Rights, Duties and Liabilities of Auditors

Three features. The access is at all times, not at times the company chooses. It extends to books kept anywhere. And the entitlement to information is measured by what he considers necessary, not by what the company thinks he needs.

The proviso: group access. The auditor of a holding company shall also have the right of access to the records of all its subsidiaries and associate companies, so far as it relates to the consolidation of its financial statements with theirs.

The six statutory inquiries: section 143(1)(a) to (f)

The auditor shall inquire into:

• (a) whether loans and advances made on the basis of security have been properly secured, and whether the terms are prejudicial to the interests of the company or its members;
• (b) whether transactions represented merely by book entries are prejudicial to the interests of the company;
• (c) where the company is not an investment company or a banking company, whether so much of its assets as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased;
• (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 that shares have been allotted for cash, whether cash has actually been received, and if not, whether the position stated in the account books and the balance sheet is correct, regular and not misleading.

These six are a favourite question and they should be learned as a list. Each corresponds to a classic way of dressing up accounts: bad lending, circular book entries, dumping assets cheaply on a friend, disguising loans as deposits, putting private spending through the company, and pretending shares were paid for.

The report and what it must state: section 143(2), (3) and (4)

Section 143(2). The auditor shall make a report to the members on the accounts examined by him and on every financial statement required to be laid in general meeting, and the report shall, after taking into account this Act, the accounting and auditing standards and the matters required to be included under the Act or the rules or an order under sub-section (11), and to the best of his information and knowledge, state whether the accounts give a true and fair view of the state of the company's affairs at the end of the financial year and of the profit or loss and cash flow for the year, and such other matters as may be prescribed.

Note who the report is to: the members. Not the Board, and not the management.

Section 143(3): the ten statements. The report shall also state:

• (a) whether he has sought and obtained all the information and explanations necessary, and if not, the details and their effect on the financial statements;
• (b) whether proper books of account as required by law have been kept, so far as appears from his examination, and whether proper returns adequate for his audit have been received from branches not visited by him;
• (c) whether the branch auditor's report under sub-section (8) has been sent to him, and how he has dealt with it;
• (d) whether the balance sheet and profit and loss account are in agreement with the books of account and returns;
• (e) whether the financial statements comply with the accounting standards;
• (f) his observations or comments 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 section 164(2);
• (h) any qualification, reservation or adverse remark relating to the maintenance of accounts and connected matters;
• (i) whether the company has adequate internal financial controls with reference to financial statements and the operating effectiveness of those controls; and
• (j) such other matters as may be prescribed.

Clause (g) is easily missed and is regularly asked. The auditor must report on directors' disqualification, which is a governance matter rather than an accounting one.

Section 143(4). Where any matter required to be included is answered in the negative or with a qualification, the report shall state the reasons.

Government companies: section 143(5), (6) and (7)

Section 143(5). For a Government company or a company owned or controlled by the Central or a State Government, the Comptroller and Auditor-General appoints the auditor under section 139(5) or (7) and directs the manner in which the accounts are to be audited, and the auditor submits a copy of the audit report to the Comptroller and Auditor-General, including the directions issued, the action taken and its impact on the accounts.

Section 143(6). The Comptroller and Auditor-General has, within sixty days of receipt, the right to:

• (a) conduct a supplementary audit by persons he authorises, and require information to be furnished to them; and
• (b) comment upon or supplement the audit report.

The proviso: any such comments or supplement shall be sent by the company to every person entitled to copies of the audited financial statements under section 136(1) and placed before the annual general meeting at the same time and in the same manner as the audit report.

Section 143(7). The Comptroller and Auditor-General may, if he considers it necessary, by order cause a test audit to be conducted, and section 19A of the Comptroller and Auditor-General's (Duties, Powers and Conditions of Service) Act 1971 applies to that report.

Branch audit: section 143(8)

Where a company has a branch office, its accounts shall be audited either by the company's auditor or by any other person qualified for appointment as auditor and appointed under section 139; and where the branch is outside India, either by the company's auditor or by an accountant or other person duly qualified under the laws of that country.

The proviso: the branch auditor shall prepare a report and send it to the company's auditor, who shall deal with it in his report in such manner as he considers necessary.

Auditing standards: section 143(9), (10) and (11)

Section 143(9). Every auditor shall comply with the auditing standards.

Section 143(10). The Central Government may prescribe the standards of auditing, as recommended by the Institute of Chartered Accountants of India, in consultation with and after examination of the recommendations of the National Financial Reporting Authority. Proviso: until standards are notified, the standards specified by the Institute shall be deemed to be the auditing standards.

Section 143(11). The Central Government may, in consultation with the National Financial Reporting Authority, by general or special order, direct that in respect of a specified class of companies the auditor's report shall also include a statement on such matters as may be specified. This is the power under which the additional reporting orders are made.

Fraud reporting: section 143(12)

Notwithstanding anything contained in this section, if an auditor, in the course of the performance of his duties, has reason to believe that an offence of fraud involving such amount as may be prescribed is being or has been committed in the company by its officers or employees, he shall report the matter to the Central Government within the prescribed time and manner.

