Unit 3
Audit of limited companies
Modes of Appointment of Auditors
The First Auditor:
a) The first auditor of a company shall be appointed by the board of directors within one month of the date of registration of the company. If the Board fails to appoint within the said period of one month, the company in general meeting may appoint the first auditors.
b) The first auditors shall hold office from the date of appointment to the conclusion of the first annual general meeting of the company.
Appointment of Subsequent Auditors [Sections 224 (1), (IB) and (1C)]:
At every annual general meeting, the auditor are appointed or reappointed by every company by passing an ordinary resolution. The appointment of auditors at an annual general meeting is an item of ordinary business. Such auditor holds office from the conclusion of the meeting in which they are appointed to the conclusion of the next annual general meeting.
Appointment of Auditors by Central Government [Section 224(3)]:
Where at any Annual General Meeting, no auditors are appointed or reappointed, in that case within 7 days of such a meeting, the company shall intimate this to the central government who may appoint a person to fill the vacancy.
Compulsory Reappointment of Retiring Auditor (Section 224(2)]: At an annual general meeting, a retiring auditor by what so ever authority appointed, shall be reappointed except under any of the following situations:
(a) Where he is not qualified for reappointment
(b) Where he has given the company notice in writing of his unwillingness to be reappointed.
(c) Where a resolution has been passed at that meeting appointing somebody instead of him or providing expressly that he shall not be reappointed.
(d) Where notice has been given or an intending resolution to appoint some person in the place of a retiring auditor passed, but by reason of the death, incapacity or disqualification of that person the resolution cannot be proceeded with.
Appointment in case of Causal Vacancy [Sec. 224 (6)]:
Where a vacancy is caused by the resignation of an auditor, the company in a general meeting shall only fill the vacancy. The Board of Directors may fill casual vacancy in the office of an auditor caused by any other reason than a resignation, while any such vacancies continues the remaining auditor or auditors, if any, may continue to act the auditor or auditors. Any auditor appointment in a casual vacancy shall hold office until the conclusion of the next annual general meeting.
Appointment by special Resolution (Sec. 224 A):
In case of a company in which not less than 25% of the subscribed share capital is held, whether singly or in any combination, by
a. A public financial institution, or a government company or the Central Government or any state government, or
b. Any financial or other institution established by any provincial or State Act, in which a State Government holds not less than 51 % of the subscribed share capital, or
c. A nationalised bank or an insurance company carrying on general insurance business,
The appointment or reappointment at each annual general meeting of the company, an auditor or auditors shall be made by a special resolution. It the company fails to pass such a special resolution for making the appointment of an auditor or auditors
It shall be deemed that no auditor or auditors had been appointed by the company at its annual general meeting. In such a case, the Central Government may appoint a person to act as the auditor of the company.
Appointment of Auditors of Government Companies (Sec. 619):
Appointment of auditors in case of a government Company is subject to the provisions of Sec 619 which overrides Sec 224 to Sec 233 dealing with appointment, etc., of the auditors in the case of nongovernment companies. The auditor of a Government Company shall be appointed or reappointed by the Comptroller and Auditor General of India; however the appointment shall be subject to ceiling limits as per Sec 224 (1B).
Removal of Auditor
Different modes of removal:
(a) Removal of first auditors before expiry of term [Section 224(5)]: The company may remove the first auditor by passing an ordinary resolution at a general meeting (usually extra ordinary general meeting. No special notice is required for such removal under s. 225. However, procedure prescribed under section 225(2) and (3) shall be followed. Although Nomination notice is required to given to the members of the company at least 14 days before the date of the meeting by this way only any other person may be appointed in place of removed auditor.
(b) Removal of subsequent auditor before expiry of their term: The company may, after obtaining the previous approval of the Central Government, remove the auditors before the expiry of their term by passing an ordinary resolution. No special notice is required for such removal. However, procedure prescribed under section 225(2) and (3) shall be observed.
(c) Removal at an AGM of first or subsequent auditor: The company may, at an annual general meeting, provide expressly that a retiring auditor shall not be reappointed or appoint an auditor other than a retiring auditor. Special notice shall be required for such. The remaining procedure prescribed under section 225(2) and (3) shall be followed for his removal.
