LAW

CORPORATE LAW
Auditors, their duties and liabilities
 Description of the module
Subject name Law
Paper name Corporate Laws
Module name/ Title Auditors, their duties and liabilities
Module Id 15
Pre- requisites
Objectives To get a brief understanding of the role of
auditors in a company.
Key words Chartered accountant, auditing

LEARNING OUTCOME
This module will elaborate on functions of an auditor for representation of true
financial status of a company. The major focus of this module is to give an overview
of duties and liabilities of an auditor under the Companies Act, 2013 for the broader
objective of corporate governance as a whole.
INTRODUCTION
Corporate governance has become the corner stone of corporate law globally. True
and fair audits are the core concern for regulators world over. The new Companies
Act has made accounts and audits a subject of special interest and has laid down
detailed provisions regarding the same. The Act also sets up a National Financial
Reporting Authority for setting the standards for the accounting and auditing.
AUDIT AND AUDITOR
A company carries on its business with the capital provided by the shareholders and
other members of the investment community. It is important for them that their
investment is safe and that it has been used for the purpose it was intendedto be . The
company has to maintain numbers of financial books, accounts and statements for the
proper accounting of the income and expenditure. These accounts, books etc must be
inspected and verified by an independent person or a firm to give the true picture of
internal financial functioning of the company.
The Institute of Chartered Accountants of India (ICAI) is a statutory body established
under the Chartered Accountants Act, 1949 which regulates the profession of
Chartered Accountants in India. ICAI lays down the pre-qualifications, accounting
standards, code of ethics as well as education of auditors in India. Only persons who
are a member of ICAI with a valid certificate of the institute for auditing may be
made an auditor of a company in India. Its “Statement on Objective and Scope of the
Audit of Financial Statements”1 lays down the following as the objectives of auditing
the financial statements:
1. The objectives 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.

1 Visit http://www.icai.org/new_post.html?post_id=450
 2. The auditor’s opinion helps determination of 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.2

The main objective of auditing is therefore, is to evaluate the financial statements and
confirm that they have been accurately and truly represented in the reports. Auditing
which is an independent examination can be done of any entity irrespective of their
size or legal form or whether the company is a non- profit making entity or a profit
making one.
For the purpose of accounting the most important person is an auditor. The recent fall
of the Indian company Satyam Computer Services Limited in which the audit and
auditing committee was involved, has made the Indian regulator placestringent
measures for the appointment as well as duties and liabilities of the auditors of a
company. The following is a brief description of how the scam was revealed:-

On 7th Jan, 2009, the company’s then chairman and founder Mr Ramalinga Raju
disclosed in a letter to Satyam Computers Limited Board o Directors that “ he had
been manipulating the company’s accounting numbers for years.”

Mr Raju claimed that he overstated assets on Satyam’s balance sheet by $1.47

billion

Nearly $ 1.04 billion in bank loans and cash that the company claimed were non-
existent.

A number of liabilities were also left underreported in the balance sheet.Satyam's

income was also overstated almost every quarter for many years .

2A.K. Majumdar and Dr G.K.Kapoor, Taxmann’s Company Law and Practice, p 825,16 th Ed, 2011,
Taxmann publications.
As a lesson learnt, the Companies Act, 2013 Chapter X Secs 139- 148 lays down
provisions relating to the appointment, disqualifications as well as duties and
liabilities of an auditor. These are discussed as follows:
1. APPOINTMENT OF AUDITORS

First auditors- general rules:

Auditors are the “gatekeepers of the corporate governance”3They uphold the integrity,
authenticity of the financial information of the company.Sec 139 of the Companies
Act lays down that an individual or a firm [which includes an LLP u/s 139(4) and 141
(2)]can be appointed as an auditor in a company.
The first auditor is to be appointed at a board of meeting within 30 days of the
registration of the company. In case the board fails to appoint within the 30 days the
auditor then, the board will inform the members and the members shall appoint the
auditors in the extra ordinary general meeting of the company.
Every appointment will be for five years provided that the company places the matter
relating to such appointment for ratification by members at every annual general
meeting.
Auditor or audit firm so appointed must give in writing consent on such appointment
and a certificate from himself or it that the appointment has been made in accordance
with the conditions prescribed and that the auditor satisfies the criteria’s provided
under the Act (Sec 141 which will be discussed subsequently in the module). A notice
of this appointment must be filed with the Registrar within 15 days of the meeting
which appoints the auditor.
Additional Conditions under Sec 139:
Under Sub sec (2) of the appointment provision no listed company or some other
companies as notified shall appoint as well as re- appoint:
(i) An individual for more than one term of the five consecutive years, or
(ii) An audit firm for more than two terms of five consecutive years

Any audit firm which has a common partner with the audit firm whose tenure has
just expired with the company may not be appointed as well.The companies are
required to comply with these requirements within three years of the
implementing of the Act.