The first proviso: below the threshold. In the case of a fraud involving less than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177, or to the Board in other cases, within the prescribed time and manner.

The second proviso: disclosure. Companies whose auditors have reported frauds to the audit committee or the Board but not to the Central Government shall disclose the details of such frauds in the Board's report in the prescribed manner. That is the clause section 134(3)(ca) matches.

Three things to fix. The trigger is reason to believe, not proof. It covers fraud by officers or employees, and it operates in the course of his duties. And there are two destinations according to the amount.

Sections 143(13), (14) and (15) complete it: nothing in sub-section (12) applies to a good faith report, the section applies to a cost accountant in practice conducting a cost audit and to a company secretary in practice conducting a secretarial audit, and failure to comply attracts a penalty.

Services an auditor may not render: section 144

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

• (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 outsourced financial services;
• (h) management services; and
• (i) any other kind of services as may be prescribed.

Nine prohibited services, and the reason for each is the same: an auditor who did the work cannot audit it. Note that approval by the Board or the audit committee is needed even for permitted services, and that the prohibition extends to the holding and subsidiary companies and to services rendered indirectly, which the Explanation defines.

Signing, attending and being heard: sections 145 and 146

Section 145. The auditor shall sign the auditor's report or sign or certify any other document of the company in accordance with section 141(2), and the qualifications, observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company mentioned in the auditor's report shall be read before the company in general meeting and shall be open to inspection by any member.

That is a real protection. A qualification cannot be buried in an annexure; it must be read out to the members.

Section 146. All notices of, and other communications relating to, any general meeting shall be forwarded to the auditor, and the auditor shall, unless otherwise exempted by the company, attend either himself or through an authorised representative who is also qualified to be an auditor, and shall have the right to be heard at such meeting on any part of the business which concerns him as auditor.

Liability: section 147

Section 147(1): the company and its officers. Contravention of any of sections 139 to 146 makes the company punishable with a fine of not less than twenty-five thousand rupees and up to five lakh rupees, and every officer in default with a fine of not less than ten thousand rupees and up to one lakh rupees.

Section 147(2): the auditor. If an auditor contravenes section 139, 143, 144 or 145, he shall be punishable with a fine of not less than twenty-five thousand rupees and up to five lakh rupees, or four times the remuneration of the auditor, whichever is less.

The proviso: the knowing case. If he has contravened knowingly or wilfully with the intention to deceive the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment up to one year and with a fine of not less than fifty thousand rupees and up to twenty-five lakh rupees, or eight times the remuneration of the auditor, whichever is less.

Section 147(3): on conviction under sub-section (2), the auditor shall be liable to:

• (i) refund the remuneration received by him to the company; and
• (ii) pay for damages to the company, statutory bodies or authorities, or to members or creditors of the company, for loss arising out of incorrect or misleading statements of particulars made in his audit report.

That is the provision to quote on "liabilities of an auditor". It is not merely a fine: he gives back his fee and pays damages, and the class of claimants includes members and creditors.

Section 147(4) provides for the Central Government to specify the authority to whom damages are payable, and section 147(5) provides that where the auditor is a firm and it is proved that the partners acted in a fraudulent manner or abetted or colluded in a fraud, the liability, whether civil or criminal, shall be of the firm and of the partners concerned jointly and severally, though only the concerned partners are criminally liable.

A worked example

Beed Sugar Mills Limited has an auditor, a firm, and a branch at Latur.

Access. The auditor may inspect the books and vouchers at all times, whether at the registered office or at the Latur branch, and may require information and explanation from the officers as he considers necessary. Because the company has a subsidiary, and its statements are consolidated, he also has access to the subsidiary's records so far as consolidation is concerned.

The six inquiries. He must inquire whether the loans to a supplier were properly secured and on terms not prejudicial, whether the year-end entries with a related party are merely book entries, whether shares in a listed company were sold below cost, whether loans have been shown as deposits, whether the managing director's travel is personal expenditure charged to revenue, and whether the cash for the rights issue was actually received.

The branch. The Latur branch is audited by another qualified person appointed under section 139. That branch auditor sends his report to the company's auditor, who deals with it as he considers necessary and states in his own report how he dealt with it: sections 143(8) and 143(3)(c).

The report. It is addressed to the members and states whether the accounts give a true and fair view, and covers the ten matters in section 143(3), including whether any director is disqualified under section 164(2) and whether internal financial controls with reference to financial statements are adequate and operating effectively. Where any answer is negative or qualified, he states the reasons.

A fraud. During the audit he has reason to believe that the Chief Financial Officer has diverted funds. If the amount is at or above the prescribed threshold, he must report to the Central Government. If it is below, he reports to the audit committee under section 177, or to the Board if there is none, and the company must then disclose the details in its Board's report.

A conflict. The company asks the audit firm to design its new accounting software and to run its internal audit. Both are forbidden by section 144(b) and (c), directly or indirectly, and the prohibition also covers the holding and subsidiary companies. Even a permitted service needs the approval of the Board or the audit committee.

The meeting. All notices of the annual general meeting are forwarded to the auditor, who attends himself or by a qualified representative and has the right to be heard on any business concerning him: section 146. His qualifications and adverse comments are read out at the meeting and are open to inspection by any member: section 145.

