The Companies Act 2013 is a rule-based legislation and mandates compliance with specific provisions outlined within its sections and accompanying rules. For students of Chartered Accountancy and professionals working in corporate governance, a comprehensive understanding of these provisions is essential, as they are actively applied in professional practice. This chapter broadly covers who is eligible to be appointed as an auditor under the Act, the conditions for disqualification, the procedures for appointment and removal, and the rights and duties conferred upon auditors.
Relevant Sections from the Companies Act 2013
The provisions regarding auditors are encapsulated in the following sections of the Companies Act 2013:
Section 139 addresses the appointment of auditors
Section 140 covers the removal and resignation of auditors and the requirement for special notice
Section 141 outlines the eligibility, qualifications, and disqualifications of auditors
Section 142 discusses the remuneration of auditors
Section 143 deals with the powers and duties of auditors and auditing standards
Section 144 restricts the auditor from rendering certain services
Section 145 mandates that auditors sign audit reports and other statements
Section 146 requires auditors to attend general meetings
Section 147 prescribes punishment for contravention of rules
Section 148 empowers the central government to mandate cost audits for specified companies
Section 141: Qualifications and Disqualifications of Auditors
Section 141 of the Companies Act 2013 consists of four sub-sections. Subsections 1 and 2 explain the qualifications required for a person to be appointed as an auditor. Subsections 3 and 4 enumerate the disqualifications that make a person ineligible to serve as a company auditor.
Qualifications of an Auditor under Section 141(1) and (2)
Section 141(1) specifies that a person shall be eligible for appointment as an auditor of a company only if they are a chartered accountant as defined under the Chartered Accountants Act 1949. A chartered accountant must hold a valid certificate of practice as defined in Section 2(17). In cases where a firm is being appointed as an auditor, the majority of the partners in the firm must be practicing chartered accountants in India. The firm may be appointed by its firm name to serve as the auditor of a company. In such cases, the company appoints the firm, not the individual partners.
Section 141(2) clarifies that if a firm, including a limited liability partnership, is appointed as the auditor of a company, then only those partners of the firm who are chartered accountants shall be authorized to act and sign on behalf of the firm. This ensures that the responsibility for audit reporting remains with qualified professionals.
Disqualifications of Auditors under Section 141(3)
Section 141(3) and Rule 10 of the Companies (Audit and Auditors) Rules 2014 enumerate several specific situations in which a person is disqualified from being appointed as an auditor of a company. These are important in ensuring the independence and objectivity of the auditor.
A Body Corporate Other Than an LLP
Any body corporate other than a limited liability partnership registered under the Limited Liability Partnership Act 2008 is disqualified. For example, if a group of chartered accountants forms a private or public limited company, that entity cannot be appointed as the auditor of another company. A body corporate, as defined under Section 2(11), includes companies incorporated under the Companies Act 2013 and foreign companies. The logic behind this rule lies in the concept of limited liability and a separate legal entity. Members of a company are only liable to the extent of unpaid capital, and no individual can be held personally responsible in case of audit failures. In contrast, at least one partner in an LLP may bear personal liability, making LLPs more accountable.
An Officer or Employee of the Company
An individual who is an officer or employee of the company is disqualified. As per Section 2(59), the term officer includes directors, managers, key managerial personnel, and any individual whose instructions the board of directors follows. Section 2(51) defines key managerial personnel to include the chief executive officer, managing director, manager, company secretary, whole-time director, chief financial officer, and other officers, such as the chief operating officer. These individuals are inherently conflicted and therefore cannot independently assess and report on the company’s financials.
Partner or Employee of an Officer or Employee
A person who is a partner or employee of an officer or employee of the company is also disqualified. This creates an indirect relationship that affects independence. The presence of such a connection undermines the impartiality expected from an external auditor.
Auditor or Relative or Partner Holding Securities or Financial Interest
A person, or his relative or partner, who holds any security in or financial interest in the company, its holding, subsidiary, or associate companies, or subsidiaries of such holding companies, is disqualified. If the auditor or his relative is indebted to the company or related entities beyond a specified threshold, or has given a guarantee or security for the indebtedness of any third party, they are also disqualified. Specifically, if indebtedness exceeds five lakh rupees or the guarantee exceeds one lakh rupees, disqualification applies.