Procedure prescribed under section 225(2) and (3):
(b) The notice for removal of an auditor shall be sent forthwith by the company to the auditor.
(c) After receiving notice auditor has the following rights:
(i) Right to be heard orally at the meeting.
(ii) Right to make a representation in writing to the company (not exceeding reasonable length).
(iii)Right to get his representation circulated among the members.
(d) Where a request is made by the auditor to circulate the representation, it shall be the duty of the company:
(i) to send a copy of the representation to every member of the company; and
(ii) to state the fact of the representation having been made in the notice given to the members.
(e) When representation is not sent by the company:
If a copy of the representation which was not sent as aforesaid because the representation was received too late or because of the company’s default, the auditor may require that the representation shall be read out at the meeting by himself.
(f) Intervention by Central Government:
The copies of the representation need not be sent out and the representation need not be read out at the meeting if the Central government is satisfied that this right is being abused by the auditor to secure needless publicity for defamatory matter. The Central government may order the company’s costs on such an application to be paid by the auditor, notwithstanding that he is not a party to the application. The application to the Central government may be made either by the company or by any other remember or director or other person.
Qualification
- A person shall be eligible for the appointment of an auditor of a company only if he is a chartered accountant.
- Where a firm including a limited liability partnership is appointed as an auditor of a company, only the partners who are chartered accountants shall be authorized to act and sign on behalf of firm.
Rights of Auditors [Section 227]-
1. Rights of Auditors to access books of accounts An auditors of a company shall have a right of access at all times to the books and accounts and vouchers of the company, whether kept at the head office of the company or elsewhere.
2. Right to obtain information and explanations [227(1)]:
An auditor of the company is entitled to require from the officer of the company such information and explanation as he may think necessary for the performance of his duties as an auditor.
3. Right to visit branch offices and access to branch account [Sec. 228(2)]:
Where the accounts of any branch office are audited by a person other than the company’s auditor, the company’s auditor is entitled to visit the branches, if he deems it necessary to do so for the performance of his duties as an auditor.
4. Right to receive notice and attend general meeting [Sec. 231]:
The auditor has the right of
- Receiving all the notices and other communication relating to any general meeting of a company which any member of the company is entitled to have
- He is entitled to attend any general meeting and
- He is entitled to be heard at any general meeting which he attends on any part of the business which concern’s him as an auditor.
5. Right to make representation [Sec. 225]:
The retiring auditor is
- Entitled to receive a copy of the special notice intending to remove him or proposing to appoint any other person as auditor.
- Further, the retiring auditor sought to be removed has a right to make his representation in writing and request that the same be circulated amongst the members of the company.
- In case, the same could not be circulated, the auditor may require that the presentation shall be read out at the general meeting. The auditor also has the right to be heard at the general meeting.
6. Remuneration of the Auditor [Section 224(8)]:
Auditor is entitled to receive remuneration as follows
a. Where appointed by the Board of Director
When an auditor is appointed by the Board of Directors, remuneration is also fixed by them.
b. Where appointed by shareholders:
In this case the remuneration is determined by the share holders at the AGM.
c. If appointed by the Central Government
In this case the remuneration is fixed by the Central Government.
d. If appointed by the Comptroller and Auditor General of India: the remuneration should be fixed by the co. In general meeting.
7. Right to correct any wrong statement
8. Right to have legal and technical advice.
Duties of Auditors:
1. Duty as to enquiry [Sec. 227(1A)]:
Without prejudice to the rights given under s. 227 (1) auditor must enquire into following matters:
(a) Whether loans and advances made by the company on the basis of security:
(i) have been properly secured and
(ii) whether the terms on which they have been made are not prejudicial to the interest of the company or its members;
(b) Whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company;
(c) Whether the company is an investment company or a banking company, whether so many of the assets of the company as consists of shares, debentures and other securities have been sold at a price less than at which they were purchased by the company;
(d) Whether loans and advances, made by the company have been shown as deposits;
(e) Whether personal expenses have been charged to revenue account; and
(f) Where it is stated in the books and papers of the company that any shares have been allotted for cash, whether the cash has actually been so received, whether the position as stated in the accounts books and the Balance Sheet is correct, regular and not misleading.
