AUDITORS: APPOINTMENT,

ROLE AND REMOVAL UNDER

THE COMPANIES ACT, 2013
Auditors: Appointment, Role and Removal under the Companies Act,
2013

Learning objectives:
1. To understand who is an auditor and why auditors are required in the company.
2. To understand who can be appointed as an auditor in the company.
3. To probe into the procedural aspects, tenure, remuneration when an auditor is
appointed.

Who is an auditor and why are auditors required?

An auditor is an independent professional qualified to perform an audit or an inspection
and to report on the results of such inspection. Such an audit can be of accounts or it can
be of systems or processes or documents. In accounting, an auditor is someone who is
responsible for evaluating the validity and reliability of a company or organization’s
financial statements.

The board of directors of a company are responsible to ensure the maintenance of the
books of accounts of the company and ensure the preparation of the financial statements
on behalf of the company. The financial statements are a major tool available to the
shareholders to know about how the company is performing. Further, on the basis of the
performance of the company, the shareholders will be approving or rejecting the proposals
for the remuneration of the directors.

It is, therefore, critical that the financial statements are prepared in accordance with the
applicable legal requirements and that they provide a reliable view to the shareholders to
enable them to take the right decisions. In view of this, it becomes necessary that an
independent expert’s view is placed before the shareholders on whether the financial
statements express the “true and fair” position of the company. This is why an auditor is
required.

The following discussion relates to the statutory auditors as specified in the Companies Act,
2013. In the case of internal auditors, the requirements can be different.

Who can be appointed as the auditor of a company?

A person is eligible to be appointed as an auditor of a company only if he is a chartered
accountant within the meaning of the Chartered Accountants Act, 1949 and who holds a
valid certificate of practice under Section 6(1) of that Act.

In the case of a firm, if the majority of partners meet the above criteria, the firm can be
appointed as the auditor. However, in such cases, only the partners who are chartered
accountants shall be authorised to act and sign on behalf of the firm.

A body corporate other than an LLP is not eligible to be appointed the auditor of a
company. This is because, in the case of a body corporate, the ownership and management
are separate and therefore, it becomes difficult to affix responsibility in the event that the
duties as an auditor are not fulfilled.

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Auditors: Appointment, Role and Removal under the Companies Act,
2013

The following persons are also ineligible to be the auditors of a company, because of an
obvious conflict of interest:

i. an officer or employee of the company;

ii. a person who is a partner or who is in the employment of an officer or employee of

the company;

iii. a person whose relative is a director or KMP of the company;

iv. a person who, either by himself or through his relative or partner is holding securities
or interest in the company or its holding/subsidiary/associate company exceeding
rupees one lakh;

v. a person who, either by himself or through his relative or partner is indebted to the
company or its holding/subsidiary/associate company for an amount exceeding
rupees five lakhs;

vi. a person who, either by himself or through his relative or partner has given a
guarantee or provided security to the company or its holding/subsidiary/ associate
company in connection with a loan given to a third party exceeding rupees one lakh;

vii. a person who either directly or indirectly has entered into a commercial transaction
except for arms-length transactions or permitted professional services with the
company or its holding/subsidiary/associate company;

Further, the following persons are also ineligible to be an auditor:

i. a person who is already an auditor of more than twenty companies. When the
appointment being considered is in a private company, OPCs, small companies,
dormant companies and private companies having paid-up capital of less than rupees
one hundred crores are excluded from this number.

ii. a person who directly or indirectly renders any service referred to in section 144 to
the company or its holding or subsidiary.

The preceding provisions of the Companies Act, 2013 restricted 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 from being appointed as auditor. The Companies (Amendment) Act, 2017 (see
here) has clarified that this restriction would only apply if the auditor directly or
indirectly rendered the services referred to in section 144 to the company, its
holding company or its subsidiary company which proposes to appoint the auditor.

This provision is similar to the US Sarbanes Oxley Act of 2002, which focuses on
auditor independence. This Act came into being following the accounting scandal at

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Auditors: Appointment, Role and Removal under the Companies Act,
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Enron which led to the dissolution of audit firm Arthur Andersen. Interested
students can read more about it here.

iii. 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;

How are auditors appointed?

In the case of companies that are required to have an audit committee, the committee shall
consider if the qualifications and experience of the individual or the firm are commensurate
with the requirements of the company. The committee will also have regard to any pending
proceedings of the particular individual or firm in respect of professional conduct before
the Institute of Chartered Accountants of India. If found suitable, the committee shall make
a recommendation to the board for the appointment. The board can either agree or
disagree with the recommendations. If it disagrees, the matter will be sent back for
reconsideration by the committee. If the board agrees, the auditors shall be appointed.