As per Section 2(77) and its accompanying rules, a relative includes members of a Hindu Undivided Family, step-parents, step-siblings, and stepchildren, except stepdaughters. An exception exists where a relative holds securities of face value not exceeding one lakh rupees. If this threshold is crossed, corrective action must be taken within 60 days. This exception does not apply to the auditor or their partner, and it does not apply if the security is held in other group companies,, such as the holding company or fellow subsidiaries. Under the Securities Contracts (Regulation) Act 1956, securities include shares, scrips, bonds, debentures, stocks, and derivatives.
Business Relationship with the Company or Group
A person or firm that has a direct or indirect business relationship with the company or its related entities is disqualified. Business relationship, as per the rules, includes any commercial transaction except those for professional services permitted under the Chartered Accountants Act or transactions in the ordinary course of business at arm’s length price, such as a sale of goods or services by companies in the business of telecommunications, hospitals, hotels, or similar sectors.
For example, if a chartered accountant’s spouse is a director in a company and holds fifty thousand rupees in shares, the accountant may initially appear to be eligible. However, upon applying the rule that disqualifies a person whose relative is a director or key managerial personnel of the company, the appointment is invalid.
Full-Time Employment Elsewhere or Overlapping Appointments
A person who is in full-time employment elsewhere cannot be appointed as an auditor. This is because a member who is employed full-time is not permitted to practice under the Chartered Accountants Act 1949 and therefore cannot be appointed as an auditor. Additionally, a person who is already serving as the auditor for more than twenty companies is disqualified. A company must not appoint such a person or firm as its auditor. This restriction ensures that auditors are not overburdened and are able to perform their duties diligently.
Conviction for Fraud
A person who has been convicted by a court for an offence involving fraud and for whom ten years have not elapsed since the date of conviction is disqualified from being appointed as an auditor. This clause upholds the integrity and trustworthiness of the audit profession.
Rendering Prohibited Services
Any person who directly or indirectly renders services referred to in Section 144 to the company, its holding, or its subsidiary company is disqualified. Section 144 outlines a list of services that are prohibited for auditors to provide to maintain independence, and this will be discussed later in the chapter.
Section 141(4): Consequences of Incurring a Disqualification
If a person appointed as an auditor of a company becomes disqualified during their tenure, as specified under Section 141(3), they are deemed to have vacated the office of auditor. This is treated as a casual vacancy, meaning that the auditor must vacate the position immediately without the need for any formal notice from the company. The auditor must remain free from any disqualification throughout their term in office.
Section 139: Appointment of Auditors
Section 139 of the Companies Act 2013 provides comprehensive guidelines for the appointment of auditors. It covers the appointment of the first auditor, reappointment of auditors in subsequent annual general meetings, rotation of auditors, and procedures for filling casual vacancies. It also differentiates between appointments in government companies and companies other than government entities.
Appointment of the First Auditor in Companies Other Than Government Companies
According to Section 139(6), the first auditor of a company, other than a government company, must be appointed by the Board of Directors within 30 days from the date of registration of the company. This responsibility lies exclusively with the board during this initial period.
If the board fails to make the appointment within this timeline, the responsibility shifts to the company’s members. The members must appoint the first auditor within 90 days through an extraordinary general meeting. The appointed auditor holds office from the date of appointment until the conclusion of the first annual general meeting. This rule ensures that a company’s financial affairs are subjected to audit right from the beginning.
Appointment of the First Auditor in Government Companies
Section 139(7) deals with the appointment of the first auditor in the case of a government company or any other company owned or controlled, directly or indirectly, by the government. In such cases, the Comptroller and Auditor General of India must appoint the auditor within 60 days from the date of registration of the company.
If the Comptroller and Auditor General fails to make the appointment within this period, the Board of Directors is then responsible for appointing the auditor within the next 30 days. If the board also fails to do so, the company’s members must appoint the auditor within the following 60 days at an extraordinary general meeting. The auditor appointed through any of these routes will serve until the conclusion of the first annual general meeting.