Rotation of Auditors :

Under Sec 139 (3) the members of a company may resolve to rotate in the audit firm
appointed, the auditing partner and his team. They may also resolve to get the audit
conducted by more than one auditor. The rules regarding the rotation are provided in
detail in the Companies Rules

Appointment in case of government company under Sec 139 (5) and (7):

3http://www.iica.in/images/Auditors.pdf
Under sub sec (7) in case of Government company or company which is owned or
controlled by the Central Government/ State Government or both Central and State
first auditor shall be appointed by Comptroller and Auditor General of India within
sixty days of registration of the company. In case of Comptroller and Auditor
General of India does not appoint first auditor within the said sixty days, the Board of
directors shall appoint such auditor within next thirty days. In case of failure of
Board to appoint first auditor within this period, the members shall appoint such
auditor within next sixty days. The first auditor shall hold office until the conclusion
of first annual general meeting
Under sub sec (5),the auditor of a Government company or a company controlled by
the Central Government /State Government / or party by both , the Comptroller and
Auditor General of India shall appoint an auditor within a period of one hundred and
eighty days from the commencement of financial year to hold office till the annual
general meeting has concluded.

In case Board fails to appoint, the

members shall appoint such
auditor within next sixty days

CAG of India does not appoint first auditor within the said
sixty days, the Board of directors shall appoint such
auditor within next thirty days.

First auditor shall be appointed by

CAGof India within sixty days of
registration of the company

Casual Vacancy under Sec 139 (8):

1. When a casual vacancy arises in acompany which is not a Government company if;
a. the vacancy is due to resignation of the auditor then new appointment shall be
filed by the board of directors within 30 days
b. the vacancy is due to resignation then the new appointment shall be approved by
the company at a general meeting convened within three months of the
recommendations of the Board and the auditor shall hold the office till the
conclusion of the next annual general meeting.
2. When a casual vacancy arises in a Government company, the new appointment has to
bemade by the Comptroller and Auditor General of India within 30 days. In case he
does not fill the vacancy within the said period then the Board of directors shall fill
the vacancy within the next 30 days.

Re- appointment of retiring auditor [ Sec 140 (4) ]

Subject to sub sec (1), a retiring auditor may be re appointed 4 at an annual general
meeting, if:
•He is not disqualified for re-appointment
1.
•He has not given the company a notice in writing of his unwillingness
2. to be re-appointed

•A special resolution has not been passed at that meeting appointing

3.

Re- appointment when no auditor is selected [Sec 139 ( 10) ]

Under sub sec (10), where at any annual general meeting, no auditor is appointed or
re-appointed, the existing auditor shall continue to be the auditor of the company.

Appointments in case of audit committee [ Sec 139 (11) ]

Under sub sec (11), where a company is required to constitute an Audit Committee
under section 177,all appointments, including the filling of a casual vacancy of an
auditor under this sectionshall be made after taking into account the recommendations
of such committee.

2. REMOVAL OF AUDITOR [ Sec 140 ]

Auditor appointed under the above sec can be removed under Sec 140 of the
Companies Act. It is as follows:

An auditor may be removed before the expiry of his time period only by a special
resolution of the company. This is to be obtained after the approval of the Central
Government in the prescribed manner. Before he is removed he has to be given a
reasonable opportunity of being heard.

In the situation where auditor has resigned from the company, he shall file within a
period of 30 days from the date of resignation the following statement depending
whether the company is a Government company or any other form of company:

In case of a Government company:

1. A statement in prescribed form with the company and registrar
2. A statement with the Comptroller and Auditor General of India indicating the reasons
and other facts as may be relevant with regards to his resignation.

In case of a company other than Government Company:

4http://www.mca.gov.in/MinistryV2/companiesact.html
Submit a statement in the prescribed manner with the company and the registrar.The
Act provides for a penalty of Rs 50,000 in case the auditor does not comply with the
above procedure.