The erstwhile provisions stated that the matter relating to the appointment of auditors be
placed for ratification by the members in each Annual General Meeting. The Companies
(Amendment) Act, 2017 has omitted this requirement related to ratification for the
appointment of the auditors by the members. This provision has been omitted as it was not
giving clarity in cases where the shareholders take the decision not to ratify an appointment
during five years.

The company is required to secure consent from the auditor prior to the appointment and
also secure a certificate that the auditor is eligible and satisfies all conditions for such
appointment.

The company shall inform the auditor, once appointed and also file a notice of such
appointment with the registrar within 15 days of the meeting in which the auditor is
appointed.

Tenure of appointment of auditors

Section 139 of the Act provides that the first auditor shall be appointed by the board of
directors within thirty days from incorporation and such auditor shall hold office up to the
conclusion of the first annual general meeting. Thereafter, the company shall appoint an
auditor at the first annual general meeting of the company to hold office from the
conclusion of that meeting till the conclusion of the sixth AGM and thereafter, till the
conclusion of every sixth meeting.

However,

- listed companies,
- unlisted public companies having paid-up share capital in excess of rupees ten crores,

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Auditors: Appointment, Role and Removal under the Companies Act,
2013

- private companies having paid-up share capital in excess of rupees fifty crore rupees
and
- other companies having borrowings from banks, financial institutions and public
deposits in excess of rupees fifty crores

cannot appoint an individual as an auditor for a term exceeding five years or a firm as
auditor for more than two consecutive terms of five years each.

Section 139 also provides for rotation of individuals and audit firms by the companies once
their statutory audit has completed one and two terms of five consecutive years
respectively. It further provides that the companies existing on the date of commencement
of section 139 shall be required to comply with the said section, in the first annual general
meeting held after 3 years from such commencement.

It must be noted that specified IFSC private and public companies are exempt from the
requirements of rotation of auditors.

Rule 6(3)(i) of the Companies (Audit and Auditors) Rules, 2014 (“Rules”) provides that the
period for which the individual or audit firm has held office as an auditor prior to
commencement of Section 139 shall be taken into an account for calculating the period of 5
or 10 consecutive years respectively. An illustration is also provided under the said Rules
and defines the term ‘consecutive year’ for the purpose of rotation of auditors.

Explanation II to the said Rule also provides that a break in the term for a continuous
period of five years shall be considered as fulfilling the requirement of rotation and that
consecutive years shall mean all the preceding financial years for which the firm has been
the auditor until there has been a break by five years or more.

Illustration to Rule 6
Number of consecutive
years for which an audit
firm has been functioning
as an auditor in the same
company [in the first AGM
held after the
commencement of
provisions of section 139(2)]
Maximum number of The aggregate period which
consecutive years for which the firm would complete in
the firm may be appointed the same company
in the same company
(including the transitional
period)

10 years (or more than 10 3 years 13 years or more

years)

6 years 4 years 10 years

Therefore, the amendment in the proviso of Section 139 now states that every company is
required to comply with the provision of rotation of statutory auditors in the first annual

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Auditors: Appointment, Role and Removal under the Companies Act,
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general meeting held after 3 years from the date on which provisions of the said section
came into effect and the said amendment in the proviso is retrospectively effective i.e.
w.e.f. April 1, 2014.

Given the above background, the period of 3 years will have to be calculated accordingly
and all the companies are required to comply with the provisions pertaining to the rotation
of statutory auditor of Section 139 of the Act in the annual general meeting which will be
held after a period of three years from the commencement of the Act.

Appointment of auditor in government companies

In the case of a Government company, the first auditor shall be appointed by the
Comptroller and Auditor General within sixty days from the date of registration of the
company and such auditor shall hold office until the conclusion of the first annual general
meeting of the company. For subsequent years, the Comptroller and Auditor-General of
India shall, in respect of a financial year, appoint an auditor duly qualified to be appointed
as an auditor of companies under the Companies Act, 2013, within a period of one hundred
and eighty days from the commencement of the financial year. Such auditor shall hold
office till the conclusion of the next annual general meeting.

What is the role of the auditor in corporate governance?

One would think as to why an auditor, who is primarily an external entity would be involved
with corporate governance, which basically relates to the internal processes of an
organisation. However, the auditor has a very relevant role in ensuring effective corporate
governance.

Auditor’s role vis a vis shareholders

If you were thinking of making an investment decision in the shares of a company, what
would you rather rely on - the unaudited financial results or an annual report containing
fully audited financial statements? There is reliability which is attached to an audited
financial statement and existing members as well as prospective investors will always place
greater confidence in the results which are accompanied by a report from a qualified
auditor. Because of this confidence, it becomes necessary for the auditor to ensure that he
or it provides a correct report on the financial statements.