Appointment and Reappointment of Auditors in Subsequent Years
Section 139(1) and the associated rules state that every company must appoint an auditor during its first annual general meeting. The company may appoint either an individual or a firm, which can also be a limited liability partnership, to serve as its auditor. The appointment is made through an ordinary resolution passed by the members.
The appointed auditor serves from the conclusion of the first annual general meeting until the conclusion of the sixth annual general meeting, constituting a five-year term. This five-year period is mandatory. No company can appoint an auditor for a term shorter than five years. It is also important to understand that the annual general meeting in which the appointment is made is counted as the first AGM for this tenure calculation.
Companies Required to Appoint Auditors
The obligation to appoint an auditor applies to all companies incorporated under the Companies Act. This includes private companies, one-person companies, companies incorporated under Section 8, and public companies. Therefore, the scope of this section is broad.
Manner and Procedure for Appointment of Auditors
Rule 3 of the Companies (Audit and Auditors) Rules 2014 outlines the process and formalities involved in appointing an auditor. If the company is required to constitute an audit committee under Section 177 of the Act, the authority to recommend the appointment of auditors lies with the audit committee. If no such committee exists, the Board of Directors is the competent authority to appoint the auditor.
Before the appointment, the proposed auditor must provide written consent to the appointment and a certificate confirming eligibility. This certificate must confirm the following:
The individual or firm is eligible for appointment and is not disqualified under the Companies Act 2013, the Chartered Accountants Act 1949, or any applicable rules or regulations
The proposed appointment complies with the terms of the Companies Act
The appointment is within the permissible limits under the law
The details of any pending proceedings related to professional misconduct against the auditor or the audit firm, or its partners,are accurate..
After obtaining the certificate and consent, the company appoints the auditor during the annual general meeting through an ordinary resolution. Once appointed, the company must inform the auditor formally. This involves sending a letter along with an extract of the relevant resolution passed during the AGM.
Furthermore, the company must file Form ADT-1 with the Registrar of Companies within 15 days from the date of the AGM. This form provides official notification of the auditor’s appointment. It is important to note that this form needs to be filed only once for the five-year term of appointment.
Role of Audit Committee in Appointment of Auditors
Section 177 of the Companies Act mandates the formation of an audit committee in specific types of companies. Where such a committee exists, the appointment or reappointment of auditors, including the filling of any casual vacancy, must be made after considering the committee’s recommendations. This ensures a layer of independent oversight in the selection of auditors, thus enhancing transparency and accountability in financial reporting.
Companies Required to Constitute an Audit Committee
The following types of companies must constitute an audit committee:
All listed companies
All public companies with a paid-up capital of ten crore rupees or more
All public companies with a turnover of one hundred crore rupees or more
All public companies with aggregate outstanding loans, borrowings, debentures, or deposits exceeding fifty crore rupees
The paid-up capital, turnover, or borrowings are determined based on the figures from the last audited financial statements. These thresholds are established to ensure that companies with significant financial obligations are subject to more rigorous financial oversight through audit committees.
Practical Implications of Auditor Appointments
The appointment process is designed to be formal, structured, and transparent. The requirement for written consent, eligibility certificates, and statutory filings with the Registrar reinforces the seriousness of the role of an auditor. These procedures ensure that only qualified and conflict-free professionals are entrusted with examining a company’s financial affairs. Additionally, having audit committees involved in the appointment process for larger companies serves to increase independence and oversight in the selection of auditors.
Tenure and Accountability
Once appointed, the auditor must remain eligible and conflict-free throughout the tenure of the appointment. Any development that causes the auditor to become disqualified, as outlined in Section 141(3), results in automatic vacation of the office without any requirement for a formal notice. This provision ensures that the integrity and independence of the audit function are maintained at all times.
Term and Rotation of Auditors Under Section 139(2)
The concept of rotation of auditors was introduced in the Companies Act 2013 to strengthen auditor independence and avoid long-term associations that may compromise objectivity. Section 139(2) and Rule 5 of the Companies (Audit and Auditors) Rules 2014 govern this provision.