Special notice
Sec 140 provides for the procedure in which when a retiring auditor is being re-
appointed or when a retiring auditor must not be appointed if he has completed 5
consecutive tenures ,or 10 as the case may be. A special notice is required to be given
on this behalf ( to re appoint or not ) before a resolution at an annual general meeting.
Once the notice is received for a resolution the company is to send a copy of the same
to the retiring auditor. The retiring auditor under the section makes a written
representation to the company which is to be notified to the members of the company.
This has to be send by the company so as to:
a. State the fact of the representation having been made; and
b. Send a copy of the representation to every member of the company to whom notice of
the meeting is sent, whether before or after the receipt of the representationby the
company.
In case the copy of the representation is receivedtoo late or not send in the first place,
then the auditor will have the right to present orally or read at the meeting itself. A
copy of the representation has to be filed with the registrar as well.

Eligibility to be appointed auditor

Under sec 141 (1) of the Act, a person or a firm whose partners are chartered
accountants may be appointed as auditors of a company in India. An LLP which is
registered may also be appointed auditor provided only the partners who are chartered
accountants shall be authorized to sign on behalf of the firm.

Disqualifications under Sec 141 (3):

Following persons shall not be eligible for appointment as an auditor of a company:

(a) A body corporate other than a limited liability partnership;

(b) An officer or employee of the company;

(c) A person who is a partner or who is in the employment of an officer of employee of the
company;

(d) A person who or his relative or partner (i) is holding any security of or interest in, or (ii)
is indebted to, or (iii) has given a guarantee or provided any security in connection with the
indebtedness of any third person to the company, its subsidiary, or its holding or its associate
company or a subsidiary of such holding company;
(e) 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;

(f) a person whose relative is a director or is in the employment of the company as a director
or key managerial personnel;

(g) 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;

(h) 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;

(i) any person whose subsidiary or associate company or any other form of entity, is engaged
as on the date of appointment in consulting and specialized services as provided in section
144.

The services under this section 144 are:

(a) accounting and book keeping services;

(b) Internal audit;

(c) Design and implementation of any financial information system;

(d) Actuarial services;

(e) Investment advisory services;

(f) Investment banking services;

(g) Rendering of outsources financial services;

(h) Management services; and

(i) Any other kind of services as may be prescribed.

It is clear that the above restrictions will prohibit an auditor from rendering certain
prescribed non audit services to the company and its holding or subsidiary company
in India. It is further submitted that though the Act lays down the services which are
prohibited yet it does not define some of them like“investment advisory services” and
“management services”. As there are no clear meaning assigned to them, they may be
subjected to varying interpretations.

3. POWERS AND DUTIES OF AUDITORS

Duties of an auditor have been stated under Sec 143 of the Companies Act which are
illustrated as under:-

Right to
access

Duty to attend
Duty to report
meetings

Duty to
Duty to sign
prepare
audit report
branch report

Comply with
Duty to report
accounting
a fraud
standards

Let us discuss them in detail :

1. Right to access
Under this Act 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 they are kept at the
registered office or any other place. He is under this provision entitled to ask the same
from the officers of the company all the information that he considers necessary for
the performance of his duties as auditors. The Sec 143 (1) (a) to (f) lays down the list
of matters on which the auditor may seek information.

These rights are also available to an auditor of a holding company:

a) Proper security for loan and advances,
b) Transaction by book entries
 c) Sale of assets in securities in loss
d) Loan and advances made shown as deposits,
e) Personal expenses charged to revenue account
f) Case received for share allotted for cash

2. Make a report on financial statements

It is the duty of the auditor to make a report on every financial statement which was
required by the Companies Act to be laid before the company in a general meeting.
This report is to be in accordance to the accounting and auditing standards required
under the Act. This report has to be placed before the members of the company at the
end of the financial year. The report shall state5:

a) whether he has sought and obtained all the necessary information and explanations
which to the best of his knowledge and belief forhis audit and if not, the details
thereof and the effect of such information on the financial statements;

(b) whether, in his opinion, proper books of account as required by law have been
kept by the company so far as appears from his examination of those books and
proper returns adequate for the purposes of his audit have been received from
branches not visited by him;

(c) whether the report on the accounts of any branch office of the company audited
under sub-section (8) by a person other than the company’s auditor has been sent to
him under the proviso to that sub-section and the manner in which he has dealt with it
in preparing his report;

(d) whether the company’s balance sheet and profit and loss account dealt with in the
report are in agreement with the books of account and returns;

(e) whether, in his opinion, the financial statements comply with the accounting
standards;

(f) the observations or comments of the auditors on financial transactions or matters

which have any adverse effect on the functioning of the company;

(g) whether any director is disqualified from being appointed as a director under sub-
section (2) of section 164;

(h) any qualification, reservation or adverse remark relating to the maintenance of

accounts and other matters connected therewith;

5 Sec 143 (3)

 (i) whether the company has adequate internal financial controls system in place and
the operating effectiveness of such controls;

(j) such other matters as may be prescribed.