Accordingly, the duties of the auditor as covered in the Companies Act, 2013 involve making
inquiries and requesting information and explanations to conclude if there are any
transactions that are prejudicial to the interests of the company. This can inter alia include
reviewing if the loans and advances are properly secured if investment assets have been
sold at lesser amounts than costs, whether personal expenses have been charged to
revenue of the company, if the cash has actually been received for shares stated to be
allotted for cash and if not, whether the books of account state the correct position in this
regard.

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Auditors: Appointment, Role and Removal under the Companies Act,
2013

The aspects which are to be covered in the auditor’s report to the shareholders are listed in
section 143(3) of the Companies Act, 2013 (the ‘Act’), Rule 11 of the Companies (Audit and
Auditors) Rules, 2014 as amended, and the Companies Auditors Report Order (CARO) Rules
2016. A template of a statutory auditor’s report can be found at page 26 here. The basic
objective is to express an opinion as to whether the financial statements provide the
information as required under the Act in the manner required under the Act and whether
or not the financial statements express a “true and fair” view in accordance with the
accounting standards. It may be noted here that as of 1 April 2017, 39 Ind-As (Indian
Accounting Standards) are applicable to all listed entities (see the details of the
implementation notification here).

The auditor’s report will also state the basis on which his or its opinion is arrived at, the key
audit points and contain a statement on the management’s responsibility to prepare
financial statements.

To be able to perform his duties effectively, every auditor of a company shall have the right
of access at all times to the books of accounts and vouchers of the company. The auditor
shall be entitled to secure from officers of the company such information and explanation
as he may consider necessary for the performance of his duties.

Auditor’s role vis a vis the management

Typically, the auditor is not required to make any reports to the board. However, by
bringing to the board’s notice any gaps in the compliance with the Act as regards the books
of accounts, the auditor does aid in the board’s duty to install and improve appropriate
accounting systems in the company.

If an auditor of a company, in the course of the performance of his duties as auditor, has
reason to believe that an offence involving fraud, which involves or is expected to involve
individually an amount exceeding rupees one crore or above is being or has been
committed against the company by officers or employees of the company, he shall report
the matter in the first instance, to the board of directors or the audit committee not later
than two days and requesting their reply or observations within 45 days. Upon receipt of
their reply, the auditor shall send his report in form FDT-4 (see the form here), together
with the reply or observations received from the board or the audit committee to the
Central Government (Secretary, Ministry of Corporate Affairs) within 15 days by Registered
Post Acknowledgement Due or Speed Post.

The auditor may sometimes be required to counter the view taken by the management, but
given that he has a duty towards the shareholders, it is necessary that he holds on to the
correct view.

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Auditors: Appointment, Role and Removal under the Companies Act,
2013

Satyam Computer Services Limited - what happens when the

auditor does not fulfil its role (see relevant article here)
S. Gopalakrishnan and Srinivas Talluri, partners of PricewaterhouseCoopers, the auditors of
Satyam Computer Services Limited were found by the CBI to be involved with the following
practices:

- The auditors had failed to collect live invoice samples directly from the relevant
computer systems while conducting the audit and instead, relied on the hard copies
provided by the accused officials of Satyam;
- The auditors failed to verify the current account balances of the company online and
rather relied upon the forged bank confirmation letters provided by the accused
officials;
- The auditors also failed to obtain direct confirmations from the debtors and vendors
of the company while performing the audit;
- The auditors did not pay attention to the System Process Audit team which pointed
out deficiencies in the IT system controls. Further, not only did they not draw the
attention of the audit committee to these findings, they in fact represented to the
audit committee that the findings were insignificant.

Given the above deviations, which were found to be blatant, a conclusion was drawn that
the auditors intentionally failed to observe the required audit standards.

The result (see relevant article here) was that the audit partners involved were arrested and
banned by the Institute of Chartered Accountants of India (ICAI) for life. They were also
penalised by the ICAI with a penalty of Rs.5 lacs.

Remuneration of auditors
The remuneration of the auditor of a company shall be fixed in its general meeting or in
such manner as may be determined therein, though the remuneration of the first auditor
can be determined by the board. It must 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.

It is imperative that the auditor is remunerated suitably according to the size and
complexity of the organisation as well as the accounting systems, since in the event that the
remuneration is not adequate if this results in compromising the quality of the audit, there
will be a question on the reliability of the financial statements and the performance of the
company itself.