Applicability of Auditor Rotation
The provision for auditor rotation does not apply to all companies. It applies specifically to the following:
Listed companies
Unlisted public companies having a paid-up share capital of ten crore rupees or more
Private limited companies having a paid-up share capital of fifty crore rupees or more
Companies that have public borrowings from financial institutions, banks, or public deposits of fifty crore rupees or more
Companies that do not fall within these thresholds, such as one-person companies and small companies, are exempt from the rotation requirements.
Rotation Period and Restrictions
Under the Act, companies to which rotation applies are restricted in the following ways:
An individual cannot be appointed as an auditor for more than one term of five consecutive years
An audit firm cannot be appointed as auditor for more than two terms of five consecutive years
After completion of the term, the individual or audit firm is not eligible for reappointment in the same company for five years from the completion of their term. This break-in service is designed to avoid the establishment of overly familiar relationships between auditors and company management, thereby reinforcing independence.
Meaning of Term and Transition Provisions
The term refers to consecutive years of appointment. If an auditor has been appointed for a period that is less than five years, that still counts as one term. Once the term is completed, the cooling-off period of five years becomes mandatory before the auditor can be considered again by the same company.
For companies already operating with the same auditor before the implementation of the Companies Act 2013, transition provisions allow the existing auditors to complete their remaining term under the old Act and then follow the rotation requirement.
Network Firms and Reappointment Restrictions
An important aspect of the auditor rotation provisions is that the restriction on reappointment is not limited to the specific individual or firm that served the previous term. It also extends to network firms.
A company cannot appoint an audit firm that is part of the same network as the outgoing audit firm for five years. This rule prevents indirect continuation of services through affiliated entities. The term network firm includes firms operating under the same brand name or trade name or are affiliated in any manner that could compromise independence.
Joint Audits and Rotation
In some companies, joint audits are conducted where more than one audit firm is appointed simultaneously to audit the same company. In such cases, the rotation requirement applies individually to each of the audit firms involved. The company must ensure that neither firm continues beyond the permitted tenure and that reappointment occurs only after the mandatory cooling-off period.
Auditor Resignation and Rotation
If an auditor resigns before completing their five-year term, the term completed until resignation is still considered a full term for rotation. For example, if an auditor resigns after serving four years, they are still considered to have completed one term and must observe the five-year cooling-off period.
Exceptions and Non-Applicability
The following types of companies are not subject to the rotation provisions of Section 139(2):
One-person companies
Small companies
Private companies with a paid-up capital of less than fifty crore rupees
Unlisted public companies with paid-up capital less than ten crore rupees
Companies with borrowings or public deposits of less than fifty crore rupees
These exemptions reduce the compliance burden for smaller entities while ensuring that larger companies maintain auditor independence through rotation.
Rationale Behind Auditor Rotation
The rotation requirement is grounded in the principle of enhancing the objectivity and independence of the audit process. Long associations between auditors and companies can lead to complacency, familiarity, and reduced scrutiny. Mandated rotation ensures that fresh perspectives are brought in and potential biases are minimized. It also opens opportunities for other audit firms and creates a competitive environment that may enhance audit quality.
Prohibited Services by Auditors Under Section 144
To maintain the independence and objectivity of auditors, Section 144 of the Companies Act 2013 restricts auditors from rendering certain services to the company they audit or its holding and subsidiary companies. This provision reinforces the principle that an auditor must remain independent not only in fact but also in appearance.
Services Prohibited Under Section 144
Auditors are prohibited from directly or indirectly rendering the following services:
Accounting and bookkeeping 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 services as may be prescribed
These restrictions ensure that auditors do not perform functions that are the responsibility of management or that would require the auditor to audit their work. It helps prevent conflicts of interest and reinforces the auditor’s role as an independent examiner.
Direct and Indirect Service Provision
Section 144 prohibits not only direct service provision but also indirect service provision. This means that an auditor cannot provide restricted services through:
Its parent firm
Its subsidiary firm
Its associate firm
Any other entity in which the auditor has a significant influence or control
These rules ensure that the prohibited services are not offered under a different entity name or structure, which could still lead to a conflict of interest.