1. To report to members.
2. To specify a few things in the report.
3. Duties under section 227(4A).
4. To report for inclusion in prospectus.
5. To certify the Statutory Report.
6. Duties regarding Investigation.
7. To submit report on the Balance Sheet and P. & L. Account appended to the declaration of solvency at the time of voluntary winding up.
Liabilities of an Auditor:
A. Civil Liabilities B. Criminal Liability
(A.) Civil Liabilities:
1. Liability for Negligence:
If the auditor owes some duty towards the plaintiff (the person who files a suit in the court), and he does not discharge his duties with reasonable skill and care, resulting in a loss to the plaintiff, the auditor is guilty of negligence.
2. Liability for Misfeasance:
If the auditor does not approach and perform his duties it is misfeasance an auditor is liable to indemnity only if the following things are proved against him:
- The auditor owned duty to the plaintiff:
- He failed to discharge his duty;
- The plaintiff suffered loss due to non-performance of duty by the auditor.\
3. Civil Liability under Indian Companies Act:
a. Under section 62: If an auditor who can also be the auditor of the company gives untrue statement as expert in the prospectus issued by the company, he is liable to indemnify to each person who, believing the prospectus applied to purchase any shares or debentures and who has suffered loss due to the untrue statement.
b. According to Section 543 of Indian Companies’ Act: The Court can compel an auditor to indemnify the company an amount deemed fit by the Court with regard to the being wound up, if he is held guilty of misfeasance and breach of trust.
Civil Liability towards Third Party:
1. Not liable for negligence: In regard to civil liabilities an auditor can be compelled to indemnify only if the auditor owed duty towards the plaintiff. Regarding company audit, as already stated, an auditor is appointed by company, therefore, he owes duty only to the company. If loss is suffered by third party due to negligence or misfeasance of the auditor, the auditor cannot be liable for it. It is only just because there is no contract between the auditor and third party.
2. Liability for fraud: An auditor is not liable to third party for negligence or misfeasance but if he is guilty of fraud, he shall be held liable to the third party also.
B. Criminal Liability:
Criminal Liability under Companies’ Act1. Violation of section 57.
- Not signing authenticating as per the Act.
- For not rendering help to the Inspector.
- Fraud in books. (Sec. 539)
- Filing a suit for a criminal action.
- For false statement in a report.
- For untrue statement in the prospectus.
- For prompting a person to invest.
- For false evidence.
- Arresting and producing the auditor in the court.
Key takeaways –
- An auditor is appointed to detect frauds, errors etc. He is responsible on account of negligence in performance of his duties.
- Any clause in the agreement between the company and the auditor whereby the auditor is freed from liability has been declared void.
Meaning
Audit report is the statement included in the financial statements. It contains the opinion of the auditor in financial statements. The auditor reports to the shareholders who have appointed him. He has to provide his opinion on the truth and fairness of financial statements. Thus, the auditor protects the interest of shareholders through audit report.
Definition of Audit Report
Lancaster has defined a report as “a report is a statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not already in possession of the full facts of subject matter of the report.”
According to Cambridge Business English Dictionary, Audit report is defined as a formal document that states an auditor’s judgment of a company’s accounts.
Under Sec. 143(3), auditor of a company must report to its members.
(a) The accounts examined by him;
(b) Balance Sheet, Profit and Loss Account, and Cash Flow statement, which are laid in general meeting of a company during his tenure of office; and
(c) The document declared to be attached to the Balance Sheet and Profit and Loss Account.
Importance
1) Getting detailed review:
When the auditors conclude their findings, the company would have a final report and it would give the stakeholders a clear picture of how the business is working.
2) Receiving additional perspective
The auditor report provides the perspective on significant and even smaller aspects which need immediate attention by the management.
A good auditor provides explicit remarks on whether the business is conducting its affairs in full compliance or the severe flaws exist in the company.
3) Improving credit rating
When the business is growing and expanding rapidly, it is good for the banks and stakeholders to know every critical aspect of the business.
The business investors would see the success the company is enjoying and would like to make it trustworthy. That signature of auditors with an opinion on business compliance which is strong with internal control is the right thing to improve credit rating.