In case the report does not mention all the necessary information that is required to be
stated, then the auditor needs to state all reason for the same.

3. Audit report to be submitted to government company

In the case of a Government company, the auditor as appointed under Sec 139, has to
prepare the accounts in the manner directed by the Comptroller and Auditor General
(CAG) of India to whom this report has to be submitted .The report shall include the
directions if any, given by the CAG, the action taken as well as its impact on the
accounts and the financial statement of the company.

After the report has been submitted to the CAG, within 60 days has a right to:
a) Conduct a supplementary audit, and
b) Comment upon or supplement such audit report. This comment/ report has to
send to by the company to every person entitled to copies of audited financial
statements under Sec 136 , sub section (1) as well as be placed before the annual
general meeting.

4. Prepare branch report

Where a company has a branch office, the accounts of that office shall be audited
either by the company’s auditor, or by any other person qualified for appointment as
an auditor of the company, where the branch office is situated in a country outside
India, the accounts of the branch office shall be audited either by the company’s
auditor or by an accountant or by any other person duly qualified to act as an auditor
of the accounts of the branch office in accordance with the laws of that country.6

The branch auditor shall also prepare a report on the accounts of the branch examined
by him. This report is to be sent to the auditor of the company who shall deal with it
in his report in such manner as he considers necessary.

5. Comply with accounting standards

One of the major duties of the auditor is to conduct audit and prepare the report as per
the accounting standards recognized by law. The Central Government notifies these
standards after consultation with the National Financial Reporting Authority created
under the Companies Act.

6. Report fraud

6 Sec 143 (8)

 A critical duty under this section that has been assigned to the auditor is that
whenever during his appointment, he has reasons to believe that an offence involving
fraud is being committed against the company by its officers or employees, he has to
immediately report the matter to the Central Government within such time and in
such manner as prescribed.

Sub section (13) further elaborates on this duty by adding that no duty to which an
auditor of a company may be subject to shall be regarded as having been contravened
by reasons of his reporting the fraud if it is done by him in good faith.

7. Duty to sign audit report

The auditor has to 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. All
the observations, qualifications as well as comments of the auditor on the financial
transactions or matters which have adverse effect on the functioning of the company
and which have been mentioned by the auditor in his report have to be read before the
company in general meeting and will be open to inspection by any member of the
company.

8. Right to attend meetings

The auditor under sec 146 has to be forwarded all notices regarding the general
meeting of the company. He, unless exempted by the company itself, has to himself
or through his authorized representative (who must be a qualified auditor as well)
must attend the general meetings and have the right to be heard at such meetings.

4. LIABILITIES OF AN AUDITOR

Auditorsappointed in a company are liable under two broadheads:

1. Civil liabilities
2. Criminal liabilities

CIVIL LIABILITIES- Under the civil liabilities of a company auditor, following

two actions can be taken against him within the common law principles (i)
negligence, (ii) misfeasance.
 Liability for
negligence Liability for
Misfeasance

(1) Liability for negligence – An auditor is meant to perform his duties as an agent of
the shareholders and other persons who have invested in the company. He is expected
to safeguard the interests of his shareholders. He must exercise his reasonable care
and diligence in the performance of his duties. If he fails to do so and in consequence
the principal suffers any lossthen he may be liable to compensate loss caused to the
company resulting from his negligence. In the case of ICAI v. S.K.Jain7 , the Court
held the chartered accountant concerned guilty of gross negligence by certifying a
statement on the export of leather goods without initially verifying facts from relevant
books of the company.

(2) Liability for Misfeasance – Misfeasance is a breach of duty or breach of trust. If

the auditor does something wrongfully in the performance of his duties or he does not
perform his duties properly in the first place resulting in a financial loss to the
company, he may be held liable for misfeasance.

CRIMINAL LIABILITIES – Thecriminal liabilities of an auditor when he does not

perform his duties effectively have been laid down in the Companies Act are as
following:

7 [2001]29SCL265
 Sec 147 sec 148
Penalty for Penalty for
non- failure to
compliance report a fraud

Sec 140(5)
Sec 245
and Sec 447
Liabilities of
Liability when
an auditor
fraud is
through class
committed by
action
the auditor

1. Penalty for non-compliance

Under Sec 147 of the Act, if any provisions stated under Sec 139 or 146 are
contravened, the company shall be punishable with a fine which shall not be less than
Rs 25,000 but which may extend to Rs 5, 00,000.
If any auditor has knowingly or willfully contravened such provisions with an
intention to deceive the company/shareholders/ creditors/ tax authorities, he shall be
punishable with imprisonment for a term which may extend to one year and with a
fine not less than Rs 1, 00,000 which can be extended till Rs 25, 00,000.