Auditor’s Consent and Certificate Before Appointment
Before being appointed, an auditor must provide a written consent and a certificate confirming that they are eligible and not disqualified under the Act. This includes a declaration that they are not providing any of the services prohibited under Section 144 to the company or its associated entities. If such services are being provided, the auditor must cease those services before accepting the audit engagement.
Consequences of Violation of Section 144
If an auditor renders any of the prohibited services after appointment, it constitutes a violation of the Companies Act. The consequences may include:
Removal from the position of auditor
Penalties and fines imposed by regulatory authorities
Professional disciplinary actions under the Chartered Accountants Act 1949
Invalidation of the auditor’s report, which can result in legal liabilities and reputational damage
Companies must be diligent in ensuring that auditors are not engaged in prohibited services. Similarly, auditors must evaluate their engagements and relationships carefully before and after accepting an audit assignment.
Relationship Between Section 141 and Section 144
Section 141(3)(i) makes it clear that any person who renders services referred to in Section 144 is disqualified from being appointed as an auditor. This interconnection ensures that companies do not engage auditors who have pre-existing or concurrent engagements for prohibited services. It also reinforces the overarching objective of maintaining auditor independence throughout the term of appointment.
Removal and Resignation of Auditors Under Section 140
Section 140 of the Companies Act 2013 deals with the removal, resignation, and related procedures concerning company auditors. It also mandates the requirement of giving special notice for certain actions involving auditors. These provisions are crucial for ensuring a structured and transparent approach to changes in audit appointments.
Removal of Auditor Before Expiry of Term
An auditor appointed under Section 139 may be removed from office before the expiry of their term only by passing a special resolution at a general meeting of the company. This process is not initiated solely by the company; it requires the prior approval of the central government. The company must apply to the central government for approval, and only after receiving such approval can the resolution for removal be placed before the shareholders.
This mechanism ensures that the auditor’s removal is not arbitrary or influenced by management dissatisfaction with adverse audit findings. It protects auditor independence by subjecting the removal to regulatory oversight.
Resignation of Auditor and Filing Requirements
When an auditor resigns from their position, they are required to file a statement with the company and the Registrar of Companies indicating the reasons for their resignation. This filing must be done in Form ADT-3 within thirty days from the date of resignation. This disclosure ensures transparency and allows regulators to track resignations that may raise questions about internal issues within the company.
In the case of listed companies, the resigning auditor must also file their resignation letter and reason for resignation with the stock exchange(s). These requirements strengthen corporate governance and allow stakeholders to assess the context of auditor departures.
Obligation to Fill Casual Vacancy
A vacancy in the office of auditor, other than due to resignation, must be filled by the Board of Directors within thirty days. If the vacancy is caused by resignation, the appointment to fill the vacancy must be approved by the company at a general meeting convened within three months of the Board’s recommendation. The newly appointed auditor shall hold office until the conclusion of the next annual general meeting.
This structured approach ensures there is no long-standing vacancy in the auditor’s position, preserving the continuity and oversight of financial audits.
Special Notice Requirement for Auditor Removal or Non-Reappointment
A special notice is required if the shareholders propose to remove an auditor or not reappoint the existing auditor at the annual general meeting. This notice must be given by the shareholders to the company at least fourteen days before the meeting. The company must then send a copy of the notice to the concerned auditor.
The auditor has the right to make a written representation and request its circulation to all members. The auditor may also attend the meeting and speak on the matter. This process ensures that auditors are given a fair opportunity to present their case before any removal or change in reappointment is finalized.
Section 142: Remuneration of Auditors
Section 142 of the Companies Act 2013 deals with the fixation of remuneration for auditors. The remuneration of the auditor appointed at the annual general meeting is decided by the shareholders. In all other cases, such as the appointment of the first auditor or an appointment by the Board, the remuneration is fixed by the Board of Directors.
Remuneration includes all expenses incurred in connection with the audit and any facilities extended to the auditor. However, it does not include payment made for any service other than audit unless specifically approved by the shareholders or the Board, as applicable.
Section 143: Powers and Duties of Auditors and Auditing Standards
Section 143 outlines the powers and duties of auditors and prescribes the standards auditors must follow. Auditors are required to comply with auditing standards notified by the central government. The section details the right of auditors to access books of accounts, vouchers, and records at all times.
