him as the auditor.

Section 147 — Punishment for Contravention

(1) Company and Officer

If any of the provisions of Sections 139 to 146 (both inclusive) is contravened, the company shall be punishable with fine which shall not be less than ₹25,000 but which may extend to ₹5,00,000, and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than ₹10,000 but which may extend to ₹1,00,000, or with both.

(2) Auditor

If an auditor of a company contravenes any of the provisions of Section 139, Section 143, Section 144, or Section 145, the auditor shall be punishable with fine which shall not be less than ₹25,000 but which may extend to ₹5,00,000 or 4 times the remuneration of the auditor, whichever is less.

Where an auditor has contravened such provisions knowingly or wilfully with the intention to deceive the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment for a term which may extend to one year and with fine which shall not be less than ₹50,000 but which may extend to ₹25,00,000 or 8 times the remuneration of the auditor, whichever is less.

(3) & (4) Additional Liability

Where an auditor has been convicted under sub-section (2), he shall be liable to refund the remuneration received by him to the company and pay for damages to the company, statutory bodies, or to members/creditors/ any other persons for loss arising out of incorrect or misleading statements of particulars made in his audit report. Where an audit is conducted by a firm, the liability shall be of the firm and of the partner(s) who acted in a fraudulent manner or abetted or colluded in any fraud.

Section 148 — Central Government to Specify Audit of Items of Cost — Cost Audit

Notwithstanding anything contained in this Chapter, the Central Government may, by order, in respect of such class of companies engaged in the production of such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of material or labour or to other items of cost as may be prescribed shall also be included in the books of account kept by that class of companies. The Central Government may also direct that an audit of cost records of such class of companies shall be conducted in the manner specified in the order.

• The Companies (Cost Records and Audit) Rules, 2014 (as amended) prescribe the class of regulated and non-regulated sector companies required to maintain cost records and undergo cost audit.
• The cost auditor shall be a cost accountant in practice (member of ICAI — now ICMAI).
• The cost audit report must be submitted to the Board within 180 days of the close of the financial year, and the company must within 30 days of receipt file the report with the Central Government (Form CRA-4).