4) Evaluating internal controls
The auditor gains an appropriate understanding of internal control of the business as it relates to financial statement reporting. Internal control is the most important part of auditing and many organizations can find a significant amount of value from having an audit conducted.
Scope of audit reports
(1) Final Report: The report which is submitted by the auditor after completing the whole work is known as final report. This is an importamt report, hence utmost care must be taken while drafting the report.
(2) Interim Report: The report which is to be submitted by the auditor in the middle of year for some special matters is known as Interim Report. Generally this type of report is submitted to declare interim dividend.
(3) Partial Report: When the auditor is appointed not to examine all the books of accounts, but is appointed to examine some books of accounts, the report so submitted is termed as partial report. In such report, the auditor should make clear that his appointment was made for partial examination and this is a partial report.
Clean and qualified audit report
(i) Clean or Unqualified Report: When the auditor is satisfied as to the fairness of the balance sheet and profit and loss account, he will give a clean report. In other words, if the auditor makes the various statutory affirmations without reservations, he is said to have given an unqualified report on the financial statements of the company.
(ii) Qualified Report: Whenever the auditor of a company is not satisfied with any explanation and information given to him or if he thinks that the Profit and Loss Account and the Balance Sheet do not exhibit a true and fair view of the state of the company’s affairs or if the accounts presented by the directors call for further elucidation, he must ask the directors to set the matters asight and if he is unsuccessful in pursuading the directors to do so, he must mention that fact in his Report. Such a report is called “Qualified Report” as distinct from a “Clean Report”.
A Qualified Report may be in respect of the following matters and the auditor should use appropriate words or phrases:
(a) Insufficient provision has been made for depreciation.
(b) No provision for depreciation has been made on fixed assets on the ground that the assets have been efficiently. Maintained by heavy repairs and renewals.
(c) Inadequate provision has been made for bad and doubtful debts.
(d) Investments have been valued at cost price which is in excess of the market price.
(e) The stock in trade has been valued at market price which is more than the cost price.
(f) There is a contingency liability in respect of bills discounted amounting to Rs. 5,00,000 which have not matured.
Examples of qualified reports. Some examples are given below:
(a) Inadequate or no provision of depreciation on assets;
(b) Incorrect valuation of Stock-in-trade;
(c) Insufficient provision for bad and doubtful debts;
(d) Disclosure of the value of raw materials consumed not properly made;
(e) Wrong treatment of a transaction in the accounts;
(f) Non-receipt of the report for audit of branch accounts:
(g) Any other contravention of laws or procedural mistakes.
Audit certificate
The term certificate refers to a written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion.
An Auditor’s certificate is a written confirmation of the accuracy of the facts relating to the accounts for a particular time or to a specific matter, which does not involve any estimate or opinion.
An auditor’s certificate represents that he has verified certain precise figures and is in a position to vouchsafe their accuracy as per an examination of documents and books of accounts.
Certification of the statutory report, certification of share transfer, certification of the value of imports and exports of a company, etc. are some of the examples of auditor’s certificate.
Differences between Auditor’s Report and Certificate
Basis | Auditor’s report | Auditor’s certificate |
1. Nature | It is an expression of opinion about the account. | It is a confirmation of correctness and accuracy about some matters. |
2. Basis of audit | The report is based on assumptions and estimations. | The certificate is based on actual figures and facts. |
3.Criticism | There may be criticism about the report. | There is no scope of criticism about the certificate. |
4. Scope | The scope of the report is large. | Its scope is limited. |
5. Scope of advice | In the scope, there is a scope of giving constructive advice to the company. | No scope of constructive advice Exists in case of a certificate. |
6. Time of issue | After the end of each accounting, the year report is mandatory. | A certificate is not mandatory in every year. |
7. Liability of auditor | As a report is merely an opinion, if it is not correct, the auditor may not be held responsible. | In case of the wrong certificate, the auditor will be held responsible. |
Divisible profits and dividends
Divisible Profit is that profit for the disbursement of which as dividend a company has legal right. Direct interest of shareholders of a company is in dividend, therefore, the management of the company always endeavours to disburse dividend to the shareholders but it cannot do so in such style as may result into the bankruptcy of the company, e.g. Out of capital.