Auditors are entitled to seek necessary information and explanations from company officers. If the auditor fails to receive satisfactory information, they must disclose this in their report. The audit report must state whether:
The company has maintained proper books of accounts
The balance sheet and profit and loss account are in agreement with the books of account
The financial statements comply with accounting standards
The financial statements give a true and fair view of the state of affairs of the company
In case of fraud, if the auditor has sufficient reason to believe that an offence involving fraud is being or has been committed against the company by its officers or employees, they must report it to the central government in the manner prescribed.
Section 145: Signing of Audit Reports
Every auditor’s report must be signed by the auditor appointed to conduct the audit. Where the audit is conducted by a firm, the report shall be signed in the firm’s name by the partner of the firm who is a chartered accountant and is responsible for the audit. The report must also indicate the membership number of the signing partner.
This provision ensures accountability and traceability of audit opinions expressed in the report.
Section 146: Auditor’s Right to Attend General Meeting
An auditor is entitled to receive notices and other communications related to any general meeting and has the right to attend such meetings. The auditor also has the right to be heard at any general meeting on matters concerning their duties as an auditor. This right reinforces the auditor’s role as a stakeholder representative and ensures that any issues arising from the audit can be addressed before shareholders.
Section 147: Penalty for Contravention
Section 147 prescribes penalties for contravention of the provisions related to auditors. If a company fails to comply with provisions under sections 139 to 146, the company is liable to a fine. The amount may extend up to five lakh rupees. Every officer in default may be punished with imprisonment for up to one year or with a fine, or both.
If an auditor contravenes the provisions of these sections knowingly or willfully, and to deceive the company, its shareholders, or creditors, the auditor may be held liable for fraud under Section 447. Such a violation may result in rigorous imprisonment ranging from six months to ten years and may also include a fine.
The auditor may also be ordered to refund the audit fees received and pay damages to the company or affected parties. These strict penalties underscore the seriousness with which audit responsibilities are treated under the law.
Section 148: Cost Audit Provisions
Section 148 empowers the central government to mandate cost audits for certain classes of companies engaged in the production of goods or provision of services. The government may direct that an audit of cost records be conducted in such manner as prescribed.
A cost auditor must be a cost accountant in practice and is appointed by the Board of Directors on the recommendation of the audit committee. The remuneration of the cost auditor is determined by the Board and is ratified subsequently by the shareholders.
A cost audit aims to ensure that the cost structure of products or services is reasonable and that there is no undue profiteering. It is especially applicable to sectors where pricing has public interest implications.
Summary of Key Compliance Obligations for Companies
To remain compliant with the provisions related to auditors under the Companies Act 2013, companies must ensure the following:
Appoint a qualified and eligible auditor within the prescribed timelines
Obtain written consent and an eligibility certificate from the proposed auditor
Follow proper procedures for appointment, removal, resignation, and filling of vacancies
Ensure that the appointed auditor does not provide prohibited services
File required forms with the Registrar of Companies promptly
Provide full access to records and facilitate the auditor’s duties without obstruction
Disclose any fraud reported by the auditor to the appropriate authorities
Appoint cost auditors, if applicable, and conduct audits as per the directions of the central government
Importance of Adherence to Auditor-Related Provisions
Auditors play a central role in maintaining the transparency and integrity of financial reporting. Compliance with the auditor-related provisions of the Companies Act 2013 ensures that companies are subject to independent, competent, and ethical financial scrutiny. These regulations safeguard the interests of shareholders, regulators, and the public and contribute to the overall stability and reliability of the corporate sector.
Conclusion
The role of a company auditor is vital in promoting financial transparency, accountability, and trust among stakeholders. The Companies Act 2013 has established a detailed and structured framework that governs the appointment, qualifications, disqualifications, rotation, duties, and removal of auditors. This framework ensures that only competent, ethical, and independent professionals are entrusted with the responsibility of examining a company’s financial records.
By clearly defining who may or may not be appointed as an auditor, the law helps maintain objectivity in financial reporting. The introduction of mandatory rotation for auditors in specified classes of companies further enhances independence by reducing familiarity threats and encouraging fresh scrutiny.