It goes wrong. The report fails to disclose a material misstatement. Under section 147(2) the firm is liable to a fine of twenty-five thousand to five lakh rupees, or four times its remuneration, whichever is less. If it is proved that the failure was knowing or wilful with intent to deceive the shareholders, the punishment is imprisonment up to one year and fifty thousand to twenty-five lakh rupees, or eight times the remuneration, whichever is less.

And on conviction the auditor must refund the remuneration and pay damages to the company, to statutory bodies or authorities, and to the members or creditors who lost by the incorrect or misleading statements: section 147(3). Where the partners acted fraudulently or colluded, the firm and the concerned partners are jointly and severally liable, though only those partners are criminally liable: section 147(5).

Distinctions that carry marks

What this does NOT mean

It does not mean the auditor reports to the Board. Section 143(2) makes the report to the members.

It does not mean he must prove fraud before reporting it. Section 143(12) is triggered by reason to believe.

It does not mean an auditor may do no other work for the company. He may render other services approved by the Board or the audit committee, so long as they are not among the nine in section 144.

It does not mean his liability stops at a fine. On conviction he must refund his remuneration and pay damages, including to members and creditors.

Quick revision

• 143(1) rights: access at all times to books and vouchers wherever kept; require information and explanation from officers; a holding company auditor may access subsidiaries and associates for consolidation.
• The six inquiries: properly secured loans and prejudicial terms; mere book entries; securities sold below cost, except for investment and banking companies; loans shown as deposits; personal expenses charged to revenue; and whether cash was actually received on shares stated to be allotted for cash.
• 143(2): report to the members, on a true and fair view of affairs, profit or loss and cash flow. 143(3): ten statements, including branch returns, agreement with the books, compliance with accounting standards, adverse comments, director disqualification under section 164(2), and internal financial controls. 143(4): give reasons for any negative or qualified answer.
• 143(5) to (7): Government companies, CAG appoints and directs, receives the report, and within sixty days may conduct a supplementary audit and comment, which the company must send to everyone entitled under section 136(1) and place before the AGM; and may order a test audit.
• 143(8): branch audit by the company's auditor or another qualified person; a foreign branch by a person qualified under that country's law; the branch auditor's report goes to the company's auditor.
• 143(9) to (11): comply with auditing standards, prescribed by the Central Government on the ICAI's recommendation in consultation with NFRA, the ICAI's standards applying until then; and the Central Government may order additional reporting.
• 143(12): reason to believe fraud by officers or employees: report to the Central Government above the prescribed amount, to the audit committee or Board below it, with disclosure in the Board's report.
• 144: nine forbidden services, directly or indirectly, to the company, its holding or subsidiary: accounting and book keeping; internal audit; design of financial information systems; actuarial; investment advisory; investment banking; outsourced financial services; management services; and as prescribed. Other services need Board or audit committee approval.
• 145 and 146: sign the report; qualifications and adverse comments read out in general meeting and open to member inspection; all notices forwarded, and a right to attend and be heard.
• 147: company twenty-five thousand to five lakh; officer in default ten thousand to one lakh; auditor twenty-five thousand to five lakh or four times remuneration, whichever is less; knowing or wilful, imprisonment up to one year and fifty thousand to twenty-five lakh or eight times remuneration, whichever is less; on conviction, refund of remuneration and damages to the company, statutory bodies, members or creditors; and for a firm, joint and several liability with the concerned partners.

Test yourself

1. State the auditor's rights of access. A right of access at all times to the books of account and vouchers, whether kept at the registered office or anywhere else, and an entitlement to require from the officers such information and explanation as he considers necessary. A holding company's auditor also has access to the records of its subsidiaries and associate companies so far as consolidation is concerned: section 143(1).

2. Name the six questions into which an auditor must inquire under section 143(1). Whether secured loans and advances are properly secured and their terms not prejudicial; whether transactions represented merely by book entries are prejudicial; whether securities have been sold below their purchase price, except in an investment or banking company; whether loans have been shown as deposits; whether personal expenses have been charged to revenue account; and whether cash was actually received where shares are stated to have been allotted for cash.

3. To whom does an auditor report a fraud? To the Central Government where the fraud involves the prescribed amount or more; and where it involves less, to the audit committee constituted under section 177, or to the Board in other cases, the company then disclosing the details in its Board's report: section 143(12).

4. Name five services an auditor may not render. Any five of the nine in section 144, for example accounting and book keeping, internal audit, design and implementation of any financial information system, actuarial services and management services, whether rendered directly or indirectly to the company or its holding or subsidiary company.

5. What happens to an auditor's qualifications in his report? They, and his observations or comments on financial transactions or matters having any adverse effect on the functioning of the company, shall be read before the company in general meeting and shall be open to inspection by any member: section 145.

6. State an auditor's liability on conviction under section 147(2). He must refund the remuneration received by him to the company and pay damages to the company, to statutory bodies or authorities, or to members or creditors for loss arising out of incorrect or misleading statements of particulars made in his audit report: section 147(3).