Divisible Profits under the Indian Companies Act 1956:
Section 205 lays down law on the following points:
- Sources of Dividend [Section 205(1)]
- Current Depreciation [Section 205 (2)]
- Transfer to Reserves [Section 205 (2A)]
- Arrears of Deprecation [Section 205 (1)(a)]
- Past Losses [Section 205(2)(b)]
It would be useful to elaborate the provisions:
(i) Sources of Dividend: As per Section 205(1), a company can disburse dividend for a certain year from the following sources:
(a) Profits of the year;
(b) Profits of the previous year;
(c) The two (a) and (b) together, that is, total thereof;
(d) Amount received for disbursement of dividend from the Central Government or any State Government for the payment of dividend in pursuance of a guarantee given by that government.
Dividend can be disbursed from the sources after making the following deductions from the profits of the company:
(a) Current Deprecation [Section 205(2)]
(b) Transfer to Reserves [Section 205(2A)]
(c) Arrears of Deprecation [Section 205(1)(a)]
(d) Past Losses [Section 205(b)]
The following points need consideration in respect of divisible profits:
(1) Section 205 of the Companies’ Act must be abided by:
(2) The rules as provided in the Articles of Association must be kept in mind.
(3) The excess of income over the current expenditure may, after deducting depreciation on current assets, as required under sections 205 and 350 of the Companies Act, and creating adequate funds for payment of liabilities, be divided as dividend among the shareholders.
(4) The capital profit can be disbursed as dividend if (i) they have been realised in cash, (ii) there is surplus after writing off capital losses, and realised in cash, (ii) there is surplus after writing off capital losses, and (iii) the company is authorised to divide it as dividend by its Articles.
(5) It is compulsory to write off revenue losses before distribution of revenue profits as dividend and, similarly, it is also required to write off capital losses before disbursement of capital profit as dividend but it is not compulsory to write off capital losses before disbursement of revenue profits as dividend.
(6) It is not obligatory to write off the existing loss of paid up capital of the company or the past debit balance of P & L. Account (before deprecation) prior to distribution of dividend, if the company has adequate funds to discharge liabilities.
Preliminaries before starting Audit1. Appointment of Auditor.
- Nature of Business of the Company.
- Accounting Year.
- Board of Director
- Acquaintance with Management.
- Knowledge of the byelaws regarding Memorandum of Association and Articles of Association.
- Study of prospectus.
- To receive the List of Books.
- Obtaining the List of Employees and job description.
- Knowledge of Internal Control.
- Acquisition of Previous Final Accounts and Audit Report
Audit of Share-Issue
- Checking the right to issue.
- Checking the Procedure of issue.
- Checking Books of original entry.
- Checking Ledger Posting.
- Presentation in Balance Sheet.
- Audit of Calls in Advance.
- Audit of Calls in Arrears.
- Underwriting Commission and Brokerage.
- Audit of Issues at premium
- Audit of Issues at Discount
Audit of Share Transfer -
1. Under the Companies’ Act.
2. Under agreement:
(i) Checking the Articles.
(ii) Checking the Transfer Registrar.
(iii) Checking the Transfer Deed.
(iv) Checking the intimation to Transferee.
(v) Action by Directors’ Meeting
(vi) Checking the Share Certificates.
(vii) Checking the Register of Membership
Audit of Debentures -
- Checking the Articles
- Looking into commission.
- Compliance of Section 293.
- Checking the restrictions on allotment.
- Checking Debenture Register.
- Checking of Transfers.
- Checking the Charges.
- Audit of Financial Books
(i) Cash Consideration
(ii) Other consideration
(iii) Commission and Discount
(iv) Application forms and Allotment
(v) Premium
(vi) Collateral security
(vii) Entries of interest
Key takeaways –
Divisible Profit is that profit for the disbursement of which as dividend a company has legal right.
References:
1. Attowood, Frank A. & Stein, Neil D.: Depaul’s Auditing
2. Choudhari, Roy A.B.: Modern Internal Auditing
3. Chatlia, S.V.: Spicer and Pegler’s Practical Auditing
4. Dinkar, Pagare: Principles and Practices of Auditing
5. Gupta, Kamal: Contemporary Auditing