The auditor so convicted has to refund the remuneration received by him to the
company as well as pay damages to the company/ bodies/ authorities/ any person for
loss arising out of an incorrect or misleading statement made by the auditor in his
audit report.

2. Penalty for failure to report a fraud

Under Sec 143 it is the duty of the auditor to report any fraud that he has reasons to
believe company’s officers or employees are committingagainst the company. Sub
section (15) lays down a fine of not less than one lakh which may extend to twenty
five lakh rupees if any auditor , cost accountant or company secretary does not
comply with the provisions of sub section (12) regarding reporting of fraud to the
central government.

3. Liability when auditor has committed a fraud

 The Company Law Tribunal has been powered under sub sec (5) of Sec 140 to either
suo motu or on an application made to it by the Central Government or by any other
person concerned if it 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:

The section further provides that if the application is made by the Central
Government and the Tribunal is satisfied that any change of the auditor is required, it
shall within fifteen 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. The Act lays down a strict consequence for the auditor after Tribunal has
passed its final order. The Act does not allow the auditor whether individual or firm
to be eligible to be appointed as an auditor of any company for a period of 5 years
from the date of passing of this order. The auditor is further liable for action under
Sec 447 as well. This step has been taken under the Act for auditors to understand the
importance of their duty of auditing and not to commit fraud

4. Action under Section 447

A person, who has been found guilty of fraud, shall be punishable with imprisonment
which shall be not less than 6 months and which may extend to 10 years. He shall
also liable to be fined with an amount which shall not be less than the amount
involved in the fraud , but which may extend to three times the amount involved in
the fraud.

5. Class action
Under Sec 245 of the Act, any 100 or more members or deposit holders of the
company or 10 % of the total number of members/ deposit holders of the company
may file a class action suit to claim damages or compensation or demand any other
suitable action against the auditor in the manner prescribed.

The action under Sec 245 can be initiated against an auditor for any improper or
misleading statement of particulars made in the audit report or for any fraudulent,
unlawful or wrongful act or conduct. In such an action liability will be of the audit
firm (in case the audit is being conducted by a firm) as well as each partner who was
involved in making such improper or misleading particulars in the audit report.

CONCLUSION
Auditors form one of the pillars of corporate governance. The auditor is responsible
for verifying whether the financial statements and books of accounts exhibit a true
and fair view of the state of affairs of the business. His audit report has to be authentic
and accurate. In this module how the auditor is appointed, his qualifications,
disqualifications, tenure as well as powers, duties and liabilities have been discussed
as per the provisions under the law. Under the new Companies Act, the reporting
responsibilities of the auditor have increased significantly. This step has been taken in
order to protect the shareholders and other investors in the company.

SELF ASSESSMENT EXERCISE

Correct answer Question number True or False
True 1. Auditors are the gatekeepers
of corporate governance.
False 2. No resolution is required for
the removal of the auditor
before the expiry of his
tenure.
False 3. An LLP of chartered
accountants cannot be made
auditors in an enterprise.
False 4. An officer/ employee of a
company may be made the
auditor of a company after
approval.
True 5 An auditor may be made
liable for negligence under
the common law

Correct answer Question number Fill in the blanks

Financial 1. An auditor helps to determine
the true and fair ________
position of an enterprise.
30 2. The first auditor is to be
appointed at a board of
meeting within_____ days of
the registration of the
company
6, 10 3. An auditor found guilty of
fraud, shall be punishable
with imprisonment which
shall be not less than ___
months and which may
extend to ____years
 Correct answer Question number Multiple choice questions
c. 1. No company shall re-appoint :
a. An individual for
more than one term of
five consecutive years,
or
b. An audit firm for more
than two terms of five
consecutive years
c. Both a and b
d. Only a
d. 2. Duties of an auditor is to:
a. Prepare a report
b. Report fraud
c. Give loans and
advances
d. Only a and b
e. a, b and c

FUTHER READINGS:

1. A. K. Majumdar and Dr G.K.Kappor, Taxmann’s Company Law and

Pactice,Taxmann Publication, 16th Edition (2011).
2. S. Balasubramanian, A Ramaiya Guide to Companies Act, LexisNexis Butterworths
Wadhwa Publication, 2013.