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Auditors: Appointment, Role and Removal under the Companies Act,
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Resignation and removal

i. Special resolution

The auditor appointed may be removed from his office before the expiry of his term
only by obtaining the previous approval of the Central Government by filing Form
ADT-2 (see the form here) within a period of 30 days from the Board resolution for
removal and convening a general meeting within a period of 60 days from receiving
the government’s approval.

ii. Resignation

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 Government company with the Comptroller
and Auditor-General of India, indicating the reasons and other facts as may be
relevant with regard to his resignation. In case of non-compliance, he shall be
punishable with a fine of INR 50,000 or the remuneration payable to him whichever is
less.

iii. National Company Law Tribunal (NCLT)

The NCLT may, either suo motu or on an application made to it by the Central
Government or by any person concerned, if it is satisfied that the auditor of a
company has, whether directly or indirectly, acted in a fraudulent manner in relation
to the company or its directors or officers, may, by order, direct the company to
change its auditors.

In the case of such an application by the Central Government for change of Auditors,
the NCLT can, within 15 days, pass an order that the auditor shall not function as such
and the Central Government will be able to appoint another auditor.

Consequences

● The auditor who is removed by the Tribunal cannot be appointed as an auditor of that
company for 5 years.

● Punishment with imprisonment for a minimum term of six months which may extend
to 10 years and shall also be liable to pay a minimum fine of an amount involved in
the fraud which may extend to 3 times the said amount.

● If the fraud involves public interest the minimum period of imprisonment will be 3
years.

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Auditors: Appointment, Role and Removal under the Companies Act,
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Requirements in relation to general meetings as regards the

Auditors
Under section 146, the company must send all notices and communication to the auditor,
relating to any general meeting, and he shall attend the meeting either through himself or
through his representative, who shall also be an auditor. Such auditor must be given
reasonable opportunity to speak at the meeting on any part of the business which concerns
him as the auditor.

As per section 101, a notice of the general meeting must be given before 21 days either in
writing or through electronic mode to the auditor in such manner as may be prescribed.
Every notice of a meeting shall specify the place, date, day and the hour of the meeting and
shall contain a statement of the business to be transacted at such meeting.

Emerging issues as regards the regulating authority for

Auditors:
A Securities and Exchange Board of India committee on corporate governance constituted
under the Chairmanship of Uday Kotak has, in October 2017, recommended among other
things, that SEBI should have clear powers to penalise auditors if lapses are found in their
review of listed companies’ numbers. The committee also recommended a penalty of Rs.1
crore on an auditor for wrongdoing and Rs.5 crores for repeat violations. The
recommendations have not been taken well by the Institute of Chartered Accountants of
India (ICAI) (see a relevant news article here) given that the auditors are covered under the
Chartered Accountants Act, 1949 which authorises ICAI to look into such matters.

On the other hand, the Government also introduced a new proposed authority called the
National Financial Reporting Authority (NFRA) in Section 132 of the Companies Act, 2013 to
replace the National Advisory Committee on Accounting Standards (NACAS). However, the
proposed NFRA has a much broader role than the NACAS in that the NFRA will not only
provide recommendations for formulating accounting standards and policies but also
monitor and enforce compliance with these standards. Further, the NFRA is also authorised
to oversee the quality of the professions associated with ensuring compliance with such
standards i.e. the auditors and chartered accountants and suggest measures required for
improvement in quality of service.

The basic reason for considering an authority to regulate the auditors beyond the ICAI is
the logic that the same body which creates Chartered Accountants cannot be made to
regulate their conduct.

There is also a general belief that the number of Chartered Accountants against whom the
ICAI has taken disciplinary action is far less than the number involved in questionable
practices.

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Auditors: Appointment, Role and Removal under the Companies Act,
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While the NFRA role seems to be recommendatory i.e. suggesting measures to improve
quality, the role of SEBI proposed by the Uday Kotak panel is exacting i.e. SEBI can levy
penalties. At best, this can make the ICAI sit up and take notice for more stringent
regulation of its members and at worst, this can make the management of companies
complacent in that the auditors will always be putting in tremendous efforts to ensure the
financial position is correctly reflected.

Recap:
1. An auditor is an independent professional qualified to perform an audit or an
inspection and to report on the results of such inspection. Such an audit can be of
accounts or it can be of systems or processes or documents.

2. A person is eligible to be appointed as an auditor of a company only if he is a

chartered accountant within the meaning of the Chartered Accountants Act, 1949 and
who holds a valid certificate of practice under Section 6(1) of that Act.

3. In the case of companies that are required to have an audit committee, the
committee shall consider if the qualifications and experience of the individual or the
firm are commensurate with the requirements of the company. The committee will
also have regard to any pending proceedings of the particular individual or firm in
respect of professional conduct before the Institute of Chartered Accountants of
India.

4. The remuneration of the auditor of a company shall be fixed in its general meeting or
in such manner as may be determined therein, though the remuneration of the first
auditor can be determined by the